(i) This question paper contains five Sections A, B, C, D and E.
(ii) Section A consists of 10 questions carrying 1 mark each.
(iii) Attempt any 10 questions from Section B, carrying 2 marks each .
(iv) Attempt any 8 questions from Section C, carrying 5 marks each.
(v) Attempt any 2 questions from Section D, carrying 10 marks each.
(vi) Attempt any 2 questions from Section E, carrying 5 marks each.
(vii) All parts of the questions should be attempted at one place.
- Q1VIEW SOLUTIONSolution:Utility refers to the satisfaction that a consumer expects to derive from the consumption of a particular good. It is a subjective concept and varies from person to person and from time to time. For example, a commodity, say, apples provide different level of satisfaction to different persons. Also, the same person can derive different level of satisfaction from consumption of apples at different points of time (for example, at the time of illness the apples may provide a consumer with a higher level of satisfaction).
- Q2VIEW SOLUTIONSolution:Demand for a commodity refers to the quantity of a commodity that a consumer is willing and is able to purchase at a particular price at any particular point of time.
- Q3VIEW SOLUTIONSolution:The concept of real cost was introduced by Alfard marshall.
- Q4VIEW SOLUTIONSolution:Market is a place where sellers and buyers interact for the exchange of goods and services. The buyers intend to get good quality product at lower price and seller intends to maximise profit.
- Q5VIEW SOLUTIONSolution:Duopoly refers to the market structure in which two firms dominate the whole market of a product or service.
- Q6VIEW SOLUTIONSolution:The word 'Macro' comes from the Greek word ‘Makros’ which means ‘large’. In terms of economics, macroeconomics is concerned about the large sections of the economy or the economy as a whole. It is that branch of economics, which deals with the economics activities by all the economic spheres, varying economic situations and economic problems for the economy as a whole.
- Q7VIEW SOLUTIONSolution:GDP implies Gross Domestic Product. It is the value of final goods and services produced in an economy in a particular year.
- Q8VIEW SOLUTIONSolution:Barter system of exchange refers to an exchange system in which goods and services are exchanged for other goods and services. Such a system is also known as commodity for commodity exchange (i.e. C-C exchange). For example- if a person having surplus wheat wants milk, then he/she can exchange wheat with a person who has milk and as well as needs wheat at the same time.
- Q9VIEW SOLUTIONSolution:Saving refers to that portion of the income that is retained and not spent as consumption . That is, savings is done to finance the future consumption.
- Q10VIEW SOLUTIONSolution:Foreign trade is the trade between different countries of the world. It consists of imports, exports . The inflow of goods in a country is called import trade whereas outflow of goods from a country is called export trade.
- Q11VIEW SOLUTIONSolution:Basic activities or functions of an economy are as follows.
1) Production - Production implies creation of goods and services with the sole motive of selling them in the market usually to earn profit. A producer in order to undertake the production process requires some basic prerequisites. These prerequisites are called inputs. The final product produced is called output.
2) Consumption - Consumption implies utilising economic goods (like money) to fulfill the needs. For example, we all use money to purchase various commodities such as food, clothes, TV, mobile, etc. to satisfy our needs. It must be noted that in economics, consumption is basically referred to the expenditure incurred only on the purchase of final goods. For example, if a person buys wheat for feeding his family and himself, then this is regarded as consumption. However, if he buys wheat for preparing biscuits that he tends to sell in the market, then this cannot be considered as consumption expenditure.
3) Capital formation- Capital formation refers to net additions of capital stock such as equipment, buildings and other intermediate goods. A nation uses capital stock in combination with labour to provide services and produce goods; an increase in this capital stock is known as capital formation.Generally, the higher the capital formation of an economy, the faster an economy can grow its aggregate income. Increasing an economy's capital stock also increases its capacity for production, which means an economy can produce more
- Q12VIEW SOLUTIONSolution:Two properties of budget line are as follows.
1) Straight line - Budged line is a diagrammatic representation of a linear budget constraint. This implies that budget line is a always a straight line. The intercepts of this straight line i.e budget line depict the maximum quantity of the commodities that can be purchased by the consumer if the consumer spends his entire money income on a particular commodity.
2) Negative slope - Budget line has a negative slope i.e it slopes downward from left to right
- Q13VIEW SOLUTIONSolution:Factors of production are as follows.
1) Land- In economics, land does not merely imply soil. In fact, it broadly refers to all the natural resources, flora and fauna, earth, building, avenues, air, water, minerals, etc. The owner of land (landlord) receives rent in exchange of his contribution to the production process.
2) Labour- It includes all physical and mental efforts of workers, employees, managers, etc. A labourer receives wages in return of his services in the production process.
3) Capital- It includes money invested in the business, machinery and tools. A money-lender or capital owner receives interest on the amount of capital contributed by him in the production.4) Enterprise- It includes the skills and efforts of the entrepreneur or the owner of the production. An entrepreneur organises the production process by hiring all the services of all the above factors to produce output. He sells the output in the market and remunerates the factor. In exchange of his dare to undertake risk of production, he receives profits in exchange
- Q14VIEW SOLUTIONSolution:
Basis Firm Industry Meaning Firm refers to a unit of industry in which goods/and services are produced. Industry refers to a group of firm engaged in the production of homogenous goods/services. Equilibrium A firm attains equilibrium when it has no incentive to increase or decrease its output level An industry attains equilibrium when the entry and exit of firms is absent and existing firms are operating.
- Q15VIEW SOLUTIONSolution:Selling costs are the costs incurred by a firm to pursuade the buyer to buy a particular product instead of its other substitutes available in the market.The main objective of incurring such cost is to increase the sales of the firm by competing with the products sold by other players in the market.
- Q16VIEW SOLUTIONSolution:Following are two areas of study under macro-economics.
1. Study of general price level and its trends
2. Study of aggregate demand and aggregate supply of an economy
- Q17VIEW SOLUTIONSolution:Methods of measuring national income are as follows.
1) Value-Added/Product Method
The value-added approach measures the national income by estimating the contribution made by each of the producing units in the economy to the total production within the domestic territory during an accounting year.
2) Income Method
According to the Income Method, national income is estimated by aggregating all the factor incomes (in the form of wages, rent, interest and profits) paid to the owners of factors of production (land, labour, capital and enterprise) within the domestic territory in an accounting year.
3) Expenditure Method
According to the Expenditure method, National Income is measured in terms total expenditure on final goods and services produced in an economy during an accounting year.
- Q18VIEW SOLUTIONSolution:The following are the principal objectives of monetary policy:
1. Full Employment:
Attaining full employment is the primary objective in monetary policy as employment eliminates poverty and improves standard of living of the people.
2. Price Stability:
Through monetary policy, RBI intends to minimise fluctuations in price level that brings uncertainty and instability in the economy.
3. Economic Growth:
Increase in real per capita income is the indicator of economic growth that RBI undertakes through monetary policy
4. Balance of Payments:
BOP equilibrium is another objectives which monetary policy establishes by maintaining a balance between exports and imports of a country.
- Q19VIEW SOLUTIONSolution:In equilibrium, saving is always equal to investment.
This is because in a situation of equilibrium in an economy, Aggregate Demand(AD) is always equal to Aggregat Supply(AS). Or, Algebraically
AD = AS
Now, Aggregate Demand is the summation of consumption and investment and Aggregate Supply is the summation of consumption and saving
C + I = C + S
or, I = S
Hence, in equilibrium, saving and investment are equal.
- Q20VIEW SOLUTIONSolution:
Basis Surplus budget Deficit budget Meaning When total revenue generated by government exceeds its total expenditure, the budget is referred as surplus budget. When total expenditure generated by government exceeds its total revenue, the budget is referred as surplus budget. Borrowings A surplus budget doesn't result in borrowings by government to finance its expenditure. A deficit budget results in borrowings by government to finance its expenditure Corrective measures Decrease in tax rates and increase in expenditure by government are corrective measures of surplus budget. Increase in tax rates and decrease in government expenditure are corrective measures of deficit budget.
- Q21VIEW SOLUTIONSolution:
Measures to Correct Budgetary Deficits
We know that budget deficit is the excess of total expenditure of the government over the total receipts of the government. Accordingly, the budget deficits can be corrected either by lowering the expenditure incurred by the government or by raising its receipts. The following are the two possible measures of correcting the budget deficit.
1. Reducing the government expenditure- We know that government expenditure can be classified as development expenditure and non-development expenditure. In developing countries, the government cannot cut down on its development expenditure such as expenditure on health, education, etc. This is because curtailing the development expenditure is not advisable from the economic point of view. However, by increasing the role of private sector in such activities the development expenditure can be lowered to some extent. On the other hand, non-development expenditure can be reduced to a greater extent by the government to correct the budget deficit.
2. Increasing the government receipts- We know that the receipts of the government can be classified as revenue receipts and capital receipts. Of the various revenue receipts, tax receipts form the major component and contribute the most to the total government receipts.
Tax receipts of the government can be in the form of receipts from direct taxes and receipts from indirect taxes. However, in developing countries such as India, direct taxes such as income tax have little scope of increment. This is because only a small fraction of population pays income tax in such countries (and majority of population falls in low-income group). On the other hand, although the indirect taxes such as the sales tax have a wider scope but cannot be increased much as they are regressive in nature (the burden has to be borne equally by the rich and the poor). Thus, a rise in the indirect taxes implies a reduction in the welfare of the people. Hence, the indirect taxes and the direct taxes cannot be increased much in the developing countries.Another form of receipts for the government can be capital receipts in the form of recovery of loans, borrowings and disinvestment. Of these three components, borrowings and disinvestment forms the two major sources of capital receipts. However, excessive dependence on the borrowings implies higher debt burden and interest burden in the future. Hence, borrowing as a source of capital receipts must be avoided. As against borrowings, disinvestment can be used to correct budget deficit to some extent as long as it is confined to the disinvestment of inefficient public enterprises. Also, the disinvestment can prove fruitful, if the funds received from disinvestment are reinvested in some productive and developmental activities in the country.
- Q22VIEW SOLUTIONSolution:
Basis of Difference Balance of Payment Balance of Trade Nature of transactions The nature of transactions coveres include goods, services as well as capital transfers. It includes only those items that are related to the trade of goods. Completeness It include both current as well as capital transactions. It includes only current account transactions. Net balance Net balance is estimated as the aggregate of current account balance as well as capital account balance. Net balance is estimated as difference between export and import of goods.
- Q23VIEW SOLUTIONSolution:Three fundamental economic problems are as follows.
1. What to Produce and in What Quantities?
The first problem that an economy faces is to decide which goods and services are to be produced. Besides this, the economy also needs to decide in what quantities these goods and services should be produced. Let understand this problem with the help of the following example.
Let us suppose that an economy can produce only two types of goods viz. consumer goods (such as, rice, wheat, Laptops, etc.) and capital goods (such as, machinery, guns, bridges, etc.). Now, with the amount of resources available, the economy need to decide how much and which of the consumer goods should be produced and how much and which of the capital goods should be produced. Thus the economy faces a choice as whether, it wants more of capital goods and less of consumer goods or vice-versa.
2. How to Produce?
The next problem that an economy faces is to decide which production technique is to be employed in the production of the decided goods and services. The following are the two techniques of production.
(a) Labour Intensive Production Technique
This production technique uses comparatively more of labour units than that of capital or machine. For example, agricultural activities in India use labour intensive production technique.
b) Capital Intensive Production Technique
This production technique uses comparatively more of capital or machine units than that of labour units. For example, production of durable goods such as, T.V, refrigerator, vehicles, etc. needs capital intensive production technique.
The economy needs to decide which particular production technique should be adopted in order to utilise its available resources in the best possible efficient and optimal manner. India, for instance, is a labour abundant country. Thus, it will be more beneficial for India to opt for labour intensive techniques, as this will not only minimise the cost of production (due to cheap availability of labour) but will also help in reducing unemployment.
3. For Whom to Produce? Or the Problem of Distribution of National Product.
This economic problem basically focuses on the distribution mix of the final goods and services produced. The distribution of the final goods and services is equivalent to the distribution of National Income (or National Product) among the factors of production such as land, labour, capital and entrepreneur.
The economy needs to decide a mechanism of distributing the final goods and services among the different segments of population, so as to reduce the inequality of income. This problem is concerned about who gets more or who gets less? Which goods should be made available free or at low (nominal) price and to which segment?
- Q24VIEW SOLUTIONSolution:Five uses of microeconomics are as follows
1) It studies about the issues pertaining to individual economic units(consumers and firms) that interact in the market of different good and services.
2) It determines how consumers make their consumption choices and decisions given their money income and the prices of goods and services.
3) It analyses how the firms decide how much to produce and by different input combinations and determines how prices are determined in both commodity market as well as in the factor market based on the demand and supply analysis.
4) It studies various market forms and determines the technicalities of their production and revenue functions for the optimization of returns.
5) It determines changes in the market equilibrium due to fluctuations in market demand and market supply.
- Q25VIEW SOLUTIONSolution:
Properties of Indifference Curve
1. Indifference curves are downward sloping to the right: Downward slope of the indifference curve to the right implies that a consumer cannot simultaneously have more of both the goods. An increase in the quantity of one good is associated with the decrease in the quantity of the other good. This is in accordance with the assumption of monotonic preferences.
2. Slope of IC: The Slope of an IC is given by the Marginal Rate of Substitution (MRS). Marginal rate of substitution refers to the rate at which a consumer is willing to substitute one good for each additional unit of the other good.
At point A:
i.e. MRS shows the rate at which the consumer is willing to sacrifice good Y for an additional unit of good X.
3. Shape of Indifference Curve: As we move down along the Indifference curve to the right, the slope of IC (MRS) decreases. This is because as the consumer consumes more and more of one good, the marginal utility of the good falls. On the other hand, the marginal utility of the good which is sacrificed rises. In other words, the consumer is willing to sacrifice less and less for each additional unit of the other good consumed. Thus, as we move down the IC, MRS diminishes. This suggests the convex shape of indifference curve.
In the above figure, IC is the Indifference Curve.
At point A,
At point B,
MRS at B < MRS at A, so MRS has fallen.
4. Two indifference curves never cross each other: Let us understand this property of IC with the help of a diagram.
Suppose, there are two indifference curves IC1 and IC2 that intersect each other at point B.
We can observe that point B and point P lie on the same indifference curve, IC1. This implies that the consumer must be indifferent between the two consumption bundles B and P. Similarly, point B and point Q lie on the same indifference curve, IC2. This implies that the consumer must also be indifferent between the two consumption bundles B and Q. i.e.
B (X,Y) ∼ P (X,Y) and B (X,Y) ∼ Q (X,Y)
By the axiom of transitivity, the above analysis implies that a consumer must be indifferent between bundle P and bundle Q i.e.
P (X,Y) ∼ Q (X,Y)
However, this is not possible because bundle P and bundle Q lie on different IC. Hence, the two consumption bundles cannot provide the consumer the same level of satisfaction. Thus, it can be concluded that two IC cannot cross each other.
5. Indifference curves are not always parallel to each other
Two indifference curves are not always parallel because the diminishing marginal rate of substitution between two goods is not always same and constant.
- Q26VIEW SOLUTIONSolution:Price elasticity of demand can take values from zero to infinity i.e 0 < ed< ∞. Based on the degree of responsiveness of demand to the price we can differentiate between three following situations.
- When the demand for a good is highly responsive to its price. In this case, the percentage change in demand is greater than the percentage change in the price and |ed| > 1. In this situation the demand is said to be elastic
- When the demand for a good is less responsive to its price. In this case, the percentage change in the demand for a good is less than the percentage change in its price and |ed| < 1. In this situation the demand is said to be inelastic.
- When the demand for a good responds exactly in the same amount as the change in its price. In this case, the percentage change in the demand for a good is equal to the percentage change in its price and |ed| =1. In this situation demand is said to be unitary elastic.
The three situations can be summarised as:
Percentage Δ in demand (<) Percentage Δ in price
|ed| < 1
Percentage Δ in demand (=) Percentage Δ in price
|ed| = 1
Percentage Δ in demand (>) Percentage Δ in price
|ed| > 1
- Q27VIEW SOLUTIONSolution:
According to the Law of Returns to Scale, if all the factor inputs are increased in the same proportion, then consequently the output will increase; but this increase may be at increasing, constant or at decreasing rate.
Based on the increase in the output, there exists following three aspects of Law of Returns to Scale.
- Increasing Return to Scale (IRS)
- Constant Returns to Scale (CRS)
- Decreasing Returns to Scale (DRS)
Increasing Returns to Scale
It holds when a proportional increase in all the factors of production leads to an increase in the output by more than the proportion.
Example- When both labour and capital inputs are increased by n times and the resultant increased in the output level is more than n times; we say that the production function exhibits IRS.
Let Qx = f (L, K)
Qx represents Quantity of output produced
L represents ‘L’ units of labour used
K represents ‘K’ units of capital used
If both the inputs are increased by ‘n’ times, then the new output, Q'x will be
Q'x = f (nL, nK)
Now, if f (nL, nK) > n . f (L, K), then the production function shows IRS.
Constant Returns to Scale
It holds when a proportional increase in all the factors of production leads to an equal proportional increase in the output.
Example- If both labour and capital input are increased by 10% and the resultant output also increases by 10%, then we say that the production function exhibits CRS.
Symbolically, it exists when
Qx = n. Q'x
That is, f (nL, nK) = n . f (L, K), then the production function shows CRS.
Decreasing Returns to Scale
It holds when a proportional increase in all the factors of production leads to less than the proportional increase in the output.
Example- If both labour and capital are increased by 10% but the resultant increase in the output is less than 10%, then we say that the production function exhibits DRS.
Symbolically, it exists when
Qx < n. Q'x
That is, f (nL, nK) < n . f (L, K), then the production function shows DRS.
- Q28VIEW SOLUTIONSolution:Oligopoly refers to the market structure in which few large firms compete against each other. The word " Oligopoly " is derived from greek words 'Oligi' means few and 'polein' means sellers.
1. Few Large Firms- There exists few but large and dominating firms. These firms account for majority of market supply, thereby control the market price and quantity of the output.
2. Mutual Dependence- There exists a very high degree of mutual interdependence between the firms in an oligopoly market. The price and the quality decisions of a particular firm are dependent on the price and the quality decisions of the rival (other) firms. Hence, a firm must take into consideration the probable rival reactions, while formulating its own price and output decisions.
3. Restricted Entry- As there exists a cut-throat competition among the firms, so it is very difficult for any new firm to enter into the industry. Moreover, as the existing firms are the only giants in the market, so it narrows the scope for a new entrant to enter the industry due to high cost associated with the entry.
4. Indeterminate Demand Curve- The demand curve faced by an oligopolistic firm cannot be determined as it is uncertain to forecasts its sales. This is because any change in the price or output decisions by a firm sets in a series of reaction of the rival firms. That is why; the demand curve is indeterminate and indefinite. The great economist Paul Sweezy, in fact suggested that an oligopolistic firm faces a kinked demand curve at any given price. The following figure shows the demand curve faced by an oligopolistic firm. In the figure, as there is a kink or bend in the demand curve at point 'K', so it is known as Kinked-shaped Demand Curve.
The upper portion of the demand curve, i.e. DK is comparatively more elastic. This is because if the firm raises its price above OP1, then this action will not be followed by the rival firms (as doing this will reduce their customer base). Consequently, for any increase in the price above OP1, the firm will lose its customers; hence this portion of the demand curve is more elastic.
On the other hand, the lower portion of the demand curve, i.e. KE is comparatively more inelastic. This is because if the firm lowers its price below OP1, then the rival firms will also follow the price reduction strategy, else the rival firms will lose their customers, thereby, profits. Consequently, the firm which initiated price reduction is not fully benefited due to the price reduction, as all the rival firms have also followed the same strategy. Hence, the lower portion of the demand curve is more inelastic.
5. Product- The products of any two oligopolistic firms can either be homogeneous such as in a steel industry or can be differentiated such as in an automobile industry.
6. Rigid Prices- Rigid prices (or sticky prices) imply that prices do not move freely as per the changes in demand. This is due to the counter decisions of the rival firms. For instance, if a firm wants to increase its price in order to earn higher profits, then the rival firms may not follow the price hike, as a result the firm (which initiated price rise) may lose its customers, thereby, incurs loss of revenues and profits. Thus, an oligopolistic firm fears loss of profits associated with the rise in its price.
On the other hand, if any firm aims to generate more profits by lowering its price and selling larger quantities, then the rival firms will also lower their prices, else they will lose their customers. Hence, the firm which initiated price reduction will not be fully benefited, as the increase in the market sales and revenues associated with lowering price will be shared by all the firms in the market. Hence, there do not exist enough incentive for the oligopolistic firms to lower or raise their prices. That is why; the prices in an oligopolistic market appear to be rigid or sticky.
- Q29VIEW SOLUTIONSolution:Features of Monopoly
The following are the basic features of monopoly market structure.
1. Single seller/firm/industry- In a monopoly market there exist only one individual seller or a group of individuals owning a single firm. As, there is only one firm in the industry, so the firm itself is regarded as the whole industry. The sole control over the production and supply of output rests on the monopolist’s decision.
2. No close substitutes- The goods produced by the monopolist have no close substitutes.
3. Restricted entry of new firms- The entry into the monopolist market is restricted. In other words, no new firm can enter the monopoly market. There may be various legal barriers such as, patent rights, cartel laws, exclusive rights, etc. to restrict the entry of the new firms.
4. A monopolist is a price maker- Since, a monopolist firm is the single firm in the market, therefore, it enjoys full control over the price and output decisions. The monopolist has the total freedom to fix the price level, which maximises his profit. Therefore, it can be said that a monopoly firm is a price-maker.
5. Monopolist has perfect knowledge- It is assumed that a monopolist has perfect knowledge about different conditions prevailing in the market. He is well informed about the types of demand prevailing at different markets segments and accordingly varies price of his product.
6. Price discrimination- Price discrimination implies charging different prices for the same product from different buyers at the same time. A monopolist firm enjoys the freedom to follow price discrimination. That is, in other words, it can sell the same product to different buyers at different prices at different time periods.
- Q30VIEW SOLUTIONSolution:The given statement is completely true. Despite of being useful, macroeconomics has a number of limitations that serve as hindrances in the study of economic variables. Such limitations can be enumerated as follows.
1) Aggregates and individual data may differ - Macroeconomies studies only aggregates of variables which doesn't necessarility depict the changes in individual variables correctly.For example, an increase in national income does not imply an increase in income of all the individuals in an economy as it dost not tell us anything abount the composition of that increase among different sectors of population.
2) It regards all individual units of study as homogenous - Macroeconomics regards all individual subsets of a data as homogenous while aggregating them to reach economic facts and data. But, in real scenario, such individual units differ from each other to a large extent.
3) Statistical approximations - The macroeconomic data involves huge figures and approximations errors in collection of such data often results in false estimates of different variables.
- Q31VIEW SOLUTIONSolution:
Primary Functions of Money
There are two main primary functions of money
a. Medium of Exchange- Money acts as medium of exchange as it facilitates exchange through a common medium i.e. currency. With money as a medium, the two components of a transaction namely, sale and purchase can be easily separated. In other words, money eliminates the need for double coincidence of wants for an exchange to take place and can be performed independently of each other. Moreover, money has widened the domain and scope of market. Today, market is no more limited to a specific geographical location. This can be verified by the increasing popularity of online transactions. Hence, it can be concluded that money has infused commercialisation, which has raised the overall level of economic activities and has made production market oriented.
b. Unit of Value- Money serves as a common medium or unit of value. The goods and services are of different types and are measurable in different units such as, meter, litre, gram, etc. Money has provided a common yardstick to measure all these different units in a common denomination known as price. This has made different goods and services comparable to each other in terms of their respective prices.
Secondary Functions of Money
These are those functions that money performs besides its primary functions. The secondary functions of money can be divided into following three parts.
a. Store of Value- Generally, people have a tendency to save certain portion of their income in form of savings and to accumulate wealth. Under the Barter system, such storage of wealth was not possible due to perishable nature of certain commodities. As against this, wealth can be easily stored in the form of money without any loss in its value. Thus, store of value as a function of money implies that money can be easily saved and used for future needs.
The store of value function of money can be justified because of the following reasons.
i. Money is the most widely accepted as a medium of exchange.
ii. There is no loss in the value of money over time (though, there exists loss of value of money due to inflation but it is negligible).
iii. Money can be stored conveniently and does not involve any cost.
b. Standard of Deferred Payments- Deferred Payments refer to the future payments and contractual payments such as loans and interest payments, salaries, etc. As money is widely accepted as medium of exchange and can be used as to store value without much loss of value, so it can be used for future payments.
c. Transfer of Value- Money can be transferred easily from one place to another and from one person to another. Therefore, it implies that with the help of money, purchasing power can be transferred. An individual who is having money has purchasing power and he/she can transfer the purchasing power to anyone just by transferring money. For example, when a father is giving pocket money to his son, he is indeed transferring purchasing power to his son to buy different goods and services.
Contingent Functions of Money
The following are the various contingent functions that money performs.
a. Facilitates Credit- Money facilitates the functioning of credit instruments such as cheques, promissory notes, bills of exchange, etc. Such credit instruments facilitate transfer of value from one person to another.
b. Facilitates Distribution of Income- Factor payments can be made easily in form of monetary remunerations such as wages, rent, interest and profit.
c. Maximises Consumers’ and Producers’ Satisfaction- Since all goods and services are valued in terms of money, therefore, it is possible for a consumer to maximise his/her satisfaction by equalising marginal utilities of various goods consumed. Similarly, all the factors of production are valued in monetary terms. Consequently, it becomes possible for a producer to maximise production by equalising marginal productivities of different factors of production.
d. Liquidity-Money is the most liquid form of all the assets and wealth. Gold, silver, land, cheques, etc. are not as liquid as money. If need arises, then these assets have to be converted into money, but on the other hand, money need not to be converted into any other form as it is readily acceptable. Apart from being liquid, money also provides guarantee of liquidity/solvency to other forms of wealth and assets. This implies that money can be converted into any type of asset and on the other hand, any type of asset can be converted into money.
- Q32VIEW SOLUTIONSolution:Investment expenditure refers to the planned (ex-ante) total expenditure incurred by all the private investors on creation of capital goods such as, expenditure incurred on new machinery, tools, buildings, raw materials, etc. This expenditure by all the private investors on the capital goods add to the total stock of capital thereby increases the overall productive capacity of the economy. Investment depends on the rate of interest (i) and income level (Y).
Investment can be categorised in the following two types.
1. Autonomous Investment (I bar): It represents that part of investment, which is independent of the income level and interest rate. It remains constant throughout all levels of incomes and interest rates.
2. Induced Investment (I): It is a dependent function of income and interest rate. It is a positive function of income but is negative function of rate of interest
- Q33VIEW SOLUTIONSolution:Public expenditure refers to the development and welfare expenditure incurred by government in an economy. It is used as an instrument of fiscal policy by the government to adjust money supply in an economy. When the general price level or inflation increases, government decreases public expenditure to reduce the money supply available in an economy which results in a decrease in the general price level. Similarly, in a situation of deflation, general price level is decreased.
- Q34VIEW SOLUTIONSolution:Following are the theories of determination of exchange rate.
1) Flexible exchange rate system
Under flexible exchange rate system, the rate of exchange is determined by the market forces of demand and supply. The equilibrium exchange rate is determined where demand for foreign currencies is equal to the supply of foreign currencies.
In the diagram, DD is the demand curve for foreign currency and SS is the supply curve of foreign currency. Point E, the point of intersection of demand curve and supply curve represents the equilibrium exchange rate.
OR is the equilibrium exchange rate and OQ is the quantity demanded and supplied of foreign currencies.
If exchange rate rises to OR1, then the supply of foreign currency exceeds the demand for foreign, forcing the exchange rate to fall back to OR. On the contrary, if the exchange rate falls to OR2, there is excess demand over supply. Hence, the rate of exchange again rises from OR2 to OR1.
2) Fixed exchange rate system
Under the fixed exchange rate system the exchange rate is held constant or fixed by the monetary authority and any decision to change the exchange rate is at the discretion of the monetary authority. The government can either revaluate the currency or devaluate the currency.
Revaluation of a currency occurs when the currency exchange rate is officially raised by the monetary authority. On the other hand devaluation of a currency occurs when the currency exchange rate is officially lowered by the monetary authority.
Suppose, the monetary authority wishes to fix the exchange rate at e1, which is lower than the equilibrium exchange rate under the flexible exchange rate system, e2 (determined by the intersection of demand curve for foreign exchange and supply curve of foreign exchange). Thus, in such a case the rupee is overvalued (revaluation). At the exchange rate of e1, demand for dollars is higher than the supply of dollars. Thus, now to prevent the exchange rate from rising the monetary authority would sell dollars for rupees in the foreign exchange market. On the contrary, if the monetary authority fixes the exchange rate at level higher than the equilibrium exchange rate under the flexible exchange rate.
- Q35VIEW SOLUTIONSolution:Law of Diminishing Marginal Utility states that as a consumer consumes more and more units of a commodity in succession then, the utility derived from consumption of each additional unit of the commodity falls.
Units of X Marginal utility 1 12 2 10 3 8 4 6 5 4 6 2 7 0 8 2
From the schedule, we can observe that the as more and more units of the commodity are consumed, the Marginal Utility derived from the consumption of each additional unit of the commodity tends to fall. With the consumption of the successive units, the Marginal Utility becomes zero and consequently becomes negative. (As per the schedule, MU is zero at the consumption of 7th unit and becomes negative at 8th unit consumed).
- Q36VIEW SOLUTIONSolution:Supply refers to different quantities of commodoties offered for sale at different prices.
According to the law of supply, quantity supplied of a commodity is positively related to the price of the commodity, other things remaining constant.
The supply curve of a commodity slopes upwards as shown in the figure. When a producer gets a higher price for his/her output,he would be willing to sell more output to tap more profits and on the contrary,when the price prevailing in the market is low,the producer won't be willing to sell his/her output at that time and would wait for the prices to rice,causing quantity supplied to fall.
Law of supply can also be understood with the help of a supply schedule. For example, as price increases from Rs 2 to Rs 3, quantity supplied also increases from 10 units to 15 units.
Price (Rs) Quantity (Units) 1 5 2 10 3 15 4 20 5 25
- Q37VIEW SOLUTIONSolution:Inclusion and exclusion of different items result in difficulties in the measurement of national income. Such items are explained as follows.
Items to be EXCLUDED while estimating National Income
The following are an exhaustive list of items that are to be excluded from the estimation of National Income by any of the methods.
1. Unearned Income in the form of Transfer Payments
The following are some of the common forms of transfer payments.
- Unemployment allowances paid by the government
- Financial help given to the war victims or victims of natural calamities
- Money received by an individual from a relative working abroad
- Old-age pension granted to the senior citizens
- Scholarships paid by the government or any other institution
- Gifts or donations given to NGOs or other non-profit organisations
- Expenditure on children’s marriage by a parent
- Payment of pocket money to children by parents
2. Leisure Activities or Activities meant for Self Consumption
The following are some of the common forms of leisure activities or activities meant for self consumption.
- Services of a housewife
- Parents teaching their own children
- Activities like growing vegetables in one’s own garden
- Voluntary work/service done for a community
3. Income from Illegal Activities such as theft, gambling, smuggling, black-marketing, etc.
4. Windfall Gains such as lotteries are to be excluded from National Income.
5. Income from Sale of Second Hand Goods or Financial Assets such as income from the sale of old house furniture, resale of vehicle, etc. or financial assets such as bonds, debentures, etc.
6. Taxes/Duties paid out of Past Savings/Wealth such as death duty, gift tax, wealth tax, etc.
7. Capital Gains such as appreciation (rise in the value) of a land or property overtime, increase in the prices of stock, etc.
8. Income from Financial Transactions such as sale and purchase of shares, bonds, debentures, etc.
9. Expenditure on Intermediate Consumption such as expenditure on raw material purchased by an industry, expenses on electricity, water, etc. by a factory and industry
II. Items to be INCLUDED while estimating National Income
The following are the items that are to be included in the estimation of National Income by any of the methods.
1. Wages earned by the Resident Employees Working outside the Domestic Territory such as salaries received by Indian employees working in Canadian Embassy, salaries received by Indian employees working in foreign owned MNC, etc.
2. Profits earned by a Resident Institution/Organisation located outside the Domestic Territory such as profits earned by an Indian company located in Canada, profits earned by branch of domestic banks in foreign, etc.
3. Services that are provided Free of Cost by the Government such as free medical services, free food services for the poor, free education, street-lighting facilities, etc.
4. Commission/Brokerage paid on the Sale and Purchase of Second Hand Goods/Financial Assets
5. Defence and Security Services provided by the Government
6. Salaries paid to the Non-Residents working in the Domestic Territory such as salaries paid to a foreign specialist working in domestically-owned companies, etc.
7. Imputed Value of the Output meant for Self -Consumption such as imputed value of rent of the owner-occupied house (dwellings), value of the part of total produce kept by the producer for self-consumption, value of the finances provided by an entrepreneur for his own business, etc.
8. Employer's Contribution to the Social Security Funds such as provident fund, retirement fund, pension fund and other components of compensation paid by the employer on the behalf of the employees.
- Q38VIEW SOLUTIONSolution:
Functions of Commercial Banks
The following are the various functions performed by a commercial bank.
1. Acceptance of Deposits- Accepting deposits from the general public is the basic function of a commercial bank. The public deposits are of the following three types.
a. Saving Account Deposits- A Saving Account caters to the needs of those individuals who wish to save a part of their income and earn interest on the amount saved. Such deposits are payable on demand i.e. such deposits can be withdrawn by the depositor as and when required. However, the banks impose a limit on the withdrawal amount from the saving account. Also these deposits are chequeable deposits i.e. cheques can be issued against such deposits.
b. Fixed Account Deposits- Fixed Account deposits (also known as Time Deposits) refer to those deposits that are held for a fixed (specific) period of time (called maturity period). These deposits cannot be withdrawn before the maturity period, hence, are not payable on demand. Also, these deposits are non-chequeable deposits. However, due to the longer lock-in period involved in the fixed account deposits, these deposits involve a higher rate of interest than that earned on the saving account deposits.
c. Current Account Deposits- Current Account deposits (also known as Demand Deposits) refer to those deposits that provide the depositor the liberty to withdraw money at any point of time. The depositor can withdraw the required amount from the account through cheques. Generally, Current Account deposits prove useful for businessmen as they are required to deal with many transactions in a single day. Such deposits do not offer any rate of interest.
2. Granting Loans and Advances- Granting loans and advances to the investors is the second most important function performed by the commercial banks. The deposits received by the banks from the public are not kept idle. Rather, the commercial banks keep only a fraction of the deposits with themselves as reserves and extend the rest as loans and advances to the borrowers for various productive purposes. The loans granted by the banks are given against certain securities i.e. the borrower is required to deposit the approved security with the bank to avail the loan. The following are the different types of loans and advances made by the commercial banks.
a. Cash Credit- In the system of Cash Credit, the banks first estimate the value of the assets held by the borrower. Based on this estimation, a credit limit is then decided by the bank for the borrower. The credit limit decided by the bank is the upper limit for borrowings by the borrower. However, the actual utilisation of credit by the borrower depends on his/her withdrawing power. The borrower is liable to pay interest only on the withdrawn portion of the credit.
b. Demand Loans- Under the Demand Loan system, the banks credit the entire loan amount to the borrower. The borrower thus, becomes liable to pay the interest on the entire loan amount. However, such loans can be recalled on demand and have no fixed maturity period.
c. Short-term Loans- Similar to the system of Demand Loans, under the system of Short-term Loans the entire loan amount is sanctioned to the borrower, thus, the borrower becomes liable to pay interest on the entire loan amount. However, as opposed to the Demand Loans, the Short-term Loans have a fixed maturity period. In other words, the Short -term Loans cannot be recalled and the repayment of these loans is done either in one instalment or in a series of instalments.
3. Agency Functions- Besides performing the major functions of acceptance of deposits and granting of loans, the commercial banks also perform various agency functions as well. The following are the major agency functions performed by the commercial banks.
a. Transfer of Funds- Banks provide easy and cheap flow of funds from one place to another via mail transfers, demand drafts, etc.
b. Collection and Payment of Funds- The banks also perform the function of collecting funds on behalf of their customers through bills, cheques, etc. In addition to this, banks also make certain payments such as taxes, insurance premium, etc., on the behalf of their customers.
c. Purchase and Sale of Securities and Foreign Exchange- Since the commercial banks are more knowledgeable in regards to the stocks and shares, thereby; they buy and sell such securities on behalf of their customers. Similarly, banks also purchase and sell foreign exchange for their customers.
d. Role of Trustee and Executor- The commercial banks also perform the role of a trustee and executor for the property of their customers.
e. Provision of Underwriting Facilities- Certain commercial banks provide the facility of underwriting the sale of new shares (underwriting refers to the act of purchasing fully or a portion of the whole or unsold portion of the new shares).
4. Discounting Bills of Exchange- The commercial banks provide financial assistance to the business community by discounting bills of exchange. A bill of exchange is a document that acknowledges the amount of money that is owed by the debtors as against the goods and services received by him. The banks purchase these bills produced by the customers (after deducting interest on the face-value of the bill). In this sense, by purchasing the bills they provide easy means of finance to the business community as and when required.
5. Credit Creation- The commercial banks create credit in the economy through demand deposits. Credit creation paves the path for the growth of the economy.
6. Investment of Funds- Apart from granting loans and advances, the banks also invest their surplus funds in securities. Investment in the securities helps the commercial banks to meet their future requirement of funds. The banks can borrow from the RBI against such securities. Also, if required the banks can sell their securities in the open market to meet their requirement of funds. The securities can be of mainly two types- Government Securities and other approved securities.
Government Securities refer to the securities of the central government and the state government. For example, National Savings Certificates, etc.
Other approved securities are those securities that are included under the provisions of Banking Regulation Act, 1949. For example, the securities of the electricity board, housing board, etc.
7. Other Functions- Apart from the above mentioned functions, the commercial banks also perform various other functions as well. These are as follows
a. Providing Locker Facility- The commercial banks provide locker facility to their customers (account holders) for keeping their valuables.
b. Issuing Traveller's Cheque and Letters of Credit- They provide their customers traveller's cheque and letters of credit. The traveller's cheque and letters of credit help the people to avoid the risk of carrying cash while travelling.
c. Providing useful business and statistical information- The banks provide critical business and statistical information as and when required by the customers.
- Q39VIEW SOLUTIONSolution:
Price Quantity demanded 8 24 10 20 12 16 14 12 16 8
Calculate the missing costs :
Output in Units TFC TVC TC AFC AVC AC 1 50 ? 70 50 ? ? 2 ? 30 ? 25 ? 40 3 50 ? 90 ? 13.33 30 4 50 60 110 12.5 15 27.5 5 50 90 ? 10 18 ?Solution: Output in Units TFC TVC TC AFC AVC AC 1 50 20 70 50 20 70 2 50 30 80 25 15 40 3 50 40 90 16.66 13.33 30 4 50 60 110 12.5 15 27.5 5 50 90 140 10 18 28
If the demand and supply function of raw cotton are Qd = 250 – 50p and Qs = 25 + 25p, find the equilirbium price and the equilibrium quantity demanded and supplied and prove that any price other than equilibrium price leads either to excess supply or excess demand.VIEW SOLUTIONSolution:In equilibirum,
Quantity demanded = Quantity supplied
250 - 50p = 25 + 25p
p = 3
When p = 3, quantity demanded and quantity supplied will be
250 - 50(3) = 100 units.
Now, if the price will be greater than 3(say, 4), the quantity demanded will be
250 - 50(4) = 50 units and,
Quantity supplied will be
25 + 25(4) = 125 units
Hence, if price > 3, excess supply will prevail in the market. Similarly, if price < 3, excess demand will prevail in the market.
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