KENDRIYA VIDYALAYA

KendriyaVidyalayaSangth
SANGTHAN

RAIPUR REGION

Study Module Of ECONOMICS

CLASS - XII
(2012 - 2013)
Chief Patron
Shri. S SRawat
Deputy Commissioner (Raipur region)
Patron
ShriSaseendran&ShriTajjuddin Sheikh
Assistant Commissioner (Raipur region)
Coordinator:- Akanksha Sharma
Principal KV Khairagarh
Resource Persons PGT Economics :Mr.D. B .Ram KV No.1 Raipur (Shift 2)
Mr.JogeshRana KV Bhawanipatna
Mr. K.K. Dash KV No.1 Raipur(Shift 1)
Ms.Prabha Seth KV Bilaspur
Mr. Sanjay KV Raigarh

Preface
A team of experienced teachers endeavour to bring out astudy module, for the session
2012-2013
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
papers
2.Read the Marking scheme given by CBSE
3.Read & learn CBSE sample papers given by CBSE along with
marking scheme
4.Practice Sums
Unit
Tipsyear
for
students
5.Read questions from previous
papers
& board papers Marks
given in various books
1
Unit
1: Introduction
6.Practice
HOTS
Questions
Suggested
sequence
in which students may 4

2
7
Unit
10: Balance
of questions
Payments
7.From
this year
value
based
REVISE
topics will also
3
10
Unit 4:practice
Forms of Market
come
in Exam.So
them, and
eg.Price
Q 11 & 19 of
Determination
CBSE
When
SAMPLE
revising
PAPER
keep
GIVEN
marking
BELOW
topics learnt
4
8
Unit 7: Money and Banking
1.Explanation
of
features
of
various
markets,
Unit
4
5
18
Unit 2: Consumer Equilibrium and Demand
2.Functions
of
Central
bank,
Unit7
6
8
Unit 9: Government Budget and the Economy
3.Credit control by Central bank ( CRR,SLR,Bank Rate, Open
7
18
Unit 3: Producer
Behaviour
and Supply
Market
Operations)
, Unit7
8
12
Unit 8: Determination
of of
Income
andUnit9
4.Components
Budget,
Employment
5.Fiscal
Deficit & its implications, Unit9
6.Components
of BOP,
Unit 10
9
15
Unit 6: National Income and related
aggregates

7.Phases showing relation

* between TP,AP,MP. , Unit3
8.Factors effecting Demand, Unit2
* 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
9. Change in demand &weightage
change in quantity demanded, Unit2
effecting Supply,
Unit3
* Write down your own notes 10.Factors
and make summaries
with the
help of this study material.
11.Market equilibrium, Shifts in Demand & Supply & effect on
equilibrium, Unit4
12.Consumer equilibrium, Unit2
13.Functions of money, Unit7
14.Producer equilibrium, Unit3
15.Sums on elasticity of Demand or supply, Unit2 &3
16.Deflationary & inflationary gap, Unit8
17.Sums from unit on determination of income, Unit8
18.Precautions in calculation of national income, Unit6

After studying above topics complete units

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; concepts
of 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, conditions
of consumer's equilibrium using marginal utility analysis.
Indifference curve analysis of consumer's equilibrium-the consumer's budget (budget set and budget
line), preferences of the consumer (indifference curve, indifference map) and conditions of consumer's
equilibrium.
Demand, market demand, determinants of demand, demand schedule, demand curve, movement
along and shifts in the demand curve; price elasticity of demand - factors affecting price elasticity of
demand; measurenment of price elasticity of demand (a) percentage-change method and (b) geometric
method (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 and
shifts in supply curve, price elasticity of supply; measurement of price elasticity of supply (a) percentagechange 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 demand
and supply.
Other Market Forms - monopoly, monopolistic competition, oligopoly - their meaning and features.

Unit 5: Simple applications of Tools of demand and supply

(not to be examined)

329

8 Periods

DESIGN OF QUESTION PAPER

ECONOMICS
Part B : Introductory Macroeconomics
Class XII

Unit 6: National Income and related aggregates

30 Periods

Marks 100

Duration 3 hrs.
Some basic concepts: consumption goods, capital goods, final goods, intermediate goods;
stocks
and
flows; gross investment and depreciation.
1.
by type
of questions
CircularWeightage
flow of income;
Methods
of calculating National Income Value Added or Product
method,
Expenditure method, Income method.
Aggregates related to National
TypeIncome: Number of Marks Total
Estimated time a
Gross National Product (GNP), Net National Product (NNP), Gross and Net Domestic
questions
candidate is expected to
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.
take to answer
GDPand Welfare
Long answer questions

Unit 7: Money and Banking

answer
questions
Money Short
its meaning
and
functions.I

36

60 minutes

24

36 minutes

18 Periods

Supply ofShort
money
Currency held by the public10
and net demand
deposits
held by commercial
answer questions II
3
30
50 minutes
banks.
Money creation by the commercial banking system.
Central bank
its answer
functionsquestions
(example of the Reserve
Bank
Veryand
short
10
1 of India).
10
15 minutes

Unit 8: Determination of Income and Employment

25 Periods

Aggregate demand and its components.

2.
Weightage
by and
content
Propensity
to consume
propensity to save (average and marginal).
Shortrun equilibrium output; investment multiplier and its mechanism.
Unit No.
Unit Title
Meaning of full employment and involuntary unemployment.
Problems of excess
demand
and deficient demand; measures to correct them - change in
1
Introduction
government
spending, availability of credit.
2

Consumer Equilibrium and Demand

Producer Behaviour and Supply

Unit 9: Government Budget and the Economy

Determination of Income and Employment

Balance of Payments

4
18

17 Periods

Government budget - meaning, objectives and components.

Classification of
- revenue
receiptsand
andPrice
capital
receipts; classification of expenditure 4 receipts
Forms
of Market
Determination
revenue
expenditure and capital expenditure.
5
National
Related
Measures of government
deficit -Income
revenue and
deficit,
fiscal Aggregates
deficit, primary deficit:their meaning.
Fiscal Policy and
its
role
(non
evaluative
topic)
6
Money and Banking

Unit 10: Balance of Payments

Marks

18
10
15
8

14 Periods
12

Balance of payments account - meaning and components; balance of payments deficit-meaning.

Foreign exchange
meaning of fixed
andand
flexible
rates and managed floating.
8 rate Government
Budget
the Economy
8
Determination of exchange rate in a free market.
7

Recommended textbooks
10

1.
Indian Economic Development, Class XI, NCERT
2.
Introductory Micro Economics, Class XII, NCERT
3.
Macro Economics, Class XII, NCERT
4.
Supplimentary Reading Material in Economics, Class XII, CBSE
Note : The above publications are also available in Hindi Medium
331

330

Total

100

3.

Difficulty level of the question paper

Level

Marks

% age of the
total marks

A. Easy

30

30

50

50

20

20

(Can be attempted satisfactorily by students who

have gone through the study material)
B. Average
(Can be attempted by students who have regularly
studied the study material but may not have given
sufficient time to writing.
C. Difficult
(Can be attempted by top students)

4.

Scheme of Options
There is no overall choice. However, there is an internal choice in one question of 6
marks, 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 questions

The question paper will contain value based question/questions to the extent of
5 marks.

332

SAMPLE QUESTION PAPER

ECONOMICS
Class XII
Maximum Marks: 100

Time: 3 hours

BLUE PRINT
Sl.
No.

Content Unit

Forms of Questions
Very Short

Short Answer

Long Answer

Answer (1 Mark)

(3,4 Marks)

(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)

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
indicate
bracketsmarks for each question.

2. The question paper will include Valuebased questions to the extent of five marks.

333

Sample Question Paper

Economics
Class XII
Time 3 Hours.

Maximum Marks 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. They
are required to be answered in one sentence each.

4.

QuestionNos. 6-10 and 22-26 are short-answer questions carrying 3 marks each. Answer
to 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 as
possible.

334

Section A
1.

State two features of resources that give rise to an economic problem.

2.

What happens to total expenditure on a commodity when its price falls and its
demand is price elastic?

(1)

(1)

3.

What happens to equilibrium price of a commodity if there is an KPETGCUG_

KP_KVU_
FGOCPF_CPF_FGETGCUG_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_KPETGCUG_KP_FGOCPF_of a commodity.

(3)

7.

Will the supply at a point on a positively sloped, straight line supply curve be
(3)

unitary elastic, elastic or inelastic?

8.

Explain why is production possibility frontier concave.

OR
Explain the cGPVTCN_RTQDNGO_JQY_VQ_RTQFWEG_
9.

(3)

How does the nature of a commodity influence its price elasticity of demand?
(3)

Explain.
10. Calculate the price elasticity of demand for a commodity when its price increases
by 25% and quantity demanded falls from 150 units to 120 units.

(3)

11. Demand for electricity hasincreased. 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 is
able to sell more quantity of output:
(i) at the same price.
(ii) only by lowering the price.

OR
Explain 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.

335

(4)

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 marginal revenue
approach. Give reasons for your answer.
Output (Units)

Average Revenue (Rs)

Total Cost (Rs)

15

21

26

33

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?

(6)

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 QT_ RCTV_QH_
question No.16
Explain when a consumer, consuming only two commodities X and Y, attains
equilibrium under the utility approach.

(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 in
prices of the imports of essential goods. What can Central Bank do to ease the
(1)

situation?
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 fiTOU_net value added at factor
cost:
(Rs in Lac)
(i)

Subsidy

40

(ii)

Sales

(iii)

Depreciation

(iv)

Exports

(v)

Closing stock

20

(vi)

Opening stock

50

(vii)

Intermediate purchases

800
30
100

500

(viii) Purchase of machinery for own use

(ix)

200

Import of raw material

60 (3)

23. Give the meaning of Nominal GDP and Real GDP. Which of these is the indicator
(3)

of economic welfare and why?

24. /CEJKPG_RWTEJCUGFKU_CNYC[U_C_HKPCN_IQQF__&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?
(3)

Give reasons for your answer.

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. 29
above:
Explain equilibrium level of national income using Savings and Investment
approach.

OR
Complete the following table:
Income

Saving

Marginal Propensity Average Propensity

to Consume
to Consume

-20

50

- 10

_________

_________

100

_________

_________

150

30

_________

_________

200

60

_________

_________

338

(4)

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
(6)

equilibrium.
32. From the following data calculate National Income by Income and Expenditure
methods:
(Rscrore)
(i)

Government final consumption expenditure

100

(ii)

Subsidies

(iii)

Rent

200

(iv)

Wages and salaries

600

(v)

Indirect taxes

(vi)

Private final consumption expenditure

10

60

(vii) Gross domestic capital formation

800
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)

50

Change in stock

OR

339

(6)

Calculate Gross National Disposable Income and Personal Income from the given
data:
(Rscrore)
(i)

Personal tax

120

(ii)

Net indirect tax

100

(iii)

Corporation tax

90

(iv)

National income

1000

(v)

Net factor income from abroad

(vi)

Consumption of fixed capital

5
50

(vii) National debt interest

70

(viii) Retained earnings of private corporate sector

40

(ix)

Net current transfers to the rest of the world

(x)

Current transfers from government

30

(xi)

National income accruing to government

80

340

(-)20

Marking Scheme
for
Sample Question Paper
Section 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.

x2

2.

Total expenditure increases.

3.

Equilibrium price increases.

4.

It is the price at which market demand and market supply of the good are
1

equal.
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.

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 of

341

1x3

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 more
quantity of one good is produced by reducing quantity of the other good. This
behaviour of the MRT is based on the assumption that no resource is equally
efficient in production of all the goods. As more of one good is produced, less
and less efficient resources have to be transferred from the production of the
other good which raises marginal cost i.e. MRT.

OR
*QY_VQ_RTQFWEG_KU_VJG_RTQDNGO_QH_EJQQUKPI_VJG_VGEJPKSWG_QH_RT
QFWEVKQP___
Techniques are broadly classified into capital intensive and labour intensive.
The problem is to use capital intensive technique in which more of capital
goods like machines, etc. are used, or to use labour intensive technique in which
more of labour is used.
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

10.

demand for comforts.

1x3

percentage change in demand

Ed= ----------------------------------percentage change in price

-30
= 150

x 100
1

25

= 0.8

11. Consumer can (1) use energy saving electrical appliances, (2) use alternate
sources of energy like solar energy, etc (or any other) (Explain).
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.
2

So, the supply of the given good decreases.

13. Output (units)

AR (Rs)

TC (Rs)

MC (Rs)

MR (Rs)

15

21

26

33

41

Equilibrium
1

The producer achieves equilibrium at 5 units of output. It is because this level of output
UCVKUHKGU_DQVJ_VJG_EQPFKVKQPU_QH_RTQFWEGTU_GSWKNKDTKWO__
1
(i)

Marginal cost is equal to marginal revenue.

(ii)

Marginal cost becomes greater than MR after this level of output.

343

1
11

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.
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_ EQPUWOGTU_ UJCTG_ KP_ VQVCN_
RWTEJCUG_
KU_ UQ_
insignificant because
of their large numbers that she cannot influence the
3

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.

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

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.

OR

Y
A
C
Y
d
o
o
G

I3
D
O

x
Good X

I2
I1
B

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

= Px/P y

MRSxy

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 income
2

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 14_2#46_QH_ Q. No. 16

ConUWOGTU_ GSWKNKDTKWO_ OGCPU_ OCZKOWO_ UCVKUHCEVKQP_

NGXGN_ QH_ VJG_ EQPUWOGT__

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.

MUx
Px
If

MUy
Py

MUy
MUx
is greater than
, the consumer will buy more units of X by
Py
Px

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

MUy
MUx
is less than
Py
Px

till the equilibrium is achieved.

2) JG_ Marginal utility falls as more is consumed i.e. the law of diminishing 3
%
marginal utility is in operation. The first condition will not be satisfied
GP
VT until the second is satisfied.

17.

18.
19.
20.

21.

22.

CN
_$
CP
M_
Section B
EC
P_
Involuntary unemployment occurs when those who are able and willing to
UV
work
CT at the prevailing wage rate do not get work.
V_
The sum of MPC and MPS is equal to one.
UG
6N
NK
The
PI_two components of money supply are: currency held by the public and
75_
demand
deposits with commercial banks.
&Q
Cash
N Reserve Ratio is the ratio of bank deposits that commercial banks must
NC as reserves with the Central Bank.
keep
TU
NVAfc
_H = (ii) + (v) (vi) (vii) (iii) + (i)
TQ
O_
KV
U_
346
T
GU
GT
XG
U
_

1
1
1

1
1

23.

= 800 + 20 50 500 30 + 40

= Rs 280 lakh

0 QOKPCN_)&2_XCNWGU_VJG_EWTTGPV_[GCTU_QWVRWV_KP_CP_GEQPQO[_CV_E
WTTGPV_[GCT_
prices.
1
4 GCN_)&2_XCNWGU_VJG_EWTTGPV_[GCTU_QWVRWV_KP_CP_GEQPQO[_at
a set of
constant
prices.

24.

25.

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.

9JGVJGT_OCEJKPG_KU_C_HKPCN_IQQF_QT_PQV_FGRGPFU_QP_JQY_KV_KU_DG
KPI_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.

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.
26.

The current account records transactions relating to the export and import of
goods and services, income and transfer receipts and payments during a
1

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.

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.
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 1

1

asset.
(d)

It is a revenue receipt as it neither creates a liability nor reduces any 1

asset.

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*.
Y
/ ent
gs m
vinst
a ve
S In

E
I

Y 2 Y*

Y1

Income/
Output

At an income level OY , planned

savings are greater than planned
1
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

348

investment are equal.

At an income level OY , 2planned savings are less than planned investment.

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

30.

Income

MPC

20

20

50

50

-10

60

40

0.8

1.2

100

50

100

40

0.8

1.0

150

50

30

120

20

0.4

0.8

200

50

60

140

20

0.4

0.7

APC

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

x8=4

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

1
LRR

31
.

AC is the consumption curve and OA is the consumption expenditure at

zero level of income.
Income minus
consumRVK
consumption level is OA. Thus, the corresponding level of savings is OA.
QP_KU_UCX
KPIU__9JGP_
KPEQOG_KU
_\GTQ__VJG
350
_GEQPQO[
U_

So, A1is the starting point of saving curve

At OB level of income consumption is equal to income, so savings are zero.
So B1is another point on saving curve

Joining A1and B and

extending we get the saving curve S.
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 :

31.

1.

Reduction in bank rate by the Central Bank.

2.

Reduction in cash reserve Ration by the Central Bank.

Income Method

National Income = iv + viii + (iii + ix) + xi +xiii x

= 600 + 55 + (200 +25) + 20 +130 -30

= Rs 1,000 crore
Expenditure Method
National Income = vi + i + vii + xiv v + ii xii x
= 800 + 100 + 120 + 70 60 + 10 10 30
= Rs 1,000 crore

OR
GNDI = iv + ii + vi ix

1
1
1
1
1

= 1000 + 100 + 50 (-20)

= Rs 1170 crore
Personal Income = (iv xi) + (vii ix + x) viii iii
= 1000 -80 + 70 (- 20) + 30 40 90
= Rs 910 crore

1
1
1

351

Sample Question Paper

Economics
Class XII
Max. Marks 100

Time : 3 hrs.
Question wise Analysis

S. No.
of Q.

Unit No.

Marks allotted

Estimated Time
(Min)

Estimate
difficulty level

1
1

1
1

10

11

12

13

14

10

15

10

16

17

10
1

18

19

10

20

21

22

B
A

1
1

A
A

1
1

23

24

25

10

26

10

352

C
A

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
y
MRT =
--------------------------------------------- =
-------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 :SN
o

Positive Economics

It deals with what is what It deals with what ought to

was.
be.

It is based on cause and It is based on ethics.

effect of facts.

It can be
actual data

In this value of judgments In this value of judgments are

are not given.
given.

verified

Normative Economics

with It cannot be verified with

actual data.

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

Wheat

100

90

70

40

Gun

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 individualan 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:- consumers
demand, market price of

3. Examples:aggregate
demand, general price

commodity, firms output.

level in the economy,

aggregate supply in the
economy.

11.
Market economy
In
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 economic system, in
which all material means of
production are owned and
operated by the private sector
with profit motive.

Planned economy
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.

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.
Wheat
1
4
2

A
B

1
0

(scarcity of resources)

C
8

Full employment of resources

*G
E

Under utilization of
resources

4
2

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
Commo
ProductionPos

Commo

sibility

dity

dity

A
B

Marginal
opportunity
cost
commodity A

15

14

15-14=1

12

14-12=2

09

12-9=3

05

9-5=4

5-0=5

Commodity A

of

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

(2) Down ward shift

When Resources depletes
y

O
15..Distinguish between a centrally planned economy and a market
economy.
SN Planned Economy
o

Market Economy

All the materials means of All the materials means of

production are owned by production are owned by private
government.
individuals.

Main objectives of production Main objectives of production are

is social welfare
maximization of profit.

Ownership of property is There is no limit to

under government control.
ownership of property.

All the economic problems All the economic problems are

are solved as per direction of solved through price mechanism
the planning commission.
i.e., demand and supply.

private

16. From the following PP schedule calculate MRT of good x.

Production possibilities

Production of good x units

Production of good y units

14

13

11

Production
of Production
good X units
good

of MRT = y /
x

Y units
0

14

13

1:1

11

2:1

3:1

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 Consumers Behaviour 18 marks

NOTE: important topics of this unit are
CONSUMERS EQUILIBRIUM in case of one commodity
marginal utility approach
CONSUMERS EQUILIBRIUM in case of two commodity
(a) marginal utility approach
(b) Indifference curve (IC) approach
Types of ELASTICITY
Sums on PRICE ELASTICITY OF DEMAND
Change in demand or Change in Quantity demanded or
factors that affect the price elasticity of demand
CONSUMERS EQUILIBRIUM
Q1. Given the price of a commodity, Explain how does consumer reach
at equilibrium. (hot question) OR
Explain consumers 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
(4Mum=1Pm)

of

money

(Mum)=4

utils.

i.e.4utils=1

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

MUx
utils

20

18

16

10

-5

MUx/Px,is
MU
in
rupees

4.
5

2.5

0.1

MUm/Pm
=4

Mu = p

Mu < p

in

Mu > p

Consumer equilibrium occurs at 3 units of consumption

where MUx/Px

Mum/Pm=4

ruppee

i.eMux in Rupees.= Px in Rupees=4

Disequilibrium occurs below or above this level of consumption:(a)i.eWhen consumer buys 1stunit
MUx/Px<

Mum/Pm

Mux in rupees= Mux (in utils)/Px = 20/4 = Rs 5,

i.e Mux>Px,

Px = Rs 4

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
equilibrium level to the right of point R
MUx/Px>

level

above

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
commodity approach with the help of schedule.

case

of

two

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
1
2

MUx
88
72

MUy
40
36

Mux/Px
11
9

MUy/Py
5
9.5

3
4
5
6
7
8
9
10

64
56
48
40
32
24
16
8

24
20
16
12
8
4
0
0

8
7
6
5
4
3
2
1

3
2.5
2
1.5
1
0.

Sol:- in case of two commodities consumer equilibrium condition

are:
(1) MUx/Px = MUy/Py =Mum/Pm

..(i)

(2) consumrs 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

consumrs expenditure equals
64+ Rs 24=88= Income

=QxPx+QyPy=8 x 8+3 x 8= Rs

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 consumers income.Here,consumrs
expenditure exceeds his income,i.e.
Rs.72(=9x8)+Rs.40(=5x8)=Rs112>Rs.88.

Q3

Change

in

demand

or

Shift

in Change

in

Quantity

demand curve

demanded
or
movement
along the same demand
curve
demand for the commodity changes Other factors affecting demand
due to change in other factors affecting remain constant like income ,
demand
like
income
,
taste
, taste , preferences etc.
preferences etc.
Price remains constant
It occurs due to fall or rise in the
price of
good
It is of two types
It is of two types
(a) increase in demand, demand curve (a)Extension in demand, upward
Shifts upwards to right from D to D1
movement
along the same
(b) decrease in demand, demand curve demand curve from A to B
Shifts downwards to left from D to D2
(b)contraction
in
demand,
downward movement along the
same demand curve from B to
A.
Price
A

Q4

Increase in demand

B
quantity demanded

Extension in demand

demand curve Shifts upwards to right upward movement along the

from D to D1
same demand curve from A to B
Price remains constant
It occurs due to fall in the price
of
good
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

Other factors affecting demand

remain constant like income ,
taste , preferences etc.

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.
Q5

Decrease in demand
contraction in demand
demand curve Shifts downwards to left It is the downward movement
from D to D2
along the same demand curve
from B to A.
Price remains constant

It occurs due to rise in the price

of
Good

Decrease in demand occurs when

Contraction in demand,
(i)When income decreases. of the Other factors affecting demand
consumer consuming normal good
remain constant like income ,
(ii)When income increases. Of the taste , preferences etc.
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.
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

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 CONSUMERS 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
each other.
So, MRSxy

IC and budget line are tangent to

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 CONSUMERS 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
each other.
So, MRSxy

IC and budget line are tangent to

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)

40

30

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

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:
Situatio
n

Price
per
unit(Rs)

Quanti
ty

Total
expendit
ure (Rs)

Elasticity of demand

Situatio
n-1

10

10

100

Ed = 1: a situation of
unitary

20

100

Elastic of
demand.

Situatio
n-2

Situatio
n-3

10

10

100

30

150

10

10

100

15

75

Ed >1 : a situation of
elastic
Demand.
Ed<1 : a situation of
inelastic
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 goodgoods 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 increasesits
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 increasesits
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 demand
Individual demand
Market demand
Price of the other good
Price of the other good
Income of the consumer
Income of the consumers
Taste
and
preferences
of Distribution of income
consumers
Expectations 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. Consumers 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 xQ/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
Or

(-) X/100 x -5/5 = 1.2 or X/100 = 1.2

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
expenditure or out lay method.

of

demand

and

Total

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.
Situat
ion

Price of
commo
dity
(Rs)

Quant
ity

Effect on
total
expendit
ure

Elasti
city of
dema
nd

Some
total

Unitary
elastic

expenditu
re.

Ed= 1

Total

Greate

(kg)

Total
expendit
ure
(Rs)

expenditu
re

r than
unitary

10

10

increases.

Ed>1

Total
expenditu
re

Less
than
Unitary

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 those factors which can be changed in
which cant be changed in short run, short run.in long run all factors inputs
they remain fixed
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 Labour
factor
(in variable factor
acres)
(in units)
2
1
2
2
2
3
2
4
2
5
2
6

Total
Product

Marginal
Product

5
12
20
27
32
34

5
7
8
7
5
2

2
2

34
32

0
-2

7
8

Increasing
returns
to
variable factor
Diminishing
positive returns
to
variable
factor
Diminishing
Negative
returns
to
variable factor

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 falls
When MPP falls & is negative, APP falls but remains positive
12.Calculate APPs and MPPs of a factor from the following table.
Level of factor
0
1 2
3
4
Employment:
TPP:
0
5
12
20
28

35

40

42

Ans.

It is
the
of

Level of Factor
0
1
2
3
4
5
6
7

its
Schedules.

TPP
0
5
12
20
28
35
40
42

APP
-5
6
6.6
7
7
6.6
6

Level of factor
Employment:
MPP:

MPP
-5
7
8
8
7
5
2

13.The following
table gives the
MPPs of a factor.
also known that
TPP at zero level
employment
is
zero. Determine
TPP and APP
1

20

22

18

16

14

Ans.
Level of Factor
0
1

TPP
0
20

APP
-20

MPP
-20

2
3
4
5
6

42
60
76
90
96

21
20
19
18
16

22
18
16
14
6

Chapter COST
1.
fixed costs
Fixed costs are those which do not change
when output is increased or decrease
These are cost of fixed factor inputs
For example Rent of Land, Insurance
charges

variable costs
Variable costs are those costs which vary
with output
These are cost of variable factors inputs.
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 Bill
c) Cost of raw materials
d) Daily wages
e) Payment for transportation of goods.
f) Interest on Capital
g) Telephone charges beyond minimum
h) Wages to permanent staff
Fixed cost.
Variable cost
a) Rent for a shed
c) Cost of raw materials
b) Minimum Telephone Bill
d) Daily wages
f) Interest on Capital
e) Payment for transportation of goods
h) Wages to permanent staff
g) Telephone charges beyond minimum
3 . Cost :- amount paid to hired factor inputs used in production process &
imputed value of self-owned factors inputs of producer
4 .Causes of increasing returns to variable factor
1. 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 & productivity

3. 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 factor
1. 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 cost
TC = TFC + TVC
Total 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.

Total
Costs,

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) TCcurve starts from point on vertical axis above origin equal to TFC
*(e)TFC remains 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 TVCis TFCwhich remains constant at all levels of
output .
7. AVERAGE COSTS
AC

AVC

AVERAGE COSTS

AFC

Quantity of output produced (Q)

Average Total Cost & Average Cost (ATC & AC ) both mean the same
(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 shaped
AC=TC/Q
AC=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.

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

M
N

Q1
Q2
Quantity of output produced

AVC

9. Explain the Relation between MC & AVC curve? OR

Why is AVC curve U shaped?

costs
AC

AVC

MC

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 increases
throughout these output levels MC is less than AVC,
so MC pulls AVC downwards &AVC decreases
When MC<AVC, AVC FALLS
*(ii) When MC is equal to AVC, AVC is at its minimum point
MC=AVC, AVC =Minimum
Minimum 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 increases
When 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? OR
Why is the Short-run Average Cost Curve U-Shaped?
MC and AC Both curves are U shaped

costs

MC

AC

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 increases
throughout these output levels MC is less than AC,
so MC pulls AC downwards &AC decreases

When MC<AC, AC FALLS

*(ii) When MC is equal to AC, AC is at its minimum point
MC=AC, AC =Minimum
Minimum 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 increases
When MC>AC, AC rises.
Hence AC becomes U shaped
11.Relationship between ATC, AVC and AFC curve

costs

AC

AVC

AFC
O

Q1
Q2
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 AC
AFC curve is a rectangular hyperbola.
AFC decreases with increase in output & it is is never zero
AFC+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
5
ATC:
240
160
140
160
180
Ans.
Output (in Units)
TFC TVC AFC AVC
ATC
TC
MC
1
120
120
120
120
240
240 120
2
120
200
60
100
160
320 80
3
120
300
40
100
140
420 100
4
120
520
30
130
160
640 220
5
120
780
24
156
180
900 260
21.From the data given below, calculate AFC, AVC and MC.

Output (in Units):

TC (in Rs.):

0
40

1
100

2
120

3
130

4
150

5
190

Ans.
Output (in Units)
0
1
2
3
4
5

TC

TFC

TVC

AFC

AVC

MC

40
100
120
130
150
190

40
40
40
40
40
40

0
60
80
90
110
150

-40
20
13.3
10
8

0
60
40
30
27.5
30

-60
20
10
20
40

22. Firms 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
TC (in Rs.):
40 120 170 180 210 260 340 440

8
550

Ans.
Output
(in units)
0
1
2
3
4
5
6
7
8

TC
(in Rs)
40
120
170
180
210
260
340
440
550

TFC
(in Rs)
40
40
40
40
40
40
40
40
40

TVC
(in Rs)
0
80
130
140
170
220
300
400
510

AFC
(in Rs)
40
20
13.3
10
8
6.6
5.7
5

AVC
(in Rs)
0
80
65
46.6
42.5
44
50
57.1
63.75

ATC
(in Rs)
120
85
60
52.5
52
56.6
62.8
68.75

FORMULAE
TC = TFC + TVC
TVC = AVC *Q Units of Output
AC = AFC + AVC
AC = TC/Q
AFC = TFC/Q, AVC = TVC/Q , TFC = AFC*Q Units of Output
TC = AC * Q

MC
(in Rs)
-80
50
10
30
50
80
100
110

Note: (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
Units
sold
1

TR
(Rs.)
10

AR
(Rs.)
10

MR
(Rs.)
10

2
3
4

20
30
40

10
10
10

10
10
10

50

10

10

TR

AR=MR

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

Chapter Producers equilibrium

AR
&
MR
AR
MR
UNITS SOLD

1.What is meant by producers

equilibrium?
Ans. Producers 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 producers 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 producers 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 bcozwhen 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

Q1
Q2
Q3
Quantity of output

B. TR and TC approach.
(i)In a competitive market situation
Condition for producers 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
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)

q
P
TR
TC
1
10
10
20
2
10
20
26
3
10
30
30
4
10
40
32
5
10
50
36
6
10
60
42
7
10
70
50
8
10
80
60
9
10
90
78
10
10
100
100
11
10
110
124

Break Even
Point

Producer
Equilibrium

-10
-6
0
8
14
18
20
20
12
0
-14

MC
10
6
4
2
4
6
8
10
18
22
24

MR
10
10
10
10
10
10
10
10
10
10
10

Break Even
Point

TC-TR Approach: (Imperfect Market)

Condition for producers 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 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)

q TR TC MC MR
1 8
20 -12 10
8
2 18 26 -8 6
10
Break Even
3 30 30 0
4
12
Point
4 46 32 14 2
16
5 60 36 24 4
14
6 72 42 30 6
12
7 82 52 30 10
10
Producer
8 88 64 24 12
6
9 92 78 14 14
4
10 94 94 0
16
2
11 95 102 -7 18
1

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 bcoz 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, bcoz 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 bcoz 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, bcoz 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
Price( 24
AR)
TC
26

2
24

3
24

4
24

5
24

6
24

7
24

50

72

92

115

139

165

Sol.TR-TC Approach
Output
Price(
AR)
TR
TC
Profit

1
24

2
24

3
24

4
24

5
24

6
24

7
24

24
26
-2

48
50
-2

72
72
0

96
92
4

120
115
5

144
139
5

168
165
3

The producer achieves equilibrium at 6 units of

output.It is because this level of output satisfies
both the conditions of producers 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
Price(
AR)
TR
TC
MR
MC

1
24

2
24

3
24

4
24

5
24

6
24

7
24

24
26
24
26

48
50
24
24

72
72
24
22

96
92
24
20

120
115
24
23

144
139
24
24

168
165
24
26

The producer achieves equilibrium at 6 units of

output.It is because this level of output satisfies
both the conditions of producers 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

TR(Rs.) 10
TC(Rs.) 4
Profit
6

19
9
10

27
15
12

34
22
12

40
30
10

The producer achieves equilibrium at 4 units of

output.It is because this level of output satisfies
both the conditions of producers 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
TR(Rs.)
TC(Rs.)
MR(Rs.
)
MC(Rs.)

1
10
4
10

2
19
9
9

3
27
15
8

4
34
22
7

5
40
30
6

The producer achieves equilibrium at 4 units of

output.It is because this level of output satisfies
both the conditions of producers 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 producers profits,which
results into a decrease in its supply.
3.Goals of the firms Supply of a commodity is
also guided by the firms 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
20
10

QUANTITY
200
100

DIAGRAM FOR CONTRACTION OF SUPPLY

TABLE FOR DECREASE IN SUPPLY

PRICE
10
10

QUANTITY
200
100

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.

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:PRICE

QUANTITY

10
20
30
40
50

SUPPLIED
100
200
300
400
500

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 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 SUPPLY

Q)
(1)

What

is

meant

by

price

elasticity

of

supply?

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 Xaxis.

2) Perfectly Inelastic Supply:- When the quantity supplied remains

unchanged whatever the price may be. Here, the supply curve is parallel to Yaxis.

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
question
6. 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
market
1 .Large number of buyers and 1. There are large number of buyers
sellers.
and large number of small sellers.
2. Firm is price taker and industry is 2.Firm is the price maker
price maker.
3. Average Revenue (AR) curve is 3. Average Revenue (AR) curve is
perfectly elastic & horizontal.
downward sloping & elastic.
4. There is no Selling cost
4. Selling costs are high.
perfect competition market
1. Large number of buyers and
sellers.
2. There is free entry into and exit
from the market.
3. Firm is price taker and industry is
price maker.
4. Average Revenue (AR) curve
perfectly elastic & horizontal.
monopoly market

monopoly
1. There is only one seller.
2. There is restricted entry into and
exit from the market.
3. Firm is the price maker
4. Average Revenue (AR) curve is
downward sloping & inelastic.

monopolistic
competition
market
1. 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 2. There is free entry into and exit
exit from the market.
from the market.
3.Selling costs are low & are 3. Selling costs are very high.
onetime costs
4 .Average Revenue (AR) curve is 4. Average Revenue (AR) curve is
downward sloping and inelastic.
downward sloping elastic.
5. Goods in this market have no 5. Goods in this market have very
close substitutes.
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

P1

P1

P1=AR=MR

quantity demanded

And supplied

quantity demanded
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

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

)is more than equilibrium price

Then quantity demanded (P3A) is less than quantity supplied (P 3B) , 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 price
Then 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
Buyers will compete with each other
and some buyers will be willing to
pay higher prices to get the good.
Sellers will increase prices,

(2) Excess Supply.

Sellers will compete with each other
to sell excess goods in their stocks,
they will reduce prices,
hence quantity demanded rises

hence quantity demanded falls and and quantity supplied falls.

quantity supplied rises.

Excess Demand occurs in following

cases
Factors effecting Demand Increase
Demand.
Factors effecting Supply Decrease
Supply.
Increase in Demand is more than
Increase in Supply
Demand Increase & Supply
decrease

Excess Supply occurs in following

cases
Factors effecting Supply Increase
Supply.
Factors effecting Demand decrease
Demand.
Increase in Supply is more than
Increase in Demand
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
P2

S
e2

P1

e1

Excess Demand D

D1

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

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 e 2 where,
quantity demanded = quantity supplied = OQ2.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ

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

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

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

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
P1A e1

P2

e2
D

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

Then quantity demanded (P 1A) is less than quantity supplied (P

Excess Supply equal to A e 1 occurs.

e 1) , so

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

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

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
New quantity supplied = P 1 A

Then quantity demanded (P 1 e 1) is less than quantity supplied (P

Excess Supply equal to e 1 A occurs.

) , so

1A

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

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

e2
D1

D2

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

(B)Decrease in demand is less than decrease in Supply

S2
Price

e 2S1

P2
P1 A

Excess demand
D1
D2

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
Excess Demand equal to A B occurs.

A) , so

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

(C)Decrease in demand is equal to decrease in Supply

S2
P rice
P1

S1
e 2 e1

D
D

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

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

e2
P2A

P1

e 1Excess demand
D2

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

Excess Demand equal to A B occurs.

A) , so

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

(b)Increase in demand is less than increase in Supply

S1
Price

e 1Excess Supply S2

P1A
P2

B
e2

D2
D1

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

(C) Increase in demand is equal to increase in Supply

S1
P rice

S2

P1

D
D

e2

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

21. What will happen to equilibrium price and quantity when supply is
perfectly elastic and demand decreases? Explain diagrammatically.
P rice
P1

e1

D
D

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

22. What will happen to equilibrium price and quantity when demand is
perfectly elastic and Supply decreases? Explain diagrammatically.
S2
P rice
P1

S1
e

e1D1

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

23. What will happen to equilibrium price and quantity when demand is
perfectly inelastic and Supply increases? Explain diagrammatically.
D1

S1

Price
Excess supply
P1

e1A

S2

P2

e2

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
Excess Supply equal to e1A occurs.

A) , so

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
e1A
P1

e2

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
so Excess Demand equal to e1A occurs.

e1 ) ,

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?
AnsPRICE

SUPPLY

1
2
3
4
5

10
20
30
40
50

DEMAN
D
50
40
30
20
10

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 priceless than the equilibrium price
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 pricemore 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)

HOUSEHHOLDS

FIRMS

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&
Payments
Payments

Transfer

Government
Sector

Net

Transfer
Tax

Payments
Tax Payments
Payment for goods and services
Factor Payments

Financial

Savings
market

Household Sector

Savings

Borrowings

Firms or Producer
Sector

Net Payment for factor services

Foreign Sector
Payments for Imports
Exports

(ROW)

Receipts

from

5.
1.
2.
3.

Leakages from
CIRCULAR
FLOW of income
These flow variables have a
negative
impact
on
the
process of production.
These are withdrawals from
the circular flow of income.
Examples: Saving,
and imports

Injections
into
from
CIRCULAR FLOW of income
These causes positive impact
on the process of production.
These are addition to
circular flow of income.

taxation Examples:
exports
and
expenditure.

the

Investment,
consumption

6.Define macroeconomics
It 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.
-----------------------------------------------------------------------------------------------------9.
Consumer goods or consumption
goods
1. These are directly used by
ultimate consumer household for
satisfaction of wants.
2. These are final goods
3. They are not used in production
by producer.
4 . They may be changed during
use by consumer like tea leaves are
used to make tea.
5.eg: Durable goods- car, washing
machine

Capital goods
1. These are fixed assets used by
the producers in the production
process.
2. These are final goods.
3. They help in production of other
goods.
4. They do not change during
production process.

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 goodsused 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
1. These are ready for final use
by consumer for consumption or
By producer for investment.

Intermediate goods
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

3.These are inside the
production boundary.
production boundary.
4. These are included in national 4. These are not included in
income
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
Flows
1. Stock
variables
are
1. Flow variables are measured
measured at a particular
over a period of time,
point in time.
2. They
have
a
time
2. They do not have a time
dimension,
dimension,
3. Eg: Capital formation during
3. Eg:
Capital
stock,
a year, change in stock,
inventory, wealth on a
national income during a
particular day.
year.
4. Stock is static concept
4. Flow is dynamic concept.

1.

2.
3.

Consumption of fixed capital

Capital Loss

It is loss in the value of fixed

assets due to normal wear and
tear
and
expected
obsolescence
It is expected loss in the value
of asset
Provision for depreciation is by
maintaining
depreciation
reserve fund.

It is loss in the value of fixed

assets due to natural calamities
and unexpected obsolescence.

Factor income
payment
1.

2.
3.

or

Factor

It is the income received in

return for rendering factor
services by the factors of
production.
These are included in national
income.

It is unexpected loss in the

value of asset.
Provision for capital loss is by
getting insurance done.

Transfer Income
payment

or

Transfer

It is the income received without

any corresponding services.
These are not
national income

included

in

Example: Rent, wages, interest, Example: old age pension,

and profit.
scholarship
of
students,
Retirement pension.
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) Employers 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 or
GDP at constant prices or
GDP at base 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.

Nominal GDP or
GDP 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 current market
prices.

2. Base year price is taken as 2. Market prices do not remain

constant.
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 nonresident 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 product
It is the Net Value of all final goods It is the Gross Value of all final
and services produced in a goods and services produced in a
financial year.
financial year.
It does not include depreciation
Net product=
depreciation

Gross

It includes depreciation

product- gross
product=
+depreciation

(3) National product

It 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
abroad

Net

product

(4) Domestic product

It is the value of all final goods and
services
produced
within
domestic
territory of a country
by all producers during
a
financial year

from It does not include Factor income

from abroad

It includes Factor income to abroad

It does not include Factor income Factor income from abroad
to abroad
Domestic
product
=National
National product = Domestic product- Net Factor income from
product +Factor income from abroad
abroad
(5) Product at Factor Cost
(6) Product at Market Price
It is the Income earned byall the It is the Market Value ofall final
factors of production in a goods and servicesproducedin a
financial year.
financial year
It does not include Indirect taxes

It includes Indirect taxes

It includes subsidies

It does not include subsidies

Product at Factor Cost= Product at Product at Market Price =Product at

Market Price Net Indirect taxes
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

NDP
-

FC

FC

Income from property and entrepreneurship accruing to the

government administrative departments
Savings of non-departmental public sector enterprises

Income from domestic

product accruing to
private sector
+ Net factor income from abroad
+ Net current transfers from rest of the world
+ Net
departments

current

transfers

from

government

administrative

+ National debt interest

Private income
-

Corporate Tax
Retained earnings of private corporations

Direct personal taxes

income
Miscellaneous receipts of
administrative departments

Personal

Personal disposable
income

fees

&

fines

by

government

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 Sector earning it

Factor
or (government,
Transfer income Firm,
or
Household)

NDPFC

factor Income

Income
from factor Income
NDP
FC
accruing
to
Government

Government
Firm
household
Government

Income earned
in
Domestic
territory or
by
normal
residents
(National
income)
Domestic
Domestic

Income
from factor Income
Firm
Domestic
NDP
household
FC
accruing
to
Private sector
Private income factor & transfer Firm
National
Income
household
Personal
factor & transfer household
National
income
Income
----------------------------------------------------------------------------------------------------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 householdswithin 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
from Abroad + Net Indirect Taxes

+Net Current Transfers

26.
Personal Disposable Income

Net
National
Disposable
Income
1. It is the income of all sectors of
an economy (Government, firm &
household sector) from all sources
during a financial year.

1. 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 includes both Direct & Indirect
2. It does not include Direct& taxes.
Indirect taxes.
3. NNDI= NNPFC +NIT + NCTfROW
3. Personal Disposable Income
=
P
is
Private
Final
Consumption Expenditure of
household + Savings of
Household

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 Intermediat
Output (Rs)
e
Consumpti
on (Rs)

Value
(Rs)

Added

Farmer sells to mill 2000

owner

2000

Mill Owner- sells to 2500

baker

2000

500

Baker sells
Shopkeeper

to 3600

2500

1100

Shopkeeper sells 4000

to customers

3600

400

8100

GVA=4000

12100

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
GVAMP =
+GVOMP

Formula2
GVAMP =
+Sales

Formula3
GVAMP =
+Domestic

Formula4
GVAMP =
+Sales

to

Sales

+Change in stocks
-Intermediate
Consumption

+Exports
+Closing Stocks
-Opening Stocks

household
+Sales
to
government
+Exports
+Closing Stocks
-Opening Stocks

Intermediate
-Domestic
Consumption
Intermediate purchase of raw
Consumption
material
-Import of Raw
material

Step 2
GDPMP = GVAMP
Tertiary Sector

Primary Sector + GVA MP

Secondary Sector + GVAMP

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 3
NDP FC =
NDP FC =
NDP FC =
+Mixed Income of self +Mixed Income of self +Mixed Income of self
employed
employed
employed
+Compensation
employees

of +Wages & Salaries

+Wages & Salaries in

cash
+Wages & Salaries in
kind

+Employers
+Employers
contribution to social contribution to social
security scheme
security scheme
+Operating Surplus
+Interest

+Interest

+Profit

+Corporate taxes
+Dividend
+Undistributed Profit

+Rent
+Royalty

+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)
(ii)

To pay corporate taxes i.e. the tax paid by the firm to the
government on profit of the firm.
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
GDPMP =
+P
+Gross
Investment

Formula2
GDPMP =
+P
+GDCF

Formula3
GDPMP =
+P
+GDFCF
+Change
Stock

+G
+X-M

+G
+X-M

+G
+X-M

Formula4
GDPMP =
+P
+Gross Business
fixed investment
in +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 NDPMP
Formula 1
NDPMP =
+P
+Net
Investment

Formula2
NDPMP =
+P
+NDCF

Formula3
NDPMP =
+P
+NDFCF
+Change
Stock

+G
+X-M

+G
+X-M

+G
+X-M

Formula4
NDPMP =
+P
+Net Business
fixed investment
in +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 ExpenditureIt 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 ExpenditureIt 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 ) & nonfactor 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 GrossInvestmentIt 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 years output.

35. Categorize the following into intermediate goods and final

goods. Give reason for your answer.
intermediate goods
final goods
ii) Purchase of food items by a i) A new car purchased by a taxi
hotel.
driver.
Ans: Purchase of food item by a Ans: A new car purchased by a taxi
hotel is an intermediate product driver is a final good since it is an
because it is used to prepare food investment and purchased by taxi
for further resale.
driver for final investment.
iii) Stationary purchased by the iv) Wheat purchased by the
government.
Households.
Ans: It is intermediate goods
because it is fully used to produce
services.
vi) Paper purchased by a publisher.
v) Purchase of equipments for
installation in a factory.
viii) Purchase of sugar by grocery vii) Milk purchased by households.
shop
ix) Cloths used by tailors
x) Construction of houses by
consumer household.
xii) Chemical fertilizer used by the xi) Purchase of milk by a consumer.
farmer.
xiv) Coal purchased by a factory.
xiii) Machine purchased by a firm
xvi) Book purchased by a book xv) Text book purchased by a
seller
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
categorisation question comes in exam.
Compensation of employees
1. Wages and salaries in cash.

of

employee

in

case

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. Employers 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 - 7
MONEY 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 Money
High 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 many

times 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 legally
required 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 who
borrow, 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 on
multiplying 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 x100/20
Total money creation = 50000.

The whole process can be explained through following table:Banks

Initial
Rs.

Deposit Legal Reserve

Ratio (20%)

Secondary
Deposit
(Lending) Rs.

A
B
.
.
.
.
N

10000
8000
.
.
.
.
.

2000
1600
.
.
.
.
.

8000
6400
.
.
.
.
.

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 banks reserves by the
particular amount.
* This directly reduces banks 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 banks ability to give credit.
* Thus money supply increases.
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.
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 supply
M1 = C + DD + OD
C = 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 banks
M4 = 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 governments 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 by
Buying & 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 banks
OR
RBI is bank of central clearance, settlement and transfer
RBI 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 SAVING That part of income which
spent on final goods and services
is not consumed
MARGINAL propensity to consumeMPC is the change in consumption due
to one unit change in income
(MPC=C/Y)

MARGINAL propensity to saveMPS is the change in saving due to

one
unit
change
in
income
(MPS=S/Y)

MPC

MPS
1. It is the rate of change in
1. It is the rate of change in
saving.
consumption.
2. The value of MPS lies in
2. The value of MPC lies in between
between 0 to 1 (0MPS1)
0 to 1 (0MPC1)
3. MPS=1-MPC
3. MPC=1-MPS

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)

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)

APC=1-APS

APS=1-APC

Q2.
Autonomous
consumption

Induced Consumption

Autonomous Consumption Induced Consumption dependent on

is independent of the level the level of national income
of national income
It is Demand for basic Demand for comfortable and luxurious
needs
necessary
for goods which changes with income
survival
which
doesnt level
depend on income
It is Consumption at zero Consumption at income other than
level of income
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
autonomous consumption )

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

C^

y1

y2

y3

Savings

Savings
R

Income

),

&S=-c^(negative

Y1
-c^

y2
S

y3
Income

Dissaving

NOTE:Diagrammatic explanation part given in this box may not be written

in answer when diagram is not asked in exam
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
Relatio between Consumption, Saving& income
Income
Consump Savi Investm AD=
Relatio
between
Y=AS
tion
ng
ent
C+I
Consumption,
C
S
I
Saving&
income
0
50
-50
50
100
(1)
When (2)
Y=0
When
C=c^, &S=- Y<C,
c^
S is
negativ
50
75
-25
50
125
e
100
100
0
50
150
When income (3)
is 100 both When
income
and Y=C,
consumption
S is
are
equal. zero
This point is
called breakeven point
(Y=C=100,
S=0)

Here saving
is zero
150
200
250

125
150
175

25
50
75

50
50
50

175
200
225

(4)Whe
n Y>C,
S
is
positive

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
Output

spending

Planned

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

AD&AS

N
E
C^

AD=C+I

M
R

y1

y2

y3

Income

Q6.Explain determination of equilibrium level of national income,

employment and output using I-S Approach

S
R
Savings

Savings
B

Investment

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
So at Equilibrium Actual I becomes equal to planned saving
Because Actual I becomes < Planned I
Actual I = Planned I decrease in inventories
(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

Q7.Explain determination of equilibrium level of national income,

employment and output using schedule.(AD-AS Approach & I-S Approach)
AD-AS
Inco
me
Y=AS
0
50
100
150

Approach
AD= EXPLANATI
C+I
ON
100
125
150
175

(1) AD >AS

Consump
tion
C
50
75
100
125

I-S Approach
Saving Investm
S
ent
I
-50
50
-25
50
0
50
25
50

EXPLANATI
ON
(1) I >S
So saving
is low
Consumpti
on is high

So
inventories
reduce
Producer
will
increase
production
.
employme
nt& income
also
rise,
till
equilibrium
is reached.

i.e. AD >AS

200

200

250
300

225
250

(2)
150
EQUILIBRIU
M
Here
AD=AS=20
0
(3) AD <AS 175
200

350

275

225

So
inventories
rise
Producer
will
decrease
production
.
Employme
nt& income
also
fall,
till
equilibrium
is reached.

50

50

75
100

50
50

125

50

So
inventories
reduce
Producer
will
increase
production.
employme
nt& income
also
rise,
till
equilibrium
is reached.
(2)
EQUILIBRIU
M Here
and I=S=50
(3) I<S
So saving
is high
Consumpti
on is low
i.e, AD <AS
So
inventories
rise
Producer
will
decrease
production.
Employme
nt& income
also
fall,
till
equilibrium
is reached.

NOTEall these Questions will have similar answer

Q .How will equilibrium level of income be reached in following
cases
1 AD>AS
AD<AS
2. C+I> Y
C+I<Y

3. I>S
4. Planned Investment > planned
Saving
5. Ex Ante Investment>Ex Ante
Saving
6.Planned Investment > actual
Investment
7.Ex Ante Investment>Ex Post
Investment
ANSWER: Point (2) of answer of Q5
& Q6.

I<S
Planned Investment < planned
Saving
Ex Ante Investment<Ex Ante
Saving
Planned
Investment
<
actual
Investment
Ex
Ante
Investment<Ex
Post
Investment
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.
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

DEFLATIONARY GAP
Q

M
Income, output & Employment

NOTE:
Measures
to
DEFLATIONARY GAP
DEFLATIONARY
Demand

correct Measures
to
INFLATIONARY GAP
GAPDeficient INFLATIONARY
demand

correct
GAPExcess

Quantitative Monetary measures-

Quantitative Monetary measures-

Increase CRR, SLR, Bank Rate

Decrease CRR, SLR, Bank Rate,

Buy Securities

Sell Securities

Fiscal Measures

Fiscal Measures

Decrease Taxes

Increase Taxes

Increase Government Expenditure

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 banks 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

AD
ADf

P
G
Q

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 banks reserves by the
particular amount.
* This directly reduces banks 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
1000

1000

1000*0.8=800

800

800*0.8=640

Rs 5000

1000*[1/(1-0.8)]

nth

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 It is investment undertaken

is
independent
of with the motive of earning
variations
in
output, profit and income.
income, rate of interest or
rate of profit.
It increases with increase in
It is income inelastic income and vice versa
function i.e. it remains
constant at all levels of It is Investment dependent on
the level of national income
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
TOGETHER

MPC,

MULTIPLIER

AND

MPS

SOME IMPORTANT POINTS

MPC

MULTIPLIER (K)

MPS

The LOWEST value

MULTIPLIER is 1

1/(1-0)=

.1

1/(1-.1)=

1.11

.9

.2

1/(1-.2)=

1.25

.8

MPC+MPS=1

.25

1/(1-.25)= 1.33

.75

MPS=1-MPC

of

& MPS= 1-MPC

.3

1/(1-.3)=

1.43

.7

.4

1/(1-.4)=

1.67

.6

.5

1/(1-.5)=

.5

.6

1/(1-.6)=

2.5

.4

.7

1/(1-.7)=

3.33

.3

.75

1/(1-.75)=

.25

.8

1/(1-.8)=

.2

.9

1/(1-.9)=

10

.1

1/(1-1)=

Higher the value of MPC,

Higher
the
value
of
MULTIPLIER(K)
Lower the value of MPC,
Lower
the
value
of
MULTIPLIER(K)
Higher the value of MPS,
Lower
the
value
of
MULTIPLIER(K)
Lower the value of MPS,
Higher
the
value
of
MULTIPLIER(K)
The
HIGHEST
MULTIPLIER is

value

of

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 Cr
Therefore AD= C+I= 800+100+0.75Y

= 900+0.75Y
Value 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 economy
B. Autonomous consumption
C. Investment multiplier
EXPLANATION: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 be
C=YS
= Y - (-200 + 0.2Y)
= Y +200 -0.2Y
= 200 + 0.8 Y
Autonomous consumption is 200
C- Here MPS = .2
Thus K = 1/MPS
= 1/.2
=5
The value of investment multiplier is 5
In 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 formula
Q. 3

INCOME

SAVING

0
20
40
60

-12
-6
0
6

CONSUMPTIO
N
C = Y-S
12
26
40
56

MPC
C/Y

APS
S/Y

14/20=0.7
14/20=0.7
14/20=0.7

-12/0 =
-6/20= -0.3
0/40 = 0
6/60 = 0.1

Q.4 Complete the following table :income

0
50
100
150
200

consumption
40
70
100
130
160

income

consumption

0
50

MPS
-

APC
-

40
70

SAVING
S= Y- C
0 40 = -40
50 70 = - 20

MPS
S/Y
20/50 = 0.4

100

100

100 100 = 0

20/50 = 0.4

150

130

200

160

150 130 = 20/50 = 0.4

20
200 160 = 20/50 = 0.4
40

APC
C/Y
40/0 =
70/50
=
1.4
100/100=
1
130/150=0
.86
160/200=0
.8

Q.5 Complete the following table :income

0

consumption
15

APS
-

MULTIPLIER(K)
-

50
100
150

50
85
120

SOLUTION
income

consumption

0
50
100
150

15
50
85
120

SAVING
S=Y-C
-15
0
15
30

MPS
S/Y
0.3
0.3
0.3

APS

MULTIPLIER (K)
=1/MPS
1/0.3 = 3.3
1/0.3 = 3.3
1/0.3 = 3.3

-15/0=-
0/50=0
15/100=.15
30/150
=0.2
IN ORDER TO SOLVE THESE PROBLEM PROCEED IN THE FOLLOWING WAY

K=1/MPS OR 1/1-MPC

K = Y/I

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
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

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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 service
Types 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
fees
Fines & 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 PSUs 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 Budget
Learn only Definition of Capital Expenditure or &Capital Receipts& relate
it to define other Components
Revenue
Receipts
Do not CL or RA
Do not Create
Liabilities(CL)
Do not Reduce
Assets (RA)

Revenue
Expenditure
Do not CA or RL
Do not Create
Assets(CA)
Do not Reduce
Liabilities(RL)

Capital Receipts

Capital
Expenditure
CL or RA
CA or RL
Create
Create
Liabilities(CL)
Assets(CA)
Reduce
Assets Reduce
(RA)
Liabilities(RL)

----------------------------------------------------------------------------------------------3. Categories the following into capital and revenue

expenditure and Give reasons for your answer.
(i)Subsidised LPG given to public
Ans. It is revenue expenditure, because it neither Create Assets nor
Reduce Liabilities
(ii)Construction of Government School building
Ans. It is capital expenditure, because it Create Assets
(iii)Salary paid to Central government employees
Ans. It is revenue expenditure, because it neither Create Assets nor
Reduce Liabilities
(iv) Old age pension given by government

Ans. It is revenue expenditure, because it neither Create Assets nor

Reduce Liabilities
(v) Help given by govt. to flood victims
Ans. 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 PSUs
Ans. It is revenue Receipts, because it neither Create Assets nor
Reduce
Liabilities
(ii) Borrowings
Ans. It is capital Receipts, because it Create Liabilities
(iii) Disinvestment
Ans. It is capital Receipts, because it involves sale of shares of PSUs
to private sector which Reduce Assets.
(iv) Gain tax
Ans. It is revenue Receipts, because it neither Create Assets nor
Reduce
Liabilities
5.
Direct tax
Indirect Tax
It is levied on income & wealth of It is levied on production of &
individual or firms
consumption
expenditure
on
Goods & services
it cannot be shifted
it can be shifted
The incidence & the burden of The incidence of tax is on one
the tax falls on the same person. person & the burden of payment
of the tax falls on
another
person
It cannot be avoided it has to be It can be avoided by not
paid
producing or purchasing goods
and services that are taxed.
Eg. Income tax ,Corporate or Eg. Sales
gain tax, wealth tax etc.
6. Categories the following into Direct tax & Indirect Tax and Give reasons
for your answer
(i)Income tax
Ans.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 duty
Ans.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 tax

Ans.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 tax
Ans.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
borrowings
OR
Fiscal Deficit = (Revenue expenditure + Capital expenditure) (Revenue
Receipts + Capital receipts excluding borrowings)
Fiscal deficit = Revenue expenditure+ capital expenditure- Revenue
receipts- capital Receipts excluding borrowings
OR
Fiscal deficit = Revenue expenditure+ capital expenditure - Tax RevenueNon Tax Revenue-recovery of loans-disinvestment
OR
Fiscal 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 payments
Net 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

ii

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..
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

iii

iv

taxation. On the other hand production of socially useful

goods like Khadi is encouraged through subsidies.
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.
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 PSUs. 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 currency
Appreciation means increase in Depreciation means decrease in
price of domestic currency due to price of domestic currency due to
changes in demand and supply of changes in demand and supply of
foreign exchange.
foreign exchange.
increasing in price of rupee from
rupee 55/$ to rupees 45/$
Appreciation occurs in Flexible
Exchange Rate

decreasing in price of rupee from

rupee55/$ to rupees 65/$
depreciation occurs in Flexible
Exchange Rate

7.
Revaluation of currency
the central monetary authority
increases
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/$
monetary authority fixes the the
exchange rate

devaluation of currency
the central monetary authority
decreases
value
of
domestic
currency in terms of foreign
currency.
For eg. Central bank devalues rupee
by decreasing its value from rupee
55/$ to rupees 65/$
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
Foreign exchange Operations of
daily nature are termed as spot
market or current market
A
foreign
exchange
spot

Forward market
Foreign exchange Operations for
future delivery are termed as
Forward market.
Forward market refers to the market

transaction
is
an
agreement
between two parties to buy one
currency against selling another
currency at an agreed
price for settlement on the spot.

in which the sale and purchase of

Foreign 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 adverse
changes in the exchange rate
(through hedging) ; (b) To make
profit (through
Speculation).

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

60Rs./$ P

Rs.55/$

Rs.40/$

M
Excess Demand

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./$)

60Rs./$

Rs.55/$

e2

e1

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 e2 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./$

Rs.55/$P

e2

S1

e1
Excess Demand
D

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 E 2, 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./$)
60Rs./$ A

Excess Supply
e1

Rs.55/$

S2

e2

D
Q1
O

Q2

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 E 2, 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

Rs.55/$

e1

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 E 2, 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

I.
Current Account
(a)Trade of goods. (tangible item or
visible trade)-Export & import of
goods.
(b)Trade of services

OR
Above the line items

(intangible

items or invisible trade) )-Export &

(It includes-

import of services
(i)Factor services like

I Current Account

II Non reserve Items of Capital income

account)

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 &

Accommodating

Transactions

or

financial assets)
Banking capital
Private capital
Government
or

public

borrowing or capital
Errors and omissions.

Official

reserve

items

transactions changes in

OR

gold,

SDRs

foreign

Exchange reserves.
Below the line items

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
payment for capital i.e. interest.

from entrepreneurship i.e profit or

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, SDRs 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, SDRs , 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, SDRs , foreign Exchange etc. with central
bank.

3.
Autonomous items or transactions

Accommodating

Or Independent

transactions

Or above the line

Or Below the line

Items / Transactions

Items/ Transactions

These

include

Current

items

or

Account These include official reserves of

items, I.e export import of

goods gold SDRs, Foreign Exchange etc.

services &Non reserve Items of

Capital account
These transactions are done by all These transactions are done only by
the

sectors

in

economy

i.e. the monetary officials (RBI)

household, firm, govt, etc.

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

Balance of Payments

(BOT)
(BOP)
It is the difference b/w exports and It includes

imports of Goods only

Current A/c, i.e export import of

BOT = (Exports Imports )of goods goods as well as services.

only

Capital A/c (non-reserve items of

Capital A/c )
In accounting terms BOP is always

It is unfavourable when imports are in equilibrium.

more than exports.

But in economic terms there can be

It is favourable when imports are disequilibrium. & BOP can have

less than exports.

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 balancesbecauses 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.