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The term productivity in general is defined as a ratio of what comes out of a business to what goes in to
the business, i.e., it is the ratio of outcome to the efforts of the business. Hence, productivity would
mean the value of output divided by the value of inputs employed. There are different kinds of
productivity ratios.
Walking inflation When the rise in prices is moderate (in the range of 3 to 7%) and the annual inflation
rate is of single digit it is called walking inflation. It is a warning signal for the government to control it
before it turns into running inflation.
Running inflation When the prices rise rapidly at a rate of 10 to 20% per annum it is called running
inflation. Such inflation affects the poor and middle classes adversely. Its control requires strong
monetary and fiscal measures; otherwise, it can lead to hyperinflation.
Hyperinflation Hyperinflation is also called by various names like jumping, runaway, or galloping
inflation. During this period, prices rise very fast (double or triple digit rates) at a rate of more than 20 to
100% per annum and become absolutely uncontrollable. Such a situation brings a total collapse of the
monetary system because of the continuous fall in the purchasing power of money.
Demand-pull Inflation The total monetary demand persistently exceeds the total supply of goods and
services at current prices so that prices are pulled upwards by the continuous upward shift of the
aggregate demand function. It arises as a result of an excessive aggregate effective demand over
aggregate supply of goods and services in a slowly growing economy. Supply of goods and services will
not match the rising demand. The productive ability of the economy is so poor that it is difficult to
increase the supply at a quicker rate to match the increase in demand for goods and services. When
exports increase, the money income of people rises. With excess money income, purchasing power,
demand, and prices move in the upward direction.
Cost-push inflation Prices rise on account of increasing cost of production. Thus, in this case, rise in
price is initiated by growing factor costs. Hence, such a price rise is termed as cost-push inflation as
prices are being pushed up by rising factor costs. A number of factors contribute to the increase in cost of
production. They are:
Demand for higher wages by the labour class.
Fixing of higher profit margins by the manufacturers.
Introduction of new taxes and raising the level of old taxes.
Q4. Define Fiscal Policy and the instruments of Fiscal policy. (Explanation of Fiscal Policy,
Instruments) 2, 8
Answer:
Fiscal Policy
Fiscal policy is an important part of the overall economic policy of a nation. It is being increasingly used
in modern times to achieve economic stability and growth throughout the world. Lord Keynes, for the
first time, emphasized the significance of fiscal policy as an instrument of economic control. It exerts
deep impact on the level of economic activity of a nation.
Instruments of fiscal policy
The instruments of fiscal policy include:
1. Public revenue: It refers to the income or receipts of public authorities. It is classified into two parts tax-revenue and non-tax revenue. Taxes are the main source of revenue to a government. There are two
types of taxes. They are direct taxes such as personal and corporate income tax, property tax, expenditure
tax, and indirect taxes such as customs duties, excise duties, sales tax (now called VAT). Administrative
revenues are the bi-products of administrate functions of the government. They include fees, licence fees,
price of public goods and services, fines, escheats and special assessment.
2. Public expenditure policy: It refers to the expenditure incurred by the public authorities like central,
state and local governments. It is of two kinds: development or plan expenditure and non-development or
non plan expenditure. Plan expenditure includes income-generating projects like development of basic
industries, generation of electricity, development of transport and communications and construction of
dams. Non-plan expenditure includes defense expenditure, subsidies, interest payments and debt
servicing changes.
3. Public debt or public borrowing policy: All loans taken by the government constitutes public debt. It
refers to the borrowings made by the government to meet the ever-rising expenditure. It is of two types,
internal borrowings and external borrowings.
4. Deficit financing: It is an extraordinary technique of financing the deficits in the budgets. It implies
printing of fresh and new currency notes by the government by running down the cash balances with the
central bank. The amount of new money printed by the government depends on the absorption capacity of
the economy.
5. Built in stabilizers or automatic stabilizers (BIS): The automatic or built-in stabilizers imply
automatic changes in tax collections and transfer payments or public expenditure programmes so that it
may reduce the destabilizing effect on aggregate effective demand. When income expands, automatic
increase in taxes or reduction in transfer payments or government expenditures will tend to moderate the
rise in income. On the contrary, when the income declines, tax falls automatically and transfers and
government expenditure will rise and thus built-in stabilizers cushion the fall in income.
Q5. Investment is a part of income which can be used for various purposes. It is necessary to create
employment in an economy and to increase national income. To understand the benefits of income,
study the various types of investment. (Explanation of investment, types of investment)
Answer:
Investment Function
Investment is the second important component of effective demand. In Keynesian economics, the term
investment has a different meaning. In the ordinary language, it refers to financial investment. i.e.
purchase of stocks, shares, debentures, bonds, etc. In this case, there is only transfer of rights or titles
from one person to another. It is an investment by one and disinvestment by another and as such, the
value transaction mutually cancels out each other. They do not add anything to the total stock of capital of
the nation. Investment, according to Keynes, refers to real investment. It implies creation of new capital
assets or additions to the existing stock of productive assets. It refers to that part of the aggregate income,
which is used for the creation of new structures, new capital equipments, machines, etc that help in the
production of final goods and services in an economy. Creation of income earning assets is called
investment. Thus, investment must generate income in the economy. Investment also refers to an addition
to capital with such investment occurring when a new house is built or a new factory is built. Investment
means making an addition to the stock of goods in existence. These activities necessitate the employment
of more labour and thus result in an increase in national income and employment.
Types of investment
Keynes speaks of 5 types of investment. They are as follows:
1. Private investment
It is made by private entrepreneurs on the purchase of different capital assets like machinery, plants,
construction of houses and factories, offices, shops, etc. It is influenced by MEC and interest rate. It is
profit elastic. Profit motive is the basis for private investment. Private entrepreneurs would take up
only those projects which yield quick results and generally those that have a small gestation period.
2. Public investment
It is undertaken by the public authorities like central, state and local authorities. It is made on building
infrastructure of the economy, public utilities and on social goods, for example, expenditure on basic
industries, defense industries, construction of multipurpose river valley projects, etc. In this case, the
basic criterion and motto is social net gain, social welfare and not profits. The principle of maximum
social advantage would govern public expenditure. It is also influenced by social and political
considerations.
3. Foreign investment
It consists of excess of exports over the imports of a country. It depends on many factors such as
propensity to export of a given country, foreigners capacity to import, prices of exports and imports, state
trading and other factors.
4. Induced investment
Induced investment is another name for private investment. Investment, which varies with the changes in
the level of national income, is called induced investment. When national income increases, the aggregate
demand and level of consumption of the community also increases. In order to meet this increased
demand, investment has to be stepped up in capital goods sector which finally leads to increase in the
production of consumption goods Therefore, we can say that induced investment is income elastic i.e.,
it increases as income increases and vice-versa.
5. Autonomous investment
Autonomous investment is another name for public investment. The investment, which is independent
of the level of income, is called as autonomous investment. Such investments do not vary with the level
of income. Therefore it is called income-inelastic. It does not depend on changes in the level of income,
consumption, rate of interest or expected profit.
Q6. Discuss any two law of returns to scale with example. (Law of returns to scale, examples) 8, 2
Answer: Laws of returns to scale
The concept of returns to scale is a long run phenomenon. In this case, we study the change in output
when all factor inputs are changed or made available in required quantity. An increase in scale means that
all factor inputs are increased in the same proportion. In returns to scale, all the necessary factor inputs
are increased or decreased to the same extent so that whatever the scale of production, the proportion
among the factors remains the same.
Three phases of returns to scale
Generally speaking, we study the behaviour pattern of output when all factor inputs are increased in the
same proportion under returns to scale. Many economists have questioned the validity of returns to scale
on the ground that all factor inputs cannot be increased in the same proportion and the proportion between
the factor inputs cannot be kept uniform. But in some cases, it is possible that all factor inputs can be
changed in the same proportion and the output is studied when the input is doubled or tripled or increased
five-fold or ten-fold. An ordinary person may think that when the quantity of inputs is increased 10 times,
output will also go up by 10 times. But it may or may not happen as expected. It may be noted that when
the quantity of inputs are increased in the same proportion, the scale of output or returns to scale may be
either more than equal, equal or less than equal. Thus, when the scale of output is increased, we may get
increasing returns, constant returns or diminishing returns. When the quantity of all factor inputs are
increased in a given proportion and output increases more than proportionately, then the returns to scale
are said to be increasing; when the output increases in the same proportion, then the returns to scale are
said to be constant; when the output increases less than proportionately, then the returns to scale are said
to be diminishing.
Increasing returns to scale
Increasing returns to scale is said to operate when the producer is increasing the quantity of all factors
[scale] in a given proportion leading to a more than proportionate increase in output.
For example, when the quantity of all inputs are increased by 10%, and output increases by 15%, then
we say that increasing returns to scale is operating. In order to explain the operation of this law, an equal
product map has been drawn with the assumption that only two factors X and Y are required. Figure 5.9
depicts the operation of the law of increasing returns to scale. In the figure, Factor X is represented along
OX axis and factor Y is represented along OY axis. The scale line OP is a straight line passing through the
origin on the isoquant map indicating the increase in scale as we move upward. The scale line OP
represent different quantities of inputs where the proportion between factor X and factor Y is remains
constant. When the scale is increased from A to B, the return increases the output from 100 units to 200
units. The scale line OP passing through origin is called as the expansion path. Any line passing
through the origin will indicate the path of expansion or increase in scale with definite proportion
between the two factors. It is very clear that the increase in the quantities of factor X and Y [scale] is
small as we go up the scale and the output is larger. The distance between each isoquant curve is
progressively diminishing. It implies that in order to get an increase in output by another 100 units, a
producer is employing lesser quantities of inputs and his production cost is declining. Thus, the law of
increasing returns to scale is operating.