economicskvsmr.files.wordpress.com · web view50 50 -10 60 40 0.8 1.2 100 50 0 100 40 0.8 1 .0 150...
TRANSCRIPT
Study Module –Of ECONOMICSCLASS - XII(2012 - 2013)
Chief PatronShri. S SRawat
Deputy Commissioner (Raipur region)
PatronShriSaseendran&ShriTajjuddin SheikhAssistant Commissioner (Raipur region)
Coordinator:- Akanksha SharmaPrincipal KV Khairagarh
Resource Persons PGT Economics :-Mr.D. B .Ram KV No.1 Raipur (Shift 2)
Mr.JogeshRana KV BhawanipatnaMr. K.K. Dash KV No.1 Raipur(Shift 1)
Ms.Prabha Seth KV BilaspurMr. Sanjay KV Raigarh
PrefaceA team of experienced teachers endeavour to bring out astudy module, for the session
2012-2013
KendriyaVidyalayaSangthanKENDRIYA VIDYALAYA SANGTHANRAIPUR REGION
The language is simple and comprehensive for students.The study material is being provided to the students hoping that this will benefit them
and help in gaining confidence before appearing in the board examinations& score 60% and above
Teachers are advised to make thorough use of this study material at the time of the revision so that the students are proficient enough to score better percentile in the
finals.
How to use this Study Material?Dear children,
NOTE:1.All students should Read and solve 5 previous years board
papers2.Read the Marking scheme given by CBSE
3.Read & learn CBSE sample papers given by CBSE along with marking scheme4.Practice Sums
5.Read questions from previous year papers & board papers given in various books
6.Practice HOTS Questions7.From this year value based questions will also come in Exam.So practice them, eg. Q 11 & 19 of
CBSE SAMPLE PAPER GIVEN BELOW
*
* Here are some tips to use this study material while revision during preboards and finally in board examination
* Go through the syllabus given in the beginning. Identify the units carrying more weightage
* Write down your own notes and make summaries with the help of this study material.
Tips for students
Suggested sequence in which students may REVISE topics
When revising keep marking topics learnt
1.Explanation of features of various markets, Unit 42.Functions of Central bank, Unit7
3.Credit control by Central bank ( CRR,SLR,Bank Rate, Open Market Operations) , Unit7
4.Components of Budget, Unit95.Fiscal Deficit & its implications, Unit9
6.Components of BOP, Unit 107.Phases showing relation between TP,AP,MP. , Unit3
8.Factors effecting Demand, Unit2
9. Change in demand & change in quantity demanded, Unit210.Factors effecting Supply, Unit3
11.Market equilibrium, Shifts in Demand & Supply & effect on equilibrium, Unit412.Consumer equilibrium, Unit2
13.Functions of money, Unit714.Producer equilibrium, Unit3
15.Sums on elasticity of Demand or supply, Unit2 &316.Deflationary & inflationary gap, Unit8
17.Sums from unit on determination of income, Unit818.Precautions in calculation of national income, Unit6
After studying above topics complete units
Unit Marks
1 Unit 1: Introduction 42 Unit 10: Balance of Payments 73 Unit 4: Forms of Market and Price
Determination10
4 Unit 7: Money and Banking 85 Unit 2: Consumer Equilibrium and Demand 186 Unit 9: Government Budget and the Economy 87 Unit 3: Producer Behaviour and Supply 188 Unit 8: Determination of Income and
Employment12
9 Unit 6: National Income and related aggregates 15
Part A : Introductory Microeconomics
Unit 1: Introduction 10 Periods
Meaning of microeconomics and macroeconomics
What is an economy? Central problems of an economy : what, how and for whom to produce; conceptsof production possibility frontier and opportunity cost.
Unit 2: Consumer Equilibrium and Demand 32 Periods
Consumer's equilibrium – meaning of utility, marginal utility, law of diminishing marginal utility, conditionsof consumer's equilibrium using marginal utility analysis.
Indifference curve analysis of consumer's equilibrium-the consumer's budget (budget set and budgetline), preferences of the consumer (indifference curve, indifference map) and conditions of consumer'sequilibrium.
Demand, market demand, determinants of demand, demand schedule, demand curve, movementalong and shifts in the demand curve; price elasticity of demand - factors affecting price elasticity ofdemand; measurenment of price elasticity of demand – (a) percentage-change method and (b) geometricmethod (linear demand curve); relationship between price elasticity of demand and total expenditure.
Unit 3: Producer Behaviour and Supply 32 Periods
Production function: Total Product, Average Product and Marginal Product.
Returns to a Factor.
Cost and Revenue: Short run costs - total cost, total fixed cost, total variable cost; Average fixed cost,average variable cost and marginal cost-meaning and their relationship.
Revenue - total, average and marginal revenue.
Producer's equilibrium-meaning and its conditions in terms of marginal revenue-marginal cost.
Supply, market supply, determinants of supply, supply schedule, supply curve, movements along andshifts in supply curve, price elasticity of supply; measurement of price elasticity of supply – (a) percentage-change method and (b) geometric method.
Unit 4: Forms of Market and Price Determination 22 Periods
Perfect competition - Features; Determination of market equilibrium and effects of shifts in demandand supply.
Other Market Forms - monopoly, monopolistic competition, oligopoly - their meaning and features.Unit 5: Simple applications of Tools of demand and supply 8 Periods(not to be examined)
329
Part B : Introductory MacroeconomicsUnit 6: National Income and related aggregates 30 PeriodsSome basic concepts: consumption goods, capital goods, final goods, intermediate goods; stocks andflows; gross investment and depreciation.Circular flow of income; Methods of calculating National Income – Value Added or Product method,Expenditure method, Income method.Aggregates related to National Income:Gross National Product (GNP), Net National Product (NNP), Gross and Net Domestic Product(GDP and NDP) - at market price, at factor cost; National Disposable Income (gross and net),Private Income, Personal Income and Personal Disposable Income; Real and Nominal GDP.GDPand Welfare
Unit 7: Money and Banking 18 PeriodsMoney – its meaning and functions.Supply of money – Currency held by the public and net demand deposits held by commercial banks.Money creation by the commercial banking system.Central bank and its functions (example of the Reserve Bank of India).
Unit 8: Determination of Income and Employment 25 PeriodsAggregate demand and its components.Propensity to consume and propensity to save (average and marginal).Short–run equilibrium output; investment multiplier and its mechanism.Meaning of full employment and involuntary unemployment.Problems of excess demand and deficient demand; measures to correct them - change in governmentspending, availability of credit.
Unit 9: Government Budget and the Economy 17 PeriodsGovernment budget - meaning, objectives and components.Classification of receipts - revenue receipts and capital receipts; classification of expenditure - revenueexpenditure and capital expenditure.Measures of government deficit - revenue deficit, fiscal deficit, primary deficit:their meaning.Fiscal Policy and its role (non evaluative topic)
Unit 10: Balance of Payments 14 PeriodsBalance of payments account - meaning and components; balance of payments deficit-meaning.Foreign exchange rate – meaning of fixed and flexible rates and managed floating.Determination of exchange rate in a free market.Recommended textbooks1. Indian Economic Development, Class XI, NCERT2. Introductory Micro Economics, Class XII, NCERT3. Macro Economics, Class XII, NCERT4. Supplimentary Reading Material in Economics, Class XII, CBSENote : The above publications are also available in Hindi Medium
330
DESIGN OF QUESTION PAPERECONOMICS
Class Ō XII
Marks Ō 100 Duration Ō 3 hrs.
1. Weightage by type of questions
Type Number ofquestions
Marks Total Estimated time acandidate is expected to
take to answer
Long answer questions 6 6 36 60 minutes
Short answer questions I 6 4 24 36 minutes
Short answer questions II 10 3 30 50 minutes
Very short answer questions 10 1 10 15 minutes
2. Weightage by content
Unit No. Unit Title Marks
1 Introduction 4
2 Consumer Equilibrium and Demand 18
3 Producer Behaviour and Supply 18
4 Forms of Market and Price Determination 10
5 National Income and Related Aggregates 15
6 Money and Banking 8
7 Determination of Income and Employment 12
8 Government Budget and the Economy 8
9 Balance of Payments 7
10 Total 100
331
3. Difficulty level of the question paper
Level Marks % age of thetotal marks
A. Easy
(Can be attempted satisfactorily by students who
have gone through the study material)
30 30
B. Average
(Can be attempted by students who have regularly
studied the study material but may not have given
sufficient time to writing.
50 50
C. Difficult
(Can be attempted by top students)
20 20
4. Scheme of Options
There is no overall choice. However, there is an internal choice in one question of 6marks, one question of 4 marks and one question of 3 marks in each section. Thus
there will be internal choice to 6 questions.
5. Value based questionsThe question paper will contain value based question/questions to the extent of
5 marks.
332
SAMPLE QUESTION PAPERECONOMICS
Class XIIMaximum Marks: 100 Time: 3 hours
BLUE PRINT
Sl.No.
Content Unit Forms of Questions
Very ShortAnswer (1 Mark)
Short Answer(3,4 Marks)
Long Answer(6 Marks)
Total
1. Unit 1 1 (1) 3 (1) - 4 (2)
2. Unit 2 1 (2) 3 (2) 4 (1) 6(1) 18 (6)
3. Unit 3 1 (1) 3 (1) 4 (2) 6 (1) 18 (5)
4. Unit 4 1 (1) 3 (1) 6 (1) 10 (3)
5. Unit 6 - 3 (3) 6 (1) 15 (4)
6. Unit 7 1 (2) - 6 (1) 8 (3)
7. Unit 8 1 (2) 4 (1) 6 (1) 12 (4)
8. Unit 9 - 4 (2) - 8 (2)
9 Unit 10 1 (1) 3 (2) - 7 (3)
Sub-Total 10 (10) 30 (10) 24 (6) 36 (6) 100 (32)
Notes:
1.Figures within brackets indicate the number of questions and figures outside the bracketsindicate marks for each question.
2. The question paper will include Valuebased questions to the extent of five marks.
333
Sample Question PaperEconomicsClass Ō XII
Time Ō 3 Hours. Maximum Marks Ō 100
Instructions
1. All questions in both the sections are compulsory.
2. Marks forquestions are indicated against each.
3.QuestionNos. 1-5 and 17-21 are very short-answer questions carrying 1 mark each. Theyare required to be answered in one sentence each.
4.QuestionNos. 6-10 and 22-26 are short-answer questions carrying 3 marks each. Answerto them should not normally exceed 60 words each.
5. Question Nos. 11-13 and 27-29 are also short-answer questions carrying 4 marks each.Answer tothem should not normally exceed 70 words each.
6.Question Nos. 14-16 and 30-32 are long-answer questions carrying 6 marks each.Answer tothem should not normally exceed 100 words each.
7. Question Nos. 11 and 19 are value based questions.
8.Answer should be brief and to the point and the above word limit be adhered to as far aspossible.
334
Section A
1. State two features of resources that give rise to an economic problem. (1)
2. What happens to total expenditure on a commodity when its price falls and its
demand is price elastic? (1)
3.What happens to equilibrium price of a commodity if there is an ŎKPETGCUGŏ_ KP_KVU_
FGOCPF_CPF_ŎFGETGCUGŏ_KP_KVU_UWRRN[! (1)
4. Give the meaning of equilibrium market price of a good. (1)
5. What is meant by cost in economics? (1)
6.State any three factors that can ECWUG_CP_ŎKPETGCUGŏ_KP_FGOCPF_of a commodity.(3)
7. Will the supply at a point on a positively sloped, straight line supply curve beunitary elastic, elastic or inelastic? (3)
8. Explain why is production possibility frontier concave.
ORExplain the cGPVTCN_RTQDNGO_őJQY_VQ_RTQFWEG_Œ (3)
9. How does the nature of a commodity influence its price elasticity of demand?Explain. (3)
10. Calculate the price elasticity of demand for a commodity when its price increasesby 25% and quantity demanded falls from 150 units to 120 units. (3)
11.Demand for electricity has”increased”. However supply cannot be “increased” due to to lack of resources. Explain how, in any two ways, demand for electricity can be “decreased”
(4)
12. Explain the relation between marginal revenue and average revenue when a firm isable to sell more quantity of output:(i) at the same price.(ii) only by lowering the price.
ORExplain the effect of the following on the supply of a commodity:(a)Fall in the prices of factor inputs.
(b)Rise in the prices of other commodities. (4)
335
13. On the basis of the information given below, determine the level of output at which
the producer will be in equilibrium. Use the marginal cost Ō marginal revenue
approach. Give reasons for your answer.
Output (Units) Average Revenue (Rs) Total Cost (Rs)
1 7 82 7 153 7 214 7 265 7 336 7 41 (4)
14. Why does the difference between Average Total Cost and Average Variable Cost
decrease as the output is increased? Can these two be equal at some level of
output? Explain. (6)
15. Explain the implications of the following features of perfect competition:
(a) large number of buyers and sellers
(b) freedom of entry and exit to firms (6)
16. A consumer consumes only two goods. For the consumer to be in equilibrium why
must marginal rate of substitution be equal to the ratio of prices of the two goods?
Explain.
OR
A consumer consumes only two goods. Why is the consumer in equilibrium when
he buys only that combination of the two goods that is shown at the point of
tangency of the budget line with an indifference curve? Explain.
The following question is for the blind candidates only in lieu of őQT_ RCTVŒ_QH_question No.16
Explain when a consumer, consuming only two commodities X and Y, attains
equilibrium under the utility approach.
(6)
(6)
336
Section B
17. Give the meaning of involuntary unemployment. (1)
18. What is the relationship between marginal propensity to save and marginal
propensity to consume? (1)
19.The market price of US Dollar has increased considerably leading to rise inprices of the imports of essential goods. What can Central Bank do to ease thesituation? (1)
20. State the two components of money supply. (1)
21. What is Cash Reserve Ratio? (1)
22. From the following data about a firm, calculate the fiTOŏU_net value added at factor
cost:
(Rs in Lac)
(i) Subsidy 40
(ii) Sales 800
(iii) Depreciation 30
(iv) Exports 100
(v) Closing stock 20
(vi) Opening stock 50
(vii) Intermediate purchases 500
(viii) Purchase of machinery for own use 200
(ix) Import of raw material 60 (3)
23. Give the meaning of Nominal GDP and Real GDP. Which of these is the indicator
of economic welfare and why? (3)
24. Ŏ/CEJKPGŏ_RWTEJCUGFKU_CNYC[U_C_HKPCN_IQQF_ŏ_&Q_[QW_CITGG!_)KXG_TGCUQPU_HQT_[QWT_answer. (3)
25. Explain the effect of depreciation of domestic currency on exports. (3)
337
OR
Explain the effect of appreciation of domestic currency on imports.
26. Distinguish between the current account and the capital account of Balance of
Payments. Is import of machinery recorded in current account or capital account?
Give reasons for your answer. (3)
27. What is a government budget? Give the meaning of :
(a) Revenue deficit
(b) Fiscal deficit (4)
28. Categorise the following government receipts into revenue receipts and capital
receipts. Give reason for your answer.
(a) Receipts from sale of shares of a public sector undertaking.
(b) Borrowings from public.
(c) Profits of public sector undertakings.
(d) Income tax received by government. (4)
29. Explain equilibrium level of national income using Savings and Investment
approach. Draw diagram in support of your explanation.
The following question is for Blind Candidates only in lieu of Question No. 29above:Explain equilibrium level of national income using Savings and Investment
approach.
ORComplete the following table:
Income Saving Marginal Propensity Average Propensityto Consume to Consume
0 -20 - -
50 - 10 _________ _________
100 0 _________ _________
150 30 _________ _________
200 60 _________ _________ (4)
338
30. Explain the process of money creation by commercial banks, giving a numerical
example. (6)
31. Draw a straight line consumption curve. From it derive a savings curve explaining
the process of derivation. Show in this diagram:
(a) the level of income at which Average Propensity to Consume is equal to one.
(b) a level of income at which Average Propensity to Save is negative.
The following question is for Blind Candidates only in lieu of Question No. 31
Explain the meaning of underemployment equilibrium. State two monetary policy
measures that can be taken to make the economy reach full employment
equilibrium. (6)
32. From the following data calculate National Income by Income and Expendituremethods:
(Rscrore)(i) Government final consumption expenditure 100(ii) Subsidies 10(iii) Rent 200(iv) Wages and salaries 600(v) Indirect taxes 60(vi) Private final consumption expenditure 800(vii) Gross domestic capital formation 120(viii) Social security contributions by employers 55(ix) Royalty 25(x) Net factor income paid to abroad 30(xi) Interest 20(xii) Consumption of fixed capital 10(xiii) Profit 130(xiv) Net exports 70(xv) Change in stock 50
OR (6)
339
Calculate Gross National Disposable Income and Personal Income from the givendata:
(Rscrore)(i) Personal tax 120(ii) Net indirect tax 100(iii) Corporation tax 90(iv) National income 1000(v) Net factor income from abroad 5(vi) Consumption of fixed capital 50(vii) National debt interest 70(viii) Retained earnings of private corporate sector 40(ix) Net current transfers to the rest of the world (-)20(x) Current transfers from government 30(xi) National income accruing to government 80
340
Marking Schemefor
Sample Question PaperSection A
1. The two features of resources that give rise to an economic problem are
(i) resources are limited and
(ii) they have alternative uses. ½ x2
2. Total expenditure increases. 1
3. Equilibrium price increases. 1
4. It is the price at which market demand and market supply of the good are
equal. 1
5. Cost of producing a good is the sum of actual expenditure on inputs and the
imputed expenditure on the inputs supplied by the owner. 1
6. The factors causing an increase in demand of a commodity are:
(i)Rise in the price of substitute goods.
(ii) Fall in the price of complementary goods.
(iii) Rise in income of its buyers (in case of a normal good).
(iv) Fall in income of its buyers (in case of an inferior good).
(v)Favourable change in taste etc for the good.
(vi) Increase in the number of its buyers.
(Any three)1x3
7. Es = 1, i.e. unitary elastic at any point on the supply curve if it touches the
origin when extended.
Es>1, i.e. elastic at any point on the supply curve if it touches the Y-axis when
extended.
Es<1, i.e. inelastic at any point on the supply curve if it touches the X-axis when
extended.
Note: No diagram is required but if this question is answered with the help of1x3
341
diagrams may also be treated as correct.
8. Production Possibility Frontier (PPF) is a downward sloping, concave curve.Concavity shows increasing Marginal Rate of Transformation (MRT) as morequantity of one good is produced by reducing quantity of the other good. Thisbehaviour of the MRT is based on the assumption that no resource is equallyefficient in production of all the goods. As more of one good is produced, lessand less efficient resources have to be transferred from the production of theother good which raises marginal cost i.e. MRT.
ORŎ*QY_VQ_RTQFWEGŏ_KU_VJG_RTQDNGO_QH_EJQQUKPI_VJG_VGEJPKSWG_QH_RTQFWEVKQP___
Techniques are broadly classified into capital intensive and labour intensive.The problem is to use capital intensive technique in which more of capitalgoods like machines, etc. are used, or to use labour intensive technique in whichmore of labour is used.
3
3
9. A commodity for a person may be a necessity, a comfort or a luxury.
When a commodity is a necessity its demand is generally inelastic.
When a commodity is a comfort its demand is generally elastic.
When a commodity is a luxury its demand is generally more elastic that the
demand for comforts. 1x3
10. percentage change in demandE = -----------------------------------d
percentage change in price
=
-30
150x 100
25
= Ō0.8
1
1½
½
11. Consumer can (1) use energy saving electrical appliances, (2) use alternate
sources of energy like solar energy, etc (or any other) (Explain). 4
12. (i) Price is constant. As price means average revenue, so average revenue is
342
also constant. Average revenue is constant only when marginal revenue is
equal to average revenue. Thus, when a firm is able to sell more quantity
of output at the same price marginal revenue is equal to average revenue.
(ii) If more can be sold only by lowering the price, it means that average
revenue falls as more is sold. Average revenue falls only when marginal
revenue is less than average revenue. Thus, when a firm is able to sell
more quantity by lowering the price, marginal revenue will be less than
the average revenue.
OR
(i) When the prices of factor inputs decrease, the cost of production decreases.
Thus, it becomes more profitable to produce the commodity and so its
supply will increase.
(ii) When the prices of other goods rise, it becomes relatively more profitable
to produce these goods in comparison to the given good. This results in
diversion of resources from the production of given good to other goods.
So, the supply of the given good decreases.
2
2
2
2
13. Output (units) AR (Rs) TC (Rs) MC (Rs) MR (Rs)
1 7 8 8 7
2 7 15 7 7
3 7 21 6 7
4 7 26 5 7
5 7 33 7 7 Equilibrium
6 7 41 8 7 1
The producer achieves equilibrium at 5 units of output. It is because this level of output
UCVKUHKGU_DQVJ_VJG_EQPFKVKQPU_QH_RTQFWEGTŏU_GSWKNKDTKWO__1
(i) Marginal cost is equal to marginal revenue. 1
(ii) Marginal cost becomes greater than MR after this level of output.11
343
14. Average Total Cost (ATC) minus Average Variable Cost (AVC) is equal to
Average Fixed Cost (AFC). AFC = TFC / Output. Therefore, as output
increases, AFC falls. So, the difference between ATC and AVC decreases with
increase in output.
ATC and AVC can never be equal at any level of output as AFC can never be
zero because TFC is positive.
3
3
15. (a) The number of sellers is so large that the share of each is insignificant in
the total supply. Hence, an individual seller cannot influence the market
on its own. 5KOKNCTN[__ C_UKPING_ EQPUWOGTŏU_ UJCTG_ KP_ VQVCN_ RWTEJCUG_ KU_ UQ_
insignificant because of their large numbers that she cannot influence the
market price on her own.
(b) The implication is that firms will earn only normal profit in the long run.
In the short run, there can be abnormal profits or losses. If there are
abnormal profits, new firms enter the market. The total market supply
increases, resulting in a fall in market price and a fall in profits. This
trend continues till profits are reduced to normal.
Similarly, if there are losses, firms start exiting. The total market supply
decreases resulting in a rise in market price, and a reduction in losses. This
trend continues till losses are wiped out.
3
3
16. Let the two goods be X and Y. MRSxy is the number of units of Y the consumer
is willing to sacrifice to obtain one extra unit of X. The ratio of prices is Px/Py
which also equals the ratio of the number of units of Y required to be sacrificed
to obtain one extra unit of X in the market.
Initially when the consumer starts purchases, MRSxy is greater than Px/Py. It
means that to obtain one extra unit of X the consumer is willing to sacrifice
more than he has to sacrifice actually. The consumer gains. As he goes on
obtaining more and more units of X, marginal utility of X goes on declining.
Therefore the consumer is willing to sacrifice less and less of Y each time he
obtains one extra unit of X. As a result MRSxy falls and ultimately becomes
2
344
equal to Px/Py at some combination of X and Y. At this combination the
consumer is in equilibrium.
If the consumer attempts to obtain more units of X beyond the equilibrium
level, MRSxy will become less than Px/Py and his total utility will start falling.
So he will not try to obtain more of X.
ORY
XBxO
y
A
C
E
DI1
I2
I3
Good X
GoodY
Let the two goods be X and Y as shown in the diagram. The tangency is at point
E where :
Slope of indifference curve= Slope of budget line
Or MRSxy = P /Px y
The equilibrium purchase is Ox of X and Oy of Y on the indifference curve I .2
The consumer cannot get satisfaction level higher than I because his income2
does not permit him to move above the budget line AB. The consumer will not
like to purchase any other bundle on the budget line AB, for example the
bundle at C and D, because they all lie on the lower indifference curve, and give
him lower satisfaction. Therefore, the equilibrium choice is only at the tangency
point E.
For the Blind candidates in lieu of Ŏ14_2#46ŏ_QH_ Q. No. 16
ConUWOGTŏU_ GSWKNKDTKWO_ OGCPU_ OCZKOWO_ UCVKUHCEVKQP_ NGXGN_ QH_ VJG_ EQPUWOGT__
3
1
2
2
2
345
given his income and prices in the market. There are two conditions of
equilibrium in utility analysis:
1) Ratio of marginal utility to price in case of expenditure on each
commodity is the same i.e.
MU MUyP Py
xx
If MUxPx
is greater than MUyPy
, the consumer will buy more units of X by
diverting expenditures MUy. It will lead to fall in MUxand rise in MUy.
The change will continue till MUx/Pxis equal to MUx/Py once again.
The change will be in the opposite direction if MUxPx
is less than MUyPy
till the equilibrium is achieved.
2) Marginal utility falls as more is consumed i.e. the law of diminishing
marginal utility is in operation. The first condition will not be satisfied
until the second is satisfied.
1
3
2
Section B
17. Involuntary unemployment occurs when those who are able and willing to
work at the prevailing wage rate do not get work. 1
18. The sum of MPC and MPS is equal to one. 1
19. 6JG_%GPVTCN_$CPM_ECP_UVCTV_UGNNKPI_75_&QNNCTU_HTQO_KVU_ŎTGUGTXGUŏ_1
20. The two components of money supply are: currency held by the public and
demand deposits with commercial banks. 1
21. Cash Reserve Ratio is the ratio of bank deposits that commercial banks must
keep as reserves with the Central Bank. 1
22. NVAfc = (ii) + (v) Ō (vi) Ō (vii) Ō (iii) + (i) 1
346
= 800 + 20 Ō 50 Ō 500 Ō 30 + 40
= Rs 280 lakh
1½
½
23. 0QOKPCN_)&2_XCNWGU_VJG_EWTTGPV_[GCTŏU_QWVRWV_KP_CP_GEQPQO[_CV_EWTTGPV_[GCT_
prices.
4GCN_)&2_XCNWGU_VJG_EWTTGPV_[GCTŏU_QWVRWV_KP_CP_GEQPQO[_at a set of constant
prices.
Real GDP is the indicator of economic welfare because it shows the quantity
of goods and services made available to the society during the year.
1
1
1
24.9JGVJGT_ŎOCEJKPGŏ_KU_C_HKPCN_IQQF_QT_PQV_FGRGPFU_QP_JQY_KV_KU_DGKPI_WUGF__
If the machine is bought by a household, then it is a final good.
If the machine is bought by a firm for its own use, then also it is a final good.
If the machine is bought by a firm for reselling then it is an intermediate
good.
1
1
1
25. Domestic currency depreciates when there is a rise in foreign exchange rate.
With the rise in foreign exchange rate the foreign counties can now purchase
more quantity of goods and services from the same amount of foreign
currency from the domestic economy. As a result exports rise.
OR
Domestic currency appreciates when there is a fall in foreign exchange rate.
With the fall in foreign exchange rate the domestic economy can now buy
more quantity of goods and services from foreign countries from the less
amount of domestic currency. As a result imports rise.
3
3
26. The current account records transactions relating to the export and import of
goods and services, income and transfer receipts and payments during a
year.
The capital account records transactions affecting foreign assets and foreign
liabilities during a year.
Since import of machinery is an import of good, it is recorded in the current
account.
1
1
1
347
27. Government budget is a statement of expected receipt and expenditure of
the government during a financial year.
Revenue deficit is the excess of revenue expenditure over revenue receipts
Fiscal deficit is the excess of total expenditure over total receipts excluding
borrowings.
1
1½
1½
28. (a) It is a capital receipt as it results in a reduction of assets.
(b) It is a capital receipt as it creates a liability.
(c) It is a revenue receipt as it neither creates a liability nor reduces any
asset.
(d) It is a revenue receipt as it neither creates a liability nor reduces any
asset.
1
1
1
1
29. The equilibrium level of national income is that level at which planned
saving and planed investment are equal. In the diagram equilibrium is at E
and equilibrium income is OY*.
At an income level OY , planned savings are greater than planned1
investment. This means that households aggregate expenditure is less than
income. As a result inventories increase. Firms, seeing a build up of
unplanned inventories start cutting production, and hence output, income
and savings fall. This process continues till planned savings and planned
1
1
I’
Y*
S’
Savings/
Investment
Income/Output
O
I
S
Y1 Y2X
Y
E
348
investment are equal.
At an income level OY , planned savings are less than planned investment.2
This means that aggregate expenditure is more than income. Firms, seeing a
depletion of planned inventories step up production, and hence output and
income increase. Savings increase. This process continues till planned
savings and planned investment are equal.
For Blind Candidates in lieu of Question No.29 above
Same as above except diagram.
OR
Income ţ; S C ţ% MPC APC
0 Ō Ō20 20 Ō Ō Ō
50 50 -10 60 40 0.8 1.2
100 50 0 100 40 0.8 1.0
150 50 30 120 20 0.4 0.8
200 50 60 140 20 0.4 0.7
1
1
½x8=4
30. Money creation (or deposit creation or credit creation) by the banks is
determined by (1) the amount of the initial fresh deposits and (2) the Legal
Reserve Ratio (LRR), the minimum ratio of deposit legally required to be
kept as cash by the banks. It is assumed that all the money that goes out of
banks is redeposit into the banks.
Let the LRR be 20% and there is a fresh deposit of Rs. 10,000. As required, the
banks keep 20% i.e. Rs. 2000 as cash. Suppose the banks lend the remaining
Rs. 8000. Those who borrow use this money for making payments. As
assumed those who receive payments put the money back into the banks. In
this way banks receive fresh deposits of Rs. 8000. The banks again keep 20%
i.e. Rs. 1600 as cash and lend Rs. 6400, which is also 80% of the last deposits.
The money again comes back to the banks leading to a fresh deposit of Rs.
6400. The money goes on multiplying in this way, and ultimately total
349
money creation is Rs. 50000.
Given the amount of fresh deposit and the LRR, the total money creation is :
Total money creation = Initial deposit x 1LRR
AC is the consumption curve and OA is the consumption expenditure at
zero level of income.
Income minus consumRVKQP_KU_UCXKPIU__9JGP_KPEQOG_KU_\GTQ__VJG_GEQPQO[ŏU_
consumption level is OA. Thus, the corresponding level of savings is Ō OA.
6
2
31.
350
So, A is the starting point of saving curve1
At OB level of income consumption is equal to income, so savings are zero.
So B is another point on saving curve1
Joining A and B and extending we get the saving curve S.1 2
The level of income at which APC is equal to one is OB
A level of income at which APS is negative is the level less than OB.
For Blind Candidates in lieu of Question No. 31
An economy is in equilibrium when aggregate demand is equal to aggregate
supply. If aggregate demand is only sufficient to support a level of aggregate
supply at less than full employment, then the economy is in under full
employment equilibrium.
The two monetary policy measures are :
1. Reduction in bank rate by the Central Bank.
2. Reduction in cash reserve Ration by the Central Bank.
2
1
1
4
2
31. Income MethodNational Income = iv + viii + (iii + ix) + xi +xiii Ō x
= 600 + 55 + (200 +25) + 20 +130 -30
= Rs 1,000 crore
Expenditure MethodNational Income = vi + i + vii + xiv Ō v + ii Ō xii Ō x
= 800 + 100 + 120 + 70 Ō 60 + 10 Ō 10 Ō 30
= Rs 1,000 crore
ORGNDI = iv + ii + vi Ō ix
= 1000 + 100 + 50 Ō (-20)
= Rs 1170 crore
Personal Income = (iv Ōxi) + (vii Ō ix + x) Ō viii Ō iii
= 1000 -80 + 70 Ō (- 20) + 30 Ō 40 Ō 90
= Rs 910 crore
1
1½
1½
1
1½
1½
1
1½
1½
1
1½
1½
351
Sample Question PaperEconomicsClass XII
Max. Marks Ō 100 Time : 3 hrs.
Question wise Analysis
S.No.of Q.
Unit No. Marks allotted Estimated Time(Min)
Estimatedifficulty level
1 1 1 1½ A 2 2 1 1½ B 3 4 1 1½ A 4 4 1 1½ A 5 3 1 1½ C 6 2 3 5 A 7 3 3 5 A 8 1 3 5 A 9 2 3 5 A 10 4 3 5 B 11 2 4 6 A 12 3 4 6 B 13 3 4 6 B 14 3 6 10 B 15 4 6 10 B 16 2 1 10 C 17 8 1 1½ A 18 8 1 1½ A 19 10 1 1½ C 20 7 1 1½ A 21 7 3 1½ A 22 6 3 5 B 23 6 3 5 A 24 6 3 5 B 25 10 3 5 B 26 10 4 5 B
352
UNIT 1 – INTRODUCTION 4marks
1. Opportunity cost:- Opportunity cost refers to value of a factor in its next best (or second best) alternative use.in other words It is the cost ofNext Best Alternative Foregone.
2. Production possibility curve(PPC)/ Production possibility frontier or boundary ortransformation line or transformation curve:- The production possibility curve shows all the possible combination of two goods that can be produced with the help of given resources and technology.
3. MARGINAL OPPORTUNITY COST: MOC of a particular good along PPC is the amount of one good which is sacrificed for production of additional unit of another good.
4. MARGINAL RATE OF TRANSFORMATION: MRT is the ratio of units of one good sacrificed to produce one more unit of another good.
Unit of one good sacrificed ∆yMRT = --------------------------------------------- = -------- More unit of other good produced ∆x
5. How is the growth of an economy be presented through PPC ?
Ans:- Rightward shift of PPC.
6. State the economic problems relating to the allocation of resources.
Ans:- The problems related to allocation of resources has three aspects:
(i) What to produce? (ii) How to produce? (iii) For whom to produce?
(i) What to produce? :- As we know resources are limited but wants are unlimited, we cannot produce everything in whatever quantity we wish to. The economy has to decide what goods and services are to be produced. For instance which of the consumer goods like sugar, cloth, wheat, ghee, etc. are to be produced and which of the capital goods like machines, tractors etc,. Are to be produced. Similarly choice has also to be made between the production of war time goods like rifles, guns, tanks and peace time goods like bread and butter.
(ii) How to produce:- How to produce means how to organise production this problem is concerned with the choice of technique of production. For example, production of cloth is possible either by handlooms or by modern machines this problem is to concerned with the efficient use of resources. There are two technique of production:-
(a) Labour intensive technique:- Under this technique, labour is used more than capital.it creates employment for large amount of labourAlso goods produced are cheap.but the quality & quantity of goods produced is less.
(b) Capital intensive technique:- Under this technique, capital is used more than labour. (iii) For whom to produce:- It is a problem relating to choice of user of the goods and services, should we produce for those who can pay high price ? If yes is the answer, we shall end up producing goods and services for a respectively richer section of society or even for a richer section of the world commodity. There quality of life would improve, but that of the poor would stagnate or deteriorate further. As such, the gulf between the rich and the poor would keep on widening. On the other hand if goods are produced for the poor only, they may not afford to buy, reducing profits of the producers. Accordingly, level of output may remain low, and the process of growth will suffer. Hence the problem of choice related to the final users of goods and services.
7. Differentiate between positive and normative economics :-
SNo Positive Economics Normative Economics
1 It deals with what is what was. It deals with what ought to be.
2 It is based on cause and effect of facts.
It is based on ethics.
3 It can be verified with actual data It cannot be verified with actual data.
4 In this value of judgments are not given.
In this value of judgments are given.
8. What is production possibility curve? state its features & give a brief discussion
Ans:- Production possibility curve shows different combinations of two goods which can be produce with the given resources on the assumptions that
(i) Resources are fully and efficiently utilised (ii) Technique of production remains constant.
Features of PPC:-
(i) Production possibility curve slopes downward:- production possibility curve slopes downward from left to right. It is because in a situation of fuller utilisation of the given resources, production of both the goods cannot be increased. More of a good-X can be produced only by giving up the production of another goods Y.
(ii) Production possibility curve is concave to the point of origin:- PPC is concave to the origin because of increasing marginal opportunity cost.
It is because to produce each additional unit of good-X, more and more units of good-Y will have to be sacrificed than before. Opportunity cost of producing every additional unit of good-X tends to increase in terms of the loss of production of good-Y.
(Production Possibility Schedule)
Goods Production possibilities
A B C D E
Wheat 100 90 70 40 0
Gun 0 10 20 30 40
Production possibility curve
9.How is the growth of a country shown with the help of production possibility curve?
Growth of resources:- Overtime an economy may generate more resources. Gulf countries, for example, have acquired additional sources of oil. By selling oil these countries have acquired more capital goods. They have enhanced their production capacity. Accordingly, their PPC has shifted to the right. Fig. shows shift in PPC to the right when availability of resources increases.
Owing to increase in resources, (which generally happens in every economy overtime) PPC shifts to the right. It shows higher level of output of both the goods. Thus, PP shows higher level of output thanAD.
10
Microeconomics Macroeconomics
1-Microeconomics studies economics issues or economic problems at thlevel of an individual-an individual firm, an individual household or individual consumer.
1. macro economics studies economic issues or economic problems at the level of the economy as a whole.
2-Allocation of resources to different uses is the central issue in microeconomics.
2. Raising the level of output and growth is the central issue in macro economics.
3. Examples:- consumer’s demand, market price of commodity, firm’s output.
3. Examples:- aggregate demand, general price level in the economy, aggregate supply in the economy.
11.
Market economy Planned economyIn a market economy decisions relating to what, how and for whom to produce are governed by the market forces of supply and demand.The government does not interfere the process of decision making.
It is an economy in whichdecisions relating to what, how and for whom to produce are taken by some central authority appointed by the government.
It is an economic system, in which all material means of production are owned and operated by the private sector with profit motive.
In this economy all material means of production are owned by the government or by a centrally planned authority. Economic decisions are taken for social welfare.
12. Draw a production possibility curve and mark the following situations:
a) underutilization of resources
b) full employment of resources
c) scarcity of resources
Ans. Every point on PP curve like ABCDEF indicates full employment and efficient uses of resources.
Any point below or inside PP curve like G underutilization of resources.
Any point above PP curves like H indicates Scarcity of resources.
A
B H (scarcity of resources)
C
Full employment of resources
*G
E
0 1 2 3 4 5
Cloth
13. Production Possibility Curve And Opportunity Cost
It refers to a curve which shows the various production possibilities that can be produced with given resources and
technology.
1. Production Possibilities
ProductionPossibilityCommodity
A
Commodity
B
Marginal opportunity
cost of commodity A
A 0 15 -
B 1 14 15-14=1
C 2 12 14-12=2
2
4
6
8
1412
10
F
Under utilization of resources
Wheat
P
D 3 09 12-9=3
E 4 05 9-5=4
F 5 0 5-0=5
Commodity A
If the economy devotes all its resources to the production of commodity B, it can produce 15 units but then the
production of commodity A will be zero. There can be a number of production possibilities of commodity A & B
If we want to produce more commodities B, we have to reduce the output of commodity A &vise versa.
14. (1) causes of Upward shift in PP curve
(a) When there is improvement in technology.
(b) Increase in resources.
y
o x
(2) Down ward shift
When Resources depletes
y
O
15..Distinguish between a centrally planned economy and a market economy.
X
SNo Planned Economy Market Economy
1 All the materials means of production are owned by government.
All the materials means of production are owned by private individuals.
2 Main objectives of production is social welfare
Main objectives of production are maximization of profit.
3 Ownership of property is under government control.
There is no limit to private ownership of property.
4 All the economic problems are solved as per direction of the planning commission.
All the economic problems are solved through price mechanism i.e., demand and supply.
16. From the following PP schedule calculate MRT of good x.
Production possibilities A B C D E
Production of good x units 0 1 2 3 4
Production of good y units 14 13 11 8 4
Production of good X units
Production of good
Y units
MRT = ∆y / ∆x
0 14 -
1 13 1:1
2 11 2:1
3 8 3:1
4 4 4:1
17.Causes of economic problem or why does economic problem arise?
1.Scarcity of resources – Availability of resources is limited in relation to need for demand.
2.Unlimited human wants-Human wants are recurring in nature.This is based on psychological behavior that as soon as one want is satisfied,another new want would take place.
3.Alternative uses-means have alternative uses.choice is to be made between different uses.When we opt for one want,we have to forgo the other.
4.Wants differ in intensity-Human wants also differ in intensity(urgency).All wants are not equal intensity.That is why,resources can be allocated according to the priority of wants.
Unit 2 Consumer’s Behaviour 18 marks
NOTE: important topics of this unit areCONSUMER’S EQUILIBRIUM in case of one commoditymarginal utility approach
CONSUMER’S EQUILIBRIUM in case of two commodity(a) marginal utility approach(b) Indifference curve (IC) approachTypes of ELASTICITYSums on PRICE ELASTICITY OF DEMAND
Change in demand or Change in Quantity demanded orfactors that affect the price elasticity of demand
CONSUMER’S EQUILIBRIUM
Q1. Given the price of a commodity, Explain how does consumer reach at equilibrium. (hot question) OR
Explain consumer’s equilibrium in case of a single commodity with the help of utility schedule
EXPLANATION USING SCHEDULE
Ans:- A consumer is at equilibrium at a consumption level where he maximises his satisfaction by spending his income on a good whose price is given , and he has no urge to change his consumption.
The two conditions for consumer equilibrium are when:
(1) MUx/Px = Mum/Pm
i.e. Mux in Rupees.= Px in Rupees
where, MUx: Marginal utility of good-X
Px: Price of good-X
Mum: Marginal utility of money.
Pm: Price ofmoney
(2) marginal utility is diminishing as consumption increases
For Example as we see in table below
Marginal utility of money (Mum)=4 utils. i.e.4utils=1 ruppee (4Mum=1Pm)
Let X be the commodity consumer wants to buy.
Let Px (price of X) = 4
Marginal utility schedule of X is as follows:
Units of X 1 2 3 4 5 6
MUx in utils 20 18 16 10 0 -5
MUx/Px,is 5 4.5 4 2.5 - 0.1
MU in rupees
MUm/Pm=4
4 4 4 4 4 4
Mu > p Mu = p Mu < p
Consumer equilibrium occurs at 3 units of consumption
where MUx/Px = Mum/Pm=4
i.eMux in Rupees.= Px in Rupees=4
Disequilibrium occurs below or above this level of consumption:-
(a)i.eWhen consumer buys 1 st unit
MUx/Px< Mum/Pm
Mux in rupees= Mux (in utils)/Px = 20/4 = Rs 5, Px = Rs 4
i.e Mux>Px, 5>4
Consumer pays (Rs 4) which is less than satisfaction consumer get s(worth Rs 5). He wants to pay more,Hence, consumer spends more & increases consumption of good X till 3rd unit
where Mux/Px =Mum/Pm=16/4=4
(B)When consumer buys 4th unit of X
MUx/Px> Mum/Pm
Mux/Px =10/4=2.5
consumer pays (Rs 4) which is more than satisfaction consumer get s(worth Rs 2.5). Hence, consumer reduces his spending & consumption & buys less unit of X till he reaches 3rd unit
where Mux/Px =Mum/Pm=16/4=4
Ans:- DIAGRAMMATIC EXPLANATION
A consumer is at equilibrium at a consumption level where he maximises his satisfaction by spending his income on a good whose price is given, and he has no urge to change his consumption.
(X-axis of the diagram shows units of commodity-X consumed.
Utility (utils) are shown on the Y-axis
MUm is a horizontal straight line showing utility of money or a rupee worth of satisfaction expected by the consumer (because MUm is constant ))
-----------------------------------------------------------------------
Consumer equilibrium occurs when
(1) MUx /Px= Mum/Pm, at point R.
(2)MUx tends to decline as more and more of commodity-X is consumed.
Disequilibrium occurs to left or right side of this level of consumption
(a)i.eWhen consumer buys at a consumption level below equilibrium level to the left of point R
MUx/Px< Mum/Pm
consumer pays less & gets more satisfaction. So consumer spends more & increases consumption of good X till he reaches point R,
where Mux in rupees=Px in Rupees
i.e. Mux/Px =Mum/Pm
(B)When consumer buys at a consumption level above equilibrium level to the right of point R
MUx/Px> Mum/Pm
consumer pays more & gets less satisfaction. So consumer spends less & reduces consumption of good X till he reaches point R,
where Mux in rupees=Px in Rupees
i.e. Mux/Px =Mum/Pm
Q2. Explain the consumer equilibrium in case of two commodity approach with the help of schedule.
Ans the consumer equilibrium in case of two commodity approach occurs at a consumption level where last rupee of his income spent on both the goods gives equal satisfaction to the consumer, & he has no urge to change.
Units of commodiy MUx MUy Mux/Px MUy/Py1 88 40 11 52 72 36 9 9.53 64 24 8 34 56 20 7 2.55 48 16 6 26 40 12 5 1.57 32 8 4 18 24 4 3 0.9 16 0 210 8 0 1
Sol:- in case of two commodities consumer equilibrium condition are:
(1) MUx/Px = MUy/Py =Mum/Pm …..(i)
(2) consumr’s expenditure equals all his given income
In the present case, Px = Py = Rs 8 per unit,
Income of the consumer is 88
So consumer equilibrium occurs when:
(1)MUx/Px = MUy/Py =3
It occurs when consumer purchases 8 units of X (spending 8 x 8 = Rs 64) and 3units of Y (spending 3 x 8 = Rs 24).
(2) consumer spends all his income
consumr’s expenditure equals =QxPx+QyPy=8 x 8+3 x 8= Rs 64+ Rs 24=88= Income
Disequilibrium occurs in following cases
(A)Consider combination X=6 and Y=1,here also MUx/Px = MUy/Py =5
But it is not an equilibrium point because here all income is not spent,i.e.Rs.48(=6x8)+Rs.8(=1x8)=Rs.56
(B)Further,when X=9 and Y=5,again MUx/Px = MUy/Py =2. But this is not affordable in terms of consumer’s income.Here,consumr’s expenditure exceeds his income,i.e.
Rs.72(=9x8)+Rs.40(=5x8)=Rs112>Rs.88.
Q3 Change in demand or Shift in demand curve Change in Quantity demanded or movement along the same demand curve
demand for the commodity changes due to change in other factors affecting demand like income , taste , preferences etc.
Other factors affecting demand remain constant like income , taste , preferences etc.
Price remains constant It occurs due to fall or rise in the price ofgood
It is of two types(a) increase in demand, demand curve Shifts upwards to right from D to D1(b) decrease in demand, demand curve Shifts downwards to left from D to D2
It is of two types(a)Extension in demand, upward movement along the same demand curve from A to B(b)contraction in demand, downward movement along the same demand curve from B to A. Price A
B O quantity demanded
Q4 Increase in demand Extension in demand
demand curve Shifts upwards to right from D to D1
upward movement along the same demand curve from A to B
Price remains constant It occurs due to fall in the price ofgood
increase in demand occurs when(i)When income increases of the consumer consuming normal good.(ii)When income decreases of the consumer consuming inferior good.(iii) due to favourable change in fashion or climate. (iv)When price of substitute good increases. (v) When price of complementary good falls. (iv) When taste of the consumer shifts in favour of the commodity (v) When price of the commodity is expected to increase in the near future. (vi) Increase in number of consumers, and (vii) When the income of the consumer is expected to increase in near future.
Other factors affecting demand remain constant like income , taste , preferences etc.
Q5 Decrease in demand contraction in demanddemand curve Shifts downwards to left from D to D2
It is the downward movement along the same demand curve from B to A.
Price remains constant It occurs due to rise in the price ofGood
Decrease in demand occurs when(i)When income decreases. of the consumer consuming normal good(ii)When income increases. Of the consumer consuming inferior good(iii) due to unfavourable change in fashion or climate. (iv)When price of substitute good decreases. (v) When price of complementary good rises. (iv) When taste of the consumer is unfavourable for the commodity (v) When price of the commodity is expected to decrease in the near future. (vi) decrease in number of consumers, and (vii) When the income of the consumer is expected to decrease in near future.
Contraction in demand,Other factors affecting demand remain constant like income , taste , preferences etc.
Q6.Properties or Feature of Indifference Curve. Explain the feature of IC.
1.it is Downward sloping to the Right:- It is due to the monotonicity of preferences.
Indifference curve:- It shows different combinations of two goods which give same level of satisfaction to consumer.
According to monotonicity of preferences if consumer has more of one good X without reducing another commodity Y then he would get higher level of satisfaction,and would reach higher Indifference curve
So to remain on the same Indifference curve if consumer has more of one good X he has to reduce consumption of another commodity Y to remain at give same level of satisfaction & to remainon the same Indifference curve. This leads to Downward sloping Indifference curve
2.Convex to origin:- it is convex to the origin due to diminishing marginal rate of substitution
Good Y
IC
O Good X
As a consumer consumes more of a good satisfaction derived from it goes on diminishing, So as consumer increases more of one good X he gets less satisfaction from X, So he is willing to Sacrifice less amount of good Y in place of X.
Secondly, as consumption of Y goes on decreasing it becomes scarce so consumer will sacrifice less & less amount of Scarce good in return for increase in X.
3. Indifference curve never intersect each other.
Good Y
b
a
c IC1
IC2
O Good X
Bundle a & c lie on IC2 ,so they give same satisfaction
Bundle a & b lie on IC1 ,so they give same satisfaction
Then by Transitivity b & c should give same satisfaction, but this is not true.
As b & c lie on different Indifference curve hence give different satisfaction
4. Higher IC indicates higher satisfaction & lower IC indicates lower satisfaction levels.
Good Y
IC2
IC1
Good X
Higher IC shows bundles having more of both goods so as more is better. hence Higher IC gives higher satisfaction
Q7 Explain CONSUMER’S EQUILIBRIUM using Indifference curve (IC) approach? (note: this is direct Question )
Consumer equilibrium occurs on buying a consumption bundle that gives maximum satisfaction to the consumer by spending all his given income,& he has no urge to change.
The consumer is in equilibrium when two condition are satisfied:
(i) Slope of Indifference curve. =slope of budget line
At the equilibrium point IC and budget line are tangent to each other.
So, MRSxy = Px/Py
( Marginal rate of substitution between Good-X and good-Y= price ratio between good-X and good-Y )
(Slope of I.C. =MRSxy=∆y/∆x)
(slope of budget line= Px/Py )
(ii)Marginal rate of substitution should be decreasing,
i.e At equilibrium point IC must be convex to the origin
i.e At the point where MRSxy = Px/Py
Explanation
Consumer is in equilibrium at point Q, Where budget line is tangent to highest possible
Indifference curve
Consumer is in Disequilibrium in following cases
(a) All other bundles at any point above the budget line are unattainable consumer cannot afford them.
(b)Any other bundle other than equilibrium bundle at any point on the budget line or below the budget line lies on lower Indifference curve so they are inferior bundles.
Q8.For a consumer to be in equilibrium why must Marginal rate of substitution be equal to the ratio of prices of two goods? (note: this is indirect HOTS Question on CONSUMER’S EQUILIBRIUM using Indifference curve (IC) approach?)
OR
Why is the consumer in equilibrium when he buys the combination of two goods that is shown at the point of tangency of the budget line with an Indifference curve.
Consumer equilibrium occurs on buying a consumption bundle that gives maximum satisfaction to the consumer by spending all his given income,& he has no urge to change.
The consumer is in equilibrium when two condition are satisfied:
(i) Slope of Indifference curve. =slope of budget line
At the equilibrium point IC and budget line are tangent to each other.
So, MRSxy = Px/Py
(ii)Marginal rate of substitution should be decreasing,
i.e At equilibrium point IC must be convex to the origin
i.e At the point where MRSxy = Px/Py
Consumer is in equilibrium at point Q, Where budget line is tangent to highest possible
Indifference curve
So, MRSxy = Px/Py
Consumer is in Disequilibrium in following cases
(a)ifconsumer buys more unit of good X than equilibrium level
MRSxy<Px/Py
MRSxy is less than Px/Py so consumer is losing as he is paying more than the satisfaction he gets.So,he will reduce consumption of good X to remain at equilibrium
(b) ifconsumer buys less unit of good X than equilibrium level
MRSxy>Px/Py
MRSxy is than morePx/Py so consumer is getting more satisfaction ,so he is willing to pay more.So,he will increase consumption of good X to reach equilibrium
(c) All other bundles at any point above the budget line are unattainable consumer cannot afford them
(d) Any other bundle other than equilibrium bundle at any point on the budget line or below the budget line lies on lower Indifference curve so they are inferior bundles.
Q9. Law of demand:- The law of demand states that other things remaining constant like income , taste , preferences etc., quantity demanded of a commodity increases with a fall in price and diminishes when price increases.
Demand schedule
Px(Rs) Qx(units)
1 40
2 30
3 20
DD slopes downward. It shows inverse relationship between price and quantity demanded.. It is therefore called the law of demand.
This is generally true in case of normal goods
10. Why does the demand curve slope downward ? Or
Causes of occurrence of law of demand. Or
Why does the consumer purchase more at lower price & less at higher price? Or
Why does is there an inverse relationship between price and quantity demanded?
Ans:- Downward slope of demand curve indicates that more is purchased in response to fall in price & vice versa due to following reasons:-
(i) Law of diminishing marginal utility - As consumer consumes more quantity of goods, according to the Law of diminishing marginal utility satisfaction goes on decreasing. So consumer is willing to buy more & demand more only at lower price as satisfaction is low. & vice versa
(ii) Income effect -as price of a good increases purchasing power of the consumer decreases so real income of consumer decreases,so due to this income effect he demands less.
Conversely ,If price of a good decreases real income of consumer increases so demand rises
(iii) Substitution effect- As price of a good increases consumer substitutes the good by relatively cheaper substitute good so his demand decreases.
Conversely if price of a good decreases consumer buys less of substitute good.
(iv) Number of consumers –as price of a good rises number of consumers who were buying it will not be able to afford it so they demand less.
Conversely if price of a good falls more consumers will be able to afford it so demand rises
(v) Different uses of goods-if price of a good falls it can be put to many uses so its demand rises. For example milk can be used to drink, make curd, tea or sweets etc.
Conversely if price of a good rises it is used for only essential purposes so its demand falls. For example milk will be used only to make tea.
PRICE ELASTICITY OF DEMAND
Q11. Types of elasticities of demand
Or types of demand curves.
(i) Perfectly elastic demand:- A perfectly elastic demand refers to the situation when demand is infinite at the prevailing price. It is a situation where the slightest rise in price causes the quantity demanded of the commodity to fall to zero.
, Ed at any point on DD =∞
(ii) Perfectly Inelastic demand:- A perfectly inelastic demand is one in which a change in price causes no change in the quantity demanded. It is a situation where even substantial changes in price leave the demand unaffected.
Ed at any point on DD = 0.
(iii) elastic demand (price elasticity is Greater than one, e>1 ):- price elasticity of Demand is greater than one when there is greater percentage change in quantity demanded in response to percentage change in price of the commodity
( when Demand is elastic there is inverse relation between total expenditure & price of a good i.e. total expenditure on the commodity increases when price decreases, and total expenditure decreases when price increases.)
(iv) inelastic demand(elasticity is Less than e<1) :- Demand is less than unitary elastic when there is less percentage change in quantity demanded in response to percentage change in price of the commodity
( when Demand is inelastic there is direct relation between total expenditure & price of a good i.e. total expenditure on the commodity increases when price increases, and total expenditure decreases when price decreases.)
12. What is shape of demand curve in case demand is one at all points on the demand curve ?
Rectangular Hyperbola
price
O Quantity demanded
13. How is elasticity of demand measured through geometric method/ point method?
Or
Explain with the help of a diagram, the geometric method of measuring price elasticity of demand.
Or
Explain the geometric method of measuring price elasticity of demand.
Ans:- Illustrates geometric method of measuring price elasticity of demand:
Ed = lower segment of a demand curve/upper segment of a demand curve.
(1)Unitary Elastic Demand at mid point C,
Ed = AC/CB=1 (since AC=CB)
(2) Elastic Demand occurs at any point Above point C
For example at E elasticity=EB/AE>1 (Since EB>AE)
(3) Inelastic Demand occurs at any point below point C
For example at D elasticity=DB/AD<1 (Since DB<AD)
(4) ) Perfectly elastic Demand occurs at A
For example at A elasticity=AB/0= ∞
(5) ) Perfectly inelastic Demand occurs at B
For example at B elasticity=0/AB=0
14.How to measure elasticity of demand by studying the change in price and
expenditure ?Or Explain total expenditure method of measuring price elasticity of demand with the help of a table.
Ans:- Using expenditure method to measure price elasticity of demand one finds out how much and in what direction expenditure changes as a result of the changes in the price of the commodity. There may be three possible situations:
(i) If total expenditure on a commodity remains unchanged before and after the price change, the elasticity is said to be unity. Ed = 1.
(ii)if there is inverse relation between total expenditure & price of a good i.e. total expenditure on the commodity increases when price decreases, and total expenditure decreases when price increases. demand is elastic & is said to be greater than unity. Ed >1.
(iii) if there is direct relation between total expenditure & price of a good i.e. total expenditure on the commodity increases when price increases, and total expenditure decreases when price decreases.), ity of demand is inelastic & it is said to be less than unity. Ed< 1.
[Note: Total expenditure method does not offer any precise value of price elasticity of demand. It only tell us whether Ed = 1, Ed< 1 or Ed >1.]
Illustration:
Situation Price per unit(Rs)
Quantity Total expenditure (Rs)
Elasticity of demand
Situation-1
10 10 100 Ed = 1: a situation of unitary
5 20 100 Elastic of demand.
Situation-2
10 10 100 Ed >1 : a situation of elastic
5 30 150 Demand.
Situation-3
10 10 100 Ed<1 : a situation of inelastic
5 15 75 Demand.
Q14 Explain any two factors that affect the price elasticity of demand of a
commodity.
Ans:- The elasticity of demand is affected by the following factors:
(i) Nature of commodity:-
(a)Necessary goods are essential for survival so Demand for necessaries (like salt) will not change by higher percentage if price changes so it has highly inelastic demand;
(b)demand for luxury goods (like ACs)will fall by greater degree than price if price increases so it has highly elastic demand; and
( c)demand for comfort goods(like air coolers) is moderately elastic
(ii) Availability of substitutes:- Commodities which have substitutes, have elastic demand, like tea and coffee because even a very small change in price of one good will cause high degree of change in quantity demanded as consumer shifts demand to substitute goods available.
Conversely, Commodities having no substitutes have inelastic demand because even if price changes consumer do not have any other good available to change quantity demanded .
(iii) Number ofAlternative uses of commodity:-
Demand for good that can be put to many uses is elastic as its price increase consumer will cut down some of the uses of the good & use it for only essential purpose so quantity demanded changes by greater degree than price.on the other hand if price falls it will be put to many uses.
Demand for good that can be put to few uses is inelastic
(iv)Proportion of income spent on the good-
goods on which small part of income is spent their Demand is inelastic like match box, salt etc.
Conversely, goods on which large part of income is spent their Demand is elastic. As consumer changes its quantity demanded by greater degree than price when expenditure on them increases due to increase in price.
(v) Time period:- Elasticity of demand is high over a long period (compared to a short period), because during a short period of time, consumption habits tend to be stable.
Q15 Explain the effect of the following on the demand for the good
(A) Price of related goods
(i)Substitute goods-These are the goods that are used in place of each other. There is direct relation between price of a good and the demand for its substitute. If price of a good increases its demand falls &demand for its substitute increases .& vice versa.
For example if tea & coffee are Substitutes If price of a tea increases its demand falls & demand for its substitute coffee increases.
(ii) Complementary goods-These are the goods that are used together. There is inverse relation between price of a good and the demand for its Complement. If price of a good increases its demand falls &demand for its Complementdecreases.& vice versa.
For example if ball pen &refil are Complement If price of a refil increases its demand falls & demand for its Complement ball pen decreases
(B) Income of the consumer
(i) Normal good - These are the goods the demand for which increases as income of the buyers rises & vice versa. There is a positive (direct) relationship between income and demand.
(ii) Inferior good- These are the goods the demand for which decreases as income of buyers rises& vice versa. Thus, there is negative (inverse) relationship between income and demand.
Q16.
Factors affecting Individual and Market demandIndividual demand Market demand Price of the other good Price of the other goodIncome of the consumer Income of the consumersTaste and preferences of consumers Distribution of incomeExpectations of buyers Population
Q17 Definitions
1. Budget set:- It refers to attainable combinations of a set of two goods, given prices of goods and income of the consumer.
2. Budget line(price line):- It is a line showing different possible combinations of good-1 and good-2, which a consumer can buy, given his budget and the prices of good-1 and good-2. Anywhere, on the budget line, a consumer is spending his entire income either on good-1 or on good-2 or on both good-1 and good-2.
3. Utility:- Want satisfying power of a good is called utility. 4. Marginal utility:- It refers to additional utility an account of consumption of an additional unit of a commodity .
5. Marginal rate of substitution:- The rate at which one more unit of good-1 (on the x-axis) is substituted for good-2 (on the y-axis) is called MRS.
6. Consumer’s equilibrium:- The consumer is in equilibrium when, given his income and market prices, he plans his expenditure (on different goods and services) in such a manner that he maximises his total satisfaction.
7. Indifference curve:- It is a locus of different combinations of two goods which give same level of satisfaction to consumer. Consumer is indifferent between Each combination. 8. Law of Diminishing marginal utility:- Law of diminishing marginal utility states that as more and more units of a commodity are consumed, marginal utility derived from every additional unit declines
9. marginal rate of substitution:-The rate of substitution of one commodity for
another is known as MRS = ∆y/∆x.MRS is the slope of Indifference curve. It has always declining trend because law of diminishing marginal rate of substitution applies upon consumer while consuming different combinations of two goods.
10.Demand:- It is the quantity Demanded of a commodity that a consumer is willing to buy and has purchasing power to buy at a given price other things remaining constant like income , taste , preferences etc..11.Individual demand schedule:- It is tabular presentation of quantities demanded of a given commodity at different prices, at a given time other things remaining constant like income , taste , preferences etc...12.Market demand schedule:- Is a table showing different quantities of a commodity that all the buyers in the market are ready to buy at different possible prices of the commodity at a point of time, other things remaining constant like income , taste , preferences etc..13.Demand curve:- The demand curve represent the maximum quantities per unit of time that consumers will be willing to buy at various prices other things remaining constant like income , taste , preferences etc..
14.Explain demand function. Ans:- Demand function shows the relationship between demand for a commodity and its various determinants.
Individual demand function:- Individual demand function shows how demand for a commodity, by an individual consumer inthe market, Is related to its various determinants. (i) fashion (ii) price of related goods- (a) substitute goods (b) complementary goods. (iii) Income of the consumer (iv) tastes and preferences (v) Expectations.
Market demand function:- Market demand functions shows how market demand for a commodity is related to its various determinants. (i) Population size (ii) Distribution of income.
15. Exception of law of demand:- Law of demand has some exceptions as well. There are some commodities whose demand increase when their price rises and decreases when their price falls. (i) Articles of distinction (ii) Ignorance (iii) Giffen goods.
16. If demand for y increases with fall in price of x. What types of good are x and y.
Ans:- Complimentary goods.
17. Given x and y are complimentary goods. How is the demand for y change with the increase in price of x.
Ans:- Decrease in demand.
18. Price elasticity of demand:- Price elasticity of demand may be defined as the percentage change in the quantity demanded of a commodity due to the percentage change in price of that commodity.
19. What is shape of demand curve in case of unitary elasticity of demand ?
When price falls from OP to OP1, total expenditure on the commodity remains constant (area OBTP = area OCRP1) According, elasticity at point T = 1.
18. Numerical problems
(1) Price of the commodity X falls from Rs 5 per kg to Rs 4 per kg and the demand of consumer A for it rises from 4 kg to 6 kg. Express your opinion regarding the nature of elasticity of demand of commodity X.
Sol:- Ed = (-) P/Q x∆Q/∆P
Here, P = 5: P1 = 4
∆ P = 4 - 5 = -1; Q = 4; Q1 = 6
∆Q = 6 - 4 = 2
Ed = (-) 5/4 x 2/-1 = 10/4 = 2.5 (greater than unity)
Ans:- Elasticity of demand is greater than unity.
(2) A consumer purchased 10 units of a commodity when its price was Rs 5 per unit. He purchased 12 units of the commodity when its price falls to Rs 4 per unit. What is the price elasticity of demand for the commodity at the price ?
Sol:- Ed = (-)P/Q x ∆Q/∆P
P = 5; P1 = 4; ∆P = 4-5 = -1
Q = 10; Q1 = 12; ∆Q = 12 -10 =2
Ed = (-) 5/10 x 2/-1 = 1 (unity)
Ans:- Elasticity of demand (Ed) is unity (= 1), or unitary elasticity of demand.
(3) A consumer buys 50 units of good a Rs 4 per unit. When its price falls by 25 per cent its demand rises to 100 units. Find out the price elasticity of demand.
Sol:- Initial price (P) = Rs 4
Fall in price by 25% = 4 x 25/100 = Re 1
New price (P1) = Rs 4 - Re 1 = Rs 3
Change in price (∆P) = P1-P = 3 – 4 = - 1
Initial quantity (Q) = 50 units; New quantity (Q1) = 100 units
Change in quantity (∆Q) = 100 -50 = 50 units
Elasticity of demand = (-) P/Q x ∆Q/∆P = (-) 4/50 x 50/-1 =4/1 = 4
Ans:- Elasticity of demand = 4 (greater than unity).
(4) As a result of 10 per cent fall in price of a good, its demand rises from 100 units to 120 units. Find out the price elasticity of demand.
Sol:- Percentage change in price = 10%
Percentage change in demand =(120-100/100 x100) = 20/100 x 100 = 20%
Elasticity of demand = (-) Percentage increase in demand/ Percentage decrease in price
= (-) 20%/-10% = 2
Ans:- Elasticity of demand = 2 (greater than unity).
(5) Supposing the initial demand was 100 units. With the rise in price by Rs 5, the quantity demanded decreases by 5 units. Elasticity of demanded is 1.2. Find out the price before the change in demand.
Sol:- Supposing the price (P) before change = X
Ed = (-) P/Q x ∆Q/∆P
Here, ∆P =5; ∆Q = -5,
P = X; Q =100 and Ed = 1.2
Ed =(-)P/Q x ∆Q/∆P =1.2
Or (-) X/100 x -5/5 = 1.2 or X/100 = 1.2
Or X = 1.2 x 100 = 120
Ans:- Price before change in demand = Rs 120.
(6) A consumer buys 100 units of good Y at Rs 5 per unit. The price elasticity of demand for the good is 2. At what price will he be willing to buy 140 units of good y ?
Sol:- Suppose consumer buys 140 units at price of Rs.X per unit.
Ed = (-) P/Qx ∆Q/ ∆P
Here, Ed = 2,P=Rs .5,P1=X, ∆p=x-5
Q =100 units Q1=140 units ∆Q=(140-100)units=40 units
Ed = (-) P/Q x ∆Q/∆P
2 = (-) 5/100 x 40/(X-5) = (-) 2/X-5
2 x (X-5) = -2 or 2X – 10 = -2
2X = -2 +10 = 8
X = 4
Ans:- The consumer will purchase 140 units of good Y at the price of Rs 4.
(7) The demand by a consumer for a commodity declines by 10 per cent when its price increases from Rs 5 to Rs 6 per unit. What is the price elasticity of demand of the commodity ?
Sol:- Ed = (-) Percentage change in Quantity demanded/percentage change in price
Percentage change in price = 6-5/5 x 100 = 1/5 x 100 = 20%
Percentage change in demand = -10%
Ed = (-) -10%/20% = 0.5
Ans:- The price elasticity of demand is less than unity.
(8) There is 50% fall in price of the commodity. But quantity demanded remains to be 150 units. Find elasticity of demand.
Sol:- Here, elasticity of demand is zero because in response to decrease in price of the commodity, the quantity demanded remains the same, i.e., 150 units.
(9) For a commodity, ∆P/P = -0.2, and elasticity of demand = -0.5. Find Quantity demanded after a fall in price when initially it was 60 units.
Sol:- Given, ∆P/P = -0.2, Ed = -0.5
Initial quantity demanded (Q) = 60 units
Ed = ∆Q/Q x P/∆P
-0.5 = ∆Q/60 x 1/-0.2
0.5 = ∆Q/12
∆Q = 6
Q1 = Q+∆Q
Q1 = 60+6 = 66
Ans:- New quantity = 66 units.
(10) A commodity shows Ed = (-) 2. Quantity demanded reduce from 300 units to 150 units, in response to increase in price. Find the increased price when initially it was Rs 20 per unit.
Sol:- Here, Ed =(-), P = Rs 20
Q = 300 units, Q1 =150 units
∆Q = Q1 – Q = 150 -300 = -150 units
Ed = P/Q x ∆Q/∆P
-2 = 20/300 x -150/∆P
-2 = -10/∆P
∆P = -10/-2 =5
P1 = P+∆P
= 20+5 =25
Ans:- New price = Rs 25.
(11) If Ed = -0.5 and ∆P/P = 0.6, find new expenditure if initially it was Rs 1,000.
Sol:- Ed = -0.2
Percentage change in price = ∆P/P x100 =0.6 x 100 = 60
Percentage change in quantity demanded = 0.2 x 60 = -12
Let the initial price be Rs 100 and initial quantity = 100 units.
When price increases by 60%, P1 = 100 + 60 = Rs 160
When quantity reduces by 12%, Q1 = 100 -12 = 88 units
New expenditure = P1 x Q1/ Old expenditure x initial expenditure
= 160x88/ 10000 x 1000 =1408
Ans:- New expenditure = Rs 1408.
(10) Relationship between elasticity of demand and Total expenditure or out lay method.
Ans:- One finds out how much and in what direction total expenditure changes as a result of change in the price of a commodity. We can consider three possible situation:-
(i) If rise or fall in price of a commodity makes no changein its total expenditure, then elasticity of demand is unitary.
(ii) If with fall in price of a commodity, total expenditure increases and with rise in its price, total expenditure decreases, then demand for that commodity is greater than unitary elastic. There is inverse relation between total expenditure & price, so demand is elastic.
(iii) If with fall in price of a commodity, total expenditure decreases and with rise in its price total expenditure increases, then demand for that commodity is less than unitary elastic. In this case, total expenditure & pricehave direct relation.
Situation Price of commodity (Rs)
Quantity
(kg)
Total expenditure
(Rs)
Effect on total expenditure
Elasticity of demand
A 2 4 8 Some total Unitary elastic
1 8 8 expenditure. Ed= 1
B 2 4 8 Total expenditure
Greater than unitary
1 10 10 increases. Ed>1
C 2 3 6 Total expenditure
Less than Unitary
1 4 4 decreases. Ed<1
Unit III PRODUCERS BEHAVIOUR (18 marks)PRODUCTION FUNCTION
1. production function-It is a technological relationship that tells the maximum output that can be produced from various combinations of factor inputs.2. total physical product (TPP)- It is the total quantity of good produced by particular firm with given inputs. With one input variable & all other inputs remain constant.3. marginal product or marginal physical product (MPP)- it is defined as the change in total physical product per unit change in one variable input when all other inputs remain constant.
MPPn = TPPn – TPPn-1
4. fixed factor inputs. variable factors inputs.Fixed factors refer to those factors which can’t be changed in short run, they remain fixed
those factors which can be changed in short run.in long run all factors inputs are variable
For eg. land ,machines, factory building
For eg. labour
5. If TPP is falling, what can you say about MPP?Ans. MPP is diminishing &negative.6. If TPP is increasing at a decreasing rate, what can you say about MPP?Ans. MPP is falling but is positive.7. If TPP is increasing at an increasing rate, what can you say about MPP?Ans. MPP is rising.8. If APP is falling, what can you say about MPP? Ans. If APP is falling, MPP is less than AP
9.explain is law of variable proportion with the help schedule and diagram.
AnsThe Law Of Diminishing Marginal Product Or The Law Of Variable Proportions Or The Law Of Diminishing Returns To Variable Factors Input
The law of variable proportions states that: When one variable input is increased keeping other factor inputs constant, marginal product of variable factor (i.e the increase in total production) increases then decreases becomes zero & then negative.. It can be explained with the help of a following schedule.Figure showing behaviour of total product, average product and marginal product
Land fixed factor (in acres)
Labour variable factor (in units)
Total Product
Marginal Product
2 1 5 5 Increasing returns to variable factor
2 2 12 72 3 20 82 4 27 7 Diminishing
positive returns to variable factor
2 5 32 52 6 34 2
2 7 34 0 Diminishing Negative returns to variable factor
2 8 32 -2
FIRST phase: At this stage TP increases at an increasing rate and MP also increases & reaches maximum. AP increases. This stage is also known as the stage of increasing returns.This phase ends when MP reaches maximum
SECOND phase:: At this stage TP continues to increase but at a diminishing rate. This stage goes to the point when TP reaches the maximum and MP decreases & becomes zero. MP decline but remain positive. AP increases & reaches maximum then declines. when AP is maximum MP=AP.This is known as stage of diminishing returns.This phase ends when TP reaches maximum & MP becomes zero
THIRD phase:: At this stage TP starts declining and MP keeps diminishing & becomes negative. AP decline but remains positive .This stage is also known as stage of diminishing negative returns.
10.Explain Relation between Marginal physical product and Total physical product When marginal product increases, total product increases at increasing rate.When marginal product decreases, total product increases at diminishing rate.When marginal product is zero total product is maximum When marginal product is negative, total product starts declining
11.Explain Relation between APP and MPP
When MPP is greater than average product, APP increases When APP is at its maximum and constant both the MPP and APP are equal.When MPP is less than APP, APP fallsWhen MPP falls & is negative, APP falls but remains positive
12.Calculate APPs and MPPs of a factor from the following table.Level of factorEmployment:
0 1 2 3 4 5 6 7
TPP: 0 5 12 20 28 35 40 42
Ans.
13.The following table gives the MPPs of a factor. It is also known that the TPP at zero level of employment is zero. Determine its TPP and APP Schedules.
Level of factor Employment:
1 2 3 4 5 6
MPP: 20 22 18 16 14 6Ans.
Level of Factor TPP APP MPP0 0 -- --
Level of Factor TPP APP MPP01234567
05122028354042
--566.6776.66
--5788752
123456
204260769096
202120191816
20221816146
Chapter COST
1.fixed costs variable costsFixed costs are those which do not change when output is increased or decrease
Variable costs are those costs which vary with output
These are cost of fixed factor inputs These are cost of variable factors inputs.
For example Rent of Land, Insurance charges
For example. Cost of raw material used in production, wages paid to labou
2. Classify the following fixed costs and variable costs.a) Rent for a shed.b) Minimum Telephone Billc) Cost of raw materialsd) Daily wagese) Payment for transportation of goods. f) Interest on Capitalg) Telephone charges beyond minimumh) Wages to permanent staffFixed cost. Variable costa) Rent for a shedb) Minimum Telephone Billf) Interest on Capitalh) Wages to permanent staff
c) Cost of raw materialsd) Daily wagese) Payment for transportation of goodsg) Telephone charges beyond minimum
3 . Cost :- amount paid to hired factor inputs used in production process & imputed value of self-owned factors inputs of producer4 .Causes of increasing returns to variable factor1. Indivisibility of the factors: -Increase in units of variable factor leads to better and fuller utilization of fixed factor. This causes the production to increase at a rapid rate.2. Division of labour and specialisation: - With more use of labour, process based division of labour and specialization becomes possible which increases efficiency & productivity3. Realisation of optimum/ideal ratio betweenvariable & fixed factor :- Increase in units of variable factors leads to optimum combination of resources maximizing production, as resources are better utilised.Causes of diminishing returns to variable factor1. Use of fixed factor beyond the optimum level-It leads to overcrowdingof variable factor over fixed factor resulting in inefficiency ,irresponsibility among workers&mismanagement . Fixed factor becomes insufficient in comparison to variable factor.
5.Total cost(TC) -Total cost of production is the sum of all expenditure incurred in producing a given volume of output.” In short period, the total cost comprises of two types of costs total fixed cost and total variable costTC = TFC + TVCTotal Fixed Cost (TFC) refers to total expenses/cost incurred on fixedfactors of production which. TFC is never zero, It exists even when there is no production as it is the payment to fixed factors like rent of land, salaries of permanent employees. TFC remains constant at all levels of output as fixed factors remain same at all levels of output. TFC curve is a straight line parallel to horizontal (X) axis.
Total Variable Cost (TVC) Refers to sum total of expenses on each unit of variable factor. As variable factor inputs change with change inoutput . with increase in output first TVC increases at a decreasing rate and then increases at an increasing rate.TVC curve is inverse S shaped due to the law of variable proportion.
6. Relationship between TC, TVC and TFC curve.
TotalCosts, TC
TVC
TC
Quantity of output produced
*(a) Total cost -Total cost of production is the sum of all expenditure incurred in producing a given volume of output.” In short period, the total cost comprises of two types of costs total fixed cost and total variable cost
TC = TFC + TVC
*(b) When there is no production, variable factor inputs are not used so Total Variable Cost is zero, but Total fixed Cost exists as payment to fixed factors production like rent of land, salaries of permanent employees has to be made even if there is no production.When Q= 0, TVC=0, TC=TFC*(c)TVCcurve starts from origin (zero)(d ) TC curve starts from point on vertical axis above origin equal to TFC*(e)TFC r emains same at all levels of output as fixed factors remain constant at all levels of output. TFC curve is a straight line parallel to horizontal (X) axis.*(f) So any change in Total cost (TC) curve is due to total variable cost (TVC) only,Hence TC and TVC are same in shape&(g)TC and TVC remain parallel to each otherat all levels of output as difference betweenTC and TVC is TFC which remains constant at all levels of output .
7. AVERAGE COSTS
AC AVC
AVERAGE COSTS
AFC
O Quantity of output produced (Q)
(a) Average cost-It is Total cost per unit of output. It is the sum of Average Fixed Cost & Average Variable Cost. It curve is U shapedAC=TC/QAC=AFC+AVC(b) Average Fixed Cost- It refers to fixed cost per unit of output.TFC is never zero; it exists even when there is no production as it is the payment to fixed factors like rent of land, salaries of permanent employees. So AFC never touches X or Y axis.
Since TFC remains constant at all levels of output AFC continuously decreases with increase in output. So AFC curve keeps on decreasing infinitely and is a rectangular hyperbola.
( c) Average Variable Cost- It is the Total variable cost per unit of output. AVC curve is U shaped, due to law of variable proportions.. It means that at first this curve falls and after reaching the minimum point it begins to rise.
Average Total Cost & Average Cost (ATC & AC ) both mean the same
8.Relationship between AVC and ATC curve(a) AC-AVC=AFC* The difference between AC & AVC is AFC ,So Average total cost curve lies above the AVC curve at a distance equal to AFC at that particular unit if output. * The distance between ATC and AVC curve decreases with increase in outputas AFC decreases with increase in output. * But ATC and AVCnever intersectasAFC is never zero * The of AVC curve reaches minimum point N at a lower level of output Q1than AC, which reaches minimum M at Q2
ATC and AVC both curves are U shaped
costs AC AVC
M
N
Q1 Q2
O Quantity of output produced
9. Explain the Relation between MC & AVC curve? ORWhy is AVC curve U shaped?
costs
AC AVC
MC
E
O Quantity of output produced
Short-run average variable cost curve is U-shaped. It means that at first this curve falls and after Reaching the minimum point it begins to rise .Firstly,AVC is U shaped due to Law of Variable Proportion.i.e.When there are increasing returns it implies diminishing cost so AVC falls& when there are decreasing returns it implies increasing costs so AVC rises.Secondly, Relation between MC & AVC curve*(i)Initially when output increases MC decreases reaches its minimum point &then increasesthroughout these output levels MC is less than AVC, so MC pulls AVC downwards &AVC decreasesWhen MC<AVC, AVC FALLS*(ii) When MC is equal to AVC, AVC is at its minimum pointMC=AVC, AVC =MinimumMinimum of MC curve is at a lower level of output than Minimum level of AC *(iii) on further increasing output MC keeps on increasing & When MC is more than AVC, it pulls AVC upwards &AVC increasesWhen MC>AVC, AVC rises.Hence AVC becomes U shaped
Note: The relationship between MC & AC curve is same as that between MC and AVC.
10. Explain the Relation between MC & AC curve? ORWhy is the Short-run Average Cost Curve U-Shaped?MC and AC Both curves are U shaped
costs MC AC
O Quantity of output produced
Short-run average cost curve is U-shaped. It means that at first this curve falls and after Reaching the minimum point it begins to rise .
Firstly,AC is U shaped due to Law of Variable Proportion.i.e.When there are increasing returns it implies diminishing cost so AC falls& when there are decreasing returns it implies increasing costs so AC rises.Secondly, Relation between MC & AC curve*(i)Initially when output increases MC decreases reaches its minimum point &then increasesthroughout these output levels MC is less than AC, so MC pulls AC downwards &AC decreasesWhen MC<AC, AC FALLS*(ii) When MC is equal to AC, AC is at its minimum pointMC=AC, AC =MinimumMinimum of MC curve is at a lower level of output than Minimum level of AC *(iii) on further increasing output MC keeps on increasing & When MC is more than AC, it pulls AC upwards &AC increasesWhen MC>AC, AC rises.Hence AC becomes U shaped11.Relationship between ATC, AVC and AFC curve
costs AC AVC
AFC
Q1 Q2O Quantity of output produced
ATC and AVC Both curves are U shaped they decrease then increase* ThefAVC curve reaches minimum point at a lower level of outputthan ACAFC curve is a rectangular hyperbola.AFC decreases with increase in output & it is is never zeroAFC+AVC= AC
(i) with increase in output from O toOQ1
AFC and AVC decreases , so AC decreases(ii) As output increase from OQ1 to OQ2
Decreases in AFC is more than increases in AVC ,so AC decreases(iii) As output increase beyond OQ2
increases in AVC is more than Decreases in AFC ,so AC increases
* The difference between AC & AVC is AFC ,So Average total cost curve lies above the AVC curve at a distance equal to AFC at that particular unit if output. * The distance between ATC and AVC curve decreases with increase in outputas AFC decreases with increase in output. * But ATC and AVCnever intersectasAFC is never zero
12.What is the reason behind the U – shape of the MC curve?Ans. The reason behind the U shape of the MC curve is the law of diminishing returns to variable factors inputs.13. Is there any change in the TFC when output changes in the short period?Ans. Total Fixed Cost remains constant at all levels of output. 14.Can AC be less than MC when AC is rising?Ans. Yes.AC will rise only when MC is more than AC. 15.At what point of AC curve, MC curve cuts it?Ans. At Minimum point of AC. 16.How is TVC derived from MC?Ans. TVCof producing a particular level of output is the sum of MCs uptil that level of output. 17.How is MC derived from TVC?Ans. MC is the addition to TVC when an additional unit is produced. 18. A firm is producing 20 units. At this level of output, the ATC and AVC are respectively equal to Rs. 40 and Rs. 37. Find out total fixed cost of the Firm?Ans. Units of Output Produced ATC AVC AFC TFC 20 40 37 3 60 19. Can TFC be Zero, when output is Zero?Ans. No,it is expense on fixed factors like rent on lend, which are done even when there is no production .20.. Suppose TFC is Rs. 120, find out TC, TVC and MC from the following data.
Output (in Units): 1 2 3 4 5ATC: 240 160 140 160 180
Ans.Output (in Units) TFC TVC AFC AVC ATC TC MC123
120120120
120200300
1206040
120100100
240160140
240320420
12080100
45
120120
520780
3024
130156
160180
640900
220260
21.From the data given below, calculate AFC, AVC and MC.Output (in Units): 0 1 2 3 4 5TC (in Rs.): 40 100 120 130 150 190
Ans.
Output (in Units)TC TFC TVC AFC AVC MC
012345
40100120130150190
404040404040
0608090110150
--402013.3108
060403027.530
--6020102040
22. Firm’s total cost schedule is given in the following table. Find output AFC, ATC and MC schedules.Output (in Units): 0 1 2 3 4 5 6 7 8TC (in Rs.): 40 120 170 180 210 260 340 440 550
Ans.Output(in units)
TC(in Rs)
TFC(in Rs)
TVC(in Rs)
AFC(in Rs)
AVC(in Rs)
ATC(in Rs)
MC(in Rs)
012345678
40120170180210260340440550
404040404040404040
080130140170220300400510
402013.31086.65.75
0806546.642.5445057.163.75
120856052.55256.662.868.75
--805010305080100110
FORMULAETC = TFC + TVC TVC = AVC *Q Units of OutputAC = AFC + AVC AC = TC/Q AFC = TFC/Q, AVC = TVC/Q , TFC = AFC*Q Units of Output TC = AC * QNote: (1) When Q=0, TVC=0,TC=TFC(2) When Q=1, TVC=AVC=MC
Chapter REVENUE
1.What is meant by revenue? Ans, Revenue is the money receipts of a firm from the sale of its output. 2. Define total revenue.Ans Total revenue is the sum of money receipts of a firm from the sale of its total output. TR = P X Q 3. What is average revenue?Ans. Average revenue is the revenue per unit sold. AR = TR/Q
4. Define marginal revenue.Ans. Marginal revenue is the net addition to the total revenue by selling one more unit of output.
MRn = TRn – TRn-1
5. What is the relationship between TR ,AR and MR under perfect competition?Ans.Relationship between AR & MR in perfect competition: As the price of the good remain same, therefore the AR curve takes the form of a straight horizontal line & MR curve is equal to AR. AR = MRas all units of output are sold at same price by the firms
6.What is the relationship between AR and MR in imperfect competition?Ans- AR & MR in an imperfect market condition:
In such a market situation, every unit of good is sold at different price & as the price of the good decreases more goods are sold ,so demand curve is downward sloping hence AR curve is downward sloping ,the MR curve is also downward sloping.MR=1/2 AR
Unitssold
TR(Rs.)
AR(Rs.)
MR(Rs.)
1 10 10 102 20 10 103 30 10 104 40 10 105 50 10 10
AR
MR
UNITS SOLD
AR
&
MR
Y
X
TR
AR=MR
Chapter Producer’s equilibrium
1.What is meant by producer’s equilibrium?Ans. Producer’s equilibrium occurs at that level of output at which producer maximizes profit.
2.What is the general profit maximizing condition of a firm?Ans. (i) profit is maximum at a output level where, MR = MC.(ii) on producing outputbeyond this output maximum profit falls, i.e MR<MC
3. Explain producer’s Equilibrium ? A. MR and MC approach.
PRODUCER EQUILIBRIUM/ EQUILIBRIUM OF A FIRM: It refers to such a situation or that level of output with an enterprise when it maximize its profits or minimize its loss out of its given scale of production & has no motive to expand or contract the level of output without changing the existing scale of production i.e. when the firm produces positive output. Condition for producer’s equilibrium:-
1. The Marginal Cost (MC) of the firm must be equal to its Marginal Revenue (MR).The firm attains equilibrium at point E & output OQ3 earns maximum profit (maximum profit =
area E1 TE) when its MC is equal to MR. It is an essential condition b’cozwhen MC<MR below OQ1 level of output, the firm still expects to get moreprofits; & when MC>MR before OQ1 & after OQ3 level of output , the firm gets loss as it spends more than what it earns from the extra unit.2. The Marginal Cost (MC) must be greater than MR after the equilibrium point, i.ebeyond equilibriumlevel of output maximum profits decline.MC must intersect MR from below but not from above. If the MC intersects from above of the MC curve i.e. MC>MR, then it implies that the firm was already facing loss & further production will accrue profits to the firm. Moreover, the question of maximizing profits does not arise as the firm was getting losses on the production of previous units of the good.MC &MR
MC
AR=MR E1 E E2
T
G
Loss
O Q1 Q2 Q3
Quantity of output
B. TR and TC approach.(i)In a competitive market situation
Condition for producer’s equilibrium:-
1. the firm attains equilibrium at the point where the gap between the Total Revenue (TR) & Total Cost (TC) is the largest or maximum; and TR>TC i.e. the firm must be earning maximum profits.(i.e TR is parallel to tangent drawn on TC at a particular level of output.2.beyond equilibriumlevel of output maximum profits decline
TR curve is upward sloping straight line passing through origin, TC curve begins at OY axis, first it increases at diminishing rate; and then it increases at increasing rate. Initially, the TC>TR, losses occur so there is disequilibrium, At levels of output where, TR>TC the firm is earning profits ,but equilibrium occurs ,only at that output level where & the gap between TR & TC is maximum . &profit is maximised .
TC-TR Approach: (Perfect Market)
Break Even Point
Producer Equilibrium
Break Even Point
TC-TR Approach: (Imperfect Market)Condition for producer’s equilibrium:-
1. the firm attains equilibrium at the point where the gapbetween the Total Revenue (TR) & Total Cost (TC) is the largest or maximum;
q P TR TC ∏ MC MR1 10 10 20 -10 10 102 10 20 26 -6 6 103 10 30 30 0 4 104 10 40 32 8 2 105 10 50 36 14 4 106 10 60 42 18 6 107 10 70 50 20 8 108 10 80 60 20 10 109 10 90 78 12 18 1010 10 100 100 0 22 1011 10 110 124 -14 24 10
and TR>TC i.e. the firm must be earning maximum profits.(i.e tangent drawn on TR is parallel to tangent drawn on TC at that particular level of output.2.beyond equilibriumlevel of output maximum profits decline
TR curve starts from origin, first it increases at increasing rate; and then it increases at diminishing rate.TC curve begins at OY axis, first it increases at diminishing rate; and then it increases at increasing rate.
Initially, the TC>TR, losses occur so there is disequilibrium, At levels of output where, TR>TC the firm is earning profits ,but equilibrium occurs ,only at that output level where & the gap between TR & TC is maximum . &profit is maximised .
TC-TR Approach: (Imperfect Market)
Break Even Point
Producer Equilibrium
Break Even Point
This table shows the producer equilibrium of a firm in the perfect market situation. The first two units lead to loss for the firm. While the firm is in break even point on 3rd & 10th unit b’coz its TR is equal to TC. Here the firm is getting normal or economic profits or zero abnormal profits. On the 8th unit, the firm maximize its profits and will produce positive output, b’coz the gap between TR & TC is maximum (MC=MR), and the profit is at its maximum.This table shows the producer equilibrium of a firm in the imperfect market structure. The first two units lead to loss for the firm. While the firm is in break even point on 3rd & 10th unit b’coz its TR is equal to TC. Here the firm is getting normal or economic profits or zero abnormal profits. On the 7th unit, the firm maximize its profits and will produce positive output, b’coz the gap between TR & TC is maximum (MC=MR), and the profit is at its maximum
Q4.From the following schedule find out the level of output at which the producer is in equilibrium.Give reason for your answer.
Output 1 2 3 4 5 6 7Price(AR) 24 24 24 24 24 24 24
q TR TC ∏ MC MR1 8 20 -12 10 82 18 26 -8 6 103 30 30 0 4 124 46 32 14 2 165 60 36 24 4 146 72 42 30 6 127 82 52 30 10 108 88 64 24 12 69 92 78 14 14 410 94 94 0 16 211 95 102 -7 18 1
TC 26 50 72 92 115 139 165
Sol.TR-TC Approach
Output 1 2 3 4 5 6 7Price(AR) 24 24 24 24 24 24 24TR 24 48 72 96 120 144 168TC 26 50 72 92 115 139 165Profit -2 -2 0 4 5 5 3The producer achieves equilibrium at 6 units of output.It is because this level of output satisfies both the conditions of producer’s equilibrium.
1.The difference between TR and TC is positive and maximum.
2.Total profits fall i.e.(5 to 3) after 6 units of output.
MR-MC Approach
Output 1 2 3 4 5 6 7Price(AR) 24 24 24 24 24 24 24TR 24 48 72 96 120 144 168TC 26 50 72 92 115 139 165MR 24 24 24 24 24 24 24MC 26 24 22 20 23 24 26
The producer achieves equilibrium at 6 units of output.It is because this level of output satisfies both the conditions of producer’s equilibrium.
1.MR=MC ,i.e.24=24
2.MC becomes greater i.e.(24 to26)than MR after 6th(equilibrium)this level of output.
Q5.From the following schedule find out the level of output at which the producer is in equilibrium.Give reason for your answer.
TR-TC Approach
Output 1 2 3 4 5TR(Rs.) 10 19 27 34 40TC(Rs.) 4 9 15 22 30Profit 6 10 12 12 10
The producer achieves equilibrium at 4 units of output.It is because this level of output satisfies both the conditions of producer’s equilibrium.
1.The difference between TR and TC is positive and maximum.
2.Total profits fall i.e.(12 to 10) after 4 units of output.
MR-MC Approach
Output 1 2 3 4 5TR(Rs.) 10 19 27 34 40TC(Rs.) 4 9 15 22 30MR(Rs.) 10 9 8 7 6MC(Rs.) - 5 6 7 8
The producer achieves equilibrium at 4 units of output.It is because this level of output satisfies both the conditions of producer’s equilibrium.
1.MR=MC ,i.e.7=7
2.MC becomes greater i.e.(7 to 8)than MR after 4th(equilibrium) level of output.
CHAPTER-THEORY OF SUPPLY
The flow of goods and commodities from the firms into the market is called supply.
Q.Briefly explain determinants of a supply of a commodity?
1.Price of the commodity-There is a direct and positive relationship between supply and price.Generally,higher the price,larger would be the supply and lower price results into lesser supply.
2.Prices of factors of production-with the rise in prices of factors of production,cost of production may also rise.It lowers producer’s profits,which results into a decrease in its supply.
3.Goals of the firms –Supply of a commodity is also guided by the firm’s goal of profit maximisation or sales maximisation.If the firm has the goal of profit maximization,it will supply more goods at a higher price.
4.Change in technology-If producers make use of new technology that helps in reducing its cost of production and higher profits,it ensures a higher level of production and its supply.
5.Price of related goods-supply of substitutes vary inversely with the prices of its substitutes(tea & coffee) whereas supply of jointly produced goods and their prices vary in the same direction(car & petrol).
Some other factors that determine market supply are:number of producing firms,taxation and subsidies,natural factors etc.
Q) Explain change in quantity supplied and change in supply. ( 6 )
OR
Differientiate between increase in supply and extension in supply.
OR
Explain decrease in supply and contraction of supply.
Ans- When supply of goods changes due to change in price, it is known as change in supply. It may be either extension of supply or
contraction of supply. When supply of a commodity increases due to increase in price, it is extension of supply but when supply of a
commodity decreases due to decrease in price, it is called as contraction of supply.
The term quantity supplied refers to specific amount of a commodity offered by the producer for sale at a specific price.
TABLE FOR CONTRACTION OF SUPPLY
PRICE QUANTITY
20 20010 100
DIAGRAM FOR CONTRACTION OF SUPPLY
TABLE FOR DECREASE IN SUPPLY
DIAGRAM FOR DECREASE IN SUPP LY
Q) Distinguish between movement along the supply curve and shift in supply curve. ( 6 )
Ans- Movement along the supply curve represents expansion and contraction of supply due to change in price of the concerned
commodity. When price increases there is an upward movement along the supply curve and when price decreases there is a
downward movement along the supply curve.
PRICE QUANTITY10 20010 100
Shift in supply curve occurs due to factors other than price of the commodity when other factors change in positive direction,
supply curve shifts to the right, showing increase in supply and when changes occur in negative direction, supply curve shifts
to the left showing a decrease in supply as following:-
SS1 indicates increase in supply
SS2 indicates decrease in supply
Q) Explain law of supply. ( 6 )
OR
Why supply curve slopes slopes upward ?
OR
Why does a producer supply more at a higher price?
Ans- The law of supply states that other things remaining the same, higher the price, greater is the quantity supplied and lower the
price, the smaller is the quantity supplied.
In the other words, supply of a commodity increases with increase in price and decreases with decrease in price of a commodity.SS
is the supply curve. Sloping upward, it shows a positive relationship between price and quantity supplied of a commodity. The
following table and diagram explain law of supply clearly:-
From the above table we observe that at higher price, the producer is supplying more of his commodity to the market. But we
observe also that very less of the commodity is being supplied by the producer at a lower price because higher price fetches more
profit and lower price fetches less profit for the producer. The producer is always interested for more profit.
In the above diagram, SS is
the supply curve, OX axis indicates the quantity of supply, OY axis indicates price of the commodity. Initially, OP is the price and OQ
is the quantity of supply. Price increases from OP to OP`, quantity supplied increases from OQ to OQ’. So, it is clear that more of a
commodity is supplied by the producer at a higher price and less is supplied at the lower price.
Q) How does technological progress affect the supply curve of a firm? ( 4 )
Ans- Technological progress will reduce the cost of production. When cost of production will be less , the firm will produce more and
more of the goods. Due to increase in production, there will be more supply of the commodity in the market. This means that supply
curve will shifts forward indicating an increase in supply. Thus technological progress leads to increase in supply. More production
due to technological progress increases the profit level of the producer. Further the society will be benefitted by getting sufficient
PRICE QUANTITY
SUPPLIED
10 100
20 200
30 300
40 400
50 500
amount of the commodity produced with the help of new technology. Traditional method is outdated now a days as it is associated
with low level of production which cannot meet the demand of the commodity concerned by the consumers of the society.
Q) Priceelasticity of supply of a goods is 5. A producer sells 500 units of his goods at Rs 5 per unit. How much will he be willing to sell at the price Rs 6 per unit? ( 3)
Ans- Suppose the producer will be willing to sell X units of his goods at price Rs 6 per unit
Es = P/Q *∆Q/∆P
Here Es =5 , P= 5 rupees, P'= 6 rupees, ∆P = 6 rupees – 5 rupees = 1 rupees,
Q=500 , Q'= X , ∆Q= X- 500
5= 5/100 * X - 500/ 1 = 1/100 * X-500/ 1 = X- 500/ 100
5= X-500/ 100 or 500= X – 500
X= 500 + 500 = 1000
So the producer will be willing to sell 1000 units ( Ans)
Q) If the supply curve passes through the origin/ X-axis/ Y-axis – What will be the kind of elasticity of supply or Es. ( 3 )
Ans- Origin- Es is 1
Y- axis - Es is >1
X- axis- Es is <1
PRICE ELASTICITY OF SUPPLYQ) What is meant by price elasticity of supply? (1)
Ans- Price elasticity of supply is a percentage change in quantity supplied in response to a percentage change in price of the commodity.
Q) When does supply become more elastic? ( 1 )
OR
When is the supply of a commodity called ‘ elastic’?
Ans- When percentage change in quantity supplied is greater than the percentage change in price.
Q) When does supply become less elastic? ( 1 )
OR
When is the supply of a commodity called ‘ inelastic’?
Ans- When the percentage change in quantity supplied is less than the percentage change in price.
Q) What is meant by zero elastic supply? ( 1 )
Ans- When quantity supplied does not respond to any change in price, it is called zero elastic supply.
Q) Using diagrams explain various degrees of price elasticity of supply. ( 6 )
Ans- 1) Perfectly Elastic Supply:- When a slight change in price causes infinite change in quantity supplied. In this case, the supply curve is parallel to X-axis.
2) Perfectly Inelastic Supply:- When the quantity supplied remains unchanged whatever the price may be. Here, the supply curve is parallel to Y-axis.
3) Unitary Elastic Supply:- When the percentage change in quantity supplied is exactly equal to percentage change in price. Here, the supply curve is a straight line passing through the origin and sloping upward.
4) More than Unitary Elastic Supply:- When percentage change in quantity supplied is greater than percentage change in price. In this case, an upward sloping straight line supply curve shoots from Y-axis.
5) Less than Unitary Elastic Supply:- When percentage change in quantity supplied is less than percentage change in price. An upward sloping straight line supply curve shooting from X-axis.
Q) The price of a commodity is 10 per unit and its quantity supplied is 500 units. If its price falls by 10 per cent and quantity supplied falls to 400 units. Calculate price elasticity of supply. ( 3 )
Ans- P= 10 rupees
Price falls by 10%.
New price ( P1 ) = 10 - 10* 10/100 = 10 rupees – 1 rupee = 9 rupees
Change in price = P1 – P = 9 rupees – 10 rupees = ( - ) 1 rupee
Q = 500; Q1 = 400 ; ∆Q = 400 – 500 = - 100
Es = P/Q * ∆Q/∆P = 10/500 * -100/-1
Price elasticity of supply = 2 ( Ans )
Q) Price elasticity of supply of a good is 5. A producer sells 500 units of this good at Rs 5 per unit . How much will he be willing to sell at the price of Rs 6 per unit ? ( 3 )
Ans- Suppose the producer will be willing to sell X units of good at Rs 6 per unit.
Es = P/Q * ∆Q/∆P
Here Es = 5; P = 5 rupees; P1 = 6 rupees;
∆P = 6 rupees – 5 rupees = 1 rupee
Q = 500 ; Q1 = X ; ∆Q = X – 500
5 = 5/500 * (X-500) /1 = 1/ 100 * (X-500) /1 = (X- 500) /100
5 = (X – 500) /100 or 500 = X – 500
X = 500 + 500 = 1000
The producer will be willing to sell 1000 units. ( Ans )
UNIT : 4 FORMS OF MARKET -10 marks
1. Define market.
It is a real or imaginary place where goods and services are purchased and sold by buyers and sellers respectively and payment is made in return for it.
2. Define perfect competition market.
It is a market in which there are large number of buyers and sellers, selling homogenous goods. There is free entry into and exit from the market and firm is price taker and industry is price maker.
3. Define monopoly market.
It is a market where there is only one seller selling a good which does not haveany substitute. Firm is the price maker and there is restricted entry into and exit from the market.
4. Define monopolistic competition market.
It is a market in which there are large number of buyers and large number of small sellers, selling differentiated goods, which are close substitutes. There is free entry into and exit from the market and firm is price maker.
5. Define oligopoly market.
In this market there are few large sellers selling homogenous or differentiated good. Firms are mutually interdependent for deciding prices either competitively or through competition. There is restricted entry into and exit from the market.
Collusive oligopoly – In this type of oligopoly firms decide price of goods through mutual cooperation with each other by forming groups or cartels.
Nom collusive oligopoly - In this type of oligopoly firms decide price of goods through competition with each other
Note: If unable to understand any indirect or hot question based on feature of market do mention the features of market given in question6. Explain the implication of following features of various markets (Eachpart is for 2 or 3marks):-
(a)Large number of buyers and sellers in perfect competition market!
Implications(i) As there are large number of sellers’ individual seller cannot influence market supply or price.
Similarly one buyer cannot affect market demand or price.
(ii) Firms become price takers as they have to accept the equilibrium price that market demand & supply decide. So market or industry is price maker.
(iii) Due to large number of buyers firm can sell any amount of good at equilibrium price. Hence they have perfectly elastic,horizontal Average Revenue (AR) curve.
(b) Homogenous goods in perfect competition market!
Implications: -Perfect competition market has homogenous goods which are same in shape, size, colour, price etc.
(i) So it is easy for new firms to enter into and exit from the market.
(ii) There is no selling cost as there is no need for advertising the good
(iii) So one firm cannot effect price market decides the price.
(c) Free entry into and exit from the market in perfect competition market!
Implications:- If in Short Run there is abnormal profit firms will enter the market & if there are abnormal losses firms will exit the market.
Hencein theLong run firms will earn Normal Profits.
(d) Differentiatedgoods monopolistic competition market!
Implications:- Differentiated goods are different in shape, size, colour, packaging etc.
(i) New firms can easily enter the market by adding new feature in their product.
(ii)Non price competition occurs firms compete on the basis of different features in good and not on the basis of prices.
(iii) Selling costs are high as differentiated goods of competitors are close substitutes so firms have to advertise & change the product qualities.
(e) Downward sloping AR curve in monopoly & monopolistic competition market!
Implications:- Due to downward slope of AR curve & demand curve in both the markets the firms have to simultaneously decide price and quantity to be sold. If firm decides to sell at a high price then AR curve indicates that less quantity will be sold. If they decide on larger quantity to be sold then AR curve will show the low price to be charged by firms.
More good can be sold at lower price and less good can be sold at higher price.
7. Differentiate between the following:-
perfect competition market monopolistic competition market1 .Large number of buyers and sellers. 1. There are large number of buyers and
large number of small sellers.2. Firm is price taker and industry is price maker.
2.Firm is the price maker
3. Average Revenue (AR) curve is perfectly elastic & horizontal.
3. Average Revenue (AR) curve is downward sloping & elastic.
4. There is no Selling cost 4. Selling costs are high.
perfect competition market monopoly1. Large number of buyers and sellers. 1. There is only one seller.2. There is free entry into and exit from the market.
2. There is restricted entry into and exit from the market.
3. Firm is price taker and industry is price maker.
3. Firm is the price maker
4. Average Revenue (AR) curve perfectly elastic & horizontal.
4. Average Revenue (AR) curve is downward sloping & inelastic.
monopoly market monopolistic competition market1. There is only one seller. 1. There are large number of buyers and
large number of small sellers.2. There is restricted entry into and exit from the market.
2. There is free entry into and exit from the market.
3.Selling costs are low & are onetime costs 3. Selling costs are very high.4 .Average Revenue (AR) curve is downward sloping and inelastic.
4. Average Revenue (AR) curve is downward sloping elastic.
5. Goods in this market have no close substitutes.
5. Goods in this market have very close substitutes.
8. Average Revenue (AR) curve of monopoly market more inelastic compared to AR curve of monopolistic competition market, why?OR
Why is Average Revenue (AR) curve of monopoly market steeper compared to AR curve of monopolistic competition market?
In monopoly there is only one seller, selling a good which has no substitute, firm is the price maker and there is restricted entry into and exit from the market.
If the firm increases price buyer do not have any substitute to buy, so quantity demanded by them changes by lesser degree than change in price. So AR curve is inelastic and steeper compared to monopolistic competition.
Whereas in monopolistic competition market there are largenumbers of small sellers, selling differentiated goods, which are very close substitutes & there is free entry into and exit from the market and firm is price maker.
If the firm increases price of the good buyers will immediately start buying goods from its competitors. Hence quantity demanded changes by greater degree compared to prices so AR curve is more elastic & flatter compared to monopoly.
9(A). What is Price discrimination?
In monopoly market firms sell same good at different prices in different markets, to different groups and at different places. This is called Price discrimination.
9(B). Q) The firm under monopoly is a price maker- Discuss ( 4 )
Ans- Under perfect competition, the firm is price taker. But under monopoly the firm is price maker. In monopoly there is
a single seller of a commodity. He has full control over the price of his product. He can increase or decrease the price of
the product. There is no competition of other firms as there is only one firm in the market. There is no close substitutes of
the monopoly product. There is no possibility for entry of new firm in the monopoly market. Hence the monopolist or the
monopoly market is price maker.
10.) Explain the feature or concept of product differentiation. ( 3 )
Ans Product differentiation- In monopolistic competition market there are large number of firms selling goods which are
close substitutes. The product of one firm is different from that of other firm only in colour, size, shape, packaging,
branding, advertising etc, this is known as Product differentiation.
Because of product differentiation, each firm can decide its price but it has to keep price of competitors in mind. . So
each firm is price maker but it has a partial control over price of its product.
11. If abnormal profits are earned in perfect competition market in the short run & there is free entry, what will happen to profits in the long run? Explain.
When firms earn abnormal profits in the short run, new firms will be attracted by profits and will enter the market due to free entry.
Market supply of goods increases.
Share of each firm in market sales falls
So firms will compete with each other and reduce prices to sell stock of goods.
Profits of each firm declines
New firms will continue to enter till the abnormal profits fall
And all firms earn only normal profits in the longrun.
12. If abnormal losses are incurred in perfect competition market in the short run & there is free exit, what will happen to losses in the long run? Explain.
When firms have abnormal losses in the short run,
Some firms will exit the market due to free exit.
Share of each firm in market sales increases.
Market supply of goods decreases, due to which prices rise
And losses of each firm declines
New firms will continue to exit till the abnormal losses fall
And all firms earn only normal profits in the longrun.
13. Why is the average revenue curve of perfect competition perfectly elastic (horizontal) ?
OR How is equilibrium price determined by perfect competition firm?
Market Equilibrium Firms Equilibrium
S
P e P
P1 P1 P1=AR=MR
D
O quantity demanded O quantity demanded
And supplied and supplied
P is Price, d-demand, S- supply
E –equilibrium, P1- equilibrium price
In perfect competition market there are large numbers of buyers and sellers, selling homogenous goods, there is free entry into and exit from the market, so no individual buyer or seller can effect market demand, supply or price.
Market demand & supply decide the equilibrium price and firms can sell any amount of goods at this price as there are infinite buyers .
Firms will not sell at a price more than equilibrium price otherwise they will lose their buyers to other sellers selling same good at equilibrium price.
Perfect competition firm earn normal profits at equilibrium price so firms will not sell at a lower price than equilibrium price as it will lead to losses.
So demand or AR curve is perfectly elastic and horizontal at equilibrium price.
14. How is equilibrium price determined in perfect competition market? Explain diagrammatically.
Excess Supply
PriceS
P1 A B
P2 e
P3L M
D
Excess Demand
O Q2
Quantity demanded and supplied
Market equilibrium occurs at a price level where quantity demanded is equal to quantity supplied.
In the diagram given above
Market equilibrium occurs at a price level OP2 at point e ,
Where, quantity demanded = quantity supplied = OQ2
Disequilibrium occurs at any price level above or below equilibrium price.
If Market price ( e.g.: OP 3 )is more than equilibrium price
Then quantity demanded (P3A) is less than quantity supplied (P3B) , so Excess Supply equal to AB occurs.
Sellers will compete with each other to sell excess goods in their stocks, they will reduce prices, hence quantity demanded rises and quantity supplied falls. Price is again reduced. This process continues till the excess supply gets wiped out and equilibrium price is reached where, quantity demanded = quantity supplied = OQ2.
If Market price ( e.g.: OP 1 )is less than equilibrium priceThen quantity demanded (P1M) is more than quantity supplied (P1N) , so Excess Demand equal to NM occurs.Buyers will compete with each other and some buyers will be willing to pay higher prices to get the good.
Sellers willincrease prices, hence quantity demanded falls and quantity supplied rises. Price is again raised. This process continues till the excess demand gets wiped out and equilibrium price is reached where, quantity demanded = quantity supplied = OQ2.
Questions Based on Market Equilibrium ( Shifts in Demand & Supply Curves)
-----------------------------------------------------------------------------------------------
NOTE: In all questions below there are only 2 basic answers whose main point will be as follows
(1) Excess Demand (2) Excess Supply.Buyers will compete with each other and some buyers will be willing to pay higher prices to get the good.Sellers will increase prices, hence quantity demanded falls and quantity supplied rises.
Sellers will compete with each other to sell excess goods in their stocks, they will reduce prices, hence quantity demanded rises and quantity supplied falls.
Excess Demand occurs in following cases Excess Supply occurs in following casesFactors effecting Demand Increase Demand. Factors effecting Supply Increase Supply.Factors effecting Supply Decrease Supply. Factors effecting Demand decrease Demand.Increase in Demand is more than Increase in Supply
Increase in Supply is more than Increase in Demand
Demand Increase & Supply decrease Supply Increase & Demand decrease
--------------------------------------------------------------------------------------------
15. If income of the consumer increasesand consumer consumes normal goods, explain the effect on equilibrium price with the help of diagram?
OR If income of the consumer decreases and consumer consumes inferior goods, explain the effect on equilibrium price with the help of diagram?
OR If there is favourable change in fashion, what will happen to equilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram.
OR If there is favourable change in tastes & preferences whatwill happen toequilibrium quantity &equilibriumprice. Explain the chain reaction with the help of diagram
Or if the price of substitute good rises, whatwill happen toequilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram
Or if the price of complementary good falls, whatwill happen toequilibrium quantity &equilibriumprice. Explain the chain reaction with the help of diagram.
Price S
P2 e2
P1 e1 A
Excess Demand D 2
D1
O Q1 Q2
Quantity demanded and supplied
Demand will increase
Demand curve will shift upwards to the right from D1 to D2
At original equilibrium price OP1
New quantity demanded = P 1 A
New quantity supplied = P 1 e 1
The new quantity demanded (P1 A) is more than new quantity supplied (P1 e1), so Excess Demand equal to ( e1 A) occurs.Buyers will compete with each other and some buyers will be willing to pay higher prices to get the good.
Sellers willincrease prices, hence quantity demanded falls and quantity supplied rises. Price is again raised. This process continues till the excess demand gets wiped out and newequilibrium is reached at point e2 where, quantity demanded = quantity supplied = OQ2.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ 2
16. If the number of firms decreases what will happen to equilibrium quantity & equilibrium price. Explain the chain reaction with the help of diagram.
OR If the government policy is unfavourable, explain the effect on equilibrium price with the help of diagram?
OR If price of input i.e. raw materials increases what will happen to equilibrium quantity & equilibrium price. Explain the chain reaction with the help of diagram.
OR If cost of technology is high what will happen to equilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram.
OR If weather is unfavourable what will happen to equilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram.
S2
Price S1
P2e2
P1A e1
Excess Demand
D 1
O Q2 Q1
Quantity demanded and supplied
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = P 1 e 1
New quantity supplied = P 1 A
The new quantity demanded (P 1 e 1) is less than new quantity supplied (P 1 A), so Excess Demand equal to (A e1 ) occurs.
Buyers will compete with each other and some buyers will be willing to pay higher prices to get the good.
Sellers will increase prices, hence quantity demanded falls and quantity supplied rises. Price is again raised. This process continues till the excess demand gets wiped out and new equilibrium is reached at point e 2 where, quantity demanded = quantity supplied = OQ2.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity decreases from OQ1 to OQ 2
17. If income of the consumer decreases and consumer consumes normal goods, explain the effect on equilibrium price with the help of diagram?
OR If income of the consumer increases and consumer consumes inferior goods, explain the effect on equilibrium price with the help of diagram?
OR If there is unfavourable change in fashion, what will happen to equilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram.
OR If there is unfavourable change in tastes & preferences whatwill happen toequilibrium quantity &equilibriumprice. Explain the chain reaction with the help of diagram
Or If the price of substitute good falls, whatwill happen toequilibrium quantity & equilibrium price. Explain the chain reaction with the help of diagram
Or If the price of complementary good rises, whatwill happen toequilibrium quantity & equilibrium price. Explain the chain reaction with the help of diagram.
PriceExcess supply S
P1A e1
P2 e2
D 1
D 2
O Q2 Q1
Quantity demanded and supplied
Demand will decrease
Demand curve will shift downwards to the left from D1 to D2
At original equilibrium price OP1
New quantity demanded = P 1 A
New quantity supplied = P 1 e 1
Then quantity demanded (P 1A) is less than quantity supplied (P 1 e 1) , so Excess Supply equal to A e 1 occurs.
Sellers will compete with each other to sell excess goods in their stocks, they will reduce prices, hence quantity demanded rises and quantity supplied falls. Price is again reduced. This process continues till the excess supply gets wiped out and new equilibrium is reached at point e 2, where new quantity demanded =new quantity supplied = OQ2.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity decreases from OQ1 to OQ 2
18. If the number of firms increases what will happen to equilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram.
OR If the government policy is favourable, explain the effect on equilibrium price with the help of diagram?
OR If price of input i.e. raw material decreaseswhat will happen to equilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram.
OR If cost of technology is low what will happen to equilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram.
OR If weather is favourable what will happen to equilibrium quantity &equilibrium price. Explain the chain reaction with the help of diagram.
S1
Price Excess SupplyS2
P1 e 1A
P2 e2
D
O Q1 Q2
Quantity demanded and supplied
Supply will increase
Supply curve will shift downwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = P 1 e 1
New quantity supplied = P 1 A
Then quantity demanded (P 1 e 1) is less than quantity supplied (P 1A) , so Excess Supply equal to e 1 A occurs.
Sellers will compete with each other to sell excess goods in their stocks, they will reduce prices, hence quantity demanded rises and quantity supplied falls. Price is again reduced. This process continues till the excess supply gets wiped out and new equilibrium is reached at point e 2, where new quantity demanded =new quantity supplied = OQ2.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ 2
19. What will happen to equilibrium quantity & equilibrium price when there is simultaneous decrease in Demand & Supply.(A) Decrease in demand is greater than decrease in Supply
PriceExcess supply S2
P1S1
P2A B e 1
e 2
D1
D2
O Q1 Q2
Quantity demanded and supplied
Demand will decrease,
Demand curve will shift downwards to the left from D1 to D2
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = P 1 A
New quantity supplied = P 1 B
Then quantity demanded (P 1 A) is less than quantity supplied (P 1B) , so Excess Supply equal to AB occurs.
Sellers will compete with each other to sell excess goods in their stocks, they will reduce prices, hence quantity demanded rises and quantity supplied falls. Price is again reduced. This process continues till the excess supply gets wiped out and new equilibrium is reached at point e 2, where new quantity demanded =new quantity supplied = OQ2.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity decreases from OQ1 to OQ 2
(B) Decrease in demand is less than decrease in Supply
S2
Price e 2S1
P2
P1 A B e 1
Excess demand
D1
D2
O Q2 Q1
Quantity demanded and supplied
Demand will decrease
Demand curve will shift downwards to the left from D1 to D2
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = P 1 B
New quantity supplied = P 1 A
Then quantity demanded (P 1B) is more than quantity supplied (P 1 A) , so Excess Demand equal to A B occurs.
Buyers will compete with each other and some buyers will be willing to pay higher prices to get the good.
Sellers will increase prices, hence quantity demanded falls and quantity supplied rises. Price is again raised. This process continues till the excess demand gets wiped out and new equilibrium is reached at point e 2 where, quantity demanded = quantity supplied = OQ2.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity decreases from OQ1 to OQ 2
(C)Decrease in demand is equal to decrease in Supply
S2
P rice S1
P1 e 2e1
D 1
D 2
O Q2 Q1
Quantity demanded and supplied
Demand will decrease
Demand curve will shift downwards to the left from D1 to D2
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = New quantity supplied = P 1 e2
So there is neither Excess Demand nor Excess Supply
Hence, So equilibrium price remains constant at OP1
&equilibrium quantity decreases from OQ1 to OQ 2
20. What will happen to equilibrium quantity & equilibrium price when there is simultaneous increase Demand & Supply?
(a) Increase in demand is greater than increase in Supply
Price S1S2
e 2
P2A B
P1 e 1Excess demand
D2
D 1
O Q1 Q2
Quantity demanded and supplied
Demand will increase
Demand curve will shift downwards to the left from D1 to D2
Supply will increase
Supply curve will shift upwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = P 1 B
New quantity supplied = P 1 A
Then quantity demanded (P 1B) is more than quantity supplied (P 1 A) , so Excess Demand equal to A B occurs.
Buyers will compete with each other and some buyers will be willing to pay higher prices to get the good.
Sellers will increase prices, hence quantity demanded falls and quantity supplied rises. Price is again raised. This process continues till the excess demand gets wiped out and new equilibrium is reached at point e 2 where, quantity demanded = quantity supplied = OQ2.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ 2
(b)Increase in demand is less than increase in Supply
S1
Price e 1Excess Supply S2
P1A B
P2 e2
D2
D1
O Q1 Q2
Quantity demanded and supplied
Demand will increase
Demand curve will shift downwards to the left from D1 to D2
Supply will increase
Supply curve will shift upwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = P 1 A
New quantity supplied = P 1 B
Then quantity demanded (P 1 A) is less than quantity supplied (P 1B) , so Excess Supply equal to AB occurs.
Sellers will compete with each other to sell excess goods in their stocks, they will reduce prices, hence quantity demanded rises and quantity supplied falls. Price is again reduced. This process continues till the excess supply gets wiped out and new equilibrium is reached at point e 2, where new quantity demanded =new quantity supplied = OQ2.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ 2
(C) Increase in demand is equal to increase in Supply
S1
P rice S2
P1 e 1 e2
D 2
D 1
O Q1 Q2
Quantity demanded and supplied
Demand will increase
Demand curve will shift downwards to the left from D1 to D2
Supply will increase
Supply curve will shift upwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = New quantity supplied = P 1 e2
So there is neither Excess Demand nor Excess Supply
Hence, So equilibrium price remains constant at OP1
&equilibrium quantity increases from OQ1 to OQ 2
21. What will happen to equilibrium price and quantity when supply is perfectly elastic and demand decreases? Explain diagrammatically.
P rice
P1 e 2 e1 S
D 1
D 2
O Q2 Q1
Quantity demanded and supplied
Demand will decrease
Demand curve will shift downwards to the left from D1 to D2
Supply curve will remain S1
At original equilibrium price OP1
New quantity demanded = New quantity supplied = P 1 e2
So there is neither Excess Demand nor Excess Supply
Hence, So equilibrium price remains constant at OP1
&equilibrium quantity decreases from OQ1 to OQ 2
22. What will happen to equilibrium price and quantity when demand is perfectly elastic and Supply decreases? Explain diagrammatically.
S2
P rice S1
P1 e 2 e1D1
O Q2 Q1
Quantity demanded and supplied
Demand curve will remain D1
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibrium price OP1
New quantity demanded = New quantity supplied = P 1 e2
So there is neither Excess Demand nor Excess Supply
Hence, So equilibrium price remains constant at OP1
&equilibrium quantity decreases from OQ1 to OQ 2
23. What will happen to equilibrium price and quantity when demand is perfectly inelastic and Supply increases? Explain diagrammatically.
D1 S1
Price
Excess supply S2
P1 e1A
P2 e2
O Q1
Quantity demanded and supplied
Demand curve will remain D1
Supply will increase
Supply curve will shift downwards to the right from S1 to S2
At original equilibrium price OP1
New quantity demanded = P 1 e1
New quantity supplied = P 1 A
Then quantity demanded (P 1 e1) is less than quantity supplied (P 1 A) , so Excess Supply equal to e1A occurs.
Sellers will compete with each other to sell excess goods in their stocks, they will reduce prices, hence quantity demanded rises and quantity supplied falls. Price is again reduced. This process continues till the excess supply gets wiped out and new equilibrium is reached at point e 2, where new quantity demanded =new quantity supplied = OQ1.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity remains constant at OQ1
24. What will happen to equilibrium price and quantity when Supply is perfectly inelastic and demand increases? Explain diagrammatically.
S1
Price
P2 e2
e1A
P1
Excess Demand D2
D1
O Q1
Quantity demanded and supplied
Supply curve will remain S1
Demand will increase
Demand curve will shift downwards to the left from D1 to D2
At original equilibrium price OP1
New quantity demanded = P 1 A
New quantity supplied = P 1 e1
Then quantity demanded (P 1 A ) is more than quantity supplied (P 1 e1) , so Excess Demand equal to e1A occurs.
Buyers will compete with each other and some buyers will be willing to pay higher prices to get the good.
Sellers will increase prices, hence quantity demanded falls and quantity supplied rises. Price is again raised. This process continues till the excess demand gets wiped out and new equilibrium is reached at point e 2 where, quantity demanded = quantity supplied = OQ1.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity remains constant OQ1
25.) With the help of a supply schedule and demand schedule,explain excess demand or excess supply. ( 6 ) OR
What will happen in the market if the price is more than or less than the equilibrium price?
Ans-
Equilibrium price and quantity of a product is determined at the point where market demand is equal to the market
supply. In the above schedule equilibrium price is 3,where demand is equal to supply(30).
At price less than the equilibrium price
PRICE
SUPPLY
DEMAND
1 10 502 20 403 30 304 40 205 50 10
At price level 1 and 2, Quantity demanded of product is more than Quantity supplied. It is a situation of excess demand.
In the situation of excess demand, price increases upto the equilibrium level(3) leading to increase in Quantity
supplied (expansion of supply) and decrease in Quantity demanded (contraction of demand) till both are equal at
equilibrium.
At price more than the equilibrium price
At price level 4 and 5, Quantity demanded of product is less than Quantity supplied. It is a situation of excess supply.
In the situation of excess supply, price decreases upto the equilibrium level(3) leading to decrease in Quantity
supplied (contraction of supply) and increase in Quantity demanded (expansion of demand) till both are equal at
equilibrium.
Note UNIT 5 is not to be evaluated in Exam No marks are allotted to it
UNIT 6
NATIONAL INCOME AGGREGATES-15marks
NOTE: While Revising in this unit first read and learn following then learn definitions and formula in the end
-precautions to be taken in calculation of national or domestic income of the country- Consumer goods or consumption goods Capital goods- Final goods & Intermediate goods-Factor income & transfer income- Concept of Domestic & National income-Questions at the end based on whether to include or not include in Concept of Domestic & National income
1. Real Flow - It refers to the flow of factor services from households to firms and the corresponding flow of goods and services from firms to households. 2. Money Flow - It refers to flow of factor payments from firms to households for their factor services and corresponding flow of consumption expenditures from households to firms for purchase of goods and services produced by the firms. It is also called nominal flow.3. CIRCULAR FLOW IN A TWO SECTOR ECONOMY
Factor Payments (Rent, Wages, Interest and Profit)
Factor Services (Land, Labour, Capital and Enterprise)
Consumption Expenditure (On goods and services)
Purchase of Goods and Services
Note: outer arrow and lines show Real flow & inner arrow lines show Money flow- There are only two sectors in the economy: Households and firms -Household sectors supplies factor services only to firms and firms hire factor services only from households. - Firms produce goods and services and sell their entire output to the households. - Households receive factor income for the services and spend the entire amount on consumption of goods and services
4. CIRCULAR FLOW IN A FOUR SECTOR ECONOMY
Subsidies& Transfer Net Transfer PaymentsPayments
Tax Payments Tax Payments Payment for goods and services
HOUSEHHOLDS FIRMS
Government Sector
Factor Payments
Savings Savings
Borrowings
Net Payment for factor services
Payments for Imports Receipts from Exports
5.
6.Define
macroeconomicsIt is the branch of economics which studies economic activities, issues and economic problems at the level of economy as a whole.
7.Give examples of macroeconomic variables.
Aggregate demand, Aggregate supply, national income, per capita income, unemployment.
8.What are the subjects studied in macroeconomics?
* Income and employment determination
*Problems related to economic growth
*unemployment problem in the economy
*problem of inflation etc..
------------------------------------------------------------------------------------------------------
NOTE: It is not the economic nature of good BUT the USE of the good that tellswhether the good isConsumer goods or Capital goods; Final goods or Intermediate goods.
-------------------------------------------------------------------------------------------------------
Leakages from CIRCULAR FLOW of income
Injections into from CIRCULAR FLOW of income
1. These flow variables have a negative impact on the process of production.
These causes positive impact on the process of production.
2. These are withdrawals from the circular flow of income.
These are addition to the circular flow of income.
3. Examples: Saving, taxation and imports Examples: Investment, exports and consumption expenditure.
Foreign Sector
(ROW)
Household Sector
Financial market
Firms or Producer Sector
9.
Consumer goods or consumption goods Capital goods1. These are directly used by ultimate consumer household for satisfaction of wants.
1. These are fixed assets used by the producers in the production process.
2. These are final goods 2. These are final goods.3. They are not used in production by producer.
3. They help in production of other goods.
4 . They may be changed during use by consumer like tea leaves are used to make tea.
4. They do not change during production process.
5.eg: Durable goods- car, washing machine 5. eg: machines , plants and equipment used in production process.
10.Define Consumer goods or consumption goods
These are final goods (Durable goods, Semi durable goods, Non-durable or perishable goods,Services) directly used by ultimate consumer household for satisfaction of wants . They may be change during use.
For example:- sugar if used by consumer to make biscuits is consumer good.
11. Define Capital goods
These are durable final goods used by the producers in the production process . They do not change during production process. For example fixed assets like machines, plants and equipment used in production process.
12. All capital goods are producer goods , but all producer goods are not capital goods. Explain.
Producer goods are all those goods which are used in production process they are:-
(a) goods used as raw material(b) fixed assets like machines
Raw material like coal, wood etc are not capital goods as they lose their identity in production process. They are intermediate or a single use producer goods and cannot be used again in the production process.
Capital goods are durable final goods used to help production. Only fixed assets are capital goods like machines,plants and equipment.So all capital goods are producer goods. But all producer goods are not capital goods , as raw materials are not capital goods.
13.
Final goods Intermediate goods1. These are ready for final useby consumer for consumption or By producer for investment.
1. These are not ready for use; they are for resale or used for further production.
2.These are:-(a)Consumer goods used for satisfaction of wants. They may change during use.(b) Capital goods which help in production process. Thy do not transform during use,;
2. These are purchased by one firm from another for following purpose:-(a) Resale during the year(b) Use as raw materialin production process. So they may change during production process
3. Once sold these pass out of production 3.These are inside the production
boundary. boundary.4. These are included in national income 4. These are not included in national income.14. Define Final goods
These refer to the goods used either for consumption or for investment. They are neither resold nor used for further production of goods.
15. Define Intermediate goods
These are goods used as raw material in production process or are for resale during the financial year.
16.
Stocks Flows1. Stock variables are measured at a particular
point in time.2. They do not have a time dimension,3. Eg: Capital stock, inventory, wealth on a
particular day. 4. Stock is static concept
1. Flow variables are measured over a period of time,2. They have a time dimension,3. Eg: Capital formation during a year, change in
stock, national income during a year. 4. Flow is dynamic concept.
Consumption of fixed capital Capital Loss
1. It is loss in the value of fixed assets due to normal wear and tear and expected obsolescence
It is loss in the value of fixed assets due to natural calamities and unexpected obsolescence.
2. It is expected loss in the value of asset It is unexpected loss in the value of asset.
3. Provision for depreciation is by maintaining depreciation reserve fund.
Provision for capital loss is by getting insurance done.
Factor income or Factor payment Transfer Income or Transfer payment
1. It is the income received in return for rendering factor services by the factors of production.
It is the income received without any corresponding services.
2. These are included in national income. These are not included in national income
3. Example: Rent, wages, interest, and profit. Retirement pension.
Example: old age pension, scholarship of students, unemployment allowance, charity ,gifts, expenditure on birthday / Marriage, pocket money, remittances from abroad, financial help to earthquake victims, beggars, meals to beggars, compensation given to accident victims etc.
17. Classify the following into factor income and transfer receipt. Give reason for your answer. i) Employer’s contribution to social security schemes. It is a factor income as it is earned because employees are rendered corresponding services to the employer. ii) Scholarship given to students by the government. It is transfer receipt as it is unearned because students are not rendered any corresponding services to the government.
iii) Old age pension given by the government. It is transfer receipt as it is unearned because pensioners are not rendered any corresponding services to the government. iv) Bonus given to employees by employer. It is a factor income as it is earned because employees are rendered corresponding services to the employer.
18. Definedepreciation or consumption of fixed capital.
It is the loss in the value of fixed assets during use due to
(a) Normal wear and tear and(b) Expected obsolescence
It does not include capital loss due to unexpected obsolescence like natural calamities, theft or accident.
19. Explain gross investment.
Total capital formation (or total investment) in a financial year is called gross investment. It includes:-
(a) Stock of raw material, work in progress and finished goods,
(b) Fixed capital assets like machinery, equipment, buildings etc.
It also includes depreciation.
20.
Real GDP orGDP at constant prices or GDP at base year prices
Nominal GDP orGDP at market prices or GDP at current year prices
1. It is the monetary value of all goods and services produced in an economy during a financial year, estimated using base year prices.
1. It is the monetary value of all goods and services produced in an economy during a financial year, estimated using current market prices.
2. Base year price is taken as constant. 2. Market prices do not remain constant.
3. This GDP changes only due to change in output of the economy. So it is a reliable measure of economic growth.
3. It changes due to change in both price and output of the economy. So it is not a reliable measure of economic growth.
21. NOTE: Application based questions come from this topic Explain Normal resident of a country. A normal resident is said to be a person: Who ordinarily resides in a country. Stay in the country should be more than a year and Interest of staying in that country should be economic A person can be citizen of a country and normal resident of some other country. For example: A larger number of Indian Nationals have settled in USA, England etc. as residents (not as nationals) of those countries. For India, they are non-resident Indians but are nationals.
Examples of Non-residents:
They are called non-residents because they do not fulfil the creation of centre of economic interest:
International organizations like the World Bank, W.H.O, IMF are not treated residence of any country but of international area. These are non-resident organizations for the country in which these are situated.
Employees of international organizations are considered residents of the countries to which they belong and not of the international area.
Workers from across the border who cross borders regularly to work in the given country. They are treated as residents of the country where they live and not the residents of the country where they work.
Foreign visitors or travellers visiting the given country for studies, medical treatment, recreation or take part in sports, cultural events etc. These are non-residents for the country they are visiting.
Foreign staff of embassies and members of foreign armed forces located in a given country.
The crew foreign ships, aircrafts etc.
---------------------------------------------------------------------------------------------------------
NOTE: These six (6) conceptsgiven below are not definitions but are HINTS to define and differentiate measures of national income
While defining aggregates
Firstly,define Gross or Net
Secondly, definemarket Price or Factor Cost
Thirdly, defineDomestic or National product.
(1) Net product (2) Gross productIt is the Net Value of all final goods and services produced in a financial year.
It does not include depreciation
Net product= Gross product- depreciation
It is the Gross Value of all final goods and services produced in a financial year.
It includes depreciation
gross product= Net product +depreciation
(3) National product (4) Domestic productIt is the value of all final goods and services produced by Normal Residents of a country within or outsidedomestic territoryin a financial year
It includes Factor income from abroad
It does not include Factor income to abroad
National product = Domestic product +Factor income from abroad
It is the value of all final goods and services produced within domestic territory of a countryby all producers during a financial year
It does not include Factor income from abroad
It includes Factor income to abroadFactor income from abroad
Domestic product =National product- Net Factor income from abroad
(5) Product at Factor Cost (6) Product at Market PriceIt is the Income earned by all the factors of production in a financial year.
It does not include Indirect taxes
It includes subsidies
It is the Market Value of all final goods and servicesproducedin a financial year
It includes Indirect taxes
It does not include subsidies
Product at Factor Cost= Product at Market Price – Net Indirect taxes
Product at Market Price =Product at Factor Cost +Net Indirect taxes
----------------------------------------------------------------------------------------------------
22.Definitions formed Using hints given above
1. GDPMP - It is the GrossMarket Value of all final goods and services producedby all producers within domestic territory of a country in a financial year
2. NDPMP- It is the NetMarket Value of all final goods and services produced by all producers within domesticterritory of a country in a financial year
3. GNPMP- It is the GrossMarket Value of all final goods and services produced byNormal Residents of a country within or outsidedomestic territory in a financial year
4. NNPMP - It is the NetMarket Value of all final goods and services produced by Normal Residents of a country within or outside domestic territory in a financial year
5. NDPFC - It is the Netfactor Income earned by all the factors of production within domestic territory of a country in a financial year
6. GDPFC-It is the Grossfactor Income earned by all the factors of production within domestic territory of a country in a financial year
7. GNPFC-It is the Grossfactor Income earned by ( all the factors of production owned by)Normal Residents of a country within or outsidedomestic territory in a financial year
8. NNPFC or National Income- It is the Netfactor Income earned by (all the factors of production owned by)Normal Residents of a country within or outside domestic territory in a financial year.
23. Calculation of Personal disposable income from NDP FC
- Income from property and entrepreneurship accruing to the government administrative departments- Savings of non-departmental public sector enterprises
+ Net factor income from abroad
+ Net current transfers from rest of the world
+ Net current transfers from government administrative departments
+ National debt interest
- Corporate Tax- Retained earnings of private corporations
- Direct personal taxes- Miscellaneous receipts of fees & fines by government administrative departments
Personal disposable income = Private final consumption expenditure + savings of households
---------------------------------------------------------------------------------------------------
NOTE: TheHints in following table will help in understanding definitions given below it
Item Type of income Factor or Transfer income
Sector earning it (government, Firm, or Household)
Income earned in Domestic territory or by normal residents (National income)
NDPFC factor Income GovernmentFirmhousehold
Domestic
Income from NDP FC
accruing to Governmentfactor Income Government Domestic
NDP FC
Income from domestic product accruing to private sector
Private income
Personal income
Personal disposable income
Income from NDP FC
accruing to Private sectorfactor Income Firm
householdDomestic
Private income factor & transfer Income Firmhousehold
National
Personal income factor & transfer Income household National------------------------------------------------------------------------------------------------------
24. Definitions
NDPFC - It is the Net factor Income earned by all the factors of production (owned by all sectors government, firm,household) within domestic territory of a country in a financial year.
Income from NDP FC accruing to Government - It is the factor Income earned by public sector ( government ) within domestic territory of a country in a financial year.
Income from NDP FC accruing to Private sector– It is the factor Income earned by all firms and households within domestic territory of a country in a financial year.
Private Income - It is the Income earned from all sources (factor & transfer Income) by allnormal residentfirms and household from within or outside domestic territory in a financial year.
Personal Income - - It is the Income earned from all sources (factor & transfer Income) by all normal residenthousehold from within or outside domestic territory in a financial year.
Personal Disposable Income – It is the personal income remaining with all households for private final consumption expenditure and savingof household.
25. Net National Disposable Income = National Income (NNPFC )+Net Current Transfers from Abroad + Net Indirect Taxes
Gross National Disposable Income = GNPFC +Net Current Transfers from Abroad + Net Indirect Taxes
26.
Personal Disposable Income Net National Disposable Income1. It is the income of all Normal resident households
of an economy, from all sources which is left with them for Final consumption and saving, during a financial year
2. It does not include Direct& Indirect taxes.3. Personal Disposable Income = P is Private Final
Consumption Expenditure of household + Savings of Household
1. It is the income of all sectors of an economy (Government, firm & household sector) from all sources during a financial year.
2. It includes both Direct & Indirect taxes.3. NNDI= NNPFC +NIT + NCTfROW
27. Problem of Double Counting Double counting means counting of the value of same product (or expenditure) for more than once. If certain items are counted for more than once resulting in over estimation of national product to the extent of the value of intermediate goods included, this will cause the problem of double counting e.g there are four producers – farmer, mill owner, baker and shopkeeper.
Producers – Product Value of Output (Rs)
Intermediate Consumption (Rs)
Value Added (Rs)
1 Farmer – sells to mill owner
2000 0 2000
2 Mill Owner- sells to baker 2500 2000 500
3 Baker – sells to Shopkeeper
3600 2500 1100
4 Shopkeeper – sells to customers
4000 3600 400
12100 8100 GVA=4000
If for the purpose of calculation we take value of output as (2000+2500+3600+4000) = 12100, this will be double counting. In this, value of wheat has been included four times, flour for three times and bread for two times, whereas value of final product is Rs 4000 only i.e the value of bread (121800-8100 = 4000). To avoid double counting, we should use the following: *Value added method. By this method we take value added only i.e, Value of output – Intermediate consumption i.e 12100 – 8100 = 4000 or, ** Final output method. By this method we take value of final good only i.e, Value of output i.eRs 4,000.
28. Value Added Method for calculation of National Income
Step 1 Calculate gross value added by Primary, Secondary & tertiary sectors
Formula 1 Formula2 Formula3 Formula4GVAMP =+GVOMP
-Intermediate Consumption
GVAMP =+Sales
+Change in stocks
- Intermediate Consumption
GVAMP =+Domestic Sales
+Exports+Closing Stocks-Opening Stocks
- Intermediate Consumption
GVAMP =+Sales to household+Sales to government+Exports+Closing Stocks-Opening Stocks
-Domestic purchase of raw material-Import of Raw material
Step 2
GDPMP = GVAMP Primary Sector + GVAMP Secondary Sector + GVAMP Tertiary Sector
Step 3
NNPFC = GDPMP – Depreciation + Net factor income from abroad + net indirect taxes
29. Income Method for calculation of National Income
Step 1
Formula 1 Formula 2 Formula 3NDP FC =+Mixed Income of self employed
+Compensation of employees
+Operating Surplus
NDP FC =+Mixed Income of self employed
+Wages & Salaries
+Employers contribution to social security scheme
+Interest
+Profit
+Rent+Royalty
NDP FC =+Mixed Income of self employed
+Wages & Salaries in cash+Wages & Salaries in kind
+Employers contribution to social security scheme
+Interest
+Corporate taxes+Dividend+Undistributed Profit
+Rent+Royalty
Step 2
NNPFC = NDP FC + Net factor income from abroad
30. Explain the components of Income method.
(1) Compensation of Employees – it is the payment employees receive from the enterprise for work done by them. It includes the following:-
(a) Wages & salaries in cash for example basic pay , bonus , dearness allowance , house rent allowance , sick leave allowance etc.
(b) Wages & salaries in kind for example rent free accommodation, transport facilities, interest free loan,and food, uniform.
(c) Employers contribution to social security scheme like their contribution to GPF, medical insurance, retirement pension etc.
(2) Operating Surplus – It is the income from property, likerent,interest,royalty,& income for running enterprise is profit.
(a) Interest – It is the price paid for borrowing assets like machinery or money borrowed by producers . Interest earned by consumers on their bank deposits is also included. Interest paid by consumers on money borrowed is not included.
(b) Profit – It is the payment to the owners of the firm for doing business. Profit is used for the following:-
(i) To pay corporate taxes i.e. the tax paid by the firm to the government on profit of the firm.(ii) To pay part of firms profit to the shareholders or owners of the firm as Dividend.(iii) The profit remaining with the firm after paying tax & dividend is called undistributed profit or retained
Earnings of Private Corporations; it is used for expansion or for future expenditure.(c) Rent – It is the income for giving land, building, machinery etc. on hire by landlords or owners. It includes imputed
rent of owner occupied houses.
(d) Royalty – It is income earned by owners for renting subsoil assets like mines of iron ores, oil, or payment for use of patents, copyrights, trade mark etc.
(3) Mixed income of self-employed - self-employed people like doctors, lawyers, shopkeepers etc., own many factors of production land, labour, capital & enterprise. The contribution of each factor cannot be identified & separated into rent, wages, interest and profit, So their income is called mixed income of self-emplo
31 (A).Expenditure Method for calculation of National Income
Step 1
Formula 1 Formula2 Formula3 Formula4GDPMP =+P+Gross Investment
+G+X-M
GDPMP =+P+GDCF
+G+X-M
GDPMP =+P+GDFCF
+Change in Stock
+G+X-M
GDPMP =+P+Gross Business fixed investment+Change in Stock+Gross residential construction investment+Gross public investment+G+X-M
Where, P is Private Final Consumption Expenditure
G is Government Final Consumption Expenditure
Net Exports = X- M = Exports – Imports
GDCF = Gross Domestic Capital Formation = GDFCF + Change in Stock
GDFCF is Gross Domestic Fixed Capital Formation
Step 2
NNPFC = GDPMP – Depreciation + Net factor income from abroad + net indirect taxes
-------------------------------------------------------------------------------------------------
[ NOTE: when any component of investment in above formula is given as NET value then in
31(B)
Step 1 we get NDP MP
Formula 1 Formula2 Formula3 Formula4NDPMP =+P+Net Investment
+G+X-M
NDPMP =+P+NDCF
+G+X-M
NDPMP =+P+NDFCF
+Change in Stock
+G+X-M
NDPMP =+P+Net Business fixed investment+Change in Stock+Net residential construction investment+Net public investment+G+X-M
Step 2 will be
NNPFC =NDPMP + Net factor income from abroad + net indirect taxes
-------------------------------------------------------------------------------------------------
32. . Explain the components of Expenditure method.
(1) Private Final Consumption Expenditure–It is the expenditure done by resident households & non-profit institutions ( like Schools, clubs ) on the purchase of goods & services. Like purchase of :-
(i) durable goods – TV, washing machine
(ii) Semidurable goods – clothes , shoes
(iii) Perishable goods (Non durable goods) - vegetables etc
(iv) Services – banking , medical facilities etc.
(2) Government Final Consumption Expenditure–It is general government purchases of goods & services in domestic market & from abroad for satisfaction of collective wants like education , health care , defence etc. It includes following :-
(i) compensation of Employees paid by government
(ii) goods & services purchased from domestic market
(iii) Net purchases from abroad
(3) Net Exports = X- M =It is the difference between Exports of goods & non-factor servicesminus imports of goods & non-factor services
Exports refer to sale of goods (eg. India sells tea, garments etc ) & non-factor services like banking, insurance etc. to foreigners in domestic territory or to other country.
Imports refer to purchase of goods & non-factor services from rest of the world.
(4)Gross Domestic Capital Formation or GrossInvestment–It is the expenditure on Gross Domestic Fixed Capital Formation & change in stock. It includes :-
(i) Business fixed investment – Expenditure by producer on purchase of plant, machinery etc.
(ii) Fixed investment expenditure by households on construction of residential buildings.
(iii) public investment by the government like expenditure on construction of roads, bridges etc.
(iv) Inventory investment – It refers to the change in stock of raw materials , work in progress & finished goods. It is the difference between closing stock & opening stock.
33. Why is GDP not a good measure of welfare?
1.It does not consider level of prices in the country. If prices are high, even high income will also not lead to high standard of living.
2. It does not show the composition of output. Increase of GDP could also be due to war goods or socially undesirable goods such as drugs etc. if share of wage goods does not increase it may not increase economic welfare.
3. Rise in GDP could be due to increase in industrialisation & urbanisation which would lead to pollution, environmental degradation which reduces welfare.
4. Increase in GDP does not indicate distribution of income . Its increase may lead to increasing income inequalities & poverty, which reduces economic welfare,
5. It does not indicate unemployment in the country .Economic welfare will increase by removing unemployment & not just by increasing GDP.
6. It does not indicate the skills of population or resources which will indicate economic welfare of people.
34. What precautions should be taken in calculation of national or domestic income of the country?
1. Transfer incomes should not be included like taxes, subsidies, gifts, donations etc. because these neither lead to flow of goods and services, nor use factors of production in return for money flow.
2.Sale of second hand good should not be included as their production would have been counted in the year in which it was produced. Counting it again would lead to double counting.
3. financial transactions like sale & purchase of share, bonds etc lead to transfer of ownership only. It does not lead to any productive activity, hence it should not be included in the calculation of national income.
4.Windfall gains, lottery capital gains etc also do not result in any productive activity so they should also not be included in national income.
5. Illegal activities like smuggling, gambling, illegal arms sale etc. should not be included as it is black money it is not accounted or reported , it is unlawfully earned to evade tax.
6. Non marketed goods and services are not included like growing vegetables in kitchen garden, because national income includes only those transactions that occur through organised market activities.
-------------------------------------------------------------------------------------------
NOTE: Following items are to be included in calculation of national or domestic income of the country
1. Imputed rent of owners occupied houses as house providers’ service to the owners. 2. Imputed value of goods and services produced for self-consumption by producer enterprise as these contribute to the current year’s output.
35. Categorize the following into intermediate goods and final goods. Give reason for your answer.
intermediate goods final goodsii) Purchase of food items by a hotel. Ans: Purchase of food item by a hotel is an intermediate product because it is used to prepare food for further resale.
i) A new car purchased by a taxi driver. Ans: A new car purchased by a taxi driver is a final good since it is an investment and purchased by taxi driver for final investment.
iii) Stationary purchased by the government. Ans: It is intermediate goods because it is fully used to produce services.
iv) Wheat purchased by the Households.
vi) Paper purchased by a publisher. v) Purchase of equipments for installation in a factory.
viii) Purchase of sugar by grocery shop vii) Milk purchased by households. ix) Cloths used by tailors x) Construction of houses by consumer
household. xii) Chemical fertilizer used by the farmer. xi) Purchase of milk by a consumer. xiv) Coal purchased by a factory. xiii) Machine purchased by a firmxvi) Book purchased by a book seller xv) Text book purchased by a student.xvii) Expenditure on research and
development by a company.xviii) Seeds purchased by a farmer.xix) Electricity consumption in a business. NOTE: ( For writing reasons from IV to XIX refer ans. I to III.)
--------------------------------------------------------------------------------------------------------------
Note following are parts of compensation of employee in case categorisation question comes in exam.
Compensation of employees
1. Wages and salaries in cash. Basic pay Dearness allowance House rent allowance Overtime allowance CCA Bonus and commissions Sick leave allowance.
2. Compensation in kind Free Housing Medical Facilities Free Uniform Free Food Fee education Conveyance facilities Creches for children of employee. Value of interest forgone on loans to employees.
3. Employer’s contribution to social security schemes such as Provident fund Life insurance Casualty insurance Provision on retirement (It is different form old age provision which is transfer
36. Will the following be included or net in the domestic factor income of India? Give reasons for your answer.i) Salaries of non-residents working in India Embassies in Russia. Ans: Yes it will be included because Indian embassy is a part of domestic territory of India.
ii) Salaries to Indian residents working in Indian embassy in Russia. Ans: Yes it will be included in the domestic factor income as the Indian embassy is a part of domestic territory of India.iii) Salaries to Russian residents working in Indian embassy in Russia. Ans: Yes it will be included in the domestic factor income as the Indian embassy is a part of domestic territory of India.
iii) Salaries to Indian residents working in Russian Embassy in India. Ans: No it will not be included in the domestic factor income as the Russian embassy is not a part of domestic territory of India.
iv) Salaries received by Indian workings in American Embassy in India.
Ans: No it will not be included in the domestic factor income as the American embassy is not a part of domestic territory of India. v) Salaries paid to non-resident Indians working in Indian Embassy in America.
Ans: Refer Ans 1 vi) Salaries paid to Koreans working in Indian Embassy in Korea.
Ans: Yes it will be included in the domestic factor income as the Indian embassy is a part of domestic territory of India. vii) Salaries to India working in Japanese embassy in India.
Ans: No it will not be included in the domestic factor income as the Japenese embassy is not a part of domestic territory of India. viii) CEO to the residents of Japan working in Indian Embassy in Japan. ix) Ans: Yes it will be included in the domestic factor income as the Indian embassy is a part of domestic territory of India.
x) Profit earned by a branch of an American Bank of India.
xii) Profit earned by an Indian company from its branch in Singapore. Ans: No it will not be included in domestic factor income of India because Singapore is not a part of domestic territory of India. xiii) Profits earned by a resident of India from his company in Singapore.
Ans: refer ans(xiii) xiv) Rent received by an Indian from his building in London.
Ans: No, it will not be included in the domestic factor income as the rent is earned outside the domestic territory of India. xv) Rent received by a resident Indian from his property in Singapore.
Ans: No, refer Ans(xv) xvi) Rent paid by the embassy of Japan in India to a resident Indian.
Ans: No, it will not be included in the domestic factor income as the Japenese embassy is not a part of the domestic territory of India.
37. Giving reasons state whether the following are included in national Income.i) Salary received by an Indian resident working in US embassy in New Delhi. Ans: Yes, it will be included in national income as salary received by Indian resident working in US embassy in New Delhi is a part of factor income from abroad. ii) Salaries paid to non-resident Indians working in Indianembassy in America.
Ans: This is a exceptional case It is included in the national income of India as salaries paid to non-resident Indians working in Indian embassy in America is a part of compensation of employees from abroad. iii) Salaries received by an Indian resident working in Russian embassy in India.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad. iv) Salaries paid to Russian working in Indian embassy in Russia.
Ans: No, it will not be included in national income as it is a part of the factor income paid to abroad. v) Wages received by Indian employees working in Pakistan embassy.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad. vi) Profit earned by foreign banks in India.
Ans: : No, it will not be included in national income as it is a part of the factor income paid to abroad vii) Profits of Reliance industries from its chemicals business in Australia.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad.
viii) Profit earned by an Indian bank from its branches abroad. Ans: Yes, it will be included in national income as it is a part of factor income from abroad. ix) Profit earned by Indian companies from their branches abroad.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad. x) Profit earned by Indian company from its branch in London.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad. xi) Rent received by Indian residents on their buildings rented out to foreigners in India.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad.
Students are suggested to attempt more questions related to concept of National and Domestic Income refer to items above
Students are advised to practice more and more numerical Questions from CBSE papers of last five years
UNIT - 7MONEY AND BANKING-8marks
Q1 .Define money.Money :- It is anything which is generally acceptable as a medium of exchange and at the same time acts as a measure of value, store of value and means of deferred payments.Q2. Define High Powered MoneyHigh Powered Money (H) :- High powered money or monetary base refers to the total liability of the monetary authority of the country i.e. Central Bank (RBI). It consists of currency (notes and coins in
circulation with the public and vault cash of commercial banks) and deposits held by Government of India and commercial banks with RBI.Q3. Define Money multiplier or deposit multiplier.Total deposits created due to a new deposit in bank is manytimes the initial deposit. The multiple by which deposits can increase due to an initial deposit is called money multiplier. Money multiplier =1/LRR, where LRR is legal reserve ratio.Q4. Explain the Process of credit creation by commercial banks.Credit creation (or deposit creation or money creation) by the banks is determined by (i) the amount of the initial fresh deposits and (ii) the Legal Reserve Ratio (LRR), the minimum ratio of deposit legallyrequired to be kept as cash or in liquid form by the banks. It is assumed that all the money that goes out of banks is redeposited into the banks, and LRR consists of CRR and SLR decided by RBI.Example :- Let the LRR be 20% and there is a fresh deposit of Rs.10,000. As required the banks keep 20% i.e. Rs.2,000 as cash. Suppose the banks lend the remaining Rs. 8,000. Those whoborrow, use this money for making payments.As assumed those who receive payments put the money back into the banks. In this way bank receives fresh deposits of Rs. 8,000. The bank again keep 20% i.e. Rs.1,600 as cash and lend Rs.6,400, which is also 80% of the last deposits. The money again comes back to the banks leading to a fresh deposit of Rs.6,400. The money goes onmultiplying in this way this process continues till new deposit become nil., and ultimately total money creation is Rs.50,000.
Total money creation = initial deposit x 1/LRR =10000 x1/20% = 10000 x100/20Total money creation = 50000.
The whole process can be explained through following table:-
Banks Initial Deposit Rs. Legal ReserveRatio (20%)
Secondary Deposit(Lending) Rs.
AB....N
100008000.....
20001600.....
80006400.....
Total 50000 10000 40000
Where Money multiplier is 1/LRR=1/20%=1/20*100=10/2= 5
It is the multiple by which total deposits increase due to initial deposit.Q5. Explain Functions of Money.Functions of Money are:-
(1) Medium of Exchange:-- It is generally accepted means of payment for exchange of goods and services.
- Facilitates trade, widens area of market by separating act of sale and purchase.- Reduces time and labour needed for trade in case of using goods for trade (Barter System).
(2) Measure of Value or Unit of Value:-- All goods and services can be given one unique value (Price) by expressing them in terms of money.-It is common unit of measurement of all goods. Thus makes exchange easier.-Helps developing efficient accounting system. Goods and services can be accounted for easily in terms of rupees. It would have been difficult to make account in many units like litres, quintals, meters etc. and adding up different units is not possible.-Comparisons can be made.-Its value remains constant.
(3) Store of Value-It is liquid store of value.-It comes in convenient denominations.-Value remains constant, it is not perishable easily portable, requires less place to store& there is no storage cost.
(4)Standard of deferred Payments -Or future payments like salaries, pension, interest etc.-Facilitates borrowing and lending.-It led to creation of financial institutions- it overcomes disagreements and risks that are there is Barter system regarding future payments to be made as value of money remain constant.
Q6. Explain Quantitative credit control measures used by Central Bank (RBI)
Quantitative credit control measures used by Central Bank (RBI) are:-1. Cash Reserve Ratio (CRR) :- It is of certain ratio of commercial banks net demand deposits & times liabilities which it has to keep with central bank RBI as cash.
If RBI increases CRR, Banks have to keep larger percentage of their deposits with RBI, their credit giving ability decreases and money supply decreases.
Conversely, if RBI decreases CRR, money supply Increases.
2, Statutory Liquidity Ratio (SLR) :- It is the ratio or percentage of net total demand & time liabilities of commercial banks which they have to keep in form of liquid assets as excess reserves, they have to invest in government securities or in securities approved by RBI and current account balances with other banks.
If RBI increases SLR then credit giving ability of bank decreases and money supply decreases.If RBI decreases SLR banks credit giving ability and thus money supply increases.3. Open Market Operations (OMO) :- It is the buying and selling of government security by the Central Bank from/to the public and banks on its own account.Sale of government securities will reduce reserves.* RBI sells securities Bank gives RBI a cheque for the securities.* The RBI collects the amount by reducing the bank’s reserves by the particular amount.* This directly reduces bank’s ability to give credit.* Therefore this decreases money supply in the economy.When RBI buys securities from banks* RBI gives the bank a cheque drawn on itself in the payment for the securities.* When cheque clears, RBI increases reserves of the bank by the particular amount.* This directly increases the bank’s ability to give credit.* Thus money supply increases.4. Bank Rate PolicyBank rate is the rate at which Central Bank lends funds to commercial banks.
If bank rate increases:* Cost of borrowing from RBI increases.* So banks borrow less* Their credit giving ability decreases.
* Banks also increase lending rates i.e. rate at which they lend to public.* This discourages businessmen from taking loans. This reduces volume of credit and money supply.
A decrease in bank rates on the other hand will increase credit and money supply.
Q7. Mention various Measures of Money Supply.Measures of Money Supply are:-
M1 is most liquid measure of money supplyM1 = C + DD + ODC = Currency held by public (currency & coins).Demand Deposits (DD):- Only net demand deposits of banks are included in money supply, as other part of demand deposit that represents inter-bank deposits held by one bank with anotherdoes not constitute demand deposit held by public.Other Deposit (OD) with RBI: - These are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of public financial institution (Like IDBI) foreign central banks, foreign government, the IMF, the World Bank etc.M2 = M1 + saving deposits with post office saving banks.M3 = M1 + Net time deposits of banksM4 = M3 + Total deposits with post office savings organisations (excluding National saving certificates).Q8. Define the following terms:-(a) LRR - Legal Reserve Ratio: - It is legally compulsory for the banks to keep a certain minimum fraction of its demand deposits as cash. This fraction is called LRR. It has two components –
(a) A part of LRR is to be kept with the Central Bank and this is called cash reserve ratio (CRR) and (b) The other part is kept by the commercial banks themselves in form of cash or liquid assets it is called statutory
liquidity ratio SLR.Q9. Explain main functions of Central Bank (RBI). Functions of Central Bank:1. Currency Authority:- Central Bank has monopoly over issue of notes (currency). Coins and one rupee note are issued by Government of India but Central Bank puts currency notes &coins into circulation and withdraws it from circulation. Issue of notes is monetary liability of Central Bank as it backs currency by assets of equal value gold coins, gold bullions, foreign securities & domestic government’s local currency securities.-Central government borrows money from RBI (Central Bank) and increases money supply.2. Banker to Government• Banker to State and Central Government:-- Carries all banking business of government- Government keeps its cash balances in current account with Central Bank (RBI).- RBI accepts receipts and makes payments for the government, &- RBI carries out exchange & other remittances.- RBI provides short term credit to government.- Agent to Government:-• RBI manages public debt by (a) Managing all new issues of govt. loan (b) Servicing public debt outstanding (c) Creating market for govt. securities.- Advises the govt. on banking and finance matters regarding - money market, capital market,Government loans, on economic policy matters etc.3. Banker to Banks’• RBI keeps cash reserves of banks as determined by CRR.- Banks also keep their surplus cash with RBI.• RBI supervises and regulates commercial bank through regulations related to:-- Licensing of banks,
- Branch expansion, liquidity of assets,- Management, amalgamation and liquidation of banks.• RBI controls banks through periodic inspection of banks and returns filed by them.- When banks fail to meet obligations of their depositors and are facing bank failures RBI lends them short term funds as a lender of last resort to commercial banks.• RBI is Clearing house for interbank payments .RBI providescentralisedclearance, settlement &transfer facilities for interbank payments.4. RBI is Custodian of Foreign Exchange Reserves.- And RBI helps overcome BOP difficulties & maintains foreign exchange rate byBuying & selling foreign currency.5. Controller of Money Supply and Credit- RBI controls money supply and credit by using monetary measures.(a) Quantitative Credit control instruments like CRR, SLR, Bank rate Policy, and open market operations.(b) Qualitative credit control instruments like moral suasion, selective credit control, Imposing margin requirement on secured loans
Q10. ) Explain the Qualitative credit control measures used by Central bank (RBI)?Qualitative credit control measures used by Central bank (RBI) are:-(i) Moral suasion – This is a combination of persuasion and pressure that the central bank applies on other banks in order to get them to fall in line with its policy. This is exercised through discussions, letters, speeches and hints to banks.The central bank frequently announces its policy and urges the banks to fall in line.(ii) Selective credit control – It is applied in a positive manner to use it to channel credit to particular sectors, usually the priority areas. It is applied in negative manner to restrict the flow of credit to particular sectors.(iii) Imposing margin requirement on secured loans – a margin is the difference between the amount of the loan and market value of the security offered by the borrower against loan. If margin imposed by central bank is 40% then the bank is allowed to give a loan only up to 60% of the value of security.If Central bank increases margin requirements people take less credit from banks and this prevents price rise or taking loans for speculative purposes.
Q11. Explain the Lender of Last Resort Function of Central Bank.Lender of Last Resort Function of Central Bank:-When commercial banks fail to meet obligations of their depositors and are facing bank failure due to Bank runs, Central bank supports them by acting as lender of Last resort. Here instead of rediscounting RBI gives short term advances to commercial banks against the bills of exchange, promissory notes, treasury bills, government securities etc. But banks have to first approach all other sources to get credit like call money market, then only approach RBI. RBI stands by commercial banks as a guarantor and extends loans to ensure the solvency of the commercial bank.
Q12. Explain the role of Central Bank as clearing house for commercial banks.Central Bank as clearing house for commercial banksORRBI is bank of central clearance, settlement and transferRBI settles mutual indebtedness between banks. It makes entire process of collecting bank to bank payments easy and much less time consuming.Central bank has a clearing house where mutual indebtedness between banks is settled.Representatives of different banks meet daily in the clearing house to settle interbank payments by debt and credit entries in the cash reserve account held by commercial bank with RBI.The differences between various banks at the end of the day of each daily clearing are settled by transfer between their respective accounts with RBI.
UNIT 8
DETERMINATION OF INCOME AND EMPLOYMENT(12 marks)
Q1.
CONSUMPTION –That part of income spent on final goods and services
SAVING –That part of income which is not consumed
MARGINAL propensity to consume-MPC is the change in consumption due to one unit change in income (MPC=∆C/∆Y)
MARGINAL propensity to save-MPS is the change in saving due to one unit change in income (MPS=∆S/∆Y)
It is the rate of change in consumption.The value of MPC lies in between 0 to 1 (0≤MPC≤1)MPC=1-MPS
MPS1. It is the rate of change in saving.2. The value of MPS lies in between 0 to 1
(0≤MPS≤1)3. MPS=1-MPC
Average propensity to consume –APC is total consumption per unit of income or It is the ratio between consumption and income at any level of income. (APC=C/Y)
APC=1-APS
Average propensity to save – It is total saving per unit income or APS is the ratio between saving and income at any level of income. (APS=S/Y)
APS=1-APC
Q2.
Autonomous consumption Induced Consumption
Autonomous Consumption is independent of the level of national income
Induced Consumption dependent on the level of national income
It is Demand for basic needs necessary for survival which doesn’t depend on income
Demand for comfortable and luxurious goods which changes with income level
It is Consumption at zero level of income
Consumption at income other than zero level of income
Q3. Explain Keynes Psychological law of consumption or Relation between Consumption, Saving& income
According to Keynes Psychological law of consumption as income in an economy increases consumption also increases but by a rate less than the rate of increase in income
Consumption Function or Propensity to Consume-Consumption function is the ratio that measures functional relationship between income (Y) and consumption (c) at various levels of income
C = c^ +bY
c^= autonomous consumption
MPC= b = marginal propensity to consume
Income starts from zero but Consumption never starts from zero because minimum consumption equal to Autonomous consumption is necessary for survival
(1) When income =0 {Y=0},
When income is zero negative saving occurs,
Because minimum consumption for Survival is done,by reducing assets or savings
Consumption =c^ (autonomous consumption ), &S=-c^(negative autonomous consumption )
(2) When (income)< (Consumption),{Y<C}
S is negative
(3) When (income)= (Consumption), Y= C
S is zero
(4)When (income) > (Consumption), Y>C
S is positive
Consumption Y
M B T C
C^
O y1 y2 y3 Income
Savings Savings
R
O
Y1 y2 y3
-c^ S Income
Dissaving
When Y=0, C=Oc^ ,S=- c^
When Y<C,Y=OY1, C=OM ,S=- Y1 S
When Y=C=y2 B ,S=0
When Y>C, C=y3 T ,S=- y3 R
Q4.Explain Keynes Psychological law of consumption or Relation between Consumption, Saving& income using Schedule
In table below income increases by 50 & Consumption increases by 25
NOTE:Diagrammatic explanation part given in this box may not be written in answer when diagram is not asked in exam
Q5. Explain determination of equilibrium level of national income, employment and output using AD-ASApproach
(1) Equilibrium occurs at income, employment and output level
Where, AD=AS=200 =OY2At point E
Planned spending = Planned Output
Adjustment mechanism when AD
& AS are not equal
(2) At income, employment and output level below equilibrium level of income
AD >AS For eg. Y1M>Y1R
If planned spending > Planned output
Consumer & firms together are buying more than what firms are producing
So undesired or unplanned decrease in inventories occurs
i.e inventories reduce
Producer will increase production.
Employment& income also rise, till equilibrium is reached. Where, AD=AS=200
(3) At income, employment and output level above equilibrium level of income
AD <AS, Y3T<Y3N
If Exante i.e. Planned spending < Planned output
Consumers & Firms are buying less than what firms are producing
Unplanned increase inventories of unsold good occurs
inventories rise
Producer will decrease production.
Employment& income also fall, till equilibrium is reached. Where, AD=AS=200
Relatio between Consumption, Saving& incomeIncomeY=AS
ConsumptionC
SavingS
InvestmentI
AD=C+I Relatio between Consumption,Saving&income
0 50 -50 50 100 (1) When Y=0C=c^, &S=-c^
(2) When Y<C, S is negative
50 75 -25 50 125
100 100 0 50 150 When income is 100 both income and consumption are equal. This point is called break-even point(Y=C=100,S=0) Here saving is zero
(3) When Y=C, S is zero
150 125 25 50 175 (4)When Y>C, S is positive
200 150 50 50 200250 175 75 50 225
AD&AS Y
N
E T AD=C+I
C^ M
R
O y1 y2 y3 Income
Q6.Explain determination of equilibrium level of national income, employment and output using I-S Approach
S
R
Savings A E Savings
B Investment
O C
Y1 Y2 y3 Income
-c^ S
Dissaving
(1) Equilibrium occurs at income, employment and output level OY2
Where, AD=AS=200
C+I=C+S
At point E , I=S
Planned investment = planned saving
(2) At income, employment and output level below equilibrium level of income
For eg.OY1
I >S ie. AY1>CY1
planned I >planned and actual S
So saving is low
Consumption is high
i.e. AD >AS
So inventories decrease due to high Consumption
Producer will increase production.
Employment& income also rise, till equilibrium is reached. Where, AD=AS=200
(3) At income, employment and output level above equilibrium level of income
For eg. At OY3
I<S i.e. BY3<RY3
When consumers are saving more than firms desire to invest. Less amount of income will be spent.
Saving is high
So Consumption is low
i.e, AD <AS
inventories rise
Producer will decrease production.
Employment& income also fall, till equilibrium is reached. Where, AD=AS=200
So at Equilibrium Actual I becomes equal to planned saving
Because Actual I becomes < Planned I
Actual I = Planned I – decrease in inventories
Q7.Explain determination of equilibrium level of national income, employment and output using schedule.(AD-AS Approach & I-S Approach)
NOTEall these Questions will have similar answerQ .How will equilibrium level of income be reached in following cases1 AD>AS AD<AS2. C+I> Y C+I<Y3. I>S I<S4. Planned Investment > planned Saving Planned Investment < planned Saving5. Ex Ante Investment>Ex Ante Saving Ex Ante Investment<Ex Ante Saving6.Planned Investment > actual Investment Planned Investment < actual Investment7.Ex Ante Investment>Ex Post Investment Ex Ante Investment<Ex Post InvestmentANSWER: Point (2) of answer of Q5 & Q6. ANSWER: Point (3) of answer of Q5 & Q6.
8.Full Employment - It is a situation in which all those who want to work at the existing rate of wage get work without any undue difficulty. In this situation there is no involuntary unemployment but voluntary unemployment can exist
Involuntary unemployment - It is a situation in which people are willing to work at existing wage rates but do not get work. This occurs either due to excess supply of labor or due to deficiency of demand in the economy.
Q9.Explain Deficient Demand or deflationary gap?
Or Explain Underemployment Equilibrium?
Deficient Demand is a situation, where aggregate demand is less than aggregate supply at the level of full employment. It creates deflationary gap
In other words, aggregate demand is less than the aggregate demand required for full employment level of output to be produced.
AD-AS Approach I-S ApproachIncomeY=AS
AD=C+I EXPLANATION ConsumptionC
SavingS
InvestmentI
EXPLANATION
0 100 (1) AD >AS
So inventories reduceProducer will increase production. employment& income also rise, till equilibrium is reached.
50 -50 50 (1) I >SSo saving is lowConsumption is high i.e. AD >AS
So inventories reduceProducer will increase production. employment& income also rise, till equilibrium is reached.
50 125 75 -25 50100 150 100 0 50150 175 125 25 50
200 200 (2) EQUILIBRIUM Here AD=AS=200
150 50 50 (2) EQUILIBRIUM Here and I=S=50
250 225 (3) AD <AS
So inventories riseProducer will decrease production. Employment& income also fall, till equilibrium is reached.
175 75 50300 250 200 100 50 (3) I<S
So saving is highConsumption is lowi.e, AD <AS
So inventories riseProducer will decrease production. Employment& income also fall, till equilibrium is reached.
350 275 225 125 50
At the full employment level of output AD <AS
AD=GN
AS=fN
deficient Demand= fG occurs
DEFLATIONARY GAP= area EfG
Consumers & Firms are buying less than what firms are producing
Unplanned increase in inventories of unsold good occurs
inventories rise
Producer will decrease production.
Employment& income also fall, till equilibrium is reached at point E. Where, AD=AS=EM
Equilibriumincome (OM) is less than at full employment level
At equilibriuminvoluntary unemployment (MN) occurs
Equilibrium output(OM) is less than at full employment level of output (ON)
Nf= full employment level
ADf= full employment level of aggregate demand
AS=Y=C+S
AD &AS
ADF
f AD
G
P E
DEFLATIONARY GAP
Q
O M N
Income, output & Employment
NOTE:
Measures to correct DEFLATIONARY GAP Measures to correct INFLATIONARY GAP
DEFLATIONARY GAP Deficient Demand INFLATIONARY GAPExcess demand
Quantitative Monetary measures-
Increase CRR, SLR, Bank Rate
Buy Securities
Quantitative Monetary measures-
Decrease CRR, SLR, Bank Rate,
Sell Securities
Fiscal Measures
Decrease Taxes
Increase Government Expenditure
Fiscal Measures
Increase Taxes
Decrease Government Expenditure
AD Decreases AD Increases
Q10.ExplainMeasures To control Deficient Demand?
Or ExplainMeasures To correct deflationary gap?
measures to control deficient demand are:-
(A) Monetary measures these increase or decrease money supply,these are taken by Central bank i.e RBI Or Quantitative credit control measures used by Central Bank (RBI) are :-
1. Cash Reserve Ratio (CRR) :- It is of certain ratio of commercial banks net demand deposits & times liabilities which it has to keep with central bank (RBI) as cash.
If RBI decreases CRR, Banks have to keep smaller percentage of their deposits with RBI,
their credit giving ability increases and money supply increases.
Purchasing power of people increases they demand more
So Aggregate demand increases
2, Statutory Liquidity Ratio (SLR) :- It is the ratio or percentage of net total demand & time liabilities of commercial banks which they have to keep in form of liquid assets as excess reserves, they have to invest in government securities or in securities approved by RBI and current account balances with other banks.
If RBI decreases SLR then credit giving ability of bank increases and money supply increases.
Purchasing power of people increases they demand more
So Aggregate demand increases
3. Open Market Operations (OMO) :- It is the buying and selling of government security by the Central Bank from/to the public and banks on its own account.
When RBI buys securities from banks
* RBI gives the bank a cheque drawn on itself in the payment for the securities.
* When cheque clears, RBI increases reserves of the bank by the particular amount.
* This directly increases the bank’s ability to give credit.
* Thus money supply increases.
Purchasing power of people increases they demand more
So Aggregate demand increases
4. Bank Rate Policy
Bank rate is the rate at which Central Bank lends funds to commercial banks.
If bank rate decreases:
* Cost of borrowing from RBI decreases.
* So banks borrow more
* Their credit giving ability increases.
* Banks also decrease lending rates i.e. rate at which they lend to public.
* This encourages businessmen to take loans. This increases volume of credit and money supply.
Purchasing power of people increases they demand more
So Aggregate demand increases
Q11. Explain Excess demand or inflationary gap?
Or Explain over fulemployment Equilibrium?
Excess demand is a situation, where aggregate demand is more than aggregate supply at the level of full employment. It creates inflationary gap
In other words, aggregate demand is more than the aggregate demand required for full employment level of output to be produced.
At the full employment level of output AD >AS
AD=fM, AS=GM
Excess Demand= fG occurs, INFLATIONARY GAP= area EfG occurs
Consumers & Firms are buying more than what firms are producing
Unplanned decrease in inventories of good occurs,inventories fall
Producer wants to increase production.
But all resources are fully employed at full employment level of output.
So production & Aggregate Supply cannot be increased
this results in Increase in prices or INFLATION.
Money value of output increases.
Income also rises, till equilibrium is reached at point E. Where, AD=AS=EN
Equilibriumincome (On) is more than at full employment level
There is full employment so at equilibriumvoluntary unemployment (MN) occurs
Equilibrium output(ON) is full employment level of output.
AS=Y=C+S
AD &AS
INFLATIONARY GAP E AD
ADf
f
P
G
Q
O M N
Income, output & Employment
ADf= full employment level of aggregate demand
Nf= full employment level
Q12.ExplainMeasures To control excess demand?
Or ExplainMeasures To correct inflationary gap?
Quantitative credit control measures used by Central Bank (RBI)
are :-
(A) Monetary measures these increase or decrease money supply,these are taken by Central bank i.e RBI Or Quantitative credit control measures used by Central Bank (RBI)
are :-
1. Cash Reserve Ratio (CRR) :- It is of certain ratio of commercial banks net demand deposits & times liabilities which it has to keep with central bank (RBI) as cash.
If RBI increases CRR, Banks have to keep larger percentage of their deposits with RBI,
their credit giving ability decreases and money supply decreases.
Purchasing power of people decreases they demand less
So Aggregate demand decreases
2, Statutory Liquidity Ratio (SLR) :- It is the ratio or percentage of net total demand & time liabilities of commercial banks which they have to keep in form of liquid assets as excess reserves, they have to invest in government securities or in securities approved by RBI and current account balances with other banks.
If RBI increases SLR then credit giving ability of bank decreases and money supply decreases.
Purchasing power of people decreases they demand less
So Aggregate demand decreases
3. Open Market Operations (OMO) :- It is the buying and selling of government security by the Central Bank from/to the public and banks on its own account.
Sale of government securities will reduce reserves.
* RBI sells securities Bank gives RBI a cheque for the securities.
* The RBI collects the amount by reducing the bank’s reserves by the particular amount.
* This directly reduces bank’s ability to give credit.
* Therefore this decreases money supply in the economy.
Purchasing power of people decreases they demand less
So Aggregate demand decreases
4. Bank Rate Policy
Bank rate is the rate at which Central Bank lends funds to commercial banks.
If bank rate increases:
* Cost of borrowing from RBI increases.
* So banks borrow less
* Their credit giving ability decreases.
* Banks also increase lending rates i.e. rate at which they lend to public.
* This discourages businessmen from taking loans. This reduces volume of credit and money supply.
Purchasing power of people decreases they demand less
So Aggregate demand decreases
13.INVESTMENT MULTIPLIER- It is the multiple (or coefficient) by which income increases due to increase in Investment multiplier - It is the multiple (or coefficient) by which income increases due to increase in investment.
K=∆Y/∆l
It is the ratio between the change in income and the change in investment.
EXPLANATION OF WORKING OF MULTIPLIER
An increase in the amount of investment lead to immediate increase in employment, increase in employment lead to cumulative increase in income, consumption, AD, investment, employment so on.
A given increase in investment therefore leads to cumulative increase in income.
Example: If MPC = 4/5=0.8
•Suppose there is initial investment increase of Rs 1000, which results in construction of a new building.
•Then the builder, the architect and labourers together will get an increase in income of Rs 1000.
•Since MPC is 4/5 they will together spend 800. (4/5 of 1000) on new consumption goods
•Producers of consumption goods will have increase of Rs 800 in their incomes They in turn will spend 640 (4/5 of 800)
•This process will go on till, consumption spending which goes on diminishing becomes nil,.
round Income Consumption
1 1000
2 1000 1000*0.8=800
4 800 800*0.8=640
‘ ‘
nth Rs 5000 1000*[1/(1-0.8)]
Change in income (∆Y) = 1000*(0.8)0+ 1000*(0.8)1+ 1000*(0.8)2+ ----- 1000*(0.8)n
It is a geometric progression of infinite terms with first term 1000 and constant ratio is 0.8
∆Y=(1000/1-0.8)
This implies ∆Y = (1 x ∆l)/1-MPC)
or
∆Y/∆l = {1/(1-MPC)} = k= multiplier
This table shows that if investment increases by 1000 cr.
Then National Income increases by 5000 cr.
That means national income increases by 5 times the investment Thus investment multiplier(K) here is 5
Q14.
Autonomous Investment Induced Investment
It is an investment which is independent of variations in output, income, rate of interest or rate of profit.
It is income inelastic function i.e. it remains constant at all levels of income
It is investment undertaken with the motive of earning profit and income.
It increases with increase in income and vice versa
It is Investment dependent on the level of national income
Q15.Aggregate demand -AD is the total amount of goods and services demanded by all the sectors in an economy during a financial year.
COMPONENTS of aggregate demand:-
AD = C+I+G+(X-M)
C-PRIVATE FINAL CONSUMPTION EXPENDITUR:- The expenditure incurred for purchase of all final goods and services such as demand for food, cloth, books etc.
I- INVESTMENT EXPENDITURE:- The amount of money spent for production purpose such as purchase of machinery, buildings, raw material etc
G- GOVERNMENT FINAL CONSUMPTION EXPENDITURE:- The expenditure done by Government for social welfare such as establishment of school, hospital, construction of roads etc.
X-M= NET EXPORTS:- It is the difference between net amount of goods and services Exported and Imported between Domestic country and ROW.
16.Aggregate Supply - It is the money value of total output of goods and services available for Sale. It is also known as National income i.e. NNPfc, it represents the cost of producing, the payment given to factors of production in the form of rent, wages, interest and profit.
AS = Consumption Saving= rent+wages+interest +profit
AS=C+S=Y
AS is a 45° line that passes through the origin.
Any point on 45° line shows equality between AD and output. This line is also known as output curve
17.Exante Saving or Planned or Estimated Saving -During a particular period, whatever, amount, the people in the economy intend or plan to save is
called Exante saving
Exante or Planned or Estimated investment - When entrepreneurs foresee an increase in their sales or rise in prices of their goods, which is called ex-ante investment
Realised or Expost or Unplanned or Actual Saving -Expost savings are the savings which household actually save from their income
Actual/Expost or Unplanned or Undesired Investment - It refers to the actual investment made by all the entrepreneurs in an economy during a given period. (Changes in inventories or stocks of goods is part of Expost investment)
Q18.
VALUE OF MPC, MULTIPLIER AND MPS TOGETHER SOME IMPORTANT POINTS
MPC MULTIPLIER (K) MPS The LOWEST value of MULTIPLIER is 1
0 1/(1-0)= 1 1
.1 1/(1-.1)= 1.11 .9
.2 1/(1-.2)= 1.25 .8 MPC+MPS=1
MPS=1-MPC
& MPS= 1-MPC
.25 1/(1-.25)= 1.33 .75
.3 1/(1-.3)= 1.43 .7 Higher the value of MPC, Higher the value of MULTIPLIER(K)
.4 1/(1-.4)= 1.67 .6
.5 1/(1-.5)= 2 .5 Lower the value of MPC, Lower the value of MULTIPLIER(K)
.6 1/(1-.6)= 2.5 .4
.7 1/(1-.7)= 3.33 .3 Higher the value of MPS, Lower the value of MULTIPLIER(K)
.75 1/(1-.75)= 4 .25
.8 1/(1-.8)= 5 .2 Lower the value of MPS, Higher the value of MULTIPLIER(K)
.9 1/(1-.9)= 10 .1
1 1/(1-1)= ∞ 0 The HIGHEST value of MULTIPLIER is∞
Q19.NUMERICALS
The students are advised to first note down the given values then compute the asked one/values in the question.
1. C= 100+0.75Y is the consumption function and investment expenditure is 800 crores. On the basis of this information calculate (i) equilibrium level of income (ii) consumption at equilibrium level of income.
EXPLANATION:- Given values:- C=100+0.75Y
I=800 CrTherefore AD= C+I= 800+100+0.75Y= 900+0.75YValue to be computed:- Y = ?
C = ?Solution As we know at equilibrium level Y=AD=
Thus Y = 900+0.75Y Y-0.75Y = 900 0.25Y = 900 Y = 900 /.25 Y = 900*4 Y = 3600
C = 100 + 0.75Y =100+0.75*3600 =100+2700 =2800 2. The savings function of an economy is S= -200 +.2Y .The economy is in equilibrium when income is equal to 2000. Calculate--------
A. Investment expenditure at equilibrium level of economyB. Autonomous consumptionC. Investment multiplierEXPLANATION:- Given values:- S = -200+0.2Y
Y=2000 A- At equilibrium level INVESTMENT = SAVING
INVESTMENT = -200 + .2*2000 = -200 + 400 = 200
B- Thus the consumption function will beC = Y – S = Y - (-200 + 0.2Y) = Y +200 -0.2Y = 200 + 0.8 Y
Autonomous consumption is 200C- Here MPS = .2
Thus K = 1/MPS = 1/.2 = 5The value of investment multiplier is 5In order to complete these table first compute consumption or saving from the given values of income and C/S. then proceed for computation of other values as asked in the question along with the right formulaQ. 3
INCOME SAVING CONSUMPTIONC = Y-S
MPC∆C/∆Y
APSS/Y
0 -12 12 - -12/0 = ∞20 -6 26 14/20=0.7 -6/20= -0.340 0 40 14/20=0.7 0/40 = 060 6 56 14/20=0.7 6/60 = 0.1
Q.4 Complete the following table :-
income consumption MPS APC0 40 - -
50 70 - -100 100 - -150 130 - -200 160 - -
income consumption SAVINGS= Y- C
MPS∆S/∆Y
APCC/Y
0 40 0 – 40 = -40 - 40/0 = ∞50 70 50 – 70 = - 20 20/50 = 0.4 70/50 = 1.4100 100 100 – 100 = 0 20/50 = 0.4 100/100= 1150 130 150 – 130 = 20 20/50 = 0.4 130/150=0.86200 160 200 – 160 = 40 20/50 = 0.4 160/200=0.8
Q.5 Complete the following table :-
income consumption APS MULTIPLIER(K)0 15 - -50 50 - -100 85 - -150 120 - -
SOLUTION
income consumption SAVINGS=Y-C
MPS∆S/∆Y
APS MULTIPLIER (K) =1/MPS
0 15 -15 - -15/0=-∞ -50 50 0 0.3 0/50=0 1/0.3 = 3.3100 85 15 0.3 15/100=.15 1/0.3 = 3.3150 120 30 0.3 30/150 =0.2 1/0.3 = 3.3IN ORDER TO SOLVE THESE PROBLEM PROCEED IN THE FOLLOWING WAY
Q.6. In an economy, marginal propensity to save is 0.2.If Investment increases by Rs. 100 crores, calculate total increase in national income.
GIVEN
∆I = 100 Cr.
MPS = 0.2
THUS K = 1/MPS = 1/0.2 = 5
K = ∆Y/∆I
5= ∆Y/100 ∆Y =100*5 = 500
7. As a result of increase in investment, national income rises by Rs. 600 crores. If marginal propensity to consume is 0.75, calculate the increase in investment
K=1/MPS OR 1/1-MPC K = ∆Y/∆I
GIVEN
∆Y = 600 Cr.
MPC = 0.75
THUS K = 1/1- 0.75 =1/1-0.25 =
= 4
K = ∆Y/∆I
4= 600/∆I ∆I =600*4 = 125
8. If National income increases by 800 Cr because an increase in investment by 80 Cr, find out the value of MPS? GIVEN ∆Y = 800 Cr, ∆I = 80 Cr
K = ∆Y/∆I =800/80 = 10, MPS = 1/K = 1/10 = 0.1
UNIT 9Government Budget and the Economy (8 Marks)
1.Government Budget -A government budget is the statement of estimated total revenue and estimated total expenditure of financial year.2.Components of Government Budget
(A) Revenue Budget- It consists of those Government receipts & Government expenditures which neither Create nor Reduce, Assets or Liabilities
1. Revenue Receipts - It consists of those Government receipts which neither Create Liabilities nor Reduce Assets.Types of Revenue Receipts
(i). Tax Revenue:- It consists of proceeds of taxes and other duties levied by the Union government. It is a compulsory payment made to the Govt. in return for which no goods or services are provided directly by Govt.
-Direct tax - Indirect Tax
(ii). Non Tax Revenue: - Income from sources other than taxes is called non-tax revenue. It arises on account of administrative function of the govt.in return for which Govt. either gives goods or services or privileges or permit to perform a serviceTypes of Non TaxRevenue
(i)Commercial revenue- It is received by Govt. in the form of prices paid by people for goods or services that Govt. Provides like railway, postage, electricity etc.
(ii)Administrative revenue-It arises on account of administrative functions of the Govt. (a) Fees-Payment received for providing certain services for public interest like
Govt. college or hospital feesFines & penalties charged for breaking of laws or disobeying rules & regulations
(b)License fee & Permit - Payment received for giving privileges or permit to perform a service. Like registration and license fee for industries or automobile.
(c) Escheat-income Govt. gets by taking possession of property which has no claimant or legal heir.
(iii) Interest Receipts- interest received by the Govt. credit corporations on loans given by them(iv) Profits of PSU’s –Profits earned by public sector enterprises or dividend received by Govt. on
investment made by it.2. Revenue Expenditure - It consists of those Government expenditures which neither Create Assets nor Reduce Liabilities.
Types of Revenue Expenditure(i) Daily expenses in running Govt offices(ii) Compensation of employees of central Govt.(iii) Interest payments(iv) Grants-in-aid to state Govt.(v) Subsidies
(B) Capital Budget- It consists of those Government receipts & Government expenditures which Create or Reduce, Assets or Liabilities
1. Capital Receipts:- It consists of those Government receipts which either Create Liabilities or Reduce Assets.Types of Capital Receipts(i) Borrowings (CL) - Borrowings by Govt. from various sources like general public, Reserve bank of India,
foreign Govt. and other bodies to meet its financial requirements.(ii) Recovery of loans (RA)-Loans recovered by Govtwhich it gives to State Govt., union territories, local
bodies etc.(iii) Disinvestment (RA)- Funds received by Govt. from the sale of the part or the whole of equity shares of
the public sector enterprises to private sector.2. Capital Expenditure - It consists of those Government expenditures which either Create Assets or Reduce Liabilities.
Types of Capital Expenditure(i) Repayment of loan (RL)(ii) Expenditure on construction & purchase of Assets (CA)
NOTE: in brackets above reason is given why those items are part of Capital Receipts or Capital Expenditure----------------------------------------------------------------------------------------
Following table will help in learning Components of Government BudgetLearn only Definition of Capital Expenditure or &Capital Receipts& relate it to define other Components
Revenue Receipts Revenue Expenditure
Capital Receipts Capital Expenditure
Do not CL or RA Do not CA or RL CL or RA CA or RLDo not Create Liabilities(CL)
Do not Create Assets(CA)
Create Liabilities(CL)
Create Assets(CA)
Do not Reduce Do not Reduce Reduce Assets (RA) Reduce
Assets (RA) Liabilities(RL) Liabilities(RL)
-----------------------------------------------------------------------------------------------3. Categories the following into capital and revenue expenditure and Give reasons for your answer. (i)Subsidised LPG given to publicAns. It is revenue expenditure, because it neither Create Assets nor Reduce Liabilities(ii)Construction of Government School buildingAns. It is capital expenditure, because it Create Assets(iii)Salary paid to Central government employeesAns. It is revenue expenditure, because it neither Create Assets nor Reduce Liabilities(iv) Old age pension given by governmentAns. It is revenue expenditure, because it neither Create Assets nor Reduce Liabilities(v) Help given by govt. to flood victimsAns. It is revenue expenditure, because it neither Create Assets nor Reduce Liabilities
4. Categories the following into capital and revenue Receipts And Give reasons for your answer(i) Profits of PSU’sAns. It is revenue Receipts, because it neither Create Assets nor ReduceLiabilities(ii) BorrowingsAns. It is capital Receipts, because it Create Liabilities (iii) DisinvestmentAns. It is capital Receipts, because it involves sale of shares of PSU’s to private sector which Reduce Assets.(iv) Gain taxAns. It is revenue Receipts, because it neither Create Assets nor ReduceLiabilities5.
Direct tax Indirect TaxIt is levied on income & wealth of individual or firms
It is levied on production of & consumption expenditure on Goods & services
it cannot be shifted it can be shiftedThe incidence & the burden of the tax falls on the same person.
The incidence of tax is on one person & the burden of payment of the tax falls on another person
It cannot be avoided it has to be paid It can be avoided by not producing or purchasing goods and services that are taxed.
Eg. Income tax ,Corporate or gain tax, wealth tax etc.
Eg. Sales
6 . Categories the following into Direct tax & Indirect Tax and Give reasons for your answer(i)Income taxAns.It is Direct tax Because it is levied on the income of individual and it cannot be shifted. The incidence & the burden of the tax falls on the same person (ii) Excise dutyAns.It is Indirect tax Because it is levied on the production &transfer of good across states and it can be shifted. The incidence of tax is on one person & the burden of payment of the tax falls on another person.(iii) Service taxAns.It is Indirect tax Because it is levied on the services given and it can be shifted. The incidence of tax is on one person & the burden of payment of the tax falls on another person(iv) Gain taxAns.It is Direct tax Because it is levied on the profits of firm and it cannot be shifted. The incidence & the burden of the tax fall on the firm.
7.Types ofBudget Deficit(1) Revenue Deficit:-It refers to the excess of total revenue expenditure of the government over its total revenue receipts.
Revenue deficit = Total Revenue expenditure - Total Revenue receipts.OR Revenue deficit = Total Revenue expenditure - Tax Revenue- Non Tax Revenue(2) Fiscal Deficit: Fiscal deficit is defined as excess of total expenditure over total receipts excluding borrowing during a fiscal year.Fiscal deficit shows the borrowings requirements of the govt. during the budget year. Fiscal deficit reflects the borrowing requirements of the govt. for financing the expenditure including interest payments.
Fiscal deficit = Total budget expenditure - Total budget receipts excluding borrowingsORFiscal Deficit = (Revenue expenditure + Capital expenditure) – (Revenue Receipts + Capital receipts excluding borrowings)
Fiscal deficit = Revenue expenditure+ capital expenditure- Revenue receipts- capital Receipts excluding borrowingsORFiscal deficit = Revenue expenditure+ capital expenditure - Tax Revenue- Non Tax Revenue-recovery of loans-disinvestmentORFiscal deficit = borrowings
(3)Primary Deficit: Primary deficit is defined as fiscal deficit minus interest payments on previous borrowings. Primary deficit shows the borrowing requirements of the govt. for meeting expenditure excluding interest payment.Gross Primary deficit = Fiscal deficit - Interest paymentsNet Primary deficit = Fiscal deficit+ Interest received - Interest payments
Deficit met by:-(i) Borrow loansing from domestic sources.(ii) Borrowing from external sources.(iii) Deficit financing (printing of extra currency notes):
8.Implications of Budget deficit
Debt Trap: Fiscal deficit refers to the total borrowings requirement of the government create problem of repayments of loans and interest payments. Interest payments increase the revenue expenditure, which leads to revenue deficit. Repayments of loans increase capital expenditure & Fiscal deficit. The government has to borrow further to correct deficit. Thus, a vicious cycle of increasing deficit is created called debt trap.
Foreign Dependence: Government also borrows from the rest of the world, which results in economic interdependence on them & economic interference by the lending countries. It causes economic slavery, if the lending county dictates its terms on the borrowing country.
Causes Inflation: The government resort to borrowing from the Reserve Bank of India (RBI) to meet its fiscal deficit. It is done by ‘Deficit Financing’ Or ’ Monetisation of Debt’ , Which means RBI prints currency 7 gives it to Govt. to finance debt. This increases the circulation of money in the economy and creates inflationary pressure, if there is excess supply of money.
Restricts Economic Development: When Govt. has to borrow to finance deficits, to repay loans and interest on loans, less money is left with the Govt. for economic development.
Financial burden for future generation: Borrowings lead to burden for future generations as payment of loans and interest on loans get accumulated whose burden is to be borne by the future generations in the form of more tax and non-tax revenues.
9. OBJECTIVES OF A BUDGET
i. Redistribution of Income and Wealth. – The government uses fiscal instruments for Equitable distribution of income & wealth to ensure social justice . To improve the distribution of income and wealth in the economy It taxes the rich and gives subsidies on essential items, expenditure is done on social security or public works etc..
ii. Reallocation of resources – The government seeks to reallocate with a view to balance the goals of profit maximization and social welfare. A production of goods which are injurious to health like wine is discouraged through heavy taxation. On the other hand production of socially useful goods like Khadi is encouraged through subsidies.
iii. Economic stability –using its revenue and expenditure policy in Budget the government ensures economic stability in the economy by maintaining price stability and high levels of employment. The forces of supply and demand generate trade cycles in the economy, which govt. tries to prevent and control.
iv. Direct participation and Economic growth by Managing Public sector Enterprises – The Government targets to increase the rate of growth by establishing public sector enterprises to produce goods and services at low cost to promote social welfare like railways. Provisions are made in the budget for these PSU’s. Often, public sector enterprises are encouraged in areas where private monopolies occur.
Unit-10 Balance of Payments Marks : 07
Chapter Foreign Exchange Rate
1. Foreign exchange rate- It is the rate at which currency of one country can be exchanged for currency of another country. For example 1$ = Rs. 45
(In other words, It is the price of domestic currency expressed in terms of foreign currency i.e. 1 Re=1/45$ or
It is the price of foreign currency expressed in terms of domestic currency i.e. 1 Re=1/45$)
2. The foreign exchange market is the market where international currencies are traded for one another.
3. Flexible Exchange Rate/ Floating Exchange Rate-In a system of Flexible exchange rate the exchange rate is determined by the demand and supply and there is no intervention by the monetary authority.
4. Fixed Exchange Rate System: It is the exchange rate which is officially fixed by the Govt. or monetary authority or central banks of a country. It is not determined by market forces.5.Managed Floating- It is a mixture of Fixed Exchange Rate System & Flexible Exchange Rate System .in this system the exchange rate is allowed to change freely due to changes in demand and supply and monetary authorities intervene to manipulate the Exchange Rate when required. There are no rules or conditions as to when to intervene.
Dirty Floating- When central bank of a country intervenes excessively in manipulating its exchange rate for its benefit and is detrimental to other country then it is called Dirty Floating
6.
Appreciation of currency Depreciation of currencyAppreciation means increase in price of domestic currency due to changes in demand and supply of foreign exchange.
Depreciation means decrease in price of domestic currency due to changes in demand and supply of foreign exchange.
increasing in price of rupee from rupee 55/$ to rupees 45/$
decreasing in price of rupee from rupee55/$ to rupees 65/$
Appreciation occurs in Flexible Exchange Rate
depreciation occurs in Flexible Exchange Rate
7.
Revaluation of currency devaluation of currencythe central monetary authority increases value of domestic currency in terms of foreign currency.
the central monetary authority decreases value of domestic currency in terms of foreign currency.
For eg. Central bank revalues rupee by increasing its value from rupee 55/$ to rupees 45/$
For eg. Central bank devalues rupee by decreasing its value from rupee 55/$ to rupees 65/$
monetary authority fixes the the exchange rate
monetary authority fixes the the exchange rate
8. The price of 1 US Dollar has fallen from Rs. 50 to Rs. 48. Has the Indian currency Appreciated or depreciated?
Ans. Indian currency has depreciated.
9.
Spot market Forward marketForeign exchange Operations of daily nature are termed as spotmarket or current market
Foreign exchange Operations for future delivery are termed asForward market.
A foreign exchange spot transaction is an agreement between two parties to buy one currency against selling another currency at an agreedprice for settlement on the spot.
Forward market refers to the market in which the sale and purchase ofForeign currency is settled on a specified future date at a rate agreed upon today to reduce the uncertainties in the exchange rate.
Forward contract is made for two reasons (a) To minimize the risk of loss due to adversechanges in the exchange rate (through hedging) ; (b) To make profit (throughSpeculation).
10. What are the Sources of demand for foreign exchange? OR
Give reasons why people want to have foreign exchange?
Ans: People demand for foreign exchange for the following purpose:-
a) To purchase goods and service from other countries (for Imports)
b) To send gifts and grants to abroad
c) To purchase i.e invest in Physical and financial assets abroad
d) To visit foreign country for education.
e) To visit foreign country for medical treatment
f) To speculate in the foreign currencies market.
g) To visit foreign country as tourists
11. What are the Sources of supply for foreign exchange:-
Ans: a) Exports of goods of the country to the rest of the world brings in the supply of foreign exchange
b) Foreigners visiting a country as tourists
c) Foreigners visiting a country for education
d) Foreigners visiting a country for purchase (i.e to invest) of Physical and financial assets
e) Direct foreign investment or any investment by foreigners in home country
f) Speculative purchase of domestic currency by the non- residents in the domestic market.
g) Gifts and grants by the foreigners.
h) Direct purchase of the goods and services by the non- residents in the domestic
Market (exports)
----------------------------------------------------------------------------------------------------
Appreciation – Increase in value of domestic currency in terms of foreign currency due to change in demand or supply for
foreign exchange in called appreciation.
For eg. Change from rupees 55/$ to Rupees 40/ $ is appreciation of rupee & depreciation of $.
NOTE: Dollar (Foreign Exchange ) behaves like a Good
*If price of a good rises its, quantity supplied rises and quantity demanded falls
*Similarly if Foreign Exchange rate rises or dollar Appreciates (i.e. price of dollar rises), its
quantity supplied rises and quantity demanded falls
# Similarly if there is Excess Demand for a good its price rises , its quantity supplied rises and
quantity demanded falls
# Similarly if there is Excess Demand for Foreign Exchange i.e.$ Dollar, its price rises (i.e.
Dollar Appreciates), its quantity supplied rises and quantity demanded falls
* Similarly if there is Excess Supply for a good its price falls , its quantity supplied falls and
quantity demanded rises
* Similarly if there is Excess Supply for Foreign Exchange i.e.$ Dollar, its price falls(i.e. Dollar
depreciates), its quantity supplied falls and quantity demanded rises.
Q12. How is equilibrium in foreign exchange rate determined under fixed exchange rate system?
Ans. Equilibrium Foreign Exchange rate is rupees55/$ at point e where demand & supply for foreign exchange (i.e. dollar
$) is equal .
(Rs./$) Excess Supply S
60Rs./$ P A B
Rs.55/$ e
Rs.40/$ R L M
Excess Demand D
O Quantity Demanded & Supplied of foreign exchange
When market foreign exchange rate in more than Equilibrium exchange rate, i.e it is rupees 60/$ then
Quantity Demanded of $=PA
Quantity supplied of $ = PB
EXCESS SUPPLY for $ occurs equal to AB.
so in order to bring the rate back to Equilibrium foreign exchange rate, Monetary authority revalues to rupees 55/ $. But
to reach this rate the monetaryauthority or the govt. buys excess $ from the market
When market foreign exchange rate in less than Equilibrium foreign exchange ratei.e rupees 40/$
Quantity Demanded of $=RM
Quantity supplied of $ = RL
EXCESS DEMAND for $ is created equal to LM.so, the central monetary authority will devalue rupee to rupees 55/$ to
bring back Equilibrium for this monetary authoritywill have to provide more dollars to the market to remove excess
demand.
Excess demand
Q13. a) What will happen to Equilibrium foreign exchange rate if The number Of tourists going abroad from India
increases. OR
b) What will happen to Equilibrium foreign exchange rate if More Indians go abroad for education? OR
c) What will happen to Equilibrium foreign exchange rate if More Indians going abroad for medical treatment. OR
d) What will happen to Equilibrium foreign exchange rate if More Indians invest abroad in financial assets or property. OR
e) What will happen to Equilibrium foreign exchange rate if Imports of India in increase. OR
Ans demand for foreign exchange increased
So demand curve for foreign exchange ($) rises upwards to the right from D1 to D2 At original Equilibrium foreign
exchange rate.
(Rs./$) S
60Rs./$ e2
Rs.55/$ P e1 A
Excess Demand
D2
D1
O Q1 Q2
Quantity Demanded & Supplied of foreign exchange
Now Quantity Demanded of $=PA
Quantity supplied of $ = Pe1
So Excess demand for $ =e1 A is created.
Hence $ will appreciate due to which Quantity supplied of $ will increase &
Quantity Demanded of $ will decrease till new Equilibrium foreign exchange is reached at point e 2 Where Quantity
Demanded of $ = Quantity supplied of $ =OQ2, at rupees 60/$
Q14.
a) What will happen to equilibrium foreign exchange rate if number of foreign tourist coming to India decrease?
b) What will happen to equilibrium foreign exchange rate if number of foreign medical tourists coming to India
decrease?
c) What will happen to equilibrium foreign exchange rate if Foreigners visiting India decreases.
d) What will happen to equilibrium foreign exchange rate if foreign exports of India decrease?
NOTE: ANSWER to all questions above will be same
Ans Supply for foreign exchange decreases.
So supply curve for foreign exchange rises upwards to left form S1 to S2.
S2
(Rs./$)
60Rs./$ e2 S1
Rs.55/$P A e1
Excess Demand
D
O Q2 Q1
Quantity Demanded & Supplied of foreign exchange
At original Equilibrium foreign exchange rate rupees 55/$
Now Quantity Demanded of $=Pe1
Quantity supplied of $ = PA
So excess demand of $ = Ae1 created.
Hence $ will appreciate, due to which Quantity supplied $ will increase
Quantity Demanded of $ will decrease this process will continue till new Equilibrium foreign exchange rate is reached at
E2, where Qd of $= Qs of $= OQ2.
Q15. Why does demand for foreign exchange ($) decreases when its price decreases? Give Reasons.
OR why does demand for $ decrease when $ appreciate? Give Reasons.
OR Why does demand for foreign exchange ($) decreases when domestic currency i.e rupees depreciates? Give Reasons.
Ans when dollar appreciate (i.e. rupee depreciates) for c.g from rupees 55/$ to rupees 60/$
So $ becomes costly for Indians, so demand for dollar decreases due to following reasons
Going abroad by Indians for education becomes costly so they demand less dollars.
Going abroad by Indian for medical treatment becomes costly. So they demand less dollars.
Import of foreign goods by Indians becomes costly So demand for $ decreases.
Investing abroad becomes costly so Indians buy less physical financial asset from abroad so demand for $ falls.
Q16. Why does supply for foreign exchange ($) increase when in price increases? Give Reasons. OR
Why does supply for $ increase when $ appreciates? Give Reasons.
OR
Why does supply for $ increase when domestic currency i.e rupees depreciates? Give Reasons.
Ans When $ appreciates for eg from rupees 55/$ to rupees 60/$ (i.e. rupee depreciates),.
Now with one Dollar ($) foreigners can buy more Rupees’. So Indian goods become cheaper for foreigners. The reason
why supply of $ increases are:-
Export of Indian goods increases as Indian goods are cheaper for foreigners so supply of $ rises.
Foreign tourist coming to India rises as it becomes cheaper to visit India supply of $ rises.
Medical treatment in India for foreigners becomes cheaper. So they come for medical treatment.
Education in India becomes cheaper for foreigners, so they come to India for education $ supply rises.
Foreign invest more money in India as it is cheaper to buy physical & financial assets in India , so $ supply rises
Q17. Why does supply of $ decrease when $ depreciates rupee appreciates?
Ans. Hint mention Sources of supply of $ which Cause decrease in $ supply
Q18. Why does demand for $ increases when $ depreciates Rupee appreciates?
Ans . Hint: Mention Sources of Demand for $ that cause increase in demand for $.
Excess supply
Q19. a) What will happen to foreign exchange rate if The no. of tourists coming to India increases.
b) What will happen to foreign exchange rate if the exports of India increase?
c) What will happen to foreign exchange rate if tourists coming to India increases?
d)what will happen to foreign exchange rate if Medical tourists from foreign countries coming to India increases .
e) what will happen to foreign exchange rate if More foreigners invest in India.
NOTE: ANSWER to all questions above will be same except first sentence
Ans It the number of tourists coming to India increases them the supply of foreign currency ($) increases,
Supply curve, Of $ shifts downwards to right from S1 toS2 ,
Supply for foreign exchange (i.e. dollar $) is equal.
S1
(Rs./$) Excess Supply
60Rs./$ A e1 B S2
Rs.55/$ e2
D
Q1 Q2
O Quantity Demanded & Supplied of foreign exchange
At original Equilibrium foreign exchange rate of OA (ruppees55/$)
Now Quantity Demanded of $=Ae1
Quantity supplied of $ = AB
So excess Supply of $ = e 1 Bcreated.
Hence $ will depreciate, due to which Quantity supplied $ will decrease
Quantity demanded of $ will increase this process will continue till new Equilibrium foreign exchange rate is reached at
E2, where Qd of $= Qs of $=OQ2.
Q20. The market price of US Dollar has increased considerably leading to rise in prices of
imports of essential goods. What can the Central bank do to ease the situation?
Ans: The Central bank can start selling US dollars from its reserves.
Q21. a)what will happen to Equilibrium foreign exchange rate if The number Of tourists going abroad from India
decreases. OR
b)what will happen to Equilibrium foreign exchange rate if less Indians go abroad for education. OR
c) what will happen to Equilibrium foreign exchange rate if less Indians going abroad for medical treatment. OR
d) What will happen to Equilibrium foreign exchange rate if less Indians invest abroad in financial assets or property. OR
e) What will happen to Equilibrium foreign exchange rate if Imports of India in decrease
NOTE: ANSWER to all questions above will be same except first sentence
Ans It the number of Indian Tourists going to Abroad decreases then,
Demand for foreign Currency decreases
Demand curve of $ Shifts downwards to left from D1 to D2
(Rs./$) Excess Supply S
60Rs./$ B A e1
Rs.55/$ P e2
D1
D2
O Q2 Q1
Quantity Demanded & Supplied of foreign exchange
At original Equilibrium foreign exchange rate of OB (ruppees55/$)
Now Quantity Demanded of $=BA
Quantity supplied of $ = B e1
So excess Supply of $ = e 1 A is created.
Hence $ will depreciate, due to which Quantity supplied $ will decrease
Quantity Demanded of $ will increase this process will continue till new Equilibrium foreign exchange rate is reached at
E2, where Qd of $= Qs of $.
Chapter: Balance of Payment
Balance of payment Account
1.Balance of Payment (BOP)-It records all the transactions during a financial year between residents a of country and rest
of the world which leads to inflow and outflow of foreign exchange.
2.Components of or Items of BOP
Autonomous Transactions or items
OR
Independent Transactions or items
OR
Above the line items
(It includes-
I Current Account
II Non reserve Items of Capital account)
I. Current Account
(a)Trade of goods. (tangible item or visible
trade)-Export & import of goods.
(b)Trade of services (intangible items or
invisible trade) )-Export & import of services
(i)Factor services like income
from entrepreneurship i.e profit or payment
for capital i.e. interest.
(ii)Non-factor services - banking , shipping
insurance
(iii)unilateral transfer – gifts, donation
remmittances.
II. Capital A/c (Short term and long
them borrowings ,sale and
purchase of physical & financial
assets)
Banking capital
Private capital
Government or public borrowing
or capital
Errors and omissions.
Accommodating Transactions or items
OR
Below the line items
Official reserve transactions –
changes in gold, SDR’s , foreign
Exchange reserves.
Current Account- It records all the exports and imports of goods and services. These transactions do not affect asset and
liability position of a country. Exports and all receipts of foriegtn exchange from unilateral transfers are recorded on the
credit side with(+) sign.
The main components of Current Account are:
i) Export and import of goods ie. Visible trade or trade of Tangible items
ii) Export and import of Services i.e. Invisible trade or trade of intangible items:
a)Non factor services like shipping, banking, insurance etc.
b)Factor services like income from entrepreneurship i.e profit or payment for capital i.e. interest.
iii) Unilateral or Transfer payments: These refer to those receipts and payments,
which take place without any service in return. It includes gifts, donations,
Personal remittances etc..
Capital Account- Any transaction between resident of a country and rest of the world whichresults in change in asset and
liability position of a country with rest of the world is recorded in capital A/c it includes long term & short term
borrowings; sale & purchase of physical and financial assets, changes in the official reserves of foreign exchange, gold,
SDR’s with the monetary authorities
The main components of Capital Account are
A)Banking capital
B)Private capital
C)Government or public borrowing or capital
D) Errors and omissions.
E) Official reserve transactions – changes in gold, SDR’s , foreign Exchange reserves.
Note in other words you can write components of Capital Account as given
below
Components of Capital account
i) Private capital transactions: Capital transactions undertaken by the private sector
of the country in the form of short-term and long-term foreign loans.
ii) Government capital transactions: It includes the transactions undertaken by the
government with the rest of the world. For example, govt. borrows from IMF.
iii) Banking capital: It refers to capital movements and investment by foreign
branches of banks.
iv) Foreign direct investment: It refers to purchase of assets in the rest of the world
such that it gives direct control over the asset. For example, acquisition of
foreign firm by an Indian firm.
v) Portfolio Investment: It refers to purchase of assets in the rest of the world such
that it does not give direct control over the asset. For example, purchase of
shares of a foreign firm by an Indian firm.
vi) errors and Omissions and
vii)official reserve transactions- These include transactions by monetary authority i.e Central bank which
causes changes in reserves of gold, SDR’s , foreign Exchange etc. with central bank.
3.
Autonomous items or transactions
Or Independent
Or above the line
Items / Transactions
Accommodating items or transactions
Or Below the line
Items/ Transactions
These include Current Account items, I.e
export import of goods services &Non
reserve Items of Capital account
These include official reserves of gold SDR’s,
Foreign Exchange etc.
These transactions are done by all the
sectors in economy i.e. household, firm,
govt, etc.
These transactions are done only by the
monetary officials (RBI)
those international economic transactions that take place due to some economic motive such as profit maximization.
These transactions are done to balance the BOP i.e. to bring Equilibrium in balance of payment in accounting terms to correct disequilibrium created by autonomous items in the BOP . like government financing, borrowings from IMF etc.
4.
Balance of Trade
(BOT)
Balance of Payments
(BOP)
It is the difference b/w exports and imports
of Goods only
BOT = (Exports – Imports )of goods only
It is unfavourable when imports are more
than exports.
It is favourable when imports are less than
exports.
It includes
Current A/c, i.e export import of goods as
well as services.
Capital A/c (non-reserve items of Capital
A/c )
In accounting terms BOP is always in
equilibrium.
But in economic terms there can be
disequilibrium. & BOP can have deficit or
surplus.
5. The balance of trade shows a deficit of Rs. 600 crores, the value of exports is
Rs.1000 crores. What is value of Imports?
Ans: Balance of Trade = Exports of goods – import of goods
Import of good = Export of goods – (B.O.T)
= 1000- (-600)
= Rs. 1600.
6.’ There can be disequibrium in BOP’. comment.how can it be corrected?
OR
BOP is always in equilibrium comment.
or BOP always balances comment.
AnsIn accounting terms BOP always balances becauses it is based on double-entry book keeping system and the sum of credit side is always equal to sum of debit side items.
The individual items in BoP may not balance but the total credits of the country must be
equal to total debits.
A deficit or surplus in current account is balanced by surplus or deficit in capital account.
If there is difference between the autonomous items, it would be settled by
accommodating items which are intended to balance the BoP. Hence Balance of payment
always balances.
Disequilibrium occurs in BOP in economic terms.
When sum of credit side of autonomous items is more than sum of debit side then there is surplus in BOP
Correction of surplus in BOP in done by monetary authority by increasing reserves of gold, foreign exchange with RBI and
increasing SDRS held with the IMF (International monetary fund)
When Debit Side of autonomous items is more than credit side, deficit in BOP Occurs.
Correction of deficit in BOP in done by monetary authority by decreasing foreign exchange reserves, reducing SD R,s held
with the IMF.
7. What is the balance of visible items in the balance of payments account called?
Ans:- Balance of trade.
8. CAUSES of DISEQUILIBRIUM in THE BALANCE OF PAYMENTS
There are a number of factors that cause disequilibrium in the balance of payments showing either a surplus or deficit. These causes are categorized into 3 factors.
I Economic factors: Large scale development expenditure that may cause large imports.
II Cyclical fluctuations in general business activities such as recession or depression.
III High domestic prices may result in imports.
II Political factors: Political instability may cause large capital outflows and hamper the inflows of foreign capital.
III Social factors: Changes in tastes, preferences and fashions may affect imports and exports.
