SYLLABUS

ECONOMICS(030)
Class XII (2014-15)

3 Hours

100 Marks

UNITS

Marks

Part A: Introductory Microeconomics

1.
2.
3.
4.

Introduction
Consumer Equilibrium and Demand
Producer behaviour and Supply
Forms of market and price determination under perfect
competition with simple applications.

Total:

06
16
16
12

50

Part B: Introductory Macroeconomics

5. National Income and Related Aggregates.
6. Money and Banking
7. Determination of Income and Employment
8. Government budget and the Economy.
9. Balance of Payments.

15
08
12
08
07

Total:

50

Note: The question paper will include value based question to the extent of 5 Marks

STUDY MATERIAL
(MICRO ECONOMICS)
UNIT-1 (MARKS-6)
INTRODUCTION
GIST OF THE LESSON
Meaning of economics: Economics is the science which studies human behavior
as a relationship between ends and scarce means which have alternative uses.
Meaning of an economy:-Economy is the system which provides people the means
to work and earn a living. Or it is a frame work within which economic activities like
production, consumption, and capital formation are undertaken.
Meaning of scarcity:-It is defined as excess of demand over available supply, i.e,
demand of resourses>supply of resources.
Economic problem:-The problem of making a choice is called economic problem.
Causes of economic problem:- It arises due to
1) Scarcity of resources
2) Unlimited human wants
3) Resources can be put to alternative uses
Scarcity and Choice go together:-Scarcity and choice are not separable because
resources are limited or scarce and the problem of choice arises due to it.
Economising of resources:-Our wants are unlimited and resources are limited, so
we have to use the resources fully and efficiently. It means that resources should be
best utilized. This is called economizing of resources.
Central Problems of an Economy:-Central problem of an economy is Allocation of
resources.The three central problems relating to allocation of resources are:1) What to produce:-The problem of what to produce and in what quantity is the
first basic or central problem. It is related to the selection of goods. Our
resources are limited. So first problem that we have to face is which goods
and services are to be produced e.g consumer goods or capital goods, war
time or peace time goods. After the decision has been taken the quantities of
these goods should also be decided.
2) How to produce:- The second important problem is the problem of choice of
technique of production. That means we have to decide whether to use labour
intensive technique(it uses more of labour than capital) or capital intensive
technique(it uses more of capital than labour).How ever the choice of
technique depends on the objective of the producer.The producer can use

labour intensive ,capital intensive or both technique of production.The main

aim is to use the efficient technique of production.
3) For whom to produce:-This is also called the problem of distribution of
National Income among the factor of production. For whom to produce is
actually the problem of determining wage rate for the use of labour ,rent for
the use of land, interest for the use of capital and profits for the producer to
ensure equitable distribution of income and welfare in the society.

Production possibility curve or frontier

A production possibility curve/ frontier shows different combinations of two
commodities that can be produced by an economy with the full use of given
resources and technology.
(i)Normally, the production possibility curve is concave to the origin. It is
because of increasing marginal opportunity cost.
(ii)A production possibility curve shifts out due to technological progress or
increase in thesupply of resources available to an economy or both.
Assumptions of PPC-1)Resources are constant.
2)Technology is given.
3)Resources are fully and efficiently used.
4)Production of only two goods can be shown in a PPC.
Features of PPC-1) It is downward sloping.
2) It is concave to the origin.

PPC can be explained with the help of a schedule

Shifting/Rotation of PPC

a) Change of Resources

(ii) Change in technology

Efficient technology for the production of Commodity X: Efficient technology

for the production of Commodity X would mean more production of
commodity X with the same resources. Accordingly, PPC would rotate (NOT
SHIFT) as shown in Fig

Efficient technology for the production of Commodity Y : Efficient technology for the
production of commodity Y would mean more production of Y with the same
resources. Accordingly, PPC would rotate (NOT SHIFT) as shown in Fig

Efficient technology for the production of both X and Y:

Efficient technology for the production of both X and Y would mean much greater
production of both X and Y with the same resources. Accordingly, PPC would shift to
the right as shown in Fig.

Opportunity Cost (Transformation cost)The opportunity cost of a factor is equal to the value of a factor in its next best
alternative use. Eg-A plot of land can be used for wheat and rice
production.Production of wheat provides earning of Rs. 1 lakh and Production of rice
provides earning of Rs. 90000.If we produce wheat then its opportunity cost is Rs.
90000,which is the value of rice sacrificed.

Marginal opportunity cost(or Marginal Rate of Transformation)The marginal opportunity cost of good X is the rate of sacrifice of the other good,
say, Y, per unit increase in the production of good X.
Or

The marginal opportunity cost of good X is defined as the amount / quantity

sacrificed of good Y per unit increase in production of good X.
Marginal opportunity cost along a PPC.

Production
of Good X
0
1
2
3
4
5

Production of
Good Y

Marginal Opportunity Cost of Good X in terms

of Good Y or amount sacrificed of good Y per
unit increase in good X

18
17
15
12
8
3

1
2
3
4
5

Note: The above table shows the case of increasing marginal opportunity cost. To
produce one more unit of Good X, increasing units of Good Y have to be sacrificed.
For example, to produce the first, second, third, fourth and fifth unit of Good X, 1,
2,3,4 and 5 units of Good Y have been sacrificed respectively.
The shape of PPC depends on MOC :
1. If MOC is increasing PPC is concave.
2. If MOC is decreasing, PPC is convex.
3.If MOC is constant, PPC is a straight line.

The Fig Illustrates the concept of marginal opportunity cost. It is assumed that
initially resources are employed such that, output in Use-1 = OK and output in Use2=OL
M.O.C = Loss of Output of Good Y/Gain of Output of Good X
= KK1 / LL1
= ab / bc= Slope of production possibility curve

Micro and Macro Economics:

Micro economics studies the behaviour of individual economic units of an economy
like a consumer, a producer for different goods and services.
Macroeconomics studies aggregates at the level of the economy as a whole like
aggregate demand, aggregate supply, problem of full employment, total saving, total
investment, aggregate price level, etc.
DIFFERENCE
MICROECONOMICS
1. It studies individual economic units.
2. It deals with determination of price and
output in individual markets.

MACROECO0NOMICS
1. It studies aggregate economic units.
2. It deals with determination of general
price level and national output in the
country.

3. It aims at optimal allocation of

resources.
4. Example-Theory of demand, theory of
supply, theory of price determination,etc.

3. It aims at determination of aggregate

output, national income, price level and
employment level in the economy.
4. Example- Aggregate demand,
aggregate supply, national income,etc.

QUESTIONS FOR BRIGHT LEARNERS

VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each)
Q.1.

Why is there a need for economizing of resources?

Ans. Because resources are limited.

Q.2.

Why does economic problem arise?

Ans. It arises mainly because of scarcity of resources.

Q.3.

Why is PPC downward sloping from left to right?

Ans. Because in situation of full employment of resources, production of one good

can be increased only with less of other good.
Q.4.

What does a rightward shift of PPC indicate?

Ans. The rightward shift of PPC indicates growth of resources or technological

progress.
Q.5.

Why does the problem of choice arise?

Ans. Relative scarcity of resources having alternative uses in relation to unlimited

wants, gives rise to an economic problem.
Q.6.

Why does PPC look concave to the origin?

Ans. PPC is concave to the origin because of increasing marginal rate of

transformation (or increasing marginal opportunity cost).
Q.7.

Which factor lead to a shift of PPC towards right hand side?

Ans. Growth of resources or technological progress leads to a shift of PPC towards

right-hand side.
Q.8.

What does a point below PPC indicate?

Ans. It shows inefficient/underutilization of resources.

Q.9. What is the slope of PPC? What does it show?
Ans. Slope of PPC refers to MRT (marginal rate of transformation).It shows that in
order to produce more units of one good, say X, some units of the other good, say Y
must be sacrificed. So slope of PPC= Y/X
Q.10. When allocation of resources is considered as inefficient?
Ans. Allocation of resources is considered as inefficient when economy performs
below the PPC curve.
Q.11.When can PPC be a straight line?
Ans. When MOC is constant.
Q.12 What is the opportunity cost of opting for higher studies rather than a job?
Ans.It is the amount of wage/salary the person would have earned in a job.
SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each)
Q.1.

Draw PPC and show the following:-

(a)

Full employment of resources,

(b)

Underutilisation of resources, and

(c)

Growth of resources.

(a) Full employment of

P
(c) Growth of
Resources
Commo
d ity Y

(b)
Underutilisati
on of
Resources
X
O

Commodity X

Ans. (a) Full employment of resources - A point anywhere on the PPC, shows the
efficient use or full employment of resources.
(b) Underutilisation of resources - A point anywhere inside of the curve, shows
inefficient/under utilisation of resources.
(c) Growth of resources It refers to the shift in PPC. If more resources are
generated, the level of production will increase. In the figure it is represented by a
shift in PPC from PP to PP.
Q.2. Why does PPC look concave to the origin? Explain.
Ans. PPC looks concave to the origin because of increasing marginal rate of
transformation/ substitution (or increasing marginal opportunity cost). It means that
more and more units of commodity y are to be sacrificed, to get each additional unit
of commodity x.
Q.3. What does a PPC show? When will it shift to the right?
Ans. Production Possibility Curve shows the different combinations of two goods
which an economy can produce with available technology and resources.
It would shift towards right-hand side in case of growth of resources or technological
progress.

Q.4. Does production take place only on the PP curve?

Ans. Yes and no, both. Yes, if the given resources are fully and efficiently utilized.
No, if the resources are underutilized or inefficiently utilized or both.

Y
A
B

PPC

Cloth

C
.U
D
X

Wheat

Refer to the above figure; on a point anywhere on the PPC the resources are fully
and efficiently employed. On point U, below the PPC or any other point but below the
PPC, the resources are either underutilized or inefficiently utilised or both. Any point
below the PP curve thus highlights the problem of unemployment and inefficiency in
the economy.

Q.5. Why does an economic problem arise? Explain.

Ans. Reasons1. Unlimited wants - Human wants go on multiplying with the expansion of education,
knowledge, scientific advancement and economic growth. A man can not satisfy all
of his wants and therefore he has to make a choice in order of urgency.
2. Limited resources - The resources are limited in relation to need for them. It is the
main cause of economic problem.
3. Alternative use of resources - A resource can be utilized in a different way and for
different purposes. Therefore choice has to be made among different uses of
resources.
Q.6. Calculate MRTXY at different production possibilities from the following
hypothetical data. Draw a PPC on the basis of the schedule

Production
Possibilities

Commodity X

Commodity Y

15

14

12

D
E
F

Ans.

Production Possibility Schedule:

Production
Possibilities

Commodity X

Commodity Y

Marginal Rate of
Transformation
(MRT) =Y/X

15

---------

14

1 Y : 1X

12

2 Y : 1X

3 Y : 1X

4 Y : 1X

5 Y : 1X

15

PPC

14

Comm1
o2d ity
Y

X
0

Commodity
X

Value based question:Q1 A basic economic problem is that there is oil shortage in INDIA. What
measures do you suggest to mee t the growing demand of oil?
Ans:-Measures taken are : 1) oil is limited so it should be efficiently and
fully(optimum use)used.
2)Massive awareness on shortage of oil and people should be encouraged
to use public transport system.
Q2. The state govt. has sanctioned acertain amount to increase production in rural
areas. Which technique of production will you suggest to the state govt. for this
project?
Ans.:-Labour intensive technique of production.
Q3. Why is it that on one hand coal is found in plenty, yet it is scarce , while a rotten
fruit is rare but not scarce?
Ans:- Coal is scarce because its demand is greater than its supply.A rotten fruit is
not scarce because there is no demand for rotten fruits.
Q4. For a devolepmental project, logs of wood another building material have to be
carried to the upper floor of building under renovation by the labour .Alternatively
elevators and lifts can do the job ,which one will you choose and buy?
Ans:- I will choose the second alternative as it is efficient and time and money saving
method.

Q5. If more and more resources are constantly explored and new and new technique
of production are constantly discovered,dont you think a day will come when our
central problems will be solved once for all?
Ans:-When new resources are explored and new technology is discovered,PPC
wouldexpand,indicating larger and larger flow of goods &services in the
economy.But our wants are limlted, so scarcity of resources in relation to human
wants will always exist.And,so long as limited resources are to colliding with
unlimited wants,central problems can never be solved once for all.

QUESTION FOR LATE BLOOMERS FOR THE SESSION 2013

Q1.What is microeconomics?
Ans:Microecomics is the study of an individual economic unit like a firm, a consumer.
Q2.What is PPC?
Ans:Production possibility curve shows different combinations of two goods which
can be produced with given resources and technology.
Q3.What is Opportunity Cost?
Ans:It is the value of a factor in its next best alternative use.
Q4.What is marginal opportunity cost?
Ans:It is the rate at which output of good Y is to be sacrificed for every additional
unit of good X.
Q5.Write two properties of PPC.
Ans:PPC slopes downward from left to right.
And PPC is concave to the origin.
Q6.Why does an economic problem arise?
Ans:An economic problem arises because resources are limited,our wants are
unlimited and resources have alternative uses.
Q7.What are the 3 basic economic problems of an economy?
Ans.The 3 basic economic problems are:
1.What to produce and in what quantity?
2.How to produce?
3.For whom to produce?

Q8.Explain the meaning of what to produce?

Ans: For answer see gist of the chapter.
Q9.Explain the meaning of how to produce?
Ans.For answer see gist of the chapter.
Q10.Explain the meaning of For whom to produce?
Ans:see gist of the chapter for this answer.
Q11.Draw PPC and show the following:
1.Overutilisation of resources.
2.Fullutilisation of resources.
3.Underutilisation of resources.
Q12.Write differences between microeconomics and macroeconomics.
Ans.See gist of the lesson.

TEST PAPER:-CLASS XII

CHAPTER :- 1 ( INTRODUCTION)
Q.1 What is an economy?( 1)
Q.2 What is scarcity .{1}
Q.3 Name the central problems of an economy.{1}
Q.4 Why do economic problems arise?.{1}
Q.5 What is the problem of what to produce? {1}
OR
Q.6 What is the problem of How to produce? {1}
Q.7 What is the problem of for whom to produce? {1}
Q.8 Define a PPC? {1}
Q.9 Define opportunity cost.{1}
OR
Q.10 What is marginal opportunity cost or marginal rate of transformation? {1}
Q.11 Define:) Micro economics.{1}

OR
Q.12 Define M acro economics.{1}
Q.13 What does a point on PPC indicate?{1}
Q.14 FILL IN THE BLANKS.
1. The PPC would shift to right when there is _------------- of resources.
2) The basic economic problem is the problem of _-----------------------.
3)Cotton textile industry is the subject matter of _----------economics. 3x1
Q.15 What is Rotation of PPC? Explain with diagram. {3}
OR
Q 16 What is shift in PPC? Explain with diagram {3}
Q.17 Why is PPC concave? Explain.{3}
Q18. Does production take place only on thePPC? Explain with diagram. {3}
Q.19A lot people died and many factories were destroyed in an earthquake{ natural
calamity}. How will it affect the PPC? {3}
Q20 Draw a ppc to represent the following on it .
a)Underemployment of resources.
b)Growth of resources
c)Fuller utilization of resources.

{4}

Q21. Draw the shape of PPC when MOC is (a)Decreasing (b)Constant (c)
Increasing. {4}
Q22. Plot the PPC by taking Rice consumption on the X axis. Comment on the
shape of the curve. {4}
RICE CONSUMPTION

FUEL CONSUMPTION

100

90

70

40

UNIT 2 (16 Marks)

CONSUMER BEHAVIOUR AND THE THEORY OF DEMAND
STUDY MATERIAL FOR BRIGHT STUDENTS
Sr. No
1

Chapters
Utility Analysis

Demand and Law of

Demand

Elasticity of Demand

Concepts
Cardinal and Ordinal Utility
Consumers Equilibrium
- One Commodity
- Two Commodity
- Indifference Curve and Budget line
Demand-Individual and Market Demand
Law of Demand
Change in Demand and Change in quantity
demanded
Concept of elasticity of demand
Factors affecting elasticity of demand
Methods of measuring price elasticity of demand
-Point Method
-Total Expenditure Method
- Geometric Method

Utility Analysis
Utility - Want satisfying Power of a good.
Cardinal Utility It says that utility can be measured in number. (Quantitative
Concept)
Ordinal Utility It says that utility being a mental concept cant be measured in
number. (Qualitative Concept)
Total Utility It is the sum total of Utility derived from the consumption all units of
consumption.TU= Sum of MU
Marginal Utility It refers to the additional utility on account of consumption of an
additional unit of commodity. MU=TUn-TUn-1

Consumption of x
1
2
3
4
5
6
7
8

TU
20
36
46
50
50
44
42
38

MU
20
16
10
4
0
-6
-2
-4

Law of Marginal Utility The law says that when a consumer consumes more and
more amount of one commodity, the utility derived from successive units of
commodity will go on declining.

Consumer Equilibrium- Consumers equilibrium is a situation where the consumer

maximises his satisfaction out of his limited income.
Indifference Curve - It refers to the locus of all possible combinations of two
commodity which gives equal level of satisfaction to the consumer.
Budget line It is the locus of all possible combinations of two commodities which
can be purchased at a given level of income.

Question and Answer

1. What do you mean by monotonic preference?
Ans . it mean that a rational consumer always prefer more of a commodity as
it offers him a higher level of satisfaction.
2. What price the consumer is ready to pay for a commodity in a state of
his equilibrium?
Ans:- in a state of equilibrium the price that the consumer is ready to pay is
exactly equal to the price prevailing in the market . Because, in a state of
equilibrium , money worth of marginal utility that the consumer gets is exactly
equal to market price he has to pay.

3. What happen when Mux/Px is greater than MUy/Py ?

Ans. This situation implies that by spending a rupee on Good X the
consumer gets grater marginal utility that in case of Good-Y. Accordingly, he
will spend more on X than Y .As consumption of X rises, Mux will fall .On
other hand ,as consumption of Y falls ,MUy will rise. The consumer will stop
buying more of X in place of Y only when Mux/Px=MUy/Py. It is here only that
the equilibrium is struck.
4. How is equilibrium of the consumer affected when Mum happens to rise
,and Px is constant.
Ans . Equilibrium is struck when Mux/Px=Mum.
If MUm rises and price is constant ,the consumer will be off the point of
equilibrium .Because Mux/Px would then be less than Mum . the consumer
will reach back his equilibrium only if Mux rises ,as Px is given to be constant .
This will happen only when consumption of commodity X is decreased.
5. How will the consumer move along his IC in a situation when MRSxy>
Px/Py
Ans. The consumer should move downward to the right along the IC .
Convexity of the IC ensure that as the consumer moves downward to the right
along his IC, MRSxy tends to fall. Implying that the consumer should start
consuming more of X in place of Y.
6. How will a consumer adjust his consumption of Good-X and Y in
asitution when MRSxy=Px/Py
Ans. The consumer should start consuming more of Y in place of X . That is,
he should move upward to the left along the IC . Convexity of the Ic ensure
that as the consumer moves upward to the left along his IC , MRSxy tends to
rise . He should stop at a point when MRSxy=Px/Py

7. Why should a consumer buy more of a commodity even when MU of

every successive units tends to decrease
Ans. Even when MU is decreasing ,its money worthy still be greater than the
price he has to pay. We know ,the consumer stops buying a good only when
its money worth of MU is equal to its price.
8. State the condition of consumers equilibrium.
Ans. Hint: A consumer strikes his equilibrium when rupee worth of marginal
utility actually received by the consumer is equal to marginal utility on money
Mux/Px=Mum

Demand and Law of Demand

Demand Demand for a commodity is defined as the amount of commodity which a
consumer purchase at a given price and at a given time.
Individual Demand It shows the amount of commodity purchased by an individual
consumer at a given price and at given time.
Market Demand It shows the amount of commodity purchased by all consumers
present in the market at a given price and at a given time.
Demand function It is the functional relationship between the quantity demanded
and the factors affecting it. Symbolically it is written as Q = f( P R I N T), where
P-Price of the commodity, R- Price of the related commodity, I Income of the
consumer
N Number of consumer, T Taste and Habits and Preference of the
consumer
Law of Demand- Law of demand says that other thing remaining same more is
demanded at a less price and less is demanded at a high price. Hence there exist an
inverse relationship between the price and quantity demanded.
Change in demand When quantity demanded of a commodity changes due to
change in the other factors, price of the commodity remaining constant, it is called
change in demand. It is also called movement of the demand curve. It is of two
types such as a) Increase in Demand
b) Decrease in demand and Increase in Demand When quantity demanded
of a commodity increases due to positive changes in the other factors, price
remaining constant, it is called increase in demand.
Decrease in Demand When quantity demanded of a commodity decreases due to
negative changes in the other factors, price remaining constant, it is called decrease
in demand.
Change in quantity demanded When quantity demanded of a commodity
changes due to change in its price, other factors remaining constant, it is called
change in quantity demanded. It is also called movement along the demand curve. It
is of two types such as:a) Expansion in demand
b) Contraction in demand.
Expansion in demand when quantity demanded of a commodity increases due to
fall in the price of the commodity, it is called expansion in demand.

Contraction in demand When quantity demanded of a commodity decreases due

to rise in the price of the commodity, it is called contraction in demand.
Elasticity of demand
Price elasticity of demand- It is defined as the degree of responsiveness in the
quantity demanded of a commodity due to change in its price, other factors
remaining constant.
Factors affecting price elasticity of demand:
1. Nature of commodity
2. Availability of Substitutes
3. Diversity of uses
4. Income level of the buyer
5. Habit of the consumer
6. Proportion of income spent on a commodity
7. Time Period
8. Postponement of use
Methods of measuring price elasticity of demand - There are three methods of
measuring price elasticity of demand. These are 1. Percentage Method
2. Total expenditure method
3. Geometric Method
Percentage Method: By percentage method the price elasticity of demand is
measured by taking the ratio between the percentage change in quantity demand
and the percentage change in price.
Ed= (-) % Change in quantity Demanded/
% Change in price.
Ed = q1-q/q*100
P1-p/p*100
= q/q
p/p
= q/q *p/p
Ed = p/q * q/ p

Question and Answer

1. If the quantity demanded of a commodity X decreases
as the household income increases, what type of good
is X?
Ans. Inferior good.
2. Write down one factor responsible for increase in demand.
Ans. Rise of income or favourable taste for a good.
3. At the given price when will be the demand of a commodity be less?
Ans. Fall in the income.
or
Ans. Fall in the price of a substitute good.

4. When two demand curves intersect with each other which will be more
elastic.
Ans. The demand curve which is more flattered will be more elastic.
5. If the demands for good Y increases as price of another good X rises
how the two goods are related?
Ans. These are substitute goods.
6. Answer in one sentence the assumption on which a demand curve is
constructed
Ans. That all the determinates are constant.
7. What is cross price effect?
Ans. Cross price effect refers to the effect of change in the price of
commodity-X on the demand for commodity Y when X and Y are related
goods.
8. What types of goods find a rise in their demand even income of the
buyer reduces?
Ans. Inferior goods
9. Why is demand for water inelastic ?
Ans. Demand for water is inelastic ,as water is an essential of life.

3/4 Mark Questions :

1.Give difference between change in demand and change in quantity
demanded.
Change in quantity demanded
1. More or less quantity is

Change in demand
1. More or less quantity is

demanded due to change of

demanded due to factors

price

other then price.

2. Movement on same demand

curve downwards or upwards
3. Extension & contraction are
two stages.

2. Shifting of demand curve

towards left and right
3. Increase and decrease
are two stages

2. Why more is purchased when price falls?

Or
Why does demand curve slope downwards?
Ans. (a)Income effect: - change in real income due to change in price is
income effect. When price falls real income increases that why a person purchases
more.
(b)Size of consumer groups: - when price falls the demand extends
because the persons who were not purchasing earlier. They also start purchasing.
(c)Substitution effect: - when the price of a substitute good increases the
demand of the given god increases as it is relatively cheaper.

(d)Law of diminishing marginal utility:- by using more and more units of a

commodity the marginal utility from each successive unit goes on decreasing. This is
why the consumer buys more commodities at low price.
3.Explain with the help of diagram, the effect of the following changes on
the demand of a commodity.
10. Fall in the price of a substitute good .
11. Fall in the income of its buyers.
Ans.

(a) Fall in the price of a substitute good will cause fall in the demand of
the given commodity from 0q to 0q1. the demand curve will shift
towards left to d1d1

(b) Fall in the income of its buyer will cause fall in the demand of normal
goods from 0q to 0q1. the demand curve will shift towards left from dd
to d1d1

4.Price of a commodity falls from Rs. 4 to Rs. 3 per unit. As a result total
expenditure on it rises from Rs. 200 to Rs. 300. Find out price elasticity of
demand by percentage method.
Ans. PriceTotal Exp.Quantity
Rs. 4Rs. 200200/4=50
Rs. 3Rs. 300300/3=100
Ed:- P / q x q / p
Ed:- (-) 4 / 50 x 100 50 / 3-4
Ed:- (-) 4 / 50 x 50 / -1Ed:- 4

5. Given the fact that the slope of a straight line demand curve =P/Q,
how do you relate it to own price elasticity of demand ?
Ans. We know ,Ed = P/Q x Q/P .
Given the fact that slope of demand curve = =P/Q ,
We can write that Ed = 1/slope of demand curve X P/Q
Diagrams +

1.

2.

Law of demand with demand curve

Market Demand Curve

A

3.

Change in quantity demanded and change in demand

Market

Price constant

Due to change in price

Shifting of demand curve

No shifting of demand curve

4 Degrees of price elasticity of demand

Ed >1

Ed <1

Ed =0

Ed=infinity

STUDY MATERIAL FOR SLOW LEARNERS (UNIT II)

CONSUMERS BEHAVIOUR AND
DEMAND
SOME BASIC CONCEPTS OF THE RELATED UNIT
Utility:-Wants satisfying quality of a commodity.
Total utility:-Total psychological satisfaction obtained from the consumption of all
the commodities.
Marginal utility:-The rate of change in total utility is known as marginal utility.
Normal good:-whose demand increases with increase in income & vice-versa.
Inferior good:- Whose demand decreases with increase in income & vice-versa.

Giffen good:-whose demand increases with increase in price & vice-versa.

Substitute good:-Goods which can be demanded in place of other good.
Complementary good:- Goods which are jointly demanded.
Demand:-It is an effective desire which can be demanded at a certain price, place &
time.
Law of demand:- other things remaining the same, higher the price lower the
demand & vice-versa.
Indifference curve:-Locus of various points where a consumer attains equal level of
satisfaction at all points.
Indifference map:- Set of indifference curve which shows different level of
satisfaction.
Budget set:-The bundle of goods a consumer can buy from his/her entire income.
Budget line :-It shows the budgetary constraints or the money income of the
consumer.
Consumers equilibrium:- when a consumer attains maximum level of
satisfaction from the
given income.
Law of diminishing marginal utility:- It declines with the consumption of
successive units of the commodity.
Change in demand:- Affected by the factor other than price.
Change in quantity demand:- Affected by price only.
Elasticity of demand:-Responsive change in quantity demand which is due to
responsive change in price.
Factors affecting demand:- price of the goods,income of consumer, change in
future price, taste0 and preference of consumer etc.
(Very Short answer Questions Carrying 1 marks each)
Q1.Define marginal utility?
Ans:- The rate of change in total utility during consumption process is known as
marginal utility.
Q2. What is demand?
Ans:- It is an effective desire which can be demanded at a certain price, place and
time.

Q3. What is law of demand?

Ans:- other things remaining the same higher the price lower the demand and viceversa.
Q4. What is normal good?
Ans:-Goods whose demand increases with the increase in income and vice-versa.
Q5. What is inferior good?
Ans:- Goods whose demand decreases with the decrease in income is known as
inferior good.
Q6. Give two examples of giffen good.
Ans:- Diamond, Precious stone, Merchandise car etc.
Q7. Define the term elasticity of demand.
Ans:- Percentage change in quantity demand which is due to percentage change in
price is known as elasticity of demand.
Q8. Write the situation when a consumers attain equilibrium in case of one good.
Ans:- Mux/Px=Mum
Q9. What do you mean by increase in demand?
Ans:-It is a situation when demand increases irrespective of without change in price.
Q10. What is inelastic demand?
Ans:- When demand does not change irrespective of change in price.
(Short Answer Questions carrying 3 Marks each )
Q1. List three factors which affects demand.
Ans:- a)Price of the commodity
b) Income of the consumer
c) Change in taste, behaviour and preference of the consumer
Q2. Distinguish between Normal good and Inferior good.
Ans:-

Normal good
# Goods whose demand increase with
increase in income
# It has positive slope

Inferior good
# Goods whose demand decreases with
.increase in income.
.# It has negatively slope.

Q3. Differentiate between increase in demand and extension in demand.

Ans:Increase in demand
# Demand increases without change in
Price
# Rightward shifting of demand curve

Extension in demand
# Demand extends due to change in
price
.# Movement along demand curve.

Q4. Write the properties of indifference curve.(any three)

Ans:-1)Higher indifference curve gives higher level of satisfaction.
2) Two indifference curve never intersect each other at any point.
3) Indifference curves are convex to origin.
Q5.Mention any three factors which effects elasticity of demand.
Ans:- a)Nature of the commodity-necessary and luxurious good
b)Time period-short and long
c) Proportion of expenditure-larger and smaller part(students will explain the points in
brief)
Q6.Calculate price elasticity of demand by total expenditure method:Price(Rs)
8
10
Ans:-

Quantity demand(units)
100
90

Price

Quantity demand

8
10

100
90

Total
expenditure
800
900

Type of
elasticity
Ed=<1

Q7.Explain the concept of law of demand with suitable schedule.

Ans:-Law of demand states that other things remaining the same higher the price
lower the demand and vice-versa.
Price (Rs)
10
5
(pupil will explain the schedule in brief)

Quantity Demand
20
40

Q8. Show the relationship between total and marginal utility with the help of curve.
Ans:-

y
TU

utility
o units of commodity

MU x

i)When TU increases MU falls.

ii) When TU is maximum MU becomes Zero.
iii) When TU declines MU becomes negative.
(Short Answers Questions having 4 marks )
Q1. Distinguish between substitute and complementary good. Give example in each
case.
Ans:- Substitute good:- Goods which are demanded in place of one another is known
as substitute goods. For example-tea and coffee, wheat and rice, bike and scooter
etc.
Complementary good:- Goods which are jointly demanded is known as
complementary good. For example-car and petrol, bread and butter, pen and ink etc.
Q2. Explain the effect of change in income of the buyers of a good on its demand.
Ans:- As we know that the income of the consumer either increase or decrease and
a rational Consumer behaves accordingly. Incase if consumer income raises then
ultimately the demand will also increase and if consumers income decline then
consequently he will demand less due to fall in income.(student may take an
example to explain the concept by taking the case of normal and inferior good).

Q3. Distinguish between individual demand and market demand.

Ans:- Individual demand:-Demand of a particular commodity by an individual
consumer in the market is known as individual demand. For ex- Rams demand for
milk.
Market demand:- Demand of a commodity by all the consumers in the market is
termed as market demand. For ex- Ram,Sohan and mohans demand for milk will be
combined known as market demand.
(Long Answer type questions carrying 6 Marks only)
Q1. Explain briefly any three factors which lead to increase in demand.
Ans:- (1)Increase in income of the consumer
(2) Expected increase in future price
(3) Increase in size of population
(Pupil will explain the mentioned points along with suitable schedule and
diagram)
Q2. Define consumers equilibrium. Write its condition in case of two commodities
with the help of suitable diagram.
Ans:-It is a situation when a consumer spends his entire income on two goods in
such a manner which gives him maximum satisfaction.
Condition of consumers equilibrium:i)Slope of IC =Slope of budget line
i.e MRSxy=Px/Py
ii) At equilibrium point IC is tangent to budget line.
iii) IC is convex to the point of origin & we obtain decreasing MRS.

IC

o
good x(Need diagram and its suitable explanation)

Test Paper for Bright Students

Unit -2
(Consumers
Behaviour)
1. What does the law of diminishing marginal utility say?
2. Mention the conditions of consumers equilibrium in single commodity case.1
3. Given the market price of a good, how does a consumer decide as to how
many units of that good to buy? Explain.3
4. Why does the demand curve downward slope? OR Give the reasons due to
which the law of demand holds.4
5. State the law of demand. What is meant by the assumption other things
remaining the same, on which the law is based.4

6. Price elasticity of demand for a good is (-) 1. At a given price the consumer
buys 60 units of the good. How many units will the consumer buy if the price
falls by 10%?4
7. Suppose there are 30 consumers for a good, having identical demand
function: d(p) =10-3P for any price less than or equal to 10/3 and d(p)=0 for
any price greater than 10/3. Write the market demand function.
6
8. Determine how the following changes (or shifts) will affect market demand
curve of a product.
23=6
a) A new steel plant comes up in Jharkhand people who were previously
unemployed in the area are now employed. How will this affect the
demand for colour T.V. and Black and White T.V. in the region?
b) In order to encourage tourism in Goa. The Government of India suggests
Indian Airlines to reduce air fare to Goa from the four major cities of
Chennai, Kolkata, Mumbai and New Delhi. If the Indian Airlines reduces
the fare to Goa, How will this affect the market demand curve for air travel
to Goa?
c) There are train and bus services between New Delhi and Jaipur. Suppose
that the train fare between the two cities comes down. How will this affect
demand curve for bus travel between the two cities?

Test Paper for Bright Students

Unit -2
(Consumers Behaviour)
1. What is MRSxy.1
2. What happens to the demand curve of an inferior good when the income of
the buyer rises? 1
3. What happens to demand of a commodity if there is an increase in price of the
complementary good?1

4. Define consumer equilibrium. Why does a consumer maximize her

satisfaction only when the slope of both Indifference curve and Budget line
are equal to each other?3
OR
How much quantity of a good will be purchased by a consumer at a given
market price to maximize her satisfaction? Explain with the help of a utility
schedule.

5.

Explain the difference between:-

A: Utility analysis and Indifference curve analysis.

B: Normal goods and Giffens goods
6 : Given Ed = - 0.02, and percentage increase in price = 20%, find change in
expenditure onthe commodity.
4
7 :Price of a commodity falls from Rs. 4 to Rs. 3 per unit. As a result total
expenditure on it rises from Rs. 200 to Rs. 300. find out price elasticity of
demand by percentage method. 4
8 Identify the effect on demand of the following6
(a)Govt enhanced the pay of the government employees. How will this affect
the demand curve of government employees?
(b)A new car factory comes up in Assam; many people who previously
unemployed, in the area are now employed .How will this affect demand curve
of television.
(c) There are train and bus service between Lucknow and Agra. Suppose the
train fare between two cities comes down, how will this affect the demand
curve for bus travel between two cities?

9 : If a product price increases, a familys spending on the product has to

increase. Defend or refute.6

TEST PAPER-2 (CONSUMER BEHAVIOUR AND DEMAND)

(FOR UNDER ACHIEVERS)
Q.1.State whether the following statements are true or false:
i. If other things remaining constant, there is positive relationship between quantity
demanded and own price of a commodity.
ii. The demand for inferior goods increases with decrease in income of consumer.
iii.When elasticity of demand is equal to zero ,the demand curve will be vertical
straight line parallel to Y-axis.
iv. Income of consumer affect the demand for an individual.
Q.2.Fill in the blanks:

1x4=4

1x4=4

a.Indifference curve is ----------------------- to the origin.

b.In case of --------------------goods demand rises with increase in income.
c.When a change in price causes no change in total expenditure then elasticity of
demand is--------------.
d.If good X and good Y are used together to fulfill a want then good X and good Y
are ------------------------goods.
Q.3.Categorise the following changes as expansion, contraction, increase or
decrease in demand (assuming given commodity is a normal good) 1x6=6
i. When price of substitute rises.
ii. When price of given commodity increases.
iii. When income of consumer decreases.
iv. When price of given commodity falls.
v. When the given commodity becomes a fashion good.
vi. When price of complimentary good increases.
Q.4.Draw demand curves having following elasticity:
1x4=4
i.Ed=0

ii.Ed=1

iii.Ed<1

iv.Ed=

Work-Sheet
Q1 What is the another name of indifference curve approach?
(a) Ordinal approach

(b) Cardinal Approach

(c) Both a and b

Q2 What is the formula of TU ?

(a) MP

(b) MC

(c) MU

Q3 What is the normal shape of IC ?

(a) Concave (b) Straight Line

(c) Convex

Q4 What is meant by change in demand ?

(a) Increase or decrease in demand
demand

(b) Extension or contraction in

(c ) Both a and b
Q5 What is meant by change in quantity demanded?
(a) Increase or decrease in demand(b) Extension or contraction in demand
(c) Both a and b

Q6 The % change in quantity demanded will be equal to % change in price if

(a) Ed = 2

(b) Ed = 3

(c) Ed = 1

Q7 What is the slope of demand curve in case of normal goods?

(a) Negative

(b) Positive (c) Parallel to X axis

Q8 What is the shape of demand curve in case of giffen goods?

(a) Negative

(b) Positive (c) Parallel to Y axis

Q9 What is the another name of total expenditure method of measuring price

elasticity of demand?
(a) Total outlay method
Method

(b) Total cost method

(c) MC and MR

Q10 What is the formula to measure the price elasticity of demand through
point method?
(a) Upper portion / lower portion
( c) None of the two.
Ans. 1.a

2.c

3.c

(b) Lower portion / Upper portion

4.a

5.b

6.c

7.a

8.b

9.a

10.b

UNIT III
PRODUCER BEHAVIOUR AND SUPPLY (16 Marks)
A. PRODUCTION FUNCTION: TOTAL PRODUCT, AVERAGE PRODUCT,
MARGINAL PRODUCT, RETURNS TO A FACTOR &
PRODUCERS EQUILIBRIUM
BASIC CONCEPTS:
1. Production function: refers to the technological relation between physical inputs
and physical output. It is the technological knowledge that determines the maximum
level of output that can be produced by employing different levels of inputs. It is
expressed in terms of a function as follows:
q = f (x1, x2),
where x1 is the amount of factor1, x2 is the amount of factor2, and q is quantity of
output to be produced.
2. Total Product: refers to total quantity of goods produced by a firm during a given
period of time by varying the units of a variable input like factor 1.
3. Average product is defined the output per unit of a variable input, say, factor1.
That is, AP1 = TP/x1.

4. Marginal product refers to addition to total product, when one more unit of
variable factor is employed, that is, MP1 =

= TPn TPn-1

5. Short Run and Long Run: Short run is a period in which some factors are
variable (variable input) and other factors remain fixed (fixed input). On the other
hand, in the long run, all factors of production are variable, nil is the fixed factor.
6. Returns to a factor refers to change in total product due change in only the
variable input in the short run, while fixed inputs remain constant.
7. Law of Variable Proportion: states that if we go on increasing more and more
units of a variable factor with fixed factor remain constant, total product increases at
an increasing rate, but beyond a certain level of employment total product increases
at a decreasing rate and finally TP falls.
8. Law of Diminishing Marginal Product states that if we keep on increasing the
employment of a variable input with other inputs fixed, finally a point will be reached
after which the marginal product will start falling.
9. Relation between: (i) TP and MP, and (ii) MP and AP in terms of a schedule:

Factor1
O
1
2
3
4
5
6
7
8

TP1
0
10
24
40
50
56
57
57
56

MP1
10
14
16
10
6
1
0
-1

AP1
10
12
13.3
12.5
11.2
9.5
8.1
7

(i) From the above schedule, the relation between TP and MP is derived as
follows:
Stages
I:IncreasingReturnto
factor1(uptofactor
employment level 3 units )
II: Diminishing Return to
factor 1 (from 4units to 0
unit)
III: Negative Return to
factor1 (after 7 units)

TP1
Increases at
increasing rate

Increasesat
diminishing rate
Starts falling

MP1
an Increasing

a Diminishing

Negative

* When TP is maximum, MP is zero.

(ii) From the above schedule, the relation between MP and AP is derived as
follows:
(a) When AP rises, MP is higher than AP,
(b)When AP falls, MP is less than AP, and
(c) When AP is maximum, MP =AP,
(d) MP may be positive, zero or negative but AP is always positive.
10. Reasons for the operation of increasing returns to a factor:
(i) better utilization of the fixed input with increase in variable input,
(ii) benefits of division and specialization of the variable input used, say, labour,
(iii) indivisibility of fixed input.
11. Reasons for the operation of diminishing return to a variable input, say,
labour:
(i) optimum combination between fixed and variable inputs is disturbed with
increasing use of the variable input,
(ii) After a certain level of employment of the variable input, the benefits from the
division of labour will diminish leading to diminishing return.
(iii) imperfect substitutes between fixed input and variable input.
QUESTIONS:
A. Very short answer questions:
1. Define production function.
2. Define average product.
3. Define marginal product.
4. Define law of variable proportions.
5. What is the law diminishing marginal product?
6. How is TP derived from MP?
7. Define Producers equilibrium.
8. What are the conditions of producers equilibrium?
9. Give the meaning returns to a factor?

10. What is the general shape of MP curve?

11. What happens to MP when TP increases at an increasing rate?
B. Short Answer Questions:
1. Explain the relation between TP and MP in terms of TP and MP curves.
2. Explain the relation between MP and AP in terms of MP and AP curve.
3. What are the conditions of producers equilibrium under MC-MR approach?
4. What are the reasons of the operation of increasing returns to a variable input?
C. Long Answer questions:
1. Explain the law of variable proportions in terms of (i) TP and MP curves, and (ii) a
schedule of TP and MP.
2. What is producers equilibrium? Explain the producers equilibrium under MC-MR
approach. Use diagram.
3. To increase the production of a good only one input is increasing while other
inputs are held constant. Explain its effect on total physical product. Give reasons.
D. NUMERICAL QUESTIONS WITH SOLUTIONS:
Q.1.

Find out APP and MPP.

(i)

Labour 1
TPP

Ans.

(ii)

40

80

110

130

140

140

130

APP

40

40

36.67

32.5

28

23.33

18.57

MPP

40

40

30

20

10

-10

20

16

12

-8

Find out the TPP and APP.

Labour 1
MPP

Ans.

24

TPP

24

44

60

72

80

80

72

APP

24

22

20

18

16

13.33

10.28

(iii)

Calculate the APP and MPP.

Labour 0
TPP

Ans.

(iv)

12

20

30

35

40

42

APP

6.66

7.5

6.66

MPP

10

The following table gives APP of a factor. It is also known

that (TPP) total product at O level of employment is O.
Determine its total product and marginal product.
Labour 1
APP

Ans.

7.

50

48

45

42

39

35

TPP

50

96

135

168

195

210

MPP

50

46

39

33

27

15

Complete the following table:

Units of
Labour

TP

AP

MP

20

--

--

---

--

21

22

66

--

---

--

---

22

22

--

21

---

9. Find out the maximum profit position of a producer by comparing MC &

MR on the basis of the following data:

Output (in units)

MR
(Rs)

MC
(Rs)

10

E. HOT Questions:
1.
2.
3.

What happens to TP when MP is zero?

What happens to MPP when TPP increases at decreasing rate?
As the variable input is increased by one unit, total output falls. What would
you say about of marginal productivity labour?
4.What happens to MPP when TPP falls?
5.Why MP curve lies above AP curve in the phase of increasing returns to a factor?
6.Why AP keeps raising even when MP declines?
7.When will the producer will be in equilibrium. Explain with the help of a
schedule.
8. Explain the conditions of producers equilibrium in case of MR & MC approach
(with the help of diagram).
9.When does a producer earn maximum profit?
10.Prove that for profit maximization:1)The market price (P) = MC.
2)MC curve is non-decreasing

F: True or False Questions:

1. State whether the following statements are true or false. Give reasons for your
answer.
(i) When there are diminishing returns to a factor TP first increases then start falling.
(ii) Average product will increase only when marginal product increases.
(iii) Under diminishing returns to a factor, total product continues to increase till
marginal product reaches zero.

G. MCQ Questions:
1. Some factors variable and some factors fixed are referred to the period as:
(a) medium run, (b) long run, (c) short run, (d) None of the above.
2. Output per unit of a variable input is called:
(a) MP (b) TP (c) AP (d) AC
3. The technological relation between inputs and output is referred to as:
(i) cost function, (ii) supply function (iii) utility function (iv) production function.

4. If we keep on increasing units a variable input, fixed inputs remain constant, the
marginal product is initially increasing. But after a certain level of employment
marginal product starts falling. What is the law?
(i) law of diminishing marginal product, (ii) law of variable proportions, (iii) law of
diminishing marginal utility, (iii) law of demand
5. What happens to MP when TP continues to increase at a diminishing rate?
(a) increasing, (b) diminishing (c) remain constant (d) negative
6. What is the value of TP if the AP is 12 at 4 unit of variable input?
(i) 6 (ii) 16 (iii) 48 (iv) 8
7. A producer is in equilibrium when:
(i) MC>MR, (ii) MC= MR, (iii) MC is increasing, (iv) both (ii) and (iii)

STUDY MATERIALS FOR UNDER-ACHIEVERS (QUESTIONS WITH

SOLUTIONS):
1. Define marginal product.
Ans: Marginal product is an addition to the total production by using an extra unit of a
variable factor.

2. Define average product.

Ans: Average product is the product per unit of a variable factor used.
3. Define production function.
Ans: Production function is defined as technological relation between inputs and
output.
4. What is the relation between TP and MP?
Ans: (i) When TP rises at an increasing rate, MP is increasing.
(ii) When TP rises at a diminishing rate MP is diminishing.
(iii) When TP starts falling, MP is negative.
(iv) When TP is maximum, MP is zero.
5. What is producers equilibrium?
Ans: Producers equilibrium refers to a position at which the producer gets maximum
profit with minimum cost.
6. State the conditions of producers equilibrium.
Ans: (i) MC = MR and
(ii) MC should be rising at the point of equilibrium.
7. From the following table, find out the level of output at which the producer will be
in equilibrium. Give reasons for your answer.

Output (in
units)
1
2
3
4
5

Marginal Revenue (Rs.)

8
8
8
8
8

Marginal Cost
(Rs.)
10
8
7
8
9

Ans:
Output (in
units)

Marginal Revenue
(Rs.)

Marginal Cost
(Rs.)

10

From the above schedule it is concluded that the producer attains equilibrium when
he produces 04 unit of the output because at this level of output both conditions of
producers equilibrium are satisfied, i.e., (i) MC = MR, and (ii) MC is increasing at
point of equilibrium.
STUDY MATERIALS FOR BRIGHT LEARNERS (QUESTIONS WITH
SOLUTIONS):
1. What type of changes take place in TP and MP when there are:
(a) increasing return to a factor (b)
diminishing return to a factor Why
do these changes take place?
Ans: (a) TP increases an increasing rate and MP is increasing.
Causes: (i) better utilization of the fixed input with increase in variable input,
(ii) benefits of division and specialization of the variable input used, say, labour,
(iii) indivisibility of fixed input.
(b) TP increases at a diminishing rate and MP is diminishing.
Causes:(i) optimum combination between fixed and variable inputs is disturbed with
increasing use of the variable input,

(ii) After a certain level of employment of the variable input, the benefits from the
division of labour will diminish leading to diminishing return.
(iii) imperfect substitutes between fixed input and variable input
2. Identify the different phases of the law of variable proportions from the following
schedule. Give reasons for your answer.
Variable input
(units)
1
2
3
4
5

TP (Units)
4
9
13
15
12

Ans:
Variable
Input
1
2
3
4
5

TP

MP

4
9
13
15
12

4
5
4
2
-3

Phases
I: Increasing return to a
factor
II: Diminishing return to a
factor
Negative return to a factor

Reasons: (i) In the 1st phase, TP increases at an increasing rate and MP is

increasing.
(ii) In the 2nd stage, TP increases at a diminishing rate and MP is diminishing.
(iii) In the 3rd stage, TP starts falling, and MP is negative.

B.COST & REVENUE:

Meaning-Cost means the total expenditure incurred in the Production of a
commodity. Broadly Costs are of two types:- Short-run costs & Long-run costs.
Short run costs-Short-run is a period of time when some factors are fixed and some
factors are Variable. Expenditure incurred in the Production of a commodity in the
short-run is known as short-run cost.
Long-run costs-Long-run is a time period when all the factors are variable.
Expenditure incurred in the production of a commodity in the long-run is known as
Long-run cost.
Types of Short-run costs:
1. Total Fixed Cost (TFC)-Expenditure incurred on the fixed factors of production
are known as Total fixed costs. Fixed costs do not vary with change in output.

2.

3.

4.

5.

6.

TFC=TC-TVC
Total Variable cost (TVC)- Expenditure incurred on the variable factors of
production are known as Total Variable Cost. Variable costs vary with change
in output.
TVC=TC-TFC
Total Cost (TC)-Total Cost is the total expenditure incurred on the production
of a commodity. It is the sum total of Total Fixed Cost and Total Variable Cost.
TC=TVC+TFC
Average Fixed Cost (AFC)-AFC is obtained by dividing the Total Fixed Cost
By the total number of units produced.
AFC=TFC/Q
Average Variable Cost (AVC)-AVC is obtained by dividing the Total Variable
Cost by the number of units produced.
AVC=TVC/Q
Average Total Cost (ATC)-ATC is obtained by dividing the Total Cost by the
number of units produced.
ATC=TC/Q
Marginal Cost (MC)-Marginal cost is the addition made to the total cost by
producing an additional unit of Output.
MC = TC/Q,
MCn = TCn-TCn-1

7.

Cost Schedule:
Out
Put
0
1
2
3
4
5
6
7
8
9
10

TFC

TVC

TC

AFC

AVC

AC

MC

40
40
40
40
40
40
40
40
40
40
40

-20
38
53
63
69
77
89
107
132
162

40
60
78
93
103
109
117
129
147
172
202

--

--

--

-20
18
15
10
6
8
12
18
25
30

40.00
20.00
13.33
10.00
8.00
6.67
5.71
5.00
4.44
4.00

20.00
19.00
17.67
15.75
13.80
12.83
12.71
13.38
14.67
16.20

60.00
39.00
31.00
25.75
21.80
19.50
18.43
18.38
19.11
20.20

Diagrams:

MARGINAL AND AVERAGE COSTS:

Marginal cost curve is U-Shaped because:
MC falls in the beginning because of increasing return to a factor(decreasing cost )
and then increases due to diminishing return to a factor(increasing costs).
Relationship:
1. Between Total Cost and Marginal cost.
MCn =TCn-TCn-1
When Total Cost increases at a diminishing rate Marginal Cost decreases.
When Total Cost increases at an increasing rate Marginal Cost increases.
2. Between Total Variable Cost and Marginal Cost.
MCn =TCn-TCn-1
When Total Variable Cost increases at a diminishing rate Marginal Cost
decreases.
When Total Variable Cost increases at an increasing rate Marginal Cost
increases.
3. Between Average Variable Cost and Marginal Cost.
When MC AVC, then AVC falls.
When MC =AVC, then AC is Minimum.
When MC AVC, then AVC rises.
MC curve always intersect AVC at its minimum point.
4. Between Average Total Cost and Marginal Cost.

When MC AC, then AC falls.

When MC =AC, then AC is Minimum.
When MC AC, then AC rises.
MC curve always intersect AC curve at its minimum point.
REVENUE
Revenue is the total money receipt of the firm from sale of its product.Three
main concepts of revenue are total revenue, marginal revenue, and average
revenue.
Total Revenue refers to the total money receipt of the firm from the sale of its total
output
TR = Number of units sold (Q) x price per unit (p)
TR = P X Q
Average Revenue: AR is revenue per unit of output sold.
MARGINAL REVENUE: It is the addition to total revenue when an extra unit of
output is sold.
MR = TRn TR n - 1
Relationship between AR & MR
i) If AR is constant MR is equal to AR

AR, MR
AR = MR

ii) If MR is above AR, AR increases.

iii) If MR is below AR, AR decreases.
AR and MR in Perfectly competitive market:
Output

In this market price or AR is constant. So MR isequal to AR. Both are

represented by the same horizontal line parallel to OX-axis.
AR & MR in non-competitive markets
1) The average revenue curve and marginal revenue curve slope downward from left
to right.
2) Since AR falls MR curve lies below the AR curve.
3) MR falls twice the rate of fall in MR.
Relationship between TR & MR:
1) As long as MR is positive TR increases.
2) When MR increases TR increases at increasing rate.

3) When MR decreases, but positive TR increases at decreasing rate.

4) When MR is zero TR is maximum.
5) When MR is negative TR diminishes.
QUESTIONS:
Very Short Answer Questions:
1. What is meant by Variable Cost?
Ans- Expenditure incurred on the variable factors of production are known as Total
Variable Cost
2. What is meant by Fixed Cost?
Ans- Expenditure incurred on the fixed factors of production are known as Total fixed
costs
3. Define marginal cost.
Ans- Marginal cost is the addition made to the total cost by producing an additional
unit of Output.
4. Define Average Variable Cost.
Ans- AVC is obtained by dividing the Total Variable Cost by the number of units
produced.
5. Express Total Variable Cost in terms of Total Fixed Cost and Total Cost.
Ans- TVC=TC-TFC
6. Explain marginal cost in terms of total cost.
Ans. MCn = TCn-TCn-1
7. Why is Average Total Cost greater than Average Variable Cost?
Ans- ATC=AVC+AFC
8. Give two examples of variable cost.
Ans- Expenditure on raw materials and expenditure on labor.
9. How does Average Fixed cost behave as out-put decreases?
Ans-AFC decreases.
10. How is MC derived from TVC?
Ans. MCn = TVCn-TVCn-1

Short Answer Questions (3/4 Marks)

1. Draw TFC, TVC and TC curves in a single diagram.
2. Distinguish between Fixed Costs and Variable Costs. Give two examples of each.
3. Why is the MC curve in the short-run U-shaped?
4. Explain the relationship between the Marginal Cost and Average Cost with the
help of a cost schedule and diagram.
Ans- When MC AC, then AC falls.
When MC =AC, then AC is Minimum.
When MC AC, then AC rises.
MC curve always intersect AC curve at its minimum point.
5. What changes will take place in Total Cost if Marginal Cost is rising? Show
with the help of a diagram.
6. Complete the following table.
Out Put
1
-3
--

TVC
10
-27
--

AVC
-8
-10

MC
-6
-13

MC
-10
8
-10

TC
-82
-99
--

7. Complete the following table.

Out Put
1
-3
-5

AFC
--20
-12

REVENUE:
8.

Find AR and MR.

(i)

Ans.

Output
TR
AR
MR

1
10
10
10

2
24

3
33

4
40

5
40

6
36

7
28

12
14

11
9

10
7

8
0

6
-4

4
-8

9.
(i)

Find out TR and MR.

Output
AR

Ans.

10.
(i)

TR
MR

10
6

9
7

8
8

60
-

63
3

64
1

Complete the following table:

Output1
PriceMR10
TR-

Ans.

Output
Price
MR
TR

Q11.
(i) Output123
MR1080
Ans.TR101818
AR1096

1
10
10
10

2
9
-

3
24

4
4
-

2
9
8
18

3
8
6
24

4
7
4
28

Calculate TR and AR

12.How do changes in MR affect TR?

Ans. i)If MR increases, TR increases at increasing rate.
ii)If MR is constant, TR increases at constant rate.
ii)IF MR falls, TR increases at diminishing rate.
13.What is MR? How is it related to AR?
Ans. MR refers to the change in TR due to sale of an additional unit.
Relation
(i)If AR (Price) is constant, MR = AR
(ii)If AR (Price) falls, MR < AR.
(iii)If AR (Price) rises, MR > AR.

HOTs:
1.At what point does the MC curve cut the AVC curve?
Ans- Minimum point of AVC.
2.What happens to ATC when MC is less than ATC?
Ans-ATC falls
3.When AC is rising What is the relation between AC and MC?
Ans-MC is greater than AC.

4
-2
16
4

4.The Average Cost of producing 5 units of a good is Rs 6 /- and that of producing 6

units is Rs 5/- What is the MC of producing 6 units?
Ans-MC of producing 6 units is 0.
Study Material For Under Achievers:
1. Define cost.
Ans- Cost means the total expenditure incurred in the Production of a commodity
2. What is Marginal cost?
Ans- 1.Marginal cost is the addition made to the total cost by producing an additional
unit of Output.
3. What do you mean by variable cost?
Ans-Expenditure incurred on the variable factors of production are known as Total
Variable Cost
4. Write the formulas for calculating AFC, AVC and MC.
Ans-AFC=TFC/Q
AVC=TVC/Q
MCn=TCn-TCn-1
5. State the relationship between AC and MC.
Ans- When MC AC, then AC falls.
When MC =AC, then AC is Minimum.
When MC AC, then AC rises.
MC curve always intersect AC curve at its minimum point.
6. What is the relationship between TC and TVC?
Ans-TC=TVC+TFC
7. Calculate TVC,AVC,AFC,AC and MC from the following data.
TFC
60
TC
90
Ans-TVC=TC-TFC

60
105

60
115

60
120

60
135

AVC=TVC/Q, AFC=TFC/Q, AC=TC/Q, MCn=TCn-TCn-1

60
160

60
200

60
260

Study Material for Bright Students:

1. What is MR? How is it related to AR?
Ans. MR refers to the change in TR due to sale of an additional unit.
Relation :
(i)

If AR (Price) is constant, MR = AR

(ii)

If AR (Price) falls, MR < AR.

(iii)

If AR (Price) rises, MR > AR.

2. What happens to ATC when MC is less than ATC?

Ans-ATC falls
3.When AC is rising What is the relation between AC and MC?
Ans-MC is greater than AC.
4. Explain the relationship between the Marginal Cost and Average Cost with the
help of a cost schedule and diagram.
Ans- When MC AC ,then AC falls.
When MC =AC ,then AC is Minimum.
When MC AC ,then AC rises.
MC curve always intersect AC curve at its minimum point.
TEST PAPER -1
1. Fill in the blanks:

1x5=5

a.
_cost increases and decreases with the volume of out-put.
b. ------------------ cannot be changed in the short period.
c. Wages is
cost of the production.
d. ATC=
+AVC.
e.
=AFC x Q

2. Choose the correct answer.

1x5=5

a. Expenditure incurred on the fixed factors of production is known asi)Total Cost. ii)Total fixed cost. iii)Total Variable Cost. iv)Marginal Cost.
b. Average Variable Cost is obtained using which of the following formulas?
i) TC/Q ii)TVC/Q iii)TFC/Q

iv) AFC/Q

c.When Total Cost rises at a diminishing rate the Marginal Cost

i)Rises.

ii) declines

iii)Constant.

iv) increases

d. Marginal Cost is calculated from

i)AVC ii)TC iii)TFC

iv)AFC

e. Cost of raw materials is an example of

i)fixed cost

_.

ii)variable cost iii)opportunity cost iv)marginal cost

3.Say whether true or false.

1x10=10

a) MC is calculated from TVC.

b) When MC is greater than AC, then AC falls.
c) Average cost is always positive.
d) Average cost is always equal to the price of the commodity.
e) Total cost is equal to the total fixed cost less total variable cost.
f) AFC is equal to TFC divided by total out-put.
g) Average cost is equal to AFC plus AVC.
h) MC=TCn+1-TCn-1
i) TFC=AFC/Q
J) TC=AFC+AVC.
C. THEORY OF SUPPLY:
1. Supply:
It is that quantity of a commodity which a seller or producer is ready to sell in the
market at a certain price within a given time period.
Factors Affecting Supply of the commodity:
1) Own price of commodity
2) State of technology
3) Prices of factors of production
4) Taxation policy
5) Price of related goods
6) Other factors like natural calamities.

Law of Supply: Other things being constant, there is a direct relation between price
of a commodity and its quantity supplied i.e. higher the price more the supply and
vice-versa.
Supply Schedule: It is a schedule / table showing different quantities supplied of a
commodity by a seller at different prices.
Price

Quantity
Supplied

20

15

12

10

Supply Curve -If supply schedule is shown on a graph, we get a curve which is
called supply curve.

Market Supply: It is the horizontal summation of the supply of a product by all the
producers in the market at a given price and at a point of time.
Tabular presentation:
Price per Unit (in Quantity
Rs)

supplied

Quantity
by

A supplied

Market
by

B (Units)

(Units)

(Units)

10

Supply

Diagrammatic Presentation:

Change in Quantity Supplied: When there is change in supply of a commodity due

to change in price (This is movement along the supply curve)
This Change is of two types.
1) Expansion in supply -Supply increases due to increase in price
(Figure 3.10)

2) Contraction in supply -Supply decreases due to decrease in price.

Change in Supply -(Shift in supply curve) When supply of a commodity changes

due to factors other than price, like technique, taxation policy, prices of factors of
production etc. This is called change in supply.
This change is of two types:
a) Increase in supply -when supply of a commodity rises due to factor other than
price it is increase in supply. In this case the supply curve shifts rightward.
b) Decrease in supply -when supply of a commodity falls due to factors other than
price it is decrease in supply. In this case the entire supply curve shifts to the left
(upward).

(Figure 3.11)
Price Elasticity of Supply:
It is the measurement of degree of change in supply of a commodity to change in its
price.
Es = % change in quantity supplied / % change in price
Es = x P

Factors Affecting Elasticity of Supply:

1. Nature of commodity
Durable goods -Elastic
Non-durable -Inelastic
2. Change in cost of production 3. Technique of production
4. Time period.
Methods of Measuring Elasticity:
1. Percentage method or Proportionate method.
Es = % Change in QS or
% change in price
2. Geometric method

Proportionate change in Supply = S x P

Proportionate change in PriceS x

a) Es > 1

(Figure 3.12)
b) Es = 1 Supply curve passes through origin.

c) Es < 1

(Figure 3.13)

VERY SHORT ANSWER QUESTIONS:

1. What causes a downward movement along a supply curve of a commodity?
Ans : Increase in cost of production
2. What causes an upward movement along the supply curve of a commodity?
Ans: Decrease in excise duties.

3. What causes a movement along the supply curve of a commodity?

An : change in price of goods.
3. State the law of supply.
Ans : The law states that as price of a good rises, quantity rises, while other
things remain constant.
5. Define supply.
6. When is the supply of a commodity called elastic?

7. Price elasticity of supply of a good is 0.8. Is the supply elastic or inelastic and
why?
8. Price elasticity of supply is 1.2. Is its supply elastic or inelastic and why?
9. Define market supply.
10. What is the price elasticity of a straight line supply curve touching the OY-axis?
11. What is the price elasticity of straight line supply curve touching the OX-axis?
SHORT ANSWER QUESTION:
1. At a price of Rs. 8 per unit, the quantity supplied of a commodity is 200 units.
Its price elasticity of supply is 1.5. If its price rises to Rs. 10 per unit, calculate
its quantity supplied at new price 3.
2. The price elasticity of supply of a commodity is 2.5. At a price of Rs. 5 per
unit, its quantity supplied is 300 units. Calculate its quantity supplied at a price
of Rs. 4 unit.
3. The price of a commodity is Rs. 12 per unit and its quantity supplied is 500
units. When its price rises to Rs 15 per unit, its quantity supplied rises to 650
units. Calculate its price elasticity of supply. Is supply elastic?
4. List any three determiners of supply of a commodity.
5. Give three reasons for a rightward shift of supply curve of a commodity?
6. Give three reasons for increase in supply of a commodity?
7. State any three causes of leftwards shift of supply curve?
8. Explain the effect of technological changes on the supply of a product?
9. Define market supply of good. Give three causes of a rightward shift of supply
curve?
10. What is meant by change in supply? State three factors that can cause
change in supply?
11. When the price of a commodity falls from Rs. 10 per unit to Rs. 9 per unit, its
quantity supplied falls by 20 percent. Calculate its price elasticity of supply?
12. The price of a commodity is rs.5 per unit and its quantity supplied is 600 units.
If its price rises to Rs. 6 per unit, its quantity supplied rises by 25 per cent.
Calculate its price elasticity of supply.
13. Due to a 10 per cent rise in the price of a commodity, its quantity supplied
rises from 400 units to 450 units. Calculate its price elasticity of supply. Is its
supply elastic?
14. A 5 per cent fall in the price of a commodity results in a fall in its quantity
supplied from 400 units to 370 units. Calculate its price elasticity of supply. Is
its supply elastic?
15. The price elasticity of supply of a commodity is 2. When its price falls from Rs.
10 to Rs. 8 per unit, its quality supplied falls by 500 units. Calculate the
quantity supplied at the reduced price.

16. When the price of a commodity rises from Rs. 10 to Rs. 11 per unit, its
quantity supplied rises by 100 units. Its price elasticity of supply in 2.
Calculate its quantity supplied at the increased price.
17.The elasticity of supply of a commodity is 3. An increase in its price from Rs.
20 to Rs. 21 per unitresults in a rise in its quantity supplied by 150 units.
Calculate its quantity supplied at the increased price.
LONG ANSWER QUESTION INCLUDING HOTS
1. Define price elasticity of supply. How is it measured by geometric method? (In
case of a straight line supply curve).
2. Distinguish between change in supply and change in quantity supplied of a
commodity.
3. Explain briefly the following determinants of supply:
i.
ii.
iii.

Increase in the prices of inputs.

Decrease in tax on total product.
Technological change.

MCQ of Supply and Producers Equilibrium:

Fill in the blanks:
1. A supply curve reflect the positive relationship between
supplied.
2. An increase in the inputs prices shift the supply curve too the

and quantity

_.

3. Elasticity of supply = % change in quantity supplied

?
4. MR=MC and other condition is
5. Breakeven point is the point where
6. A/An

is equal to TC.

in supply will rise the supply curve, at the same price, .

(Increase, Decrease, Constant)

7. Market supply is

of individual supply.

(Addition, Subtraction, Division)

8. Unitary elastic supply equal to

(2,>1, <1, 1)
9. If MC is more than MR at particular level of output, then Producer
will
the production to maximize the profits.

(Increase, reduce, constant)

10. Profit refers to

(Cost=Revenue, Cost>revenue, Revenue>cost)

Find True and False and Give reasons:
1. Contraction of supply occurs due to change in factors other than price of the given
commodity.
2. Supply is always Unitary elastic for all supply curves starting from the origin.
3. In case of zero elastic supply, supply curve is a horizontal straight line.
4. Law of supply does not indicate the magnitude of change in quantity supplied of a
commodity due to change in its price.
5. At the state of Producers Equilibrium, marginal cost of the firm should rising.
6. To maximize the profits of a firm, the only condition needed is equality between
marginal cost and marginal revenue.
VALUE BASED QUESTIONS:
Production Function: Returns to a Factor:
1. A producer produced 35 units by employing 4 laborers, but it produces 42 units by
employing 5 laborers. What is the amount as marginal production?
(1)
Ans. MP = 42 - 35 = 7 units.
2. In Indian agriculture, we obtain 120 Million tons of food grains by employing 20mns
of laborers if it employs 1 more millions of labor, production rises by 6 million tons
which type of return it is?(1)
Ans. Constant returns.
3. A firm employs form laborers and it had following value-additions. Comment on it.
(2)

Units of labor
1
2
3
4
Total product
4
10
18
28
Ans. We can calculate marginal product from it, to decide about the law of return
applying upon this firm, shown through following table:
Labor

Total product
1
2
3
4

4
10
18
28

Marginal products
4
6
8
10

Since marginal product is increasing with additional laborer, therefore law of

increasing returns is applicable on firms productions.
4. A countrys electronic industry is passing through diminishing returns to scale. It
wants to raise product defeating the effect of diminishing stage. Suggest two ways.
(2)
Ans. In diminishing return to scale, firms cost of production rises which can lower
firms profits. It can improve its profit ability through following measure:
(i)By introducing new technology that helps in reducing its cost of production.
(ii)By improving managerial skills so that labor cost as well as marketing costs
are reduced.

5. Determine various stages of law of variable of proportions for a firm which has
following total productivity table:(3)
Labor
1
2
3
4
5
6
Total product
20
55
75
90
90
80
Ans. various stages of law of variable of proportion are determined on the basis of
marginal product. Therefore, we rewrite the table in following manner:
LaborTotal product
120
255
375
490
590
680
Ist Stage: till MP is highest at second laborer.
IInd stage: Till MP was zero at 5th laborer.
IIIrd stage: when MP becomes negative at 6th laborer.

Marginal product
20
35 (Ist stage)
20
15
0 (2nd stage)
-10 3rd stage

6. Production function of a firm is given as Y= 5L+2K

(1)

A firm employs zero units of labor and to units of capital, what would be its total
output?
Ans. Y= 5L+2K(where L=0 & K=10)
Y =5(0) + 2(10) =20units

7. Total production in an economy is given as such:

Fixed factor10mn hectares of land
Labor (millions)
1
Total production
25
(million tons)

(2)
2
54

3
55

Determine the stage of law of returns to a factor.

Ans. Law of returns to a factor can be determined on the basis of marginal
production which is given as such.

4
5

Fixed factors
(Millions)
10 million hectares
of land

Labor

Total product
(Million tons)
10
25
20
35
30
45
40
55
Law of diminishing constant returns to a factor is being applied.

Marginal product
(million tons)
--10
10
10

Supply and Elasticity of

Supply:
8. A firm raises its supply without any incentive of rise in price, mention three reasons.
(3)

Ans.
(i)Improvement in technique in production.
(ii)Fall in factor pricing.
(iii)Subsidies provided by the state.

9. An electronic company has enough period to raise the supply of A.Cs. what type of
elasticity of supply it will have
Ans. Elastic

(1)

10. Demand for a good is elastic whereas its supply is inelastic. What impact it will have,
when demand for good increases? Explain.
Ans. When supply is inelastic, it means supply for such a product cannot be
increased. Now when demand for it increases, it will raise price for such a good.

(1)

11. Supply of agricultural goods is inelastic. Explain.

Ans. Yes, it is true that supply of agricultural goods is inelastic because it is not
inspired by price-rise rather it depends upon natural, climatic and biological factors.
Such goods take lot of time in its production, therefore no price-frame can guide
there production.

(2)

12. Imports of production with less elastic supply can fetch higher revenue. Explain.
Ans. True, those imported goods which are inelastic or less elastic like petrol and
diesel and can fetch higher revenue. It is because of the reason that such goods will
be sold at high price because of limited supply. Therefore, the yield from such import
will be higher.

(2)

13. Which of the following is an example of increase in supply? Explain with reason.
X- commodity
Price Rs.Supply
10100
50
1212
50

Y- commodity
Price Rs

.Supply
1000
1200

(2)

Ans. Supply of Y-commodity is an example of increase in supply because in this case

supply increases even when price per unit remains to be Rs. 50. In case of Xcommodity, there is extension in supply because here supply rises with every
increase in price. In case of Y-Commodity, supply increases due to factors other than
price rise.
Concepts of
Costs:
14. Rent paid for hiring a building and depreciation of machine is a fixed on variable
cost?(1)
Ans. Fixed costs
15. When cost of producing one commodity is expressed in terms of alternative
commodity, it is known as which costs?(1)
Ans. Opportunity Cost
16. Total cost for 6 units of a good is given through the following table. Determine total
variable cost and marginal cost from it.
Output (unit
0
1
2
3
4
5
6
Total cost
60
160
240
300
400
560
780
(3)
Ans. Rs. 60 is total fixed cost as it is cost of producing zero units. Here TVC=TCTFC and MC=TVCn-TVCn-1. It is calculated as follows:
Output (units)
0
1
2
3
4
5
6

T.C.(Rs)
60
160
240
300
400
560
780

TFC (Rs.)
60
60
60
60
60
60
60

TVC (Rs.)
0
100
180
240
340
500
720

M.C. (Rs.)
--100
80
60
100
160
220

17. Supply curve of a firm is represented through which type of costs?

(2)
Ans. Supply curve of a firm is represented through an average cost curve (AC) and
Marginal cost cure (MC).

Concepts of
Revenue:
18. Total revenue earned from 20 units was Rs.800, what was average revenue? What
is its alternative name?(1)
Ans. AR=TR/Q = 800/20 =Rs.40. It is also known as price.
19. In case of perfect competition, what shape of AR curve?
(1)
Ans. It is parallel to x-axis.

20. Average revenue for 4 units was Rs.10 each; determine the value of total revenue
and marginal revenue. Use table
(3)
Ans. TR=AR x Q and MR=TRN-TRN-1.
Units sold

AR (Rs.)
1
2
3
4

TR(Rs.)
10
10
10
10

MR(Rs.)
10
20
30
40

10
10
10
10

21. In your opinion, which market can yield more revenue perfect competition or
monopoly?(3)
Ans. Under perfect competition, price is kept as competitive which results into higher
sale and higher revenue. On the other hand under monopoly, monopolist wants to
change a higher price and sales lower amount of good. It therefore, under perfect
competition, there is larger revenue earned with lesser amount of profits.

22. Suggest a suitable price policy that helps a firm to make value addition.
(3)
Ans. A firm should adopt following of price policy for promoting its sale and overall
revenue of the firm.
(i)Keep a competitive price that helps a firm to raise its sale.
(ii)Spend some amount on advertisement of the good show as to attract new
buyers.
(iii)Provide cash discounts, guarantee of qualitative product, and home delivery
of goods and warranty of durable goods.

23. Why equilibrium is essential for a producer? (1)

Ans. Because it will help him in maximizing profits.
24. Given below is AC and price of different units produced by a firm. Determine
producers equilibrium level where it (1)can earn maximum possible profit. Use
total approach.

Output (units)

50

Output
Price (Rs.)
(units)(Rs.)(Rs.)
50
20
60
20
70
20
80
20

60

70

80

Average cost

Total revenue (Rs

Total cost (Rs Total profit

15
15
18
20

1000
1200
1400
1600

750
900
1260
1600

250
300
140
0

Ans. Producer will be in equilibrium, when he produces 60 units [he earns

maximum amount of profit in this situation.

25. Under perfect competition, when a producer would gain higher profits, during short
period or long period.(3)
Ans. During short period, a producer has risk of earning losses as well as super
normal profits. But during long period, he will earn normal profits by which his
aggregate amount of profits will be higher. It is therefore long period yields higher
amount of profits to the producers.

26. Demand and Supply equation for a product are given below:
(3)
Yd =100-P
Ys =70+2P
Determine equilibrium price and quantity.
Ans.

Under equilibrium:
Yd = Ys

100-P = 70+2P
30 = 3P
P = Rs. 10
Putting the value of P in the equation
Yd =100-10 = 90 units
Ys =70+2(10) = 90 units
Therefore, equilibrium quantity = 90units
UNIT IV
FORMS OF MARKET AND PRICE DETERMINATION UNDER
PERFECT COMPETITION WITH SIMPLE APPLICATIONS
(12 MARKS)
Market: It refers to a region in which buyers & sellers interact with each other may
be directly or indirectly in order to exchange the commodities at certain price.
Types of Market: Market can be categorised on the basis of time, location and
competition. On the basis of competition, the market is classified into two categories
i.e. perfect and imperfect markets.

Perfect market / competitive market- It refers to such a market structure where the
firms are price takers and the price of the good remains same.
Imperfect market/ non-competitive market- It refers to the market structure where
the prices of the goods differ and firms are not only price taker but also price maker.
Perfect Competition Market: It refers to such a market structure where there are
large numbers of buyers and sellers and firm sell a homogenous product at uniform
price.
Characteristics / Features/ Conditions of the perfect competitive market
1. Large number of buyers and sellers There are large number of buyers and
sellers in perfect competitive market it means no single buyer or seller can
influence the market It is because each seller sells a very small portion of
the market supply, similarly the demand of each buyer is also very small in the
market.
2. Homogeneous product - The product sold in the market is homogeneous or
identical in all respect i.e. shape, size, colour, composition, etc.
3. Free entry and exit of firms - Under perfect competition there are no barrier
to entry and exit of firms in industry. But entry and exit may take time so it
happens only in long runs. This freedom ensures that firms earn just the
normal profits in the long run.
4. Perfect knowledge of market- In this market all the sellers as well as buyers
have the complete information about the market situation. It means they are
well aware about the product and its price. Thus the price remain same.
5. Perfect mobility The factors of production i.e. land, labour, capital and
entrepreneur are perfectly mobile. There is no geographical and occupational
restriction on their movement. It means factors of production are free to move
from one place to another place and one job to another job in which they get
better price.
6. No selling and transportation cost- It assumes that there is no selling and
transportation cost. Thus the price remains same everywhere.

Monopoly Its a market situation where there is a single seller of a commodity

which has no close substitutes.
Main features of a monopoly market are1. Single seller- Under monopoly there is an only seller of commodity in the
industry, so the difference between firm and industry get vanished. It means
the monopolist has full control over the supply and price of commodity.
2. No close substitute- The monopolist produces a distinct product which has
no close substitute in the market. Therefore the monopoly firm has no fear of
competition from any other commodity.
3. Barriers on entry- There are strong or significant barrier to the entry of new
firms. These barriers may be legal barriers like patent right or licensing etc.;
as a result monopolist firm can earn abnormal profit in the long run.
4. Price discrimination- When a monopolist charge different prices from
different buyers for the same product is called price discrimination. Its a
distinct feature of monopoly market. E.g. railways charge different fare for
senior citizens, children and others for same journey.

5. Independent price policy - In monopoly, firm and industry are same so the
firm has complete control over the output and it fixes its price by itself. Thus
firm is price marker in monopoly.

Monopolistic Competition- It refers to such a market structure where there are

large number of buyers and sellers and the firms produce & sell differentiated
product which has many close substitute available.
Characteristics /feature/conditions1. In this kind of market situation, there exist a fairly large number of firms which
have a greater competition among themselves. Due to this, the firms do not
have total control over the market supply of the product.
2. The firms produce & sell heterogeneous (differentiated) products, in this kind
of markets, which enable the firms to have control on their own output, & thus
the firms are price makers.
3. There is a freedom of entry & exit of firms in the market, to a considerable
extent, due to which the number of firms always remain fairly large. As a
result, the firms can earn only the normal profits in the long run.
4. The unique feature of this type of market situation is prevalence of selling
cost, i.e. the expenditure made by the firms to promote the sales of their
products viz. sale exhibition, discount offer, showroom demonstration,
advertisement & wide campaigning cost etc.
5. The firms, in this type of markets, are price makers, as all these firms have
distinct consumers of their product. As the firms produce & sell differentiated
product, the price of products of each firm is different, irrespective of their
similarity. Because of this, the AR (demand) curve slopes negatively at
gradual rate.

Oligopoly is a market structure in which there are few large sellers of a commodity,
which sell homogenous and differentiated product.
If in an oligopoly market, the firms produce homogeneous products, it is called
perfect oligopoly.
If the firms produce differentiated products, it is called imperfect oligopoly.
Collusive oligopoly is one in which the firms cooperate with each other in deciding
price and output.
Non collusive oligopoly is one in which firms compete with each other.
Features of oligopoly
1. Few firms - Few firms mean either only a few firms in number or a few big
firms producing most of the output of the industry. The exact number of firms is
not defined. The word few signifies that the number of firms is manageable
enough to make a guess of the likely reactions of rival by a firm.
2. Firms are interdependent in taking price and output decisions -When there
are only a limited number of firms, it is likely that rivals have some knowledge as
to how these firms operate. It one firm does something about the price and
quantity of the product it produces, the rivals are likely to take quick note of it and

react by changing their own price and output plAns- It makes each firm
dependent on other firms in the industry.
3. Barriers to the entry of firms- The main reason why the number of firms is
small is that there are barriers which prevent entry of firms into industry. Patents,
large capital, control over the crucial raw materials etc. prevent new firms from
entering into industry. Only those who are able to cross these barriers are able to
enter.
4. Non-price competition- Firms try to avoid price competition for the fear of price
war. They use other methods like advertising, better services to customers, etc
to compete with each other.
Difference between Perfect Competition Market & Monopoly market
Perfect Competition Market

Monopoly Market

1. In this kind of market, there is an

1. In this kind of market, a single firm exist
existence of large numbers of firms which
which has no close competitor, & thus, the
have perfect competition among each question of competition does not arise.
other.
2. The product been produced and sold in
2. The product, produced & sold in this
the market is homogenous, i.e. the product market is unique which have no close
have close substitute available.
substitute available.
3. The firms, in this market, are price taker
3. The firm itself is an industry, & thus it is a
i.e. the firms have to accept the price which price maker i.e. the firm has the capacity to
is determined in the market.
Make its own price.
4. In this market situation, the firms have
the freedom of making entry or exit from
the market.

4. The entry or exit of the firm is not very

possible due to various constraints & patent
right.

5. The elasticity of demand for the product

been sold in this market, is perfect; and relatively
therefore, the DD or AR curve is straight
line parallel to OX axis.
Y
Y

5. The product been sold in this market is

inelastic in demand, and therefore,
the DD or AR curve has rapid negative slope.

AR
AR=MR

6. The firms, in this market, earn normal

6. The monopoly firm enjoy an abnormal
profits in the long run, because the profits in the long run, because there is no
freedom of entry & exit of the firms is existence of
close competetors & substitutes.
possible.

Perfect Competition Vs Monopolistic Competition Market

Perfect Competition Market

Monopolistic

Competition

Market
1. In this kind of markets, the firms produce &
sell homogenous product which have no close
substitute, i.e. the cross elasticity of demand for
the products is equal to zero.

1. In this market situation, the firms

produce & sell heterogeneous product,
which are similar but not identical, &
therefore the price of the good differs.

2. The firms, in this market, are price takers,

since the number of firms is large, & the firms kind of
produce & sell homogenous product.

2. The firms are price makers, in this

markets, because the firms
produce & sell heterogeneous product,
although the number of firms is large.

3. The demand for the product, in this market, is

perfectly elastic i.e ep= , & thus the demand
curve (AR Curve) is a straight horizontal line
parallel to X axis.

3. The demand for the product, in this

kind of market situation, is relatively
more elastic i.e. ep>1, & thus the DD
(ARC) has a gradual negative slope.
Y

AR=MR

MR

4. In this market situation, The price is equal to

MR (as we can see from the above figure).

4. In this case, the Price(AR) is greater

than MR.

5. There is no prevalence of selling cost in this

kinds of market.

5. Prevalence of selling cost is the

unique feature of this kind of market
situation.

Monopoly Market Vs. Monopolistic Competition Market

Monopoly Market
1. In this case, there is existence of single
firm which has no close competitor, & the
firm produces & sell unique product which
has no close substitute in the market.

Monopolistic Competition Market

1. In this case, a large number of firms exist in the
market which produce & sell heterogeneous
product, & thus, there is availability of close
substitute of the product.

2. There is no prevalence of selling cost,

as it is not required.

2. Prevalence of selling cost is the most prominent

feature of this market as there is a cut- throat
competition among the firms.

4. The entry & exit of the firms in this

market is not possible due to various
constraints & patent right.

4. There is a freedom of entry & exit of the firms in

the market.

5. The demand for the product is less

elastic, i.e ep<1 & therefore the DD has
rapid negative slope

5. The demand for the product has more elasticity,

i.e ep >1, & therefore the DD has gradual negative
.slope.
Y

6. The monopoly firm has total control over

the market output of the product in the
market.

6. The firms do not have control over the total

output of the product, since large number of firms
produce similar kind of product.

Short answer question(For Low Achievers) ( 1 Marks)

1. Define Market
Ans- Market may be defined as the entire area in which buyers and sellers are
in contact with each other for the purchase and sale of the commodity.
2. Define perfect competition?
Ans- Perfect competition is a form of the Market in which large number of buyers
and sellers, selling homogeneous products at a uniform price
3. Define Monopoly
Ans- Monopoly refers to a Market situation in which there is a single seller and
there are no close substitutes of the commodity

4. Under which Market form, a firm is a price Maker?

Ans -Under Monopoly
5. In which Market form a firm faces a perfectly elastic demand curve?
Ans- Under perfect competition Market, a firm faces perfectly elastic demand
curve as shown below.
Y

AR=MR
AR/MR
Output

6. What is the shape of average revenue curve in Monopoly ?

Ans- AR curve under Monopoly is downward sloping.
7. What is price discrimination?
Ans- Selling the same goods at different prices to different buyers is known as
price discrimination
8. In which market form is there product differentiation ?
Ans- Under Monopolistic competition
9. In which market Form the goods are sold at uniform price ?
Ans- Under perfect competition.
10. Give an example of Monopoly ?
Ans- Railways
11. State the various ways in which a monopoly market structure may rise?
Ans- I) Grant of patent rightsII) Licensing by GovernmentIII)
Forming a Cartel
12. The firms are earning abnormal profits. Will the number of firms in the
industry change?
Ans- If firms are getting abnormal profit new firms will enter in the industry.
13. If firms are making abnormal losses will the number of firms in the industry
change?
Ans- When firms are suffering losses, the number of firms in the industry will
decrease as some firms may exit from the industry.

Short Answer Questions (3&4) Marks

1. Write three features of perfect competition.
Ans- A) Large number of buyers and sellers
B) Freedom Entry and exit of Firms
C) Homogeneous products

2. Explain any three features of Monopoly.

Ans- A) A Single seller.
B) No close substitutes of the product.
C) No freedom of entry of new firm.
3. Which features of monopolistic competition are monopolistic in nature?
Ans- i) Product differentiation ii) Control over price iii) Downward sloping
demand curve
Short answer question(For High Achievers) ( 3&4 Marks)
4. Explain briefly why a firm under perfect competition is a price taker not a
price maker?
Ans - A firm under perfect competition is a price taker not a price maker because
the price is determined by the market forces of demand of supply. This price is
known as equilibrium price. All the firms in the industry have to sell their outputs
at this equilibrium price. The reason is that, number of firms under perfect
competition is so large. So no firm can influence the price by its supply. All firms
produce homogeneous product.

5. What are the reasons which give emergence to the monopoly market?
Ans- The main reasons are as underi) Patent Rights- Patent rights are the authority given by the government to a
particular firm to produce a particular product for a specific time period.
ii) Formation of Cartel- Cartel refers to a collective decision taken by a group of
firms to avoid outside competition and securing monopoly right.
iii) Government licensing- Government provides the license to a particular firm
to produce a particular commodity exclusively
6. Why is demand curve facing a monopolistic competition firm likely to be
more elastic?
Ans- In monopolistic competition market the demand curve of a firm is likely to
be more elastic, the reason behind this is that all the firm in the industry produce
close substitute of each other. If close substitute of any good is available in the
market then elasticity of demand is very high because whenever there is a hike
in price the consumer will shift to its substitutes. That is why a firms demand
curve under monopolistic competition is more elastic.
7. Explain how the efficiency may increase if two firms merge.
Ans- When two firms merge then there combined efforts and efficiency brings
more output to the firm. Increase in the sale of output and economies of scale
can be availed. It leads to division of labour and can get advantage of the
specialization. Use of better and advanced technology saves the cost of
production.

8. Explain the implication of the feature product differentiation under

Monopolistic competition.
Ans- Product differentiation is a distinct feature of monopolistic market. It
means that buyers differentiate between the products produced by different
firms. Therefore, they are willing to pay different prices for the products of

different firms. Different groups of buyers prefer products of different firms. This
gives an individual firm some monopoly power, i.e. power to influence the
demand for its product by changing price.
9. Explain the implication of the feature freedom of entry & exit of firms under
perfect competition.
Ans- Free entry and exit of firms: It means that there is no barrier for entry and
exit of firms in the industry. This freedom ensures that firms earn just the normal
profits in the long run. If the existing firms earn above-normal profits, new firms
enter in the industry, raise supply, which brings down the price. The profits fall till
each firm is once again earning only the normal profits.

If the existing firms are having losses, the firms start leaving, supply falls and
price goes up. The price continues to rise till the losses are wiped out and firms
are just earning normal profits.
Price determination under perfect competition
Under perfect completion price of commodity is determined by demand and supply of
a commodity in an industry.
Equilibrium price is the price at which demand and supply of commodity are equal.
The market equilibrium is determined by equality between quantity demanded and
quantity supply. It means at equilibrium point - Quantity demanded = Quantity
supplied
The price determined at equilibrium point is called equilibrium price.
The price has a tendency to persist. If at a price , market demand is not equal to
market supply there will be either excess demand or excess supply and the price will
have tendency to change until it reach a point where demand and supply are equal.
Explanation We can show it with the help of demand-supply schedule and curve
Price
( )
1
2
3

Market demand
(Units)
1000
800
600

4
5

Market supply
(Units)
200
400
600

400
200

Remark
Excess demand
Market
Equilibrium
Excess supply

800
1000

Y
Price 5

Excess supply

4
E

3
2
1
O

S
200

Excess demand
400

600

D
800

1000

In the above schedule and diagram market equilibrium is established at a price of

3 per unit, because at this price both the market demand and market supply are
equal.
Suppose a price is less than the equilibrium price and if it is 2 per unit. At this price
market demand is greater than market supply. It is called an excess demand
situation. In this case the buyers will not be able to buy all what they want to buy.
The pressure of excess demand will push the market price up. This will have two
effects. Extension of supply and contraction of demand. The tendency of supply
going up and demand going down will continue till market supply becomes equal.
This is achieved at price 3 per unit. The equilibrium is restored and vice versa.
Ceiling Price: it refers to fixing the maximum price of a commodity at a level lower than the equilibrium
price.
Floor Price: it refers to the minimum price (above the equilibrium price), fixed by the government,
which the producers must be paid for their produce.
Q- How an increase in demand of a commodity affect the equilibrium price?
Explain
Ans- When demand of commodity increases it lead to excess demand situation at
equilibrium point. So competition among the buyers increase. Hence price of
commodity increases.
We can explain it with the help of diagram as follows
In the diagram, demand and supply of
good are equal at point E. So E is
equilibrium point. At this
point OP is equilibrium price and OQ
is equilibrium quantity. When demand
increases,
demand curve shifts to right i.e. D1 D1, then at OP
price there is EF excess demand. This results
competition among buyers which will raise the
price. Due to increase in price there
will be contraction of demand and
extension of supply.
This reduces the gap between quantity

Y
D

Price

P1
P

E
E

demanded
F

and quantity supplied.

D

S
O

D
Q

Quantity

These changes will continue till we reach the new equilibrium point E 1 where quantity
demanded is equal to quantity supplied.
Now OP1 is new equilibrium price. Since new equilibrium price [OP1] is higher than
the old equilibrium price [OP] which shows that equilibrium price has increased.
Q- How an increases in supply of a commodity affect the equilibrium price?
Explain
Ans- An increase in supply of a commodity results in a rightward shift of supply
curve as shown by dotted supply curve in the diagram which lead to decrease in
price It can be explain by diagram as follow -

We can explain it with the help of following diagram:

In diagram, demand and supply of
good are equal at point E. So E is
equilibrium point. At this point OP is
equilibrium price and OQ is
equilibrium quantity. When supply
increases new supply curve S1S1
shifts to right, it shows that at OP
price, there is EE2 excess supply. This
excess supply results competition
among the sellers leading to fall in
the price.

Price

S
E

E2

P
D
S

E1

A fall in price results in rise in

quantity demanded (a downward
movement along the new demand
curve) and fall in quantity supplied (a
downward movement along new
supply curve).

Q 1 Q2

Quantity
These changes continue till quantity demanded and supplied are equal at point E 1.
So E1 is new equilibrium point and OP1is new equilibrium price.
Since OP1< OP which shows that equilibrium price has decreased.
Q.1. When will equilibrium price not change even if demand and supply
increase?
Ans: - When proportionate increase in demand is just equal to proportionate increase
in supply. Equilibrium price will not change. It can be shown in the following
diagrams.
Price

P
O

E1E
Q

Q1

In the above diagram increase in demand is just equal to increase in supply.

Demand curve shift from D to D1 and supply curve shift from S to S1 which intersect
at point E. Thus equilibrium price remain unchanged at OP though equilibrium
quantity increased from OQ to OQ1.
Q.2 . How does increase in price of substitute goods in consumption affect the
equilibrium price of a good? Explain with a diagram.
Ans:- An increase in price of substitute goods (coke) will cause increase in demand
for its related goods (Pepsi) . The demand curve for Pepsi will shift to the right side.

The supply curve of Pepsi remains the same. It will lead to an increase in equilibrium
price of Pepsi and increase in quantity also.
Price

P1
1E1
E
P
O

Q1

Result: Price increases from OP to OP1.Quantity demand increases from OQ to

OQ1
Q.3. How does the equilibrium price of a normal commodity change when
income of its buyers rises? Explain the chain effects.
Ans:en income rises demand also rises

ges continue till a new equilibrium price is established where demand

equal supply.
Note: the diagram of Q. 2 should be used to explain this answer.
Q.4. Equilibrium price may or may not change with shifts in both demand and
supply curve. Comment.
Ans:- There can be 3 situations of a simultaneous right wards shift of supply curves
and demand curves.
i) When demand increases more than supply price and quantity both will increase.

Pricece D

P11

E1

E
O

When increase in demand is more than increase in supply price increases from OP
to OP1. Quantity increases from OM to OM1. Increase in price is less than increase
in quantity.
ii) When demand increases less than supply, price will fall but quantity will rise.

Price

P
P1

E
O

Q1

When supply increases more than demand price falls from OP to OP1 and quantity
demand increases from OM to OM1.
iii) When demand and supply increases equally then equilibrium price remain same.

Price

E1E

Q1

When increase in demand is equal to increase in supply price remains unchanged at

OP. Quantity exchanged increases from OQ to OQ1.
Q.5.what will be the effect on the equilibrium price of a good when:
a. price of related goods increases
b. govt. increases per unit tax on the good
c. factor prices increases
d. number of firms decreases

ans: in all above cases the supply of the concerned good will decrease due to which
the supply curve will shift towards left and the equilibrium price will increase.
Price

1P1

E1

E
O

Q1 Q

Result: Price increases from OP to OP1.Quantity decreases from OQ to OQ1

Q.6.what will be the effect on the equilibrium price of a good when:
a. price of related goods decreases
b. govt. decreases per unit tax on the good
c. factor prices decreases
d. number of firms increases
ans: in all above cases the supply of the concerned good will increase due to which
the supply curve will shift towards right and the equilibrium price will decrease.

Price

P
O

E
Q Q1

Result: Price decreases from OP to OP1.Quantity increases from OQ to OQ1

Q.7.what will be the effect on the equilibrium price of a good when:
a. price of substitute goods increases
b. income of the consumer increases
c. price of complementary goods decreases
ans: in all above cases the demand for the concerned good will increase due to
which the demand curve will shift towards right and the equilibrium price will
increase.

Price

E1

1P1

E
O

Q1

Q.8.what will be the effect on the equilibrium price of a good when:

a. price of substitute goods decreases
b. income of the consumer decreases
c. price of complementary goods increases
ans: in all above cases the demand for the concerned good will decrease due to
which the demand curve will shift towards left and the equilibrium price will increase.
Price

D1

P11

E1

Q Q1

Economic viability of an Industry?

Ans- Economic viability of an industry refers to the situation when demand and
supply curves of the industry meet at some positive level of output. But if demand
curve and supply curve do not intersect each other at any positive quantity, the
industry is economically non-viable.

Short questions for Low Achievers (1 mark)

1. Define Market Equilibrium?
Ans- Market equilibrium refers to a situation where quantity demanded
and quantity supplied are equal.
2. What is Equilibrium Price?
Ans- Equilibrium Price is the price at which quantity demanded is equal
to quantity supplied.
3. Give the meaning of Excess demand for a product?
Ans- When at a given price, the quantity demanded of a product exceeds
its quantity supplied, there is excess demand for a product.
4. Give the meaning of excess supply of the product ?
Ans- When at a given price, the quantity supplied of a product exceeds its
quantity demanded, there is excess supply for a product
5. Give one example each of direct intervention and indirect intervention of
the Government in the Market Mechanism ?
Ans- Direct Intervention :- Price control ( Fixing price below equilibrium price)
Indirect Intervention: - Imposing taxes and giving subsidies.
Practice Questions
Very Short Answer Questions:
1. How many firms are there in a monopoly market?

2. Define Monopolistic competition?

3. Define Monopoly.
4. What is the profit maximizing condition of a competitive firm in the long
run?
5. Name the three forms of imperfectly competitive market.
6. What is a cartel?
7. What is the relationship between the AR curve & demand curve in a
monopoly market?
8. What is the shape of AR & MR curve under monopoly?
9. What are selling cost/persuasive cost?
10. Under which market form, a firm is a price taker?
11. Under which market form, the firm is a price maker?
12. In which market form are the products homogenous?
13. What is meant by normal profit?
14. What is meant by abnormal loss?
15. What is meant by abnormal profit?
16. What is breakeven price?
17. In which market form are average revenue and marginal revenue of a firm
always equal?
18. What is the profit maximizing condition of a competitive firm in the long
run?
19. What is the relationship between price& MC at the monopoly equilibrium?

Short Questions Carrying 3-4 Marks:

1.
2.
3.
4.
5.

Distinguish between perfect competition & monopoly.

Distinguish between perfect competition & monopolistic competition.
Distinguish between monopolistic competition & monopoly.
How is a homogenous product different from heterogeneous product?
Identify the market forms for the two sellers of goods A & B, given the
following information. Give reasons for your answers:
Output sold

Price of A (Rs)

Price of B (Rs)

(Units)
10

20

30

6. Define monopoly & state the main features.

7. Define monopolistic competition. Can a seller in such a market influence
the price? Explain.
8. Explain the condition of perfect competition. Why is the demand curve
facing a firm under perfect competition perfectly elastic?
9. How is price of a good determined in a perfectly competitive market?
Explain, use diagram.
10. Explain the features differentiated products of a market with monopolistic
competition.

11. Why is the AR curve of a firm under perfect competition parallel to X-axis &
negatively sloped under monopoly?
12. Distinguish between perfect competition & pure competition.
13. What are the causes of existence of monopoly? Discuss.

Long Questions Carrying 6 marks:

1.
2.
3.
4.
5.
6.

7.
8.

Explain the features of perfectly competitive market.

Explain the features of monopoly.
Explain the features of monopolistic competition.
What is monopoly? Give its main features. Also draw the AR & MR
curves facing a monopolist firm.
Explain briefly the conditions that are necessary for perfect competition.
How is a seller under perfect competition a price taker? What is the
relevance of the characteristics that there are large numbers of sellers in
the context?
Under perfect competition, the seller is a price taker, under monopoly, he
is a price maker. Explain.
Define a market. Explain briefly the four bases on which different markets
are defined.

Very Short Answer Questions Carrying 1 Mark:

1. Define the term equilibrium.
2. What is equilibrium price?
3. How does a favourable change in taste affect the market price and the
quantity exchanged?
4. How does a cost saving technological progress affect the market price
and the quantity exchanged?
5. How does an increase in the price of a substitute goods in consumption
affect the equilibrium price?
6. How will the price of a car be affected, if new discoveries of oil reduces
the price of petrol?
7. How does an increase pin excise tax rate affect the market price and the
quantity exchanged?
8. When profit is realized by a firm under competition market?
9. When profit is earned by the monopolist in the long run?
10. Define price discrimination.

Short Questions carrying 3 Marks:

1. How is equilibrium price of a commodity affected by charges in its
supply?
2. How will the equilibrium price & quantity be affected, if supply curve shifts
downward, which demand curve remains constant?
3. Changes in both demand and supply of a commodity may a may not
affected its equilibrium price. Explain.
4. Is it demand or supply which is more active in determining price?
Explain.

5. What can be the effect of a decrease in both the market demand &
market supply of a commodity on its price? Explain.
6. Favorable change in taste affects the market price & quantity
exchanged. Comment.
7. What can be the effect of an increase in both the market demand and
market supply of a commodity on its price? Explain.
8. Cost saving technological progress affects the market price and
quantity exchanged. Do you agree?
9. Explain the effect of increase in demand over equilibrium price & output.
10. Explain the effect of decrease in supply over equilibrium price & output.
11. Explain the effect of decrease in demand over equilibrium price & output.
12. Explain the effect of increase in supply over equilibrium price & output.

Long Answer Type Questions:

1. Define equilibrium price with the help of diagrams. Show the effect of
shift in the supply on the equilibrium price of the commodity when:
a) Demand remains unchanged.
b) Demand also changes.
2. Show with the help of diagram the effect of change in demand on the
equilibrium price of a commodity when:
a) The supply remains unchanged.
b) When supply decreases.
3. At a given price of a commodity, there is excess demand. Is this price
an equilibrium price? If not, how will the equilibrium price be reached?
Use Diagram.
4. If at a given price of a commodity, there is excess supply, how will the
equilibrium price be reached? Explain with the help of a diagram.
5. What is the effect of simultaneous change in demand & supply over
equilibrium price & output? Explain, use diagram.
6. What is the effect of simultaneous change in demand & supply in
opposite direction over equilibrium price & output? Explain.
7. What is the effect of the following over equilibrium price & output:
a) Change in income.
b) Change in market size.
c) Change in excise tax rate.
d) Change in input prices.
e) Change in price of related goods.

UNIT 4

TEST PAPERS

Fill in the blanks1.

2.
3.
4.
5.
6.

MR is less than AR in
market.
-----------number of firms is there in monopoly market.
Profit over and above the normal profit is -------------- profit.
Selling cost is high in ----------------market.
Product differentiation is a feature of ----------------market.
Price discrimination is the feature of ----------------

7. Excess demand is the one where quantity demanded ------------ quantity

supplied.
8. --------------------market has homogeneous and differentiated products.
9. Price rigidity is the key feature of ---------------.
10. ----------------------market can earn only normal profit in the long run.

Match the followings1. Patent rights

2. Equilibrium price
3. Price rigidity
4. Price maker
5. Homogeneous product
6. Single seller
7. No transportation cost
8. Product differentiation
9. Availability of close substitutes
10. Few large firms

1 Monopoly
2 Prefect competition market
3 Perfect competition
4 Monopolistic competition
5 Monopoly
6 Quantity demand=Quantity supplied
7 Oligopoly
8 Monopoly
9 Oligopoly
10 Monopolistic competition

HOTS
1 Identify the market form for two sellers of good X and good Y From the following
Output sold
Price of X
Price of Y
150
15
25
200
14
25
300
12
25
Ans Market for good X is either monopoly or monopolistic competition as seller
has sold more units by reducing the price whereas market for good Y is perfectly
competitive because seller has sold more units at the same price.

QSuppose the demand and supply curves of a commodity x in a perfectly

competitive market are given byQd=700-P nad Qs=500+3P.find the Equilibrium price
and equilibrium quantity.
Ans .At equilibrium price
Qd=Qs=700-P = 500 + 3P
(demand side)=700-P=700-50=65

4P=200 or P=50 Equilibrium quantity

Equilibrium quantity (supply side) =500+3P = 500+150= 650

UNIT 5: NATIONAL INCOME AND RELATED AGGREGATES (15 marks)

Macroeconomics: Its meaning
Some basic concepts of macroeconomics: consumption goods, capital goods, final
goods, intermediate goods; stocks and flows; gross investment and depreciation.
Circular flow income ; Methods of calculating National Income Value Added or
Product method , Expenditure method , Income method.
Concepts and Aggregates related to National Income:
Gross National Product (GNP), Net National Product (NNP), Gross and Net
Domestic Product (GDP and NDP) at market price, at factor cost; National
Disposable Income (gross and net), Private Income, Personal Income and Personal
Disposable Income; Real and Nominal GDP.
GDP and Welfare.
KEY CONCEPTS

Macro Economics: Its meaning

Consumption goods, capital goods, final goods, intermediate goods, stock
and flow, gross investment and depreciation.
Circular flow of income
Methods of calculation of national income
Value added method (product method)
Expenditure method
Income method
Concepts and aggregates related to national income
Gross national product
Net National product
Gross and Net domestic product at market price and at factor cost.
National disposable income (Gross and net)
Private income
Personal income
Personal disposable income
Real and Nominal GDP
GDP and welfare

Macro Economics:
Macroeconomics is the study of aggregate economic variables of an economy.
It studies the economy as a whole.
Consumption goods:
Consumption goods can be defined as the goods which are bought by consumers as
final or ultimate goods to satisfy their wants.
e.g: Durable goods like -car, television, radio etc.
Non-durable goods and services like- fruit, oil, milk, vegetable etc.

Semi durable goods such as- crockery etc.

Compulsory goods, like medicine, rice, pulses, edible oil etc.
Capital goods
Capital goods can be defined as the goods, which are used and help in the process
of production of other goods and services. E.g.: plant, machinery, land, buildings
etc.
Final goods:
Final goods can be defined as the goods, which are used either for final consumption
or for investment.
It includes final consumer goods and final production goods.
They are not meant for resale. So, no value is added to these goods. Their value is
included in the national income.
Intermediate goods
Intermediate goods can be defined as the goods, which are used either for resale or
for further production.
Example for intermediate good is- milk used by a tea shop for selling tea. Wheat
flour for baking bread, cake etc.
Stock:
Quantity of an economic variable which is measured at a particular point of time.
Stock has no time dimension.
Stock is static concept.
Eg: wealth, water in a tank.
Flow:
Flow is that quantity of an economic variable, which is measured during the period of
time.
Flow has time dimension- like per hr, per day etc.
Flow is a dynamic concept.
Eg: Investment, water in a stream.
Investment:
Investment is the net addition made to the existing stock of capital.
It can be defined as the expenditure made on creation of assets or final goods like:
Purchase of land, Buildings, Machines, establishment of power plants, construction
of dams, etc.
It is also called as Gross investment, because, it also include depreciation value of
assets.
Net Investment
It can be defined as the difference between Gross Investment and Depreciation
value of the assets.
Net Investment = Gross investment Depreciation.
Depreciation:
Depreciation refers to fall in the value of fixed assets due to normal wear and tear,
passage of time and expected obsolescence.
It is also known as the consumption of fixed capital during production process.

Circular flow of National Income:

It is a pictorial illustration of interdependency between the major sectors of
the economy.
It refers to flow of money income or the flow of goods or services across
different sectors of the economy in a circular form.
Types of Circular flow :
1. Product Flow (Real Flow): This is the flow of factor services and
flow of goods.
2. Income Flow: This refers to the money flow in the form of factor
payments and consumption expenditure.
Significance of Circular flow of Income :
1. Knowledge of Interdependence.
2. Size of National income.
3. Level of Economic Activity.
4. Injections and Leakages.

Circular Flow of Income in a Two Sector Economy:

1. The circular flow in a two sector economy will keep on flowing without end as
there is no leakage from and injection in the income stream.
2. Whatever is produced by firms is consumed by the household sector.
3. Factor payments by firms are equal to factor income of household sector.
4. Whatever is the factor income of the household sector is spent on
consumption.

Circular flow in a two sector economy.

Payment for goods and services (Money Flow)

Firms

Supply of goods and

services
(Real Flow)

House hold

Supply of Factors of Production

(Real Flow) Payment for Factor
services (Money Flow)

Producers (firms) and households are the constituents in a two sectors economy.
Households give factors of production to firm and firms in turn supply goods and
services to households.

Related aggregates
ECONOMIC TERRITORY:
Economic territory includes the followinga)-Political frontiers including territorial waters and air space
b)-Embassies, consultants, military bases etc. located abroad
c)-Ships, aircrafts etc., operated by the residents between two or more countries
d)-Fishing vessels, oil and natural gas rigs etc, operated by residents in the
international waters or other areas over which country enjoys exclusive rights or
jurisdiction.
RESIDENT:
A resident, whether a person or an institution, is one whose centre of economic
interest lies in the economic territory of the country. In which he lives or is located.
INDIRECT TAXES:
The burden of these taxes is shifted to buyers. Since the burden indirectly falls on
buyers. They are called indirect taxes e.g. sales tax, excise duty etc.
SUBSIDIES: Subsidies are financial assistance by government to enterprises on
production of a certain commodity. The effect of subsidies is to bring down the price
like: indirect tax it is also generally passed on to the consumers.
Gross Domestic product at market price
It is the money value of all final goods and services produced during an accounting
year within the domestic territory of a country.
Domestic territory means the geographical boundaries of the nation.
Gross National product at market price:
It is a money value of all final goods and services produced by a country during an
accounting year including net factor income from abroad.
GNPmp = GDPmp + NFIA
Net factor income from abroad:
Difference between the factor incomes earned by our residents from abroad and
factor income earned by non-residents within our country. Factor income earned by
non-residents is also known as the factor income to abroad.
NFIA = FIFA FITA
Where, FIFA = Factor income from abroad.
FITA = Factor income to abroad.
Components of Net factor income from abroad
Net compensation of employees
Net income from property and entrepreneurship (other than retained earnings
of resident companies of abroad)
Net retained earnings of resident companies abroad

Formulas
NNP Mp = GNPmp - depreciation
NDP Mp = GDPmp - depreciation
NDP Fc = NDP mp Net indirect taxes (indirect tax subsidy)
GDP Fc = NDPFc + depreciation
NNP Fc = GDPmp - depreciation + Net factor income from abroad Net indirect
taxes
(NNP FC is the sum total of factor income earned by normal residents of a
country during the accounting year)
NNP Fc = NDP Fc + Net factor income from abroad.

Concept of domestic (economic) territory:

Domestic territory is a geographical territory administered by a government within
which persons, goods and capital circulate freely. (Areas of operation generating
domestic income, freedom of circulation of persons, goods and capital)
Scope identified as
*Political frontiers including territorial waters and air space.
*Embassies, consulates, military bases etc. located abroad but including those
locates within the political frontiers.
*Ships, aircrafts etc., operated by the residents between two or more countries.
*Fishing vessels, oil and natural gas rigs etc. operated by the residents in the
international waters or other areas over which the country enjoys the exclusive rights
or jurisdiction.
Resident (normal resident):Normal resident is a person or an institution who ordinarily resides in that country
and whose center of economic interest lies in that country.
(The Centre of economic interest implies :-( 1) the resident lives or is located within
the economic territory. (2) The resident carries out the basic economic activities of
earnings, spending and accumulation from that location 3. His center of interest lies
in that country.

Relation between national product and Domestic product.

Domestic product concept is based on the production units located within
domestic (economic) territory, operated both by residents and non-residents.
National product concept based on residents and includes their contribution to
production both within and outside the economic territory.
National product = Domestic product + Residents contribution to production outside
the economic territory (Factor income from abroad) - Non- resident contribution to
production inside the economic territory (Factor income to abroad)
Methods of calculation of national income
1- PRODUCT METHOD (Value added method):
Value of output = Sales + change in stock
Change in stock = closing stock opening stock
Gross value added (GDPMp) = Value of output - Intermediate consumption

NNPfc (N.I) = GDPmp - consumption of fixed capital + Net factor income from
abroad - Net indirect tax.

2- INCOME METHOD:
Components are:
1. Compensation of employees. (wages, Salary and contribution made by the
employers)
2. Operating surplus.

Income from property

Rent & Royalty

Income from Entrepreneurship

Interest
Profit
CorporateCorporatedividend
TaxSavings
(Net retained earnings)

3. Mixed income of self-employed.

Thus ,
NDP fc = Compensation of employee + Operating Surplus + Mixed income of
the self employed.
NNP fc = NDP fc + Net factor income from abroad
GNP mp = NDP fc + consumption of fixed capital + Net indirect tax
[Net Indirect Taxes = Indirect tax subsidy]
Expenditure method:
Components are:
1. Government final consumption expenditure.
2. Private final consumption expenditure.
3. Net Export.
4. Gross domestic capital formation. (Gross investment expenditure)
Gross Domestic fixed+
Capital formation
Thus,
GDPmp = (1) + (2) + (3) + (4)
GNPmp = GDPmp + NFIA
NDPmp =GDPmp Depriciation
NNP fc = NDPmp - Net indirect taxes

Change in stock

Concept of Transfer Payments:

CALCULATION OF NATIONAL DISPOSABLE INCOME, PRIVATE INCOME,

PERSONAL INCOME AND PERSONAL DISPOSABLE INCOME
National Disposable
Private Income includes factor
Personal Income
Income
income as well as Transfer
income (Earned income +
Unearned income)
It is the income from
all the sources
(Earned Income as
well as transfer
payment from abroad)
available to resident of
a country for
consumption.
expenditure or saving
during a year
Net National
Disposable income
= NNPFC + Net
Indirect tax + Net
current transfer from
abroad
Gross National
Disposable Income
includes =Net National
disposable income +
depreciation

Factor income from net domestic

product accruing to private
sector includes income from
enterprises owned and
controlled by the private
individual.
Excludes:1. Property and entrepreneurial
income of the Gov. departmental
.enterprise
2. Savings of the Non
departmental Enterprise.
.Factor Income from NDP
Accruing to private sector =
NDPFC - income from properly
entrepreneurship accruing to the
govt departmental Enterprises savings of Non departmental
enterprises.
Private Income Includes* Factor income from net

PI is the income Actually

received by the
individuals and
households from all
sources in the form of
factor income and
current transfers.
Personal income =
Private Income corporation tax
-- Corporate Savings OR
Undistributed profits
Personal disposable
income
= Personal income (-)
Direct
Personal tax (-)
Miscellaneous
Receipts of the govt.
Administrative
department.

domestic product accruing to private

sector

+ Net factor income from abroad

+ Interest on National Debt
+ Current transfer from Govt.
+ Current transfer from rest of
the world.
Question for Bright Students along with HOTS
One Mark questions.
1. When will the domestic income be greater than the national income?
Ans: When the net factor income from abroad is negative.
2. What is national disposable income?
Ans.It is the income, which is available to the whole economy for spending or
disposal
NNP Mp + net current transfers from abroad = NDI
3. What must be added to domestic factor income to obtain national income?
Ans. Net factor income from abroad.
4. Explain the meaning of non-market activities
Ans. Non marketing activities refer to acquiring of many final goods and services not
through regular market transactions. E.g. vegetable grown in the backyard of the
house.

5. Define nominal GNP

Ans. GNP measured in terms of current market prices is called nominal GNP.
6. Define Real GNP.
Ans. GNP computed at constant prices (base year price) is called real GNP.
7. Meaning of real flow.
Ans. It refers to the flow of goods and services between different sectors of the
economy. Eg. Flow of factor services from household to firm and flow of goods and
services from firm to household.
8. Define money flow.
It refers to the flow of money between different sectors of the economy such as firm,
household etc. Eg. Flow of factor income from firm to house hold and consumption
expenditure from house hold to firm.

3- 4 Mark Questions
1. Distinguish between GDPMp and GNP FC
Ans. The difference between both arise due to (1) Net factor income from abroad.
and 2) Net indirect taxes. In GDPMp Net factor income from abroad is not included
but it includes net indirect taxes.
GNP FC = GDPMp + net factor income from abroad net indirect taxes
2. Distinguish between personal income and private income
Ans. Personal income: -It is the sum total of earned income and transfer incomes
received by persons from all sources within and outside the country.
Personal income = private income corporate tax corporate savings (undistributed
profit)
Private income consists of factor income and transfer income received from all
sources by private sectors within and outside the country.
3. Distinguish between nominal GNP and real GNP
Ans. Nominal GNP is measured at current prices. Since this aggregate measures the
value of goods and services at current year prices, GNP will change when volume of
product changes or price changes or when both changes.
Real GNP is computed at the constant prices. Under real GNP, value is expressed in
terms of prices prevailing in the base year. This measure takes only quantity
changes. Real GNP is the indicator of real income level in the economy.

4. Explain the main steps involved in measuring national income through product
method
Ans.
a) Classify the producing units into industrial sectors like primary, secondary
and tertiary sectors.
b) Estimate the net value added at the factor cost.
c) Estimate value of output by sales + change in stock
d) Estimate gross value added by value of output intermediate consumption
e) Deduct depreciation and net indirect tax from gross value added at market
price to arrive at net value added at factor cost = NDP Fc
f) Add net factor income received from abroad to NDP Fc to obtain NNP FC
which is national income

5...Explain the steps involved in calculation of national income through income

method
a) Classify the producing enterprises into industrial sectors like primary,
secondary and tertiary.
b) Estimate the following factor income paid out by the producing units in each
sector i.e.
*Compensation of employees
*Operating surplus
*Mixed income of self employed
c) Take the sum of the factor income by all the industrial sectors to arrive at the
NDP Fc
(Which is called domestic income)
d) Add net factor income from abroad to the net domestic product at factor cost
to arrive at the net national product at factor cost.
6. Explain the main steps involved in measuring national income through expenditure
method.
a) Classify the economic units incurring final expenditure into distant groups like
households, government, firms etc.
b) .Estimate the following expenditure on final products by all economic units
Private final consumption expenditure
Government final consumption expenditure
Gross domestic capital formation
Net export
(Sum total of above gives GDPMp)
c) Deduct depreciation, net indirect taxes to get NDP Fc
d) Add net factor income from abroad to NDP Fc to arrive at NNP FC.
7. What are the precautions to be taken while calculating national income through
product method (value added method)
a) Avoid double counting of production, take only value added by each
production unit.
b) The output produced for self-consumption to be included
c) The sale & purchase of second hand goods should not be included.
d) Value of intermediate consumption should not be included
e) The value of services rendered in sales must be included.
8. Precautions to be taken while calculating national income through income method.
a) Income from owner occupied house to be included.
b) Wages & salaries in cash and kind both to be included.
c) Transfer income should not be included
d) Interest on loans taken for production only to be included. Interest on loan
taken for consumption expenditure is non-factor income and so not included.
9. Precautions to be taken while calculations N.I under expenditure method.
a) Avoid double counting of expenditure by not including expenditure on
intermediate product
b) Transfer expenditure not to be included
c) Expenditure on purchase of second hand goods not to be included.
10. Write down the limitations of using GDP as an index of welfare of a country
1) The national income figures give no indications of the population, skill and
resources of the country. A country may be having high national income but it may
be consumed by the increasing population, so that the level of peoples wellbeing or
welfare standard of living remains low.

2) High N. I may be due to greater area of the country or due to the concentration
of some resources in out particular country.
3) National income does not consider the level of prices of the country. People
may be having income but may not be able to enjoy high standard of living due to
high prices.
4) High N. I may be due to the large contribution made by a few industrialists
5) Level of unemployment is not taken into account.
6) National income does not care to reduce ecological degradation. Due to
excess of economic activity which leads to ecological degradation reduces the
welfare of the people.
Hence GNP and economic welfare are not positively related. Income in GNP does
not bring about increase in economic welfare.
11. Machine purchased is always a final good do you agree? Give reason for your
answer
Whether machine is a final good or not depends on how it is being used (end use). If
machine is bought by a household, then it is a final good. If 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
resale then it is an intermediate good.
12. What is double counting? How can it be avoided?
Counting the value of commodities at every stage of production more than one time
is called double counting.
It can be avoided by a) taking value added method in the calculation of the national
income.
b) By taking the value of final commodity only while calculating N.I
1. State whether following is true or false. Give reason for your answer.
a) Capital formation is a flow
True, because it is measured over a period of time.
b) Bread is always a consumer good.
False, it depends upon the end use of bread. When it is purchased by a household it
is a consumer good. When purchased by restaurant for making sandwich, it is an
intermediate (producer) good.
c) Nominal GDP can never be less that real GDP
False. Nominal GDP can be less than the prices in the base year.
d) Gross domestic capital formation is always greater than gross fixed capital
formation.
False, gross domestic capital formation can be less than gross fixed capital
formation if change in stock is negative.

2. Why are exports included in the estimation of domestic product by the

expenditure method?
Or
Can the gross domestic product be greater than the gross national product?
Explain
Expenditure method estimates expenditure on domestic product i.e., expenditure on
final goods and services produced within the economic territory of the country. It
includes expenditure by residents and non residents both. Exports though

purchased by non residents are produced within the economic territory and therefore
a part of domestic product.
Domestic product can be greater than national product, if the factor income paid to
the rest of the world is greater than the factor income received from the rest of the
world i.e, when net factor income received from abroad is negative.
3. How will you treat the following while estimating domestic product of India?
a) Rent received by resident Indian from his property in Singapore.
No, it will not be included in domestic product as this income is earned outside the
economic territory of India.
b) Salaries if Indians working in Japanese Embassy in India.
It will not be included in domestic product of India as embassy of Japan is not a part
of economic territory of India.
c) Profits earned by branch of American bank in India.
Yes, it is included as part of domestic product since the branch of American bank is
located within the economic territory of India.
d) Salaries paid to Koreans working in the Indian embassy in Korea.
Yes, it will be part of domestic product of India because the income is earned within
the economic territory of India. Indian embassy in Korea is a part of economic
territory of India.
4 How are the following treated in estimating national income from expenditure
method? Give reason.
a) Purchase of new car by a household:
purchase of car is included in the national income because it is final consumption
expenditure, which is part of national income.
b) Purchase of raw material by purchase unit:
purchase of raw material by purchase unit is not included in the national income
because raw material is intermediate goods and intermediate goods and service are
excluded from the national income. Purchase of raw material, if included in national
income will result in double counting.
c) Expenditure by the government on scholarship to student:
It is not included in the national income because it is a transfer payment and no
productive service is rendered by the student in exchange.

5 Are the following item included in the estimating a countrys national

income? Give reason.
1) free cloth given to workers:
free cloth given to worker is a part of wages in kind i.e. compensation to employee
such compensation to employee is paid for the productive services in the economy, it
is included in the national income.
2) Commission paid to dealer in old car:
commission paid to dealer in old car is included in the estimation of national income
because it is the income of the dealer for his productive services to various parties.
3) Growing vegetable in a kitchen garden of the house:
growing vegetable in a kitchen garden of the house amount to production, though not
for sale for self-consumption. It is included in the national income because it adds to
the production of goods.

NATIONAL INCOME NUMERICALS

1.Calculate Value Added at factor cost from the following.
ITEMS
Rs. CRORES
A .Purchase of raw materials
30
b.Depreciation
12
c. Sales
200
d.Excise tax
20
e.Opening stock
15
f.Intermediate consumption
48
g.Closing stock
10

Ans: Sales + in stock = value of output

200 + (cl. St op. st)
200 + (10 -15)
= 200 -5=195
Value of output intermediate consumption
= value added at MP
195-48 = 147
V.A at FC = V.A at MP Net indirect tax
147 20
127 crores
2.Calculate (a) Net National Product at MP, and (b) Gross National
Disposable Income
ITEMS
Rs. CRORES
a.Private final Consumption expenditure
200
b.Net indirect taxes
20
c.Change in stocks
(--)15
d.Net current transfers from abroad
(--)10
e.Govt. final consumption expenditure
50
f.Consumption of fixed capital
15
g.Net domestic capital formation
30
h.Net factor income from abroad
5
i.Net imports
10
Ans: (a) + (e) + (g) + (-i) = NDP MP
200 + 50+ 30 -10
280 -10 = 270 crores
NNP MP = NDP MP + NFIFA
270 + 5 = 275
NNP MP + 275 crores

GNDI = NNP PC + NFIFA + Net indirect taxes + Net current transfers from
abroad + Depreciation (comp of fixed capital)
NNP MP net in tax = 275 20 =255 crores
GNDI = 255 + 20 + 5 + (-10) + 15
= 295 10 = 285 crores
GNDI = 285 crores

3.

Calculate Gross Domestic Product at Market Price by

(a) Production Method and (b) Income Method
ITEMS
Rs. CRORES
a. Intermediate consumption by
i) Primary sector
500
ii) Secondary sector
400
iii) Tertiary sector
400
b.Value of output by
i) Primary sector
1000
ii) Secondary sector
900
iii) Tertiary sector
700
c.Rent
10
d.Compensation of employees
400
e.Mixed income
650
f.Operating surplus
300
h.Net factor income from abroad
(--)20
i.Interest
5
j.Consumption of fixed capital
40
k.Net indirect taxes
10
Ans: GDP MP by production method
(b) (i) + (ii) + (iii) a (i) + (ii) + ( iii) = value added
(1000+ 900 + 700) (500 -400-400)
2600 1300 = 1300 crores Value added at MP (GDP MP)
Income method
Compensation of employees + operating surplus + mixed income = NDP
= 400 + 300 + 650 = 1350 crores
GDP MP = NDP FC + conspn of fixed capital + net In. tax
FC
= 1350 _ 40 + 10
GDP MP =1400

4. Calculate Net National Disposable Income from the following data.

ITEMS
Rs. CRORES
a.Gross domestic product at MP
1000
b.Net factor income from abroad
(-) 20
c.Net indirect taxes
120
d.Consumption of fixed capital
100
e.Net current transfers from abroad
50
Ans: NNDI = GDP MP conspn of fixed capital + Net FIFA + Net current transfer
from abroad
= 1000- 100 + 50 + (-20)
= 880 + 50 = 930 crores
5.Calculate Gross National Disposable Income from the following.
ITEMSRs. CRORES
a)National Income2000
b)Net current transfers from rest of the world200
c)Consumption of fixed capital100
d)Net factor income from abroad(-) 50
e)Net indirect taxes25
Ans: GNDI= (a) + (b) +(c) + (e)
= 2000 + 200 + 100 + 250= 2550 crores

6. ESTIMATE NATIONAL INCOME BY

(a) EXPENDITURE METHOD (b) INCOME METHOD FROM THE
FOLLOWING DATA
Rupees in crores
1. Private final consumption expenditure
210
2. Govt: final consumption expenditure
50
3. Net domestic capital formation
40
4. Net exports
(-) 5
5. Wages & Salaries
170
6. Employers contribution
10
7. Profit
45

8. Interest
20
9. Indirect taxes
30
10. Subsidies
05
11. Rent
10
12. Factor income from abroad
03
13. Consumption of fixed capital
25
14. Royalty
15
Ans: National Income (NNP FC)
Expenditure Method
(1) + (2) + (3) + (4) = NDP MP
210 + 50 + 40 + (-5) = 295
NNP FC = NDP MP + factor Income from abroad net Indirect tax ( Indirect tax
subsidy)
295 + 3 (30 -5)
295 + 3 25
= 298 25 = 273
NNP FC= 273 crores
Income method:
(5) + (6) + (7) + (8) + (11) + (15)
170 + 10 + 45 + 20 + 10 + 15
= 270 (NDP FC)
NDP FC = NDP FC + FIFA
= 270 + 3= 273 crores
(7)FROM THE FOLLOWING DATA CALCULATE
(a) NATIONAL INCOME (b) PERSONAL DISPOSIBLE INCOME.
1.Profit
500
2.Rent
200
3.Private income
2000
4.Mixed income of self-employed
800
5.Compensation of employers
1000
6.Consumption of fixed capital
100
7.Net factor income from abroad
-(50)
8.Net retained earnings of private employees
150
9.Interest
250
10.Net exports
200
11.Co-operation
100
12.Net indirect tax
160
13.Direct taxes paid by houses holds
120
14.Employers contribution to social security scheme
60
Ans: NNP FC (N. I) = (5) + (9) + (4) + (1) + (2)

1000 + 250+ 800 + 500 + 200

NDP FC = 2750 crores
NNP FC = NDP FC + (7)
= 2750 + (-50)
NNP Fc = 2700 crores
PDI = (3) (8) (11) (13)
2000 150 100 -120
PDI = 2000 370 = 1630 crores
(8) CALCULATE NATIONAL INCOME AND GROSS NATIONAL DISPOSABLE
INCOME FROM THE FOLLOWING DATA.
Net indirect tax
05
Net domestic fixed capital formation
100
Net exports
(-) 20
Gov.: final consumption expenditure
200
Net current transfer from abroad
15
Private final consumption expenditure
600
Change in stock
10
Net factor from abroad
05
Gross domestic fixed capital formation
125
Ans: National Income (NNP FC)
= (4) + (6) + (2) + (7) + (3) = NDP MP
= 200 + 600 + 100 + 10 + (-20)
= 910 -20 = 890
NDP MP = 890 crores
NNP FC = NDP MP + (8) (1)
= 890 + 5 -5
NNP FC = 890
Depreciation = (9) (2)
125 100 = 25 crores
GNDI = NNP FC + Net Indirect Tax + Net Current transfers from abroad +
depreciation
= 890 = 05+ 15 + 25
GNDI = 935 crores
(9)CALCULATE NNP AT MARKET PRICE BY PRODUCTION METHOD AND
INCOME METHODCrores
1.Inter mediate consumption
(a) primary sector
500
(b) Secondary sector
400
(c) tertiary sector
300
2.Value of output of
(a) primary sector
1,000
(b) Secondary sector
900
(c) tertiary sector
700
3.Rent
10
4.Emoluments of employers
400
5.Mixed income
650
6.Operating surplus
300
7.Net factor income from abroad
-20
8.Interest
05
9.Consumptive of fixed capital
40

10.Net indirect tax10

Ans: NNP MP by production method
(2) Value of output (1) Intermediate conspn = value added at MP
(2) a + b+ c (1) a + b + c
1000 + 900 + 700 500 + 400 + 300
2600 1200
1400 = GDP MP
NNP MP = GDP MP (9) + (7)
= 1400 40 + (-20)
NNP MP = 1340
Income Method:
NNP MP = (4) + (5) + (6) + (10) + (7)
= 400 + 650 + 300 + 10 + (-20)
NNP MP = 1350 + 10 20

(10) CALCULATE GNP at FACTOR COST BY INCOME METHOD AND

EXPENDITURE METHOD.
Rupees in crores
1. Private final consumption expenditure
1000
2. Net domestic capital formation
200
3. Profit
400
4. Compensation of employers
800
5. Rent
250
6. Gov.: final consumption expenditure
500
7. Consumption of fixed capital
60
8. Interest
150
9. Net current transfer from row
(-)80
10. Net factor income from abroad
(-)10
11. Net exports
(-)20
12. Net indirect taxes
80
Ans: GNP FC by Income method
GNP FC = 4 + 3 + 5 + 8 + 10 + 7
800 + 400 +250 + 150 + (-10) + 60
GNP FC = 1650 crores
GNP FC by Expenditure Method
GNP FC = 1 + 2 + 6 + 10 + 11 -12 + 7
= 1000 + 200 + 500 + (-10) + (-20) -80 + 60
= 1700 -110 + 60
GNP FC = 1650 crores

(11)
.

CALCULATE PRIVATE INCOME AND PERSONAL DISPOSABLE INCOME

FROM THE FOLLOWING DATA
Rupees in crores
1. National income
5050
2. Income from property and entrepreneurship to gov.
administrative department
500
3. Saving of non-department public enterprises
100
4. Corporation tax
80
5. Current transfer from govt: administrative depart
200
6. Net factor income from abroad
-50
7. Direct personal tax
150
8. Indirect taxes
220

9. Current transfer from Raw

10. Saving of private corporate sector

80
500

Ans: Private Income = 1 2- 3 + 5 + 9

5050 500 100 + 200 + 80
5430 500
Private Income = 4930 crores
PDI = Private Income 4 -10 -7
4930 -80 -500 -150
PDI = 4200 crores
12) Calculate private income
1. Income from domestic product accruing to private sector
2. Net current transfer from raw
3Net current transfer from govt: administrative dept
4. National debt interest
5. Net factor income from abroad
Ans: Private Income = 1 + 2+ 3 + 4 + 5
250 + 40 + 10 + 20 + 5
= 325 crores
(13) CALCULATE NET NATIONAL DISPOSABLE INCOME AND PERSONAL
INCOME FROM THE FOLLOWING DATA
1. Net indirect taxes
90
2. Compensation of employers
400
3. Personal taxes
100
4. Operating surplus
200
5. Corporation profit tax
80
6. Mixed income of self-employed
500
7. National debt interest
70
8. Saving of non-departmental enterprises
40
9. Current transfer from govt
60
10. Income from property and entrepreneurship to govt administrative
Department
30
11. Net current transfer from RAW
20
12. Net factor income from abroad
-50
13. saving of private corporate sector
20
Ans: NDPFC = 2 + 4 + 6
400 + 200 + 500 = 1100 crores
NNDI = NDP FC + 12 + 1 + 11
=1100 + (-50) + 90 + 20
NNDI = 1210 50
= 1160 crores
Personal Income
Ans:
Private Income = NDP FC 8 10
1160 -40 30=1090 crores
1090 + 7 + 9 +11 +12
1090 + 70 + 60 + 20 + (-50) = 1190 crores
Personal income = Private Income Corporation Profit Tax Savings of private
corporate sectors=1190 80 20= 1090 crores

250
40
10
20
05

(14) CALCULATE FROM THE FOLLOWING DATA (A) PRIVATE INCOME (B)
PERSONAL INCOME (C) PERSONAL DISPOSABLE INCOME.
RS IN CRORES
1. Factor income from NDP accruing to private sector
300
2. Income from entrepreneurship and property
30
3. Accruing to govt administrative departmental
70
4. Savings of non-departmental enterprises
60
5. Factor income from abroad
20
6. Consumption of fixed capital
35
7. Current transfer from rest of the world
15
8. Corporation taxes
25
9. Factor income to abroad
30
10. Current transfer from govt governmental admi depart
40
11. Direct taxes paid by house hold
20
12. National dept interest
05
13. saving of private corporate sector
80
Ans Private Income = 1 + 5 + 7 -9 + 10 + 12
300 + 20 + 15 -30 + 40 + 05
Private Income = 350 crores
Personal Income = Private income 8 13
= 350 25 80
Personal Income = 245 crores
PDI = Personal Income - 11
245 20
PDI = 225 crores

15.

From the following data, calculate:

(a) Gross national Disposable Income
(b) Private Income
(c) Personal Disposable Income

(Rs. In Crores)
(1) Net national product at factor cost
700
(2) Indirect taxes
60
(3) Subsidies
10
(4) Consumption of fixed capital
40
(5) Income from property and entrepreneurship
Accruing to government administrative departments
50
(6) Current transfers from rest of the world
45
(7) Profits
100
(8) Direct tax paid by households
50 (9)
Savings of private corporate sector
60
(10) Saving of non-departmental enterprises
35
25
(11) Current transfer from govt: administrative departments
70
(12) A factor income abroad
20
(13) Factor income to abroad
30
(14) Corporation tax
Ans GNDI = 1 + 2 -3 + 6 + 4
700 + 60 10 + 45 + 40= 805 -10 + 40 GNDI = 835 crores
b) Private Income = 1 5 -10 + 6 +11
700 50 -25 + 45 +70

Private Income = 740 crores

c) PDI = Private Income 14 9 8
740 35 60 50
PDI = 594 crores
16.Calculate Gross National Disposable Income from the following data:
(Rs. In Crores)
(1) National income
2000
(2) Net current transfer from rest of the world
200
(3) Consumption of fixed capital
100
(4) Net factor income from abroad
(-)50
(5) Net indirect taxes
250
Ans: GNDI = 1 + 5 + 2 + 3
2000 + 250 + 200 + 100
GNDI = 2550 crores

17. Calculate Net National Disposable Income from the Following Data:
(Rs. In Crores)
(1) Gross national product at factor cost
800
(2) Net current transfer from rest of the world
50
(3) Net indirect taxes
70
(4) Consumption of fixed capital
60
(5) Net factor income from abroad
(-)10
Ans: NNDI = 1 + 2 + 3 -4
800 + 50 + 70 -60
= 860 crores

18. Will the following be a part of domestic factor income of India? Give reasons for
your answers.

(6 marks)

(i)

Old age pensions given by the Government.

(ii)

Factor income from abroad

(iii)

Salaries to Indian residents working in Russian Embassy in India.

(iv)

Profits earned by a company in India, which is owned by a non-resident.

Ans:
(i)

Old age pensions are not a part of domestic income because no factor
service is rendered in return.

(ii)

Factor income from abroad is not a part of domestic income because it is

earned by the residents from outside the economic (domestic) territory.

(iii)

Salaries to Indian residents working in Russian Embassy is not a part of

domestic product of India because Russian embassy is a part of Russian

economic territory. It is factor income from abroad.
(iv)

Profits earned by a non-residential owned company in India is a part of

domestic product of India because the income is created within the
economic (domestic) territory of India

19. From the following data, calculate National Product at Market Price by
income method and (ii) expenditure method:

(i)

(6 marks)

(Rs. Crores)
(i)
(ii)

Mixed income of self- employed

400

Compensation of employees

500

Private final consumption expenditure

900

Net factor income from abroad

(-) 20

Net indirect tax

100

Consumption of fixed capital

120

Net domestic capital formation

280

(iii)
(iv)
(v)
(vi)
(vii)

(viii) Net exports

(-)30

(ix)

Profits

350

(x)

Rent

100

(xi)

Interest

150

(xii)

Government final consumption expenditure

450

Ans: (i) GNPMP = COE + R + I + P + Mixed I + NFIA + CFC + NIT +

(Income method) = ii + x + xi + ix + i + iv + vi + v
= 500 + 100 + 150 + 350 + 400 + (-20) + 120 + 100

= Rs. 1700 crores.

GNPMP = PFCE + GFCE + GDCF + Net X + NFIA
(Exp. Method) = iii + xii + (vii + vi) + viii + iv
= 900 + 450 + (280 + 120) + (-30) + (-20) = Rs. 1700 crores
20. Will the following be included in domestic factor income of India? Give reasons
for your answer.

(6 marks)

(i)

Profit earned by a foreign bank from its branches in India.

(ii)

Scholarships given by Government of India.

(iii)

Profits earned by a resident of India from his company in Singapore.

(iv) S Salaries received by Indians working in American Embassy in India.

Ans:
(i)

Profit earned by a foreign bank is included in domestic product of India because the
banks branches are located in the Indian domestic territory.

(ii)

Scholarships is a transfer payment because no service is provided in return. So, it

is not included in domestic income.

(iii) Profits earned by an Indian company in Singapore is not included in domestic

product of India because company is located outside the economic (domestic)
territory of India.
(iv) S Salaries received by Indians working in American Embassy in India is not
included because the embassy is treated as a part of American domestic territory
and not of India.

21. Will the following be included in National Income of India? Give reasons for your
answer.

( 6 marks)

(i)

Financial help given to flood victims.

(ii)

Profits earned by an Indian bank from its branches abroad.

(iii)

Salaries paid to non-resident Indians working in Indian Embassy in

America.

(iv)

Interest received by an individual from banks.

Ans:
(i)

Financial help is a transfer payment because no factor service is provided in

return. It is, therefore, not included in national income.

(ii)

Profit earned by an Indian bank from its branched abroad is factor income
from abroad, and so included in national income.

(iii) Salaries paid to NRIs working in Indian embassy in America is factor

income paid to abroad. It is not include in Indias national income.
(iv) Interest received by an individuals from banks is a factor payment by a
productive enterprise. It is included in national income.

22. From the following data calculate national income by (a) income method and (b)
expenditure method.

(6 marks)
Rs. (Crores)

(i)
(ii)
(iii)
(iv)
(v)
(vi)

Private final consumption expenditure

2,000

Net capital formation

400

Change in stock

50

Compensation of employees
1,900
Rent
200

Interest

(vii)
(viii)

150

Operating surplus

720

(ix)

Net indirect tax

(x)

Employees contribution to social security schemes

(xi)

100

Net exports

(xii)
(xiii)

400

Net factor income from abroad

Government final consumption expenditure
Consumption of fixed capital

20
(-)20
600
100

Ans: N.I. (Income method) = iv + vii + xi

= 1900 + 720 + (-20) = 1900 + 720 20
= Rs. 2600 crores.
N.I. (Exp. Method) = i + xii + ii + x + viii + xi
= 2000 + 600 + 400 + 20 - 400 + (-20) = 2000 + 600 + 400 + 20 400 20
= Rs.2600 crores

23. Will the following factor incomes be included in domestic factor income of India?
Give reasons for your answer.
(i)

( 6 marks)

Compensation of employees to the residents of Japan working in Indian

embassy in Japan.

(ii)

Profits earned by a branch of foreign bank in India.

(iii)

Rent received by an Indian resident from Russian embassy in India.

(iv)
Profits earned by a branch of State Bank of Indian in England.
Ans:
(i)

It is a part of domestic factor income of India because the

Indian embassy in Japan is a part of domestic territory of
India.

(ii)

It is a part of domestic factor income of India because the

foreign bank is located in the domestic territory of India.

(iii)

It is not a part of domestic income of India because Russian

embassy in India is not a part of domestic territory of India.

Quick Revision
QUESTION-ANSWER for Average and Slow bloomers
1.Define Macroeconomics.
Ans.That branch of Economics which studies aggregate
economic variables of an economy.
2.Define circular flow of income.
Ans.It refers to the flow of goods and services or the flow
of money across different sectors of the economy.
3.What is real flow?
Ans. It shows Flow of goods and services across different
sectors of the economy.

4.What is money flow?

Ans.It shows flow of income across different sectors. It is
also known as money flow.
5.What are injections?
Ans.The government spending, invest ment,exports are
important injections into the circular flow. Increase in such
variables raises the level of economic activities.
6. What are leakages?
Ans.Savings, taxes and imports are the important
withdrawals (leakages) from the circular flow. Increase in
these variables reduces the level of economic activity in
the economy.
7. State any four importance o0f circular flow
Ans. The four importance of circular flow of income are as
follows:
a)It helps us to understand interdependence between
different sectors of the economy.
b) It helps us to understand the size of national income.
c) It tells about the level of economic activities in an
economy.
d) It gives us information on injections like investment,
government expending and exports and leakages like
saving tax and imports.
8. Show circular flow in two sector economy.
Ans.In a closed economy there are two sectors
Household sector and Firm sector.
The Household sector provides factors of production to
the firm sector and the total income received is wages
plus rent plus interest plus profit. They are consumers of
goods and services and make consumption expenditure to
the business sector. The firm sector hires factors of
production from the household sector. They produce and
sell goods and services to the household sector and
receive income from them. They make factor payments to
the household sector.

9. What do you mean by stock and flow?

Ans.Stock : Stock means quantity of an economic
variable which is measured at a particular point of time. It
has no time dimension. It is a static concept. Wealth,
water in a tank and inventories are the examples of
stock.Flow:Flow is that quantity of an economic variable
which is measured during a period of time. It is dynamic
concept and has time dimension like per hour, per month
etc. Investment, water in a stream and changes in
inventories are the examples of flow.

10. Define intermediate goods.

Ans.Goods which are used to produce final goods. E.g.wheat flour
11. Define Final goods?
Ans. Goods that be consumed directly by the consumers.
12. Define depreciation?
Ans.Loss in the value of fixed assets due to normal wear
and tear or consumption of fixed capital is known as
depreciation.
13. What is intermediate cost?
Ans. Expenditure incurred on purchase of intermediate
goods is known as intermediate cost.
14. What are transfer payments?
Ans. When payments are made without receiving any
service it is called transfer payments. For examplescholarship, old age pension etc.
15. What is Value of Output?
Ans: It is sum of the Sales and Change in stock.
Test Paper (Unit -6) for bright students
Q.1) Complete the following formula:
A) National Income = Domestic Income +
B) Net Export = ExportC) Factor Cost = Market Price-

Q.2) State true or false:

A)National Income is always greater than domestic Income.
B) Resident is a person whose economic interest lies in the country in which he
resides.
C) Stock has no time dimension.
d) Distance between Delhi and Kolkota is flow concept.
e) Old age pension is the example Factor Income.
Q.3) Answer in one word or one line:
A)
B)
C)
D)
E)
F)
G)
H)
I)

How is Net Indirect Tax Calculated?

Name four factors of production.
Give two examples non factor income.
Who gives subsidy to whom?
What is the the difference between Gross investment and Net investment.
What is transfer payment?
Mention three major components Domestic Income.
Define corporate Tax.
What do you mean by royalty?

Q.4) Match the following:

1.) wages and salary
opening stock.

a) is difference between closing stock and

2.) Wind fall gains

than once.

b) means counting value of some things more

3.) Double counting

c) is component of profit.

4.) Dividend

d) are not included in national income.

5.) change in stock

e) component of COE.
TEST PAPER
Unsolved numerical for Bright Students

NUMERICALS TO BE CALCULATED BY STUDENTS

1.Calculate Net National Disposable Income From The Following Data:
(Rs. In Crores)
(i) Gross domestic product at market price
1,000
(ii) Net factor income from abroad
(-)20
(iii) Net indirect taxes
120
(iv) Consumption of fixed capital
100
(v) Net current transfer from rest of the world
70

2.

Calculate Gross National Disposable Income The Following Data:

(Rs. In Crores)
(i) National income (or NNPfc)
800
(ii) Net indirect taxes
100
(iii) Net factor income from abroad
30
(iv) Net current transfer from rest of the world
50
(v) Consumption of fixed capital
70

3.Calculate Gross National Disposable Income And net National Disposable

Income from the Following Data:
(Rs. In Crores)
(i) Consumption of fixed capital
30
(ii) Net national product at market price
240
(iii) Net Indirect taxes
40
(iv) Net current transfers from rest of the world
(-)20
(v) Net factor income from abroad
(-) 10
4.Find Out GNPMP, NDPFC And Gross National Disposable Income.
(Rs. In Crores)
(i) National income
520
(ii) Net factor income from abroad
10
(iii) Indirect taxes
40
(iv) Subsidies
10
(v) Consumption of fixed capital
50
(vi) Net current transfer received from abroad
20
5.Calculate NNPFC, net National Disposable Income and Gross National Disposable
Income from following data:
(Rs. In Crores)
(i) GNPMP
(ii) Net Indirect taxes
(iii) Net current transfer received from rest of the world
(iv) Subsidies
(v) Consumption of fixed capital
(vi) Net factor income paid to the rest of the world

1000
100
(-)20
25
50
(-)10

6.Find Out (a) Personal Income and (b) Personal Disposable Income from
following data:
(Rs. In Crores)
1.Private income
48,800
(ii) Interest on national debit
1,000
(iii) Net factor income from abroad
300
(iv) Corporate Savings
800
(v) ) Corporation tax
210
(vi) Personal income tax
540

7.From The Following Data Calculate:

Private Income and (b) Personal disposable income.
(i) Income from Domestic product accruing to the private sector
(ii) Savings of non-departmental public enterprises
(iii) Current transfer from government administrative departments
(iv) Savings of private corporate sector
(v) Current transfers from rest of the world
(vi) Net factor income from abroad
(vii) Corporation tax
(viii) Direct Personal tax

(Rs. In Crores)
4,000
200
150
400
50
(-) 4
60
140

8.Calculate (a) Personal Income (b) Personal Disposable Income from

following data:
(Rs. In Crores)
(i) Income from property and entrepreneurship accruing to
Government administrative department
500
(ii) Savings of non-departmental public enterprises
100
(iii) Corporation tax
80
(iv) Income from Domestic product accruing to the private sector
4,500
(v) Current transfer from government administrative departments
200
(vi) Net factor income from abroad
(-)50
(vii) Direct Personal tax
150
(viii) Indirect taxes
220
(ix) Current transfers from rest of the world
80
(x) Savings of private cooperate scooter
500
9.From the following data calculate National Income by
(i) Income method and (ii) Expenditure method.
(Rs. In Crores)
(i) Compensation of employees
1,200
(ii) Net factor income from abroad
(-)20
(iii) Net indirect taxes
120
(iv) Profit
800
(v) Private final consumption expenditure
2,000
(vi) Net domestic capital formation
770
(vii) Consumption of fixed capital
130
(viii) Rent
400
(ix) Interest
620
(x) Mixed income of self- employed
700
(xi) Net exports
(-)30
(xii) Government final consumption expenditure
1,100

10.From the following data, calculate Gross national product at Market Price
by(i) Income method. (ii) Expenditure method:
(Rs. In Crores)
(i) Mixed income of self-employed
400
(ii) Compensation of employees
500
(iii) Private final consumption expenditure
900
(iv) Net factor income from abroad
(-)20
(v) Net indirect taxes
100
(vi) Consumption of fixed capital
120

(vii) Net domestic capital formation

(viii) Net exports
(ix) Profits
(x) Rent
(xi) Interest
(xii) Government final consumption expenditure

280
(-)30
350
100
150
450

11.Calculate (a) National Income and (b) Gross National Disposable Income
from the following data
(Rs. In Crores)
(i) Net factor income from abroad
(-)20
(ii) Government final consumption expenditure
200
(iii) Subsidies
10
(iv) Private final consumption expenditure
800
(v) Net current transfers from the rest of the world
30
(vi) Net domestic fixed capital formation
100
(vii) Indirect taxes
80
(viii) Consumption of fixed capital
40
(ix) Change in stock
(-)10
(x) Net exports
(-)50

12.From the following data, calculate gross value added at factor cost
(Rs. In Crores)
(i) Sales
500
(ii) Change in stock
30
(iii) Subsidies
40
(iv) Consumption of fixed capital
60
(v) Purchases of intermediate products
350
(vi) Profit
70
13.From the following data, calculate:
(a) National income, and (b) Personal disposable income
(Rs. In Crores)
(i) Compensation of employees
1,200
(ii) Rent
400
(iii) Profit
800
(iv) Consumption of fixed capital
300
(v) Mixed income of self- employed
1,000
(vi) private income
3,600
(vii) net factor income from abroad
(-)50
(viii) net trained earnings of private enterprises
200
(ix)interest
250
(x) net indirect taxes
350
(xi) net exports
(-)60
(xii) direct taxes paid by households
150
(xiii) corporation tax
100

14. From the following data calculate national income by

(a) Income method and (b) Expenditure method.
(Rs. In cores)
(i) Private final consumption expenditure
2,000
(ii) Net capital formation
400
(iii) Change in stock
50
(iv) Compensation of employees
1,900
(v) Rent
200
(vi) Interest
150
(vii) operating surplus
720
(viii) Net indirect tax
400
(x) Employers contribution to social security schemes
100
(xi) Net exports
20
(xii) Net factor income from aboard
(-)20
(xii) Government final consumption expenditure
600
(xvi) Consumption of fixed capital
100

15.Find gross national product at market price by income method and

expenditure method.

a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.

ITEMS
Mixed income of the self-employed
Compensation of employees
Private final consumption expenditure
Net factor income from abroad
Net indirect taxes
Consumption of fixed capital
Net domestic capital formation
Net exports
Rent
Interest
Government final consumption expenditure

Test paper (unit 6)

Rs. CRORES
400
500
900
(--)20
100
120
280
(--) 30
100
150
450

(For slow learners)

State true or false

Q1 Net factor income from abroad is added to NDPFC to get national Income.
Q2 Capital formation is flow concept.
Q3 Real flow is also known as nominal flow.
Q4 National Income of a country is stock concept.
Q5 Bread is always consumer good.
Q5 In final goods no value is to be added.
Q7 The concept of normal resident applies to individuals only.
Q8 Market Price is always more than factor cost.

Q9 Gross investment can be equal to Net investment.

Q10 Domestic Income Of country can be more its national income.
Q11 Private includes earned income of private sector from all sources.
Q12 National disposable income is the disposable income of private income.
Q13 Goods produced for self consumption will be included in national income.
Q15 National income is affected by both factor as well as transfer income.
Q16 Production of services for self consumption is not included in National Income.
Q17 Purchase of car by a consumer is a part of Gross domestic capital formation.
Q18 Free services provided by the Govt. will not be included in national income.
Q19 Measurement of national income at current prices provides a reliable base of
comparison.
Q20 Generation and distribution are the two phases in circulation income.

TEST PAPER
Questions For Average and Slow learner students
Fill in the blanks:
1. received by factors of production for rendering of factor
services in production process.
2. Transfer income received . Any productive services in
return.
3. Capital goods are those final goods, which help in of other goods
and services.
4. Gross = + Depreciation.
5. Net = Gross - ..
6. Net Indirect Tax = Indirect tax - .
7. Market price = .. + net indirect taxes.
8. Factor cost = Market price -
9. Domestic Income = National Income - ..
10. National Income = . + NFIA.

11. GDP fc = GDPmp - ..

12. Personal Income = Private income Corporation tax -
13. Private Income = Income from NDPfc accruing to private sector + National Debt
interest + . + Current transfer from government +

14. Personal Disposable income = .. Personal

direct taxes miscellaneous receipts from government.
15. NDPfc = Wages + + Interest + Rent + .. + Mixed income of selfemployed.
16. = Compensation of Employees + Operating Surplus + Mixed
Income + NFIA
17. .. = Govt. Final Consumption Expenditure +
Private Final Consumption Expenditure + Gross Domestic Capital Formation + Net
Export.
18. Output = Sales +
19. Gross Value Added (GVA) = Output -
20. Gross National Disposable Income (GNDI) = GNPmp +
MONEY AND BANKING (UNIT-6)
MARKS (8)
Barter System:
Barter system refers to directly exchange of goods known as barter system. It is also
known as C-C economy.
Difficulties in Barter System: Following difficulties in barter system:

Problem of double coincidence of want.

Lack of measuring unit.

Lack of value store

Money:
Money is what money does. Or any commodity which refer to money which have,
Medium of exchange, Measuring unit and differed payment.
Primary function of Money:

Medium of Exchange: It means that money acts as a medium for the sale
and purchase of goods and services.

Measure of value: money serves as a measured of value in terms of unit of

account.

Secondary function of Money:

Store of Value: It implies that store of wealth.

Standard of Differed Payment: Differed payment refers to those payments

which are made some time in the future.

Transfer of Value: money also serves as a convenient mode of transfer of

value.

Supply of Money:
It refers to total stock of money held by the people of a country at a point of time.
Measurement of Money Supply:

M1= C+DD+OD

M2= M1+DEPOSITS WITH POST OFFICE SAVING BANK ACCOUNT

M3= M1+NET TIME DEPOSIT WITH THE COMMERCIAL BANK

M4= M3+TOTAL DEPOSITS WITH POST OFFICES

Forms of Money:
Narrow Money:
If M1 or M2 measures are used, then it is known as Narrow Money.
Broad Money:
If M3 or M4 measures are used, then it is known as Broad Money.
Fiat Money:
It refers to money backed with the order of the government.
Fiduciary Money:
It refers to money backed with mutual trust between the payer and the payee.
Full Bodied Money:
Money value = commodity value
Credit Money:
Money value of coins and notes > Commodity value of coins and notes.
High Powered Money:

It consists of currency and cash reserves with banks.

HM = Currency with the Public + Cash reserves with the banks
Liquidity:
Liquidity of assets refers to its convertibility in to money/cash. Faster an asset can be
converted into cash, more liquid it is.
Commercial Bank and the Central Bank
Commercial Bank:
Commercial Bank is an institute which accepts deposits and advances loans with the
view to earn profit.
Functions of Commercial Bank:
Primary Function of Commercial Bank:

Accepting Deposits: A bank accepts deposit from the public. People can
deposits their cash balances.

Advancing Loans: Banks advance loans mostly for the productive purposes,
against some collateral.

Secondary Functions:

Overdraft Facilities

Credit Creation

Agent as advisor

Draft facility provider

Credit Multiplier:
It indicates the maximum credit that the commercial banks can create with their
additional cash reserve.
Credit Multiplier = 1/CRR
Money Multiplier:
Money multiplier or deposit multiplier measures the amount of money that the bank
is able to create in the form of deposits with every unit of money it keeps as reserve.
Money Multiplier = 1/LRR

Credit Creation by Commercial Bank:

The deposits held by banks are used for giving loans. However banks can not used
the whole of deposits for lending.
It is legally compulsory for the banks to keep a certain minimum fraction of their
deposits as resources. The friction is called legal reserve ratio (LRR) is fixed by the
central bank.
Example: suppose initial deposits in is bank are rupees 1000 and LRR is 20%
It means, banks are required to keeps only Rs. 200 as cash reserves and free to
lend Rs. 800.
This 800 will again come in the bank as deposit.
With new deposit of Rs.800, banks keep 20% as reserves and lend the balance Rs.
640 to other person, and so on.

Initial deposit
Round I
Round II
..
.....
..

Deposits (in Rs.)

Loans (in Rs.)

1000
800
640
..

5000

800
640
512

..
4000

Cash Reserves
(20%)
200
160
128
..
...
1000

Money Multiplier = 1/LRR= 1/0.2=5

Total Deposit = Initial Deposit X Money Multiplier
= 1000X5 = 5000
Cash Reserve Ratio (CRR):
This refers to the legally required cash reserves of the commercial banks with the
central bank as a percentage of their total deposits.
Statutory Liquidity Ratio (SLR):
This refers to liquid assets of the commercial banks which they are required to
maintain as a minimum percentage of their total deposits.
Bank Rate:
It is the rate at which the central bank gives credit to the commercial banks.

Legal Reserve Ratio (LRR):

It is legally compulsory for the banks to keep a certain minimum fraction of these
deposits as cash. The fraction is called the legal reserve ratio.
Central Bank:
Central Bank is the apex institution which controls, operates, regulates and directs
the entire monetary system of the country.
Functions of Central Bank:

Issuing of Notes: Central bank of a country has the exclusive right of issuing
notes. This is called currency authority function of the central bank.

Banker to the Government: Central bank is a banker, agent and financial

advisor to the government; it manages accounts of the government.

Bankers Bank: It is an apex bank of all banks in the country. The central
bank has almost the same relation with other banks in the country as a
commercial bank has with its customer.

Lender of the last resort: When commercial bank finds trouble in their
liquidity condition they directly contact to the central bank for assistance.

Custodian of foreign exchange: Central bank is the custodian of nations

foreign exchange reserves.

Control of credit: It implies increase or decrease in the supply of money by

regulating the creation of credit by the commercial bank.

Credit Control by the Central Bank:

The central bank adopts various measures to control the supply of money in the
economy. It can be broadly classified in two categories:

Quantitative Instruments:

Bank Rate: It is the important instruments for Central bank to control

money supply in the economy. In order to increase or decrease money
supply central bank increases or decreases bank rate.

CRR: It is the important instruments for Central bank to control money

supply in the economy. In order to increase or decrease money supply
central bank increases or decreases bank rate.

SLR: It is the important instruments for Central bank to control money

supply in the economy. In order to increase or decrease money supply
central bank increases or decreases bank rate.

Open Market Operation: its refers to the sale and purchase of

securities in the open market by the central bank. To increase money
supply central bank purchases the securities from the commercial
banks and vice versa.

Qualitative Instruments:

Margin Requirements: it is refers to the difference between the

current value of the security offered for loan and the value of loan
granted.in order to increase money supply central bank reduce the
margin requirement and vice versa.

Rationing of Credit: Rationing of credit refers to fixation of credit

quotas for different business activities.

Moral Suasion: Some times, the central banks makes the member
banks agree through persuasion or pressure to follow its directives on
the flow of credit.
MONEY AND BANKING

Q.1 Define barter system.

Ans. Barter system refers to directly exchange of goods known as barter system. It
is also known as C-C economy.
Q.2 What were the difficulties in Barter System?
Ans. These were the Following difficulties in barter system:

Problem of double coincidence of want.

Lack of measuring unit.

Lack of value store.

Q.3 Define Money.

Ans. Money is what money does. Or any commodity which refer to money which
have, Medium of exchange, Measuring unit and differed payment.
Q.3 Give the Primary function of Money?
Ans. These are the primary function of money

Medium of Exchange: It means that money acts as a medium for the sale
and purchase of goods and services.

Measure of value: money serves as a measured of value in terms of unit of

account.

Q.4 Give the Secondary function of Money?

Ans. These are the secondary function of money

Store of Value: It implies that store of wealth.

Standard of Differed Payment: Differed payment refers to those payments

which are made some time in the future.

Transfer of Value: money also serves as a convenient mode of transfer of

value.

Q.5 What do you mean by Supply of Money?

Ans. It refers to total stock of money held by the people of a country at a point of
time.
Q.6 What are the components of money supply?
Ans. M1,M2,M3,M4 are diffrent forms of money and its have also different
components.

M1= C+DD+OD

M2= M1+DEPOSITS WITH POST OFFICE SAVING BANK ACCOUNT

M3= M1+NET TIME DEPOSIT WITH THE COMMERCIAL BANK

M4= M3+TOTAL DEPOSITS WITH POST OFFICES

Q.7 Define narrow money.

Ans. If M1 or M2 measures are used, then it is known as Narrow Money.
Q.8 Define Broad Money.
Ans. If M3 or M4 measures are used, then it is known as Broad Money.
Q.9 Define Fiat Money.
Ans. It refers to money backed with the order of the government.
Q.10 Define Fiduciary Money.
Ans. It refers to money backed with mutual trust between the payer and the payee.
Q.11 Define Full Bodied Money.
Ans. Money value = commodity value
Q.12 Define Credit Money.
Ans. Money value of coins and notes > Commodity value of coins and notes.

Q.13 Define High Powered Money.

Ans. It consists of currency and cash reserves with banks.
HM = Currency with the Public + Cash reserves with the banks
Q.14 What do you mean by Liquidity?
Ans. Liquidity of assets refers to its convertibility in to money/cash. Faster an asset
can be converted into cash, more liquid it is.
Commercial Bank and the Central Bank
Q.1 Define Commercial Bank.
Ans. Commercial Bank is an institute which accepts deposits and advances loans
with the view to earn profit.
Q.2 Explain the Functions of Commercial Bank.
Ans. Primary Function of Commercial Bank:

Accepting Deposits: A bank accepts deposit from the public. People can
deposits their cash balances.

Advancing Loans: Banks advance loans mostly for the productive purposes,
against some collateral.

Secondary Functions:

Overdraft Facilities

Credit Creation

Agent as advisor

Draft facility provider

Q.3 What is Credit Multiplier?

Ans. It indicates the maximum credit that the commercial banks can create with their
additional cash reserve.
Credit Multiplier = 1/CRR
Q.4 Define Money Multiplier.
Ans. Money multiplier or deposit multiplier measures the amount of money that the
bank is able to create in the form of deposits with every unit of money it keeps as
reserve.
Money Multiplier = 1/LRR

Q.5 What is the minimum value of money multiplier?

Ans. The minimum value of money multiplier is 1.
Q.6 Explain the process of Credit Creation by Commercial Bank.
Ans. The deposits held by banks are used for giving loans. However banks can not
used the whole of deposits for lending.
It is legally compulsory for the banks to keep a certain minimum fraction of their
deposits as resources. The friction is called legal reserve ratio (LRR) is fixed by the
central bank.
Example: suppose initial deposits in is bank are rupees 1000 and LRR is 20%
It means, banks are required to keeps only Rs. 200 as cash reserves and free to
lend Rs. 800.
This 800 will again come in the bank as deposit.
With new deposit of Rs.800, banks keep 20% as reserves and lend the balance Rs.
640 to other person, and so on.

Initial deposit
Round I
Round II
..
.....
..

Deposits (in Rs.)

Loans (in Rs.)

1000
800
640
..

5000

800
640
512

..
4000

Cash Reserves
(20%)
200
160
128
..
...
1000

Money Multiplier = 1/LRR= 1/0.2=5

Total Deposit = Initial Deposit X Money Multiplier
= 1000X5 = 5000
Q. 7 What is Cash Reserve Ratio?
Ans. This refers to the legally required cash reserves of the commercial banks with
the central bank as a percentage of their total deposits.
Q.8 Define Statutory Liquidity Ratio (SLR).
Ans. This refers to liquid assets of the commercial banks which they are required to
maintain as a minimum percentage of their total deposits.
Q.9 Dedfine Bank Rate.
Ans. It is the rate at which the central bank gives credit to the commercial banks.

Q.10 Define the Central Bank and explain its functions.

Ans. Central Bank is the apex institution which controls, operates, regulates and
directs the entire monetary system of the country.
Functions of Central Bank:

Issuing of Notes: Central bank of a country has the exclusive right of issuing
notes. This is called currency authority function of the central bank.

Banker to the Government: Central bank is a banker, agent and financial

advisor to the government; it manages accounts of the government.

Bankers Bank: It is an apex bank of all banks in the country. The central
bank has almost the same relation with other banks in the country as a
commercial bank has with its customer.

Lender of the last resort: When commercial bank finds trouble in their
liquidity condition they directly contact to the central bank for assistance.

Custodian of foreign exchange: Central bank is the custodian of nations

foreign exchange reserves.

Control of credit: It implies increase or decrease in the supply of money by

regulating the creation of credit by the commercial bank.

Q.11 How central bank controlled credit creation by the commercial banks?
Ans. The central bank adopts various measures to control the supply of money in
the economy. It can be broadly classified in two categories:

Quantitative Instruments:

Bank Rate: It is the important instruments for Central bank to control

money supply in the economy. In order to increase or decrease money
supply central bank increases or decreases bank rate.

CRR: It is the important instruments for Central bank to control money

supply in the economy. In order to increase or decrease money supply
central bank increases or decreases bank rate.

SLR: It is the important instruments for Central bank to control money

supply in the economy. In order to increase or decrease money supply
central bank increases or decreases bank rate.

Open Market Operation: its refers to the sale and purchase of

securities in the open market by the central bank. To increase money
supply central bank purchases the securities from the commercial
banks and vice versa.

Qualitative Instruments:

Margin Requirements: it is refers to the difference between the

current value of the security offered for loan and the value of loan
granted.in order to increase money supply central bank reduce the
margin requirement and vice versa.

Rationing of Credit: Rationing of credit refers to fixation of credit

quotas for different business activities.

Moral Suasion: Some times, the central banks makes the member
banks agree through persuasion or pressure to follow its directives on
the flow of credit.

Q.12 Calculate the value of money multiplier and the total deposits created if
initial deposit is of rupees 500 crores and LRR is 10%.
Ans. Money multiplier = 1/LRR =1/10%=10
initial deposit is 500 crores
Total deposit= Initial deposit X money multiplier
= 500 X 10 = 5000 Crores.
Q.13 If total deposits created by commercial bank are rupees 12000 crores,
LRR is 25% calculate initial deposit.
Ans. Money Multiplier = 1/LRR = 1/.25 = 4
Initial deposit = Total deposit/Money Multiplier
= 12000/4 = 3000 crores.
Q.14 If initial deposit is rupees 200 crores and total deposits is rupees 1600
crores, calculate LRR.
Ans. Money Multiplier = Total deposit/Initial deposits
= 1600/200 = 8
Money Multiplier = 1/LRR 8 = 1/LRR LRR = 1.25
MONEY AND BANKING
Very Short Answer Questions (1 Mark)
1. Define Barter System?
2. State two components of money supply.
3. What is Money?
4. What is the meaning of Commercial Bank?

5. Define Bank rate?

6. Define Cash Reserve Ratio?
7. Give the meaning of money supply.
8. What is demand deposit?
9. What is fiat money?
10. What is high powered money?
11. Define C-C economy?
12. Name the primary functions of a bank.
13. What is the name of central bank of India?
14. What is a central Bank?
15. Define SLR.
Short Answer Questions (3 and 4 Marks)
1. Explain any two function of money.
2. Explain the function of a central bank as bankers to the government.
3. Explain the currency authority of central bank.
4. Mention the items included in narrow money.
5. What role of RBI is known as lender of last resort?
6. Explain how does a central bank control credit creation by commercial bank
changing the bank rate?
7. Explain the unit of value and medium of exchange function of money.
8. What are the difficulties in barter system?
9. Distinguish between commercial banks and central bank.
10. Give the three functions of commercial banks.
Long Answer Question (6 Marks)

1. How does the central bank control the credit creation by commercial
banks?
2. Explain the process of money creation by commercial banks.
3. Discuss the function of central bank.
UNIT - 7

Determination of Income and Employment (12 marks)

1. Define involuntary unemployment.
It refers to a situation where able bodied persons are willing to work at the
prevailing wage rate but unable to find job.
2. What is full employment?
It refers to a situation in which all those people, who are willing and able to
work at the existing wage rate, get employment.

3. What is Aggregate demand?

It refers to the total demand for goods and services in an economy during an
accounting year,
4. What is aggregate supply?
It is the money value of all final goods and services available in an economy
during an accounting year.
5. Define equilibrium level of income.
It refers to a situation where demand in equal to aggregate supply at full
employment level aggregate.
6. Define says law of market.
Supply creates its own demand.
7. What is consumption function?
It shows the functional relationship between consumption and income
8. What is saving function?
It shows the functional relationship between saving and income.
9. Define MPC.
It is the ration of change on consumption to change in income. Symbolically
MPC=c/y.
10. Define MPS.
It is a ratio of change in saving to change in income MPS =S/Y
11. Define investment.
It refers to the addition to the stock of capital goods in the nature of structure
equipment and inventory
12. Define Ex-ante investment
It refers to the intended or planned investment in an economy in a particular
year
13. Define Ex-post investment
It refers to the actual of realized investment done in an economy in a
particular year.
14. What is APC?
It is the ration of consumption expenditure to total income APC = C/y
15. What is APS?
It is the ratio of total saving to total income APS = S/Y
16. If the value of MPS is 0.25, what is the value of multiplier?
Given MPS=0.25 K = 1/MPS=1/0.25=100/25 =4, k = 4
17. What can be the maximum value of MPC?
The maximum value of MPC = 1
18. If the value of MPS is 0.25, what is the value of MPC?
The value of MPC = 0.75
19. Define Multiplier.
It is the ratio of a change in income to a change in investment k= Y/I
20. What is the relationship between MPC and MPS?
One (1)
21. What is the value of MPC, when MPS is zero?
One (1)

22. Why can the value of MPC not greater than one?
The value of MPC cannot be greater than one because change in
consumption cannot be more than change in income.
23. What is induced investment?
The investment for profit motive.
24. Define Autonomous investment.
It is the investment made irrespective the level of income. It remain same at
all levels of income
25. What will be the value of multiplier, if MPS is 0.5?
The value of multiplier will be two (2)
26. What is marginal efficiency of capital?
It is the expected rate of return from an additional unit of investment.
27. Define autonomous consumption.
It refers to the minimum level of consumption even when income is zero.
28. What is relationship between APC and APS?
One (1)
29. What is equilibrium income?
The level of income where aggregate demand and aggregate supply are
equal
30. What is the value of Multiplier, if MPS is 0.25?
Four (4)
Problems of Excess Demand and Deficient Demand
1. Define excess demand.
It refers to a situation where aggregate demand is more than aggregate
supply at full employment level.
2. What is deficient demand?
It refers to a situation where aggregate demand is less than aggregate
supply at full employment level.
3. What is monetary policy?
It is the policy of central bank to control money supply in the economy
4. What is fiscal policy?
It is policy of the government related to total revenue and total
expenditure to affect the level of aggregate demand in an economy.
5. Define Bank Rate?
It is the rate at which central bank advances loans to the commercial
bank
6. Define CRR.
It is ratio that every commercial bank has to keep with central bank in
cash form.
7. What is open market operation?
It refers to the process of buying and selling of government security in
the open market by the central bank
8. Define trade cycle.
The process of moving upwards and downwards of economic activities
in the economy.

9. What is meant by export surplus?

Export surplus is the excess of export over imports.
10. What is import surplus?
Export surplus is the excess of import over export.

SHORT QUESTION ANSWERS (3/4 MARKS)

1. Briefly explain the components of aggregate demand.
Aggregate demand is the total demand for goods and services in the
economy. Aggregate demand in fact represents the total expenditure of goods
and services in an economy.
There are four components of aggregate demand (AD):
(i)Consumption (ii) investment (ii) government expenditure
(iv)net export
AD=C+I+G+(X-M)
2. Distinguish between MPC and MPS?
Marginal propensity to consume is the ration of change in consumption to
change on income.
Symbolically, MPC = c/Y
Where c= change in consumption
Y=change in income
Marginal propensity to save is the ration of change in saving to change on
income.
Symbolically, MPS = S/Y
Where S= change in saving
Y=change in income
3. What is consumption function? Draw the consumption schedule.
The relationship between consumption and income is called consumption
function consumption function shows the relationship between consumption
and income in terms of equation, it is written as under C = f(Y)

INCOME

CONSUMPTION

0
100
200
300
400
500

(Rs. crores)

50
100
150
200
250
300

4. What is saving function? Draw the saving schedule.

The relationship between saving and income is called saving function. Saving
function shows the relationship between saving and income in terms of equation, it is
written as under S = f(Y)

Income
0
100
200
300
400
500

Saving(Rs. Crores)
-50
0
50
100
150
200

5. What is meant by investment multiplier? Explain the relation between MPS

and investment multiplier?
Investment multiplier is defined as the ratio of change in income due to
change in investment
Symbolically,
Multiplier (k)
= Y / I
Relationship between multiplier and MPS: the value of the multiplier varies
inversely with MPS
Higher the MPS, the lower will be the size of multiplier and lower the MPS, the
larger will be the value of the multiplier. The relationship expressed as
k=1/MPS
FOR example, if MPS =. 10= 1/10, = 10.

6. Distinguish between Autonomous investment and induced investment .

Autonomous investment: autonomous investment is not affected by the
level of income of expected profitability. This is the investment made by the
government with a view to increase the aggregate demand in an economy.
The volume of autonomous investment is same at all the level of income.so AI
curve is a horizontal straight line parallel to x axis.
Induced investment: induced investment is made with the profit motive by
the private sector. Induced investment is positively related with the level of
income in an economy.at the higher level of income, consumption increases.
7. Briefly explain the meaning of involuntary unemployment and full
employment?
Involuntary unemployment: it refers to a situation when a person is
unemployed at his own will and he does not want to work at the prevailing rate
in the market.
Full employment: full employment is the situation in which all those who are
willing to work and are able to work at the existing wage rate, get the work
8. Explain the relationship between investment multiplier and marginal
propensity to consume.
The value of multiplier is determined by the MPC .Higher the MPC, greater
the size of multiplier and vice versa. There is a direct relationship between
multiplier and MPC
Symbolically, k = 1/1-MPC

According to the Keynes, the value of MPC is always greater than zero but
less than one accordingly, the value of multiplier would be greater than one
but less than infinity. The value of multiplier thus varies from unity to infinity.
Since we know that
MPC+MPS = 1
So we can write the investment multiplier.
K= 1/MPS
So when MPC is equal to 1
K = 1/1-MPC= 1/1-1=1/0 =
It is clear that value of MPC is equal to 1 or MPS is zero then multiplier value
will be

K = 1/MPS =1/1=1
K=1
Problems of Excess Demand and Deficient Demand

1. Explain the concept of inflationary gap. Explain by diagram

Inflationary gap may be defined as an excess of aggregate demand over
aggregate supply at the full employment level. The inflationary gap results
in the rise in general price level which is called inflation. The amount by
which aggregate demand exceeds the level of aggregate production
corresponding to full employment level of national income is known as
inflationary gap.

2. What is fiscal policy? How is it used to correct Excess demand suggesting

two measures?
Fiscal policy refers to the expenditure and taxation policy of the
government. To correct excess demand two fiscal measures can be taken:
(i)Reducing Govt Expenditure: There is a lot of non-essential and
non-productive expenditure which can be reduced to control excess
demand. Govt can cut down its subsidies as on various items such
as food, fertilizers, power supply export etc.

(ii)Increasing Taxes: when there is excess demand in in the economy

Govt should map up more resources from the public by increasing
imposing taxes
3. Explain the meaning of deflationary gap.
Deflationary gap is the situation when aggregate demand is less than
aggregate supply at full employment level .It is the difference between
actual level of aggregate demand and the level of aggregate demand
required to achieve the full employment equilibrium.
4. Explain the role of CRR and Bank Rate to correct deficient demand.
Cash reserve ratio is reduced to increase deficient demand. Bank rate is
also reduced to increase demand.
5. Distinguish between fiscal policy and monetary policy to control money
supply?
Fiscal policy is undertaken by Govt but monetary policy is taken by Central
bank of the country to reduce money supply.

Long Answer Questions (6 Marks)

1. Explain the determination of equilibrium level of income by aggregate
demand and aggregate supply.
According to Keynes, equilibrium level of income and output is
determined at that point where Aggregate demand and Aggregate
supply are equal to each other.
AD= It is the summation of consumption demand and investment
demand. Or AD= C+I.
AS=It refers to the flow of goods and services in the economy in an
accounting year.
Diagram to be used for the said purpose.

2. Explain the equilibrium level of income with the saving and investment
curve.
The equilibrium level of income is determined at the point where
savings and investment are equal. S=I
Diagram to be used for the purpose.

3. Why should planned savings and planned investment be equal at

equilibrium level of income? Explain with the help of diagram.
Equilibrium GDP is stuck when S=I. S indicates withdrawal while I
indicates injection into the circular flow, thus equilibrium GDP is
achieved when withdrawal and injection exactly counterbalance each
other.

Problems of Excess Demand and Deficient Demand(6 marks)

1. Explain the concept of deflationary gap. What is its impact on output,
employment and price level in the economy?
It is a situation when resources are not fully utilized and there is excess
capacity in the economy. The economy drifting towards a situation of
deflation. Accordingly deficiency of AD (compared to its full employment
level) is often describe as a situation of deflationary Gap.
Impact:
(i)When AD fails to facilitate fuller utilization of factors and there is
excess capacity with the producers, they tend to build up unwanted
inventory stock.
(ii)Passive inventory stock would forces the producers to plan lesser
production. Implying in a cut in planned AS.
2. Explain the concept of inflationary gap. What is its impact on output,
employment and price level in the economy?
In a situation of excess demand, the level of output does not rise. Infact it
cannot raise because factors are already full employed. Output level remain
constant corresponding to the full employment level. Only price tend to rise.

IMPACT:
(i)When AD increases beyond its full employment level, output remains
constant. But, the pressure on demand on the existing supply starts
mounting up.
(ii)Mounting pressure on demand on the existing output causes a rise in
the prices.
(iii)Excess demand also generates pressure of demand on existing
resources, further it causes rise in the general price level.
3. What is fiscal policy? Explain the various fiscal measures used to control the
situation of excess demand.
fiscal policy refers to revenue and expenditure policy of the Government .it is
also called budgetary policy of the Government.
Measures to correct the situation of excess Demand
(i)The Government should step down its expenditure on public
programmer.
(ii)The Government should increase the tax as well as new tax might be
introduced by the Government.
4. What is monetary policy? Suggest monetary measures to control the
situation of deficient demand.
Monetary policy is that policy of the Government which corrects the situations
of excess and deficient demand by regulating interest rate and availability of
credit in the economy.
Measure to control the situation of deficient Demand:

(i)
(ii)
(iii)
(iv)

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.

Bank rate is lowered; following which market rate of interest is

reduced.
CRR and SLR are lowered. This rises the capacity of the commercial
bank to create credit.
Margin requirement is reduced.
Moral pressure on the commercial bank to be liberal in lending.

TEST PAPER (QUESTIONS)

Define involuntary unemployment.
What is full employment?
What is full employment?
What is aggregate supply?
Define equilibrium level of income.
Define says law of market.
What is consumption function?
What is saving function?
Define MPC.
Define MPS.
Define investment.
Define Ex-ante investment
Define Ex-post investment

14.
15.
16.
17.
18.
19.

20.

What is APC?
What is APS?
If the value of MPS is 0.25, what is the value of multiplier?
What can be the maximum value of MPC?
If the value of MPS is 0.25, what is the value of MPC?
Define Multiplier.

What is the relationship between MPC and MPS?

GOVERNMENT BUDGET &THE ECONOMY(UNIT-8)
(MARKS-8) (SLOW LEARNERS)
VERY SHORT ANSWER TYPE QUESTIONS Marks-(1)

Q.1 What is Government budget.

ANS.A government budget is a statement showing estimated receipts and
expenditure of the government during a fiscal year
Q 2. What is Revenue receipts.
ANS. Revenue receipts are those receipts which do not either create a liability or
cause a reduction in assets.
Q 3. What is Capital receipts.
ANS. Capital receipts are the receipts which either create a liability or causes a
reduction in assets.
Q 4. What is Revenue expenditure.
ANS. Revenue expenditure is that expenditure which does not cause increase in
assets or decrease in liability.
Q 5. What is Capital expenditure.
ANS. Capital expenditure is an expenditure which causes increase in assets or
reduction in liabilities.
Q 6. What is Revenue budget and capital budget.
ANS. Revenue budget is the statement of estimated revenue receipts and
estimated revenue expenditure during a fiscal year.
Capital budget is the statement of estimated capital receipts and estimated capital
expenditure during a fiscal year
Q 7. What is Tax and non-tax receipts.
ANS. Tax revenue receipts are receipts from all types of direct and indirect taxes,
like income tax, corporation tax, wealth tax, sales tax, excise duty, etc.

Non-tax revenue receipts are receipts from interest, dividend, profit, external grants
etc.
Q 8. What is Fiscal deficit.
ANS. Fiscal deficit is equal to the excess of total expenditure over the sum of
revenue receipts and capital receipts excluding borrowing.
Q 9. What is Revenue deficit.
ANS. Revenue deficit is equal to the excess of total revenue expenditure over the
total revenue receipts.
Q 10. What is Primary deficit.
ANS. Primary deficit is equal to fiscal deficit reduced by interest payments.
Q 11. What is Direct and indirect tax.
ANS. Direct tax is a tax levied on income and wealth and its final burden cannot be
shifted on to others.
Indirect tax is a tax levied on goods and services and its final burden can be shifted
on to others.
Q 12. What is Deficit financing.
ANS. Deficit financing refers to the financing mechanism of the government to
cover the gap between expenditure and receipts
SHORT ANSWER TYPE QUESTIONS Marks (3)
Q.1 What are the objectives of the government budget ?
Ans. The government budget has four objectives:
(1) Redistribution of income &wealth(explain)
(2) Reallocation of resources (explain)
(3) Economic Stability (explain)
(4) Managing public enterprises(explain)
Q.2 Distinguish between Revenue receipts &Capital receipts ?
Ans. (a)Revenue receipts: (1)These are those receipts which do not either create a
liability or cause a reduction in assets.(2) all types of tax revenues & non tax
revenues are the components of this types of receipts
(b) Capital receipts :(1) Capital receipts are the receipts which either create a
liability or causes a reduction in assets.(2) income from agriculture ,industry
&profit of public sector undertakings are this types of receipts

Q.3 Distinguish between Revenue Expenditure &Capital Expenditure ?

Ans. (a)Revenue Expenditure : (1) Revenue expenditure is that expenditure which
does not cause increase in assets or decrease in liability. (2) Expenditure on road
,transport &communication ,administration &defence .
(b) Capital Expenditure: (1) Capital expenditure is an expenditure which causes
increase in assets or reduction in liabilities. (2) Expenditure on productive sectors
like - agriculture ,industry & Expenditure on giving loan to state government .
Q.4 Distinguish between Tax Revenue &Non-Tax Revenue ?
Ans. (a) Tax Revenue: (1) Tax revenue receipts are receipts from all types of direct
and indirect taxes (2) income tax, corporation tax, wealth tax, sales tax, excise duty,
etc.
(b) Non-Tax Revenue: (1) Non-tax revenue receipts are receipts from interest,
dividend, profit, external grants etc. (2) revenue like fees, fines &penalty from
different sources.
Q.5 What are the different types of deficits found out in government budget ?
Ans. Following are the different types of deficits in government budget:
(1) Revenue deficit: Revenue deficit is equal to the excess of total revenue
expenditure over the total revenue receipts.
(2) Fiscal deficit: . Fiscal deficit is equal to the excess of total expenditure over
the sum of revenue receipts and capital receipts excluding borrowing
(3) Primary deficit: Primary deficit is equal to fiscal deficit reduced by interest
payments
Q.6 What are the different types Non-tax revenue of found out in government budget
?
Ans. Following are the different types of Non-tax revenue in government budget:
(1) Fees it refers to charges imposed by government to cover the cost of
recurring services.
(2) Fines &Penalities:They refer to those payments which are imposed on law
brakers.
(3) Escheats: It refers to claim of govt. on the property of a person who dies
without leaving behind any legal heir or a will .
(4) Forfeitures: These are in the form of penalties which are imposed by the
courts for non-compliance of orders or non fulfilment of contracts.
(5) License Fees: It is a payment charged by the govt. to grant permission for
something.
(6) Grants and Gifts: Govt receives gifts and grants from foreign govt, and
international organisations.

Q.7.Distinguish between Direct Tax and Indirect Tax?

Ans- Direct Tax-(1)It refers to taxes that are imposed on property and income of
individuals and companies and are paid diretly by them to govt.

(2)The liability to pay the tax and actual burden of the tax lie on the same person.
(3)Its burden can not be shifted to others.
(4) Eg. Income tax ,Coporation Tax
Indirect Tax (1)It refers to taxes which affect the property and income of
individuals and companies through their consumption expenditure.
(2)They are imposed on goods and services
(3) The liability to pay the tax and actual burden of the tax lie on the
different person.
(4) Its burden can be shifted to others.
(5)Eg:Sales Tax ,Excise Duties,Custom Duties .

SHORT ANSWER TYPE QUESTIONS Marks (4)

(BRIGHT STUDENTS)
Q 1.What is the of Revenue Deficit and what are its implications?
Ans- Revenue deficit: Revenue deficit is equal to the excess of total revenue
expenditure over the total revenue receipts.
Revenue deficit= Revenue Expenditure Revenue Receipts
Implications: (1) It indicates the inability of Govt. to meet its regular and recurring
expenditure in the proposed budget.
(2) It implies that govt is dis- saving
(3) It also implies that the govt. has to make Up this deficit from
capital Receipts
(4)Use of capital Receipts for meeting the extra consumption
expenditure leads to an inflationary situation in the economy.
Q 2.What is the of Fiscal Deficit and what are its implications?
Ans-Fiscal deficit: . Fiscal deficit is equal to the excess of total expenditure over the
sum of revenue receipts and capital receipts excluding borrowing.
Fiscal Deficit= Total Expenditure- Total Receipts Excluding Borrowings
Implications: (1)It creates a vicious circle of fiscal deficit and revenue deficit
,Wherein govt tax more loans to repay the earlier loans.
(2)It increases the money supply in the economy and creates
inflationary pressure
(3)Govt . also borrows from the rest of the world which raises its
dependences on the other countries.
(4)Borrowing increases the financial burden for future generation and
this affects the future growth.
Q 3.What is the of Primary Deficit and what are its implications?
Ans-Primary deficit: Primary deficit is equal to fiscal deficit reduced by interest
payments.
Primary Deficit=Fiscal Deficit- Interest Payments

Implications:(1)It indicates how much of the govt. borrowings are going to meet
expenses other than the interest payment
(2) The differences between the fiscal deficit and primary deficit shows
the amount of interest payment on the borrowings in the past .
(3) So a low or zero primary deficit indicates that interest
commitments have forced the govt to borrow .
Q4. From the budget estimates of Govt of India for the year 2012-13. Calculate
i)Revenue deficit
ii)Fiscal deficit
iii)Primary deficit
S.N
Particulars
Rs in crores
A
Revenue receipts
2037
B
Revenue Expenditure
2811
C
Capital receipts
1348
D
Capital Expenditure
574
E
Recoveries of loan and other receipts
235
F
Borrowings and other liabilities.
1113
G
Interest payments
.1013

Ans:
I)

Revenue deficit = Revenue Expenditure - Revenue receipts

= 2811 2037
= Rs.774 crores.

(II)Fiscal deficit = total Expenditure( Revenue expenditure + Capital

Expenditure)
Revenue Receipts- Non debt capital receipts (Recoveries of loan and other
receipts)
=(2811+574)-2037-235
=3385-2037-235
=Rs 1113Crores.

III)Primary deficit = fiscal deficit- interest payment

= 1113-1013
= Rs 100 crores

GOVERNMENT BUDGET AND ECONOMY

CHAPTER-8 (MACRO ECONOMICS)
TEST PAPER INCLUDING VALUE BASED
QUESTION
QUESTION SETI
Define the following concepts:
1. Government budget.
2. Revenue receipts.
3. Capital receipts.
4. Revenue expenditure.
5. Capital expenditure.

QUESTION SETII (VALUE BASED QUESTION )

Defend or refute the following statements. Write yes or no with reason:
1. Balanced budget is that budget in which revenue receipts = revenue expenditure.
2. Government budget is a statement of all actual receipts and payments of the
government.
3. Expenditure on law and order is a component of development expenditure.
4. Non-plan expenditure contributes to economic growth.

5. Fiscal deficit is zero in case there is no provision for borrowing in the government
budget.
6. Revenue deficit is the excess of capital receipts over and above revenue receipts
of the government.
7. Primary deficit does not include interest payments, while fiscal deficit does.

QUESTION SETIII
Write your comment on each of the following statements in a sentence or two:
1. Borrowing by the government is a measure of revenue deficit.
2. Tax is a capital receipt of the government.
3 Repayment of loan by the government is a capital expenditure.
4. Sales tax is a direct tax.
5. Loans offered by the central government to the state government are to be treated
as capital
expenditure of the central government.
6. Payment of interest is a capital expenditure.

7. Subsidies are not treated as capital expenditure of the government.

9. Grants by the government are treated as revenue expenditure.

QUESTION SETIV
Complete the following sentences:
1. Subsidies are revenue expenditure, because
.
2. Borrowing is not revenue expenditure because
.
3. Other things remaining constant, if tax rates are increased, fiscal deficit is
.
4. Two examples of direct tax are (i)
_, and (ii)
.
5. Two examples of non-tax receipts are (i)
_, and (ii)
.
6. Three components of capital receipts are (i)
, (ii)
and (iii)

7. Two principal components of revenue receipts are (i)

(ii)
.
8. Two examples of non-development expenditure are (i)
(ii)
.
9. Dividends on investment is not a capital receipt because
.
10. Mounting fiscal deficit is bad because

, and
, and

.
HOTS (Higher Order Thinking Skills)
(1.) Write true or false with a reason:
(i) If revenue budget balances, capital budget also balances.
(ii) Government budget is a statement of government receipts and expenditure over
the
past one year.
(iii) Budgetary deficit points to failure of the government to manage its budget.
(iv) Revenue deficit increases when the government fails to recover its loans.
(V) Write a note on the importance of government budget.
(VI) Briefly describe how the government budget stimulates the process of growth.
(2.) Write a note on the importance of government budget.
(3.) Briefly describe how the government budget stimulates the process of
growth.

UNIT -9
Balance of Payments and Foreign
Exchange Rate (7 Marks)
Foreign Exchange Rate: - Foreign Exchange Rate is the price of one currency in
terms of another currency.Or
It is the rate at which units of currency of a country is converted to one unit of currency
of another country.
Foreign Exchange Market: - Foreign Exchange Market is the market where the
currencies of different countries are traded for one another.
Determination of foreign Exchange Rate through demands for and supply of
foreign exchange:-

1) Demand for foreign exchange:- People desire to have foreign exchange for the
following reasons:a) To purchase goods and services from other countries.
b) To purchase financial assets from abroad
c) Payments for unilateral transfers.
d) Speculating on the value of foreign currencies.
2) Supply of foreign exchange: Foreign currencies flow into the domestic
economy due to the following reasons:
a) Payments made to domestic suppliers for the goods they have exported.
b) The amount foreigners invest in the home country.
Unilateral transfers eg: receiving gifts from abroad

Equilibrium in the foreign Exchange Market:

Foreign exchange market like any other market contains a document sloping document
curve and an upward rising supply curve. Price is shown on the vertical axis and the
horizontal axis measures the quantity demanded or supplied. The intersection of the
supply & demand curve determined in equilibrium exchange rate.

Exchange

Rate In Rs.

R1

S
S >D

for 1 unit
of foreign

currences

E
R2D>S

n
D & S of foreign exchange

Types of Exchange Rate:

1) Fixed Exchange Rate System: - Under the gold standard system the value of
currency of each country was expressed in terms of gold and the exchange rate
was fixed according to the gold value of the currencies that have to be
exchanged.
Merits: 1. Elimination of Risk
2. Prevention of speculation
3. Removal of uncertainties
2. Flexible Exchange Rate System :- determined by demand for and supply of
foreign exchange.
Merits: 1. Increase in efficiency by achieving optimum resource allocation.
2. Continuous adjustment
3. Helps in removing barrier to trade and capital movements.
4. No need for central bank to hold international reserves.

BALANCE OF PAYMENT
What is Balance of Payments?
It is a systematic record of all economic transactions between the residents of
a country & rest of the world during a financial year. In other words, it is a summary
record of all international economic transactions of a resident country with the rest of
the world during a given period of time.
Balance of Trade: It refers to the systematic record of visible items in a financial
year. In other words, it is the value of imports and exports of commodities i.e.
merchandise. If the exports exceed imports, the BOT is said to be favourable, and
unfavourable in case of vice versa. Thus, Favourable BOT = Exports receipts >
Import payments.

Difference between BOP & BOT

The term Balance of Payments refers to the account of both visible items & invisible
items while Balance of Trade refers to the record of visible items only. BOT is only
one of the components of BOP while the BOP is a wider concept & therefore offers a
more comprehensive picture of economic transactions of a country with the rest of
the world. Moreover, the BOT may be balanced, deficit or surplus, while BOP as a
whole always remain balanced. BOT is a simple statements related to the foreign
trade of the country while BOP presents a classified record of all receipts on account
of goods exported, services rendered and capital received, and payments made on

account of goods imported, services rendered from, and capital transferred to

abroad.
Items included in BOP account
1. Visible Items include all merchandise imports and exports i.e. the items which
are recorded at the port & made of some material.
2. Invisible Items include receipts & payments for the services viz. shipping,
banking, insurance, travel etc.; receipts and payments of income on foreign
investments; interest on foreign loans & remittances of NRIs etc; govts
current expenditure in abroad viz. expenditure on embassies etc.; transfer
payments & receipts.
3. Capital transfers include the capital receipts & capital expenditure of a
resident country.
Structure of BOP: BOP account is categorized into Current Account & Capital
Account.

BOP on Current Account refers to transactions related to goods, services,

income on investments & unilateral transfers. BOP on current account reveals the
net income of the country generated in abroad. Both visible & invisible items
constitute the current account of BOP. It need not always be in balance. It may show
a surplus or deficit. It represents the difference between payments & receipts of
currently produced & consumed goods & services. A deficit in current account
indicates lowering down the level of income, creating problem of the payments to the
foreigners & have adverse impact on countrys exchange reserves, & may increase
external borrowings. The components of BOP on current account are:

1) Visible trade includes the export and import of the physical goods
2) Invisible items include cost of non-factor services; investment income, &
unilateral transfers.
(i)The non-factor services include transportation, finance, tour & travel
etc. The services rendered by the resident country to the ROW are
recorded on the credit side, while the services rendered by the
foreigners for the resident country are recorded on the debit side.
(ii)Income on investment includes interest payments on foreign loans
& credits, transfer of profits & miscellaneous for patents, royalties
etc. The interest & dividend payments made by the foreigners are
recorded on the credit side, and vice versa.
(iii)Unilateral Payments includes foreign gifts & grants, donations, military
aid, technical assistance etc. These are also referred to as
unrequired transfers. These refer to those receipts or payments
which take place without getting anything in return. These transfers
are further classified into Official & Private transfer payments.
Official unilateral transfers are the foreign donations & aids, while
Private transfers refer to the gifts & donations from foreign residents
to the domestic residents & vice versa. Payments of these transfers
are recorded as debit & receipts are recorded as credit.
Thus, the balance of visible trade, invisible trade & unilateral transfers is recorded as
BOP on current account.

BOP on Capital Account: It refers to the international transactions in financial

assets viz. bonds, equities, loans, bank account etc.; fixed plants & equipments, and
direct investments. It is a record of those transactions which leads to change in
assets or liability of the resident country. In other words, it is record of capital
transactions i.e. the private & the official capital transfers as well as the banking
capital flows. BOP on capital account deals with payments of debts and claims. The
components of BOP on capital account are:

Private Capital Transactions which refer to those transactions which affect assets or
liabilities of the
resident country i.e. the individuals, traders & other non-governmental agencies. It is
further classified into short term & long term capital transactions. Short term capital
includes purchase of short term securities, speculative purchase of foreign
currencies, & cash balance held by foreigners. Long term private capital includes
foreign direct investment (FDI), portfolio investment, long term loans, foreign
currency deposits etc. Foreign direct investment refers to the purchase of assets in
abroad & the power to control them. It includes the acquisition of a firm in the
resident country by a non resident firm; transfer of firms from the parent company
abroad to the subsidiary enterprise in the resident country. It also includes the import
or export of capital goods. Portfolio investment refers to the purchase of an asset
without any control over them. It includes the purchase of shares, govts bonds,
loans to firms or govt. of abroad. The notable feature of this transaction is that export
of capital is a debit item as it causes outflow of foreign exchange & vice versa.

Official Capital Transactions refer to the transactions which affect assets &
liabilities of the govt. It includes loans, repurchase & resale of securities
sold to foreign residents, debt service, gold & foreign exchange reserves,
& miscellaneous receipts & payments.
Banking Capital Transactions includes movement in the external financial
assets and liabilities of
those banks which are authorized to deal in the foreign exchange.
Difference between BOP on current account & capital account: The current account
deals with the receipts & payments for those goods which are currently produced,
while the capital account deals with debts & claims. Secondly, the BOP on current
account has a direct influence on the level of income of a country, while the capital
account influences the volume of assets of the country.

Other items in the BOP: There are certain items which do not form the part of
current & capital account. These items are kept for balancing the BOP. These items
are as follows:
I. Errors & Omissions are the balancing items in the BOP accounts which are
used for correcting the BOP
as it is difficult to keep an accurate record of all the transactions which may be due to
sample of transactions, dishonesty of traders, smuggling etc.

II. Official Reserve Transactions refer to those transactions which are carried out
by the govt. and the
Central bank on behalf of govt. with regard to certain economic policy & their effect
on BOP, & the exchange rates. It includes the Countrys Official Reserve Assets &
Foreign official Assets in the country.
The Official Reserves are held in the form of foreign currency or foreign
securities, gold & Special Drawing Rights (SDR) with the IMF. Reduction in these
reserves implies purchase of foreign exchange which is taken as credit items in the
BOP since it causes inflow of foreign exchange. On the contrary, an increase in
these reserve assets is taken as a debit in the BOP as it causes outflow of foreign
exchange.

The Foreign Official assets in the country are in the form of rupee reserves of
foreign central banks. Increase in these rupee reserves of foreign banks is taken as
a credit item as it causes inflow of foreign exchange in the resident country (India),
while decrease in these reserves is taken as debit as it causes outflow of foreign
exchange.

AUTONOMOUS & ACCOMODATING ITEMS

Items in the BOP account can be also classified into two categories viz.
Autonomous or above the line items and Accommodating or below the line items.
Autonomous items refer to those items which are taken with the motive of
profit maximization. These transactions are not related to the countrys BOP position.
It is, therefore, these items are called as autonomous items. These items are taken
as first items before calculating deficit or surplus in BOP account, therefore these
items are called as above the line items. If the receipts from autonomous items
exceed the payments for autonomous items; the BOP is called to be as surplus, and
vice versa. It implies that the resident country has net claims against the ROW. On
the other hand, if the payments for these items exceed the receipts from these items,
it implies that the ROW has some net claims against the resident country.

Accommodating items refer to those items which are undertaken by the govt.
to keep the BOP balanced. These items are transacted when a country faces
disequilibrium in the BOP. Through these transactions, the govt. or monetary
authorities settle the deficit or surplus in the BOP.

Disequilibrium in the BOP: It refers to such a situation when the BOP of the
country is deficit or surplus. In other words, it is a situation when the net balance of
all receipts & payments is not zero. If the net balance is in (+), it is surplus; while the
negative (-) balance is deficit. In both of the situation, the BOP is in disequilibrium.
Causes for disequilibrium in BOP: Disequilibrium in BOP may be due to the
following reasons:

Economic Factors viz. Cyclical fluctuations, huge public expenditure on development

projects, hike in inflation which induces large imports of essential goods,
development of import substitutes, change in cost structure of the trading partner
countries etc; Demonstration effect which implies the effect of developed countries
on the lifestyle & consumption pattern of the less developed countries which leads to
rise in imports; Political instability which may lead to large scale capital outflow;
Social factors viz. changes in the social structure & norms which may affect the
propensity to consume, comforts & exports; etc.

Measures to correct adverse BOP: Dear money policy, depreciation of the external
value of domestic currency, devaluation of the currency, exchange control
restrictions, tariff & import duties, fixing of import quotas, export promotion
measures, import substitution etc.
Exercise Questions for revision:
Very Short Answer Questions: (1mark questions).
Q1

What is the meaning of foreign exchange rate?

Ans:

Foreign Exchange Rate is the price of one currency in terms of another. It

is the rate at which exports and an import of a nation is valued at a given
point of time.

Q2:

What is a foreign Exchange Market?

Ans

The foreign exchange market is the market where the national currencies
are traded for one another.

Q3:

State any one function of foreign exchange market?

Ans:

1) Transfer Function: To transfer the purchasing power between

countries.
Or
2) Credit Functions: To provide credit channels for foreign trade
Or

Q4:

3) Hedging Function:- To protect against foreign exchange risks.

Give two reasons for the people to acquire foreign exchange.

Ans:

Two reasons for the people to acquire foreign exchange are:

a) To purchase goods and services from the other countries.
b) To purchase financial assets in a particular country.

Q5:

Give two ways through which foreign currencies can flow into
the domestic economy.

Ans

Foreign currencies can flow into the domestic economy due to :

Q6:

1) Foreigners purchasing home countrys goods and service (through

exports)
2) Foreign investment in home country
What is the shape of the demand curve the foreign exchange
market?

Ans:

The demand curve is downward sloping

Q7:

What is the shape of the supply curve of foreign exchange?

Ans:

The supply curve of foreign exchange is upward sloping.

Q8:

What is meant by currency depreciation?

Ans:

When there is an increase in the exchange rate, which means more

rupees are required to buy one US dollar, we say that our currency is
depreciating.

Q9:

What is fixed exchange rate system?

Ans:

Under the fixed exchange rate system the exchange rate is officially
declared and it is fixed. Only a very small deviation from this fixed
value is possible. it is not determined by supply of and demand for
foreign exchange.

Q10:
Ans:

Q11:
Ans:

What is flexible exchange rate system?

In the flexible exchange rate system there is no intervention by the
central bank. The exchange rate is determined by supply of and
demand for foreign exchange.
State four main sources of demand for foreign currency
The four main sources of demand for foreign currency are:1. The purchase goods and services from other countries.
2. To send a gift abroad.
3. To purchase financial assets in a particular country and
4. To speculate on the value of foreign currencies

Q12:

State three main source of supply of foreign currencies into the

domestic economy.

Ans:

1. Foreigners purchasing home countrys goods and services through

exports.
2. Foreign investment in home country through joint ventures or
through financial market operation and
3. Foreign currencies flow into the economy due to currency dealers
and speculators.

Q13:

Describe the equilibrium in the foreign exchange market.

Ans:

Equilibrium in the foreign exchange market in determined in the same

way as the price of a commodity through the forces of supply and
demand. The foreign exchange market, like any other normal market,
contains a downward sloping demand curve and an upward sloping
supply curve. The price on the vertical axis is stated in terms of
domestic currency (i.e how many rupees for one US dollar).The
horizontal axis measures the quantity demanded or supplied. The
intersection of the supply and demand curve determines the
equilibrium foreign exchange rate. This is Shown as:DS

Exchange
Rate(Rs./S)
P
S

A
O

Very Short Answer type Question ( 1 Mark each )

Q1. What is meant by balance of payment?
Ans. The balance of payment of a country is a systematic record of all
economic transactions between the residents of the reporting
country and the residents of foreign countries during a given period
of time
Q2:- What is meant by balance of trade?
Ans. Balance of trade takes into account only those transactions arising
out of the experts and imports of goods(the visible items).It does
not consider the exchange of services.

Q3. Give two examples of invisible items of balance of payments.

Ans. The two examples of invisible items of balance of payments are:1) Services like shipping, insurance banking
2) Expenditure by tourists.
Q4. Name the two accounts of balance of payment.
Ans. 1) Current account
2) Capital account
Q5. What type of activities are recorded in the current account of
balance of payment?
Ans. The current account records imports and exports of goods and
services and unilateral transfers.
Q6. What type of transactions are recorded in the capital account of
balance of payments?
Ans. The capital account records all international transactions that
involve a resident of the domestic country changing his assets with
a foreign resident or his liabilities to a foreign resident.
Q7. What are unilateral transfers or unrequited transfers?
Ans. Unilateral transfer are receipts which residents of a country make
without getting anything in return eg. Gifts etc.
The net balance of visible trade, invisible trade and of unilateral
transfers is the balance on current account.
Q8. Are exports and imports recorded as positive or negative items in
foreign exchange?
Ans. Exports cause an inflow of foreign exchange into the country so
they are entered as positive items. Imports cause an outflow, so they
are entered as a negative item.
Q9. Give an example of private unrequited transfers.
Ans. Gifts that domestic residents receive from or make to foreign residents eg. An
Indian resident working in Dubai sending backmoney to their relative in India.

Q10. Give an example of official unrequited transfers.

Ans. Receipt of or giving of foreign aid from development countries to
developing countries.
Q11. What is meant by Portfolio Investment in the capital account
transactions?
Ans. Portfolio Investment is the acquisition of an asset that does not give
the purchaser control over the asset. For eg. Investment in the
purchase of shares in a foreign company or of bonds issued by a
foreign govt.
Q12. What is meant by Direct Investment in the capital account
transactions?
Ans. Direct investment is the act of purchasing an asset and at the same
time acquiring control of it. For example, acquisition of a firm in
one country by a firm in another country.
Short Answer Questions :-

Q1. Differentiate between balance of payment and balance of trade.

Ans.
Balance of Trade
1. Balance of trade is a record of

Balance of Payments
1. Balance of payments is a record

only visible items i.e. exports

of both visible items (goods) and

and imports of goods.

invisible items (services)

2. Balance of trade is a narrower

2. Balance of payments is a wider

concept as it is only a part of

and more useful concept as it is a

the balance of payments

record of all transactions in

account.

foreign exchange.

3. Balance of trade can be in a

deficit, surplus or balanced

3. Balance of payments must always

balance

Q2. Explain the components of capital account

Ans. It records are international transactions that involve a resident of
the domestic country changing his assets with a foreign resident or
his liabilities to a foreign resident.
Various forms of capital account transactions :1) Private Transactions :- There are transactions that effect the
liabilities and assets of individuals.
2) Official Transactions :- Transactions affecting assets and
liabilities by the govt. and its agencies.
3) Portfolio Investment :- It is the acquisition of an asset that does
not give the purchaser control over the asset.
4) Direct Investment :- It is the act of purchasing an asset and at the
same time acquiring control of it.
The net value of the balance of direct and portfolio investment is
called the balanced on Capital Account.
Q3. Differentiate between autonomous and accommodating items.
Ans.
Autonomous Items
1. Autonomous items refer to international
economic transactions that take place due
to some economic motive such as profit
maximization. These transactions are
independent of the state of the countrys
BOP.

Accommodating Items
1. This refers to transactions that occur
because of other activity in the BOP, such
as government financing.

2. These items are called below the

2. These items are often called above the
line items in the BOP.

line items

Q4. Describe the cause for disequilibrium in the BOP.

Ans. The cause of disequilibrium in the BOP are :1) Economic Factors :- Large scale development expenditure that
may cause large imports
Cyclical fluctuations in general business activity such as recession or
depression.
High domestic prices may result in increase in imports.
New sources of supply, new and better substitutes to existing products
and changes in costs will bring about a change in trade flows and hence
BOP over a period of time.
2) Political Factors :- Political instability can cause large capital
outflows and reduce the inflow of foreign capital.
3) Social Factor :- Changes in tastes, preferences and fashion may
affect imports and exports and hence the balance of trade.

TEST PAPER
SHORT ANSWER TYPE QUESTIONS (1 MARK):
1. Define Balance of Payments.
2. Define the term fixed exchange rate.
3. What are the visible and invisible items?
4. Define the term Balance of trade.
5. What is meant by Hedging function of foreign exchange market?
6. What are the sources of demand for foreign exchange?
7. What are the sources of supply of foreign exchange?
8. Define capital account of balance of payment.
9. Name the items which are not included in the current account of Indias
BOP.
10. Differentiate between depreciation and devaluation.
11. In which account of BOP tourism services to tourist are included?
12. When will balance of trade show a deficit?
13. When will there be surplus in balance of trade account?
14. What are the two main components of balance of payments account?

SHORT ANSWER TYPE QUESTIONS (3/4 MARKS):

1. Explain how Balance of trade is different to Balance of payments on
current account.
2. Explain how the rise in foreign exchange rate affects the demand of
foreign exchange with the help of a diagram?
3. Differentiate between fixed and flexible foreign exchange rate.

4. Explain how the flexible foreign exchange rate is determined with the help
of a diagram.
5. Explain the effect of rise in foreign exchange rate on the supply of foreign
exchange.
6. Explain merits and demerits of fixed exchange rate system.
7. Balance of payment always balances. Discuss it.
8. Should a current account deficit be a cause for concern?
Fill in the blanks:
1. Balance of trade shows difference between
_.
2. Two accounts of BOP are(i)
&
(ii)
.
3. Items of current account of BOP are (i)
4. The two types of investment are(i)
(ii)

(ii)
&

_& (iii)

State whether the following items constitute demand or supply of foreign

exchange:
(i)Indian going to USA for medical treatment.
(ii)Donation of 500 million $ received from Microsoft.
(iii)Import of goods from China.
(iv)Indian students going to Australia for MBA.
(v)Foreign tourists to India to visit Taj Mahal.
(vi)Purchase of land in England.
(vii) Bought 500 pounds to sell for speculation.

Answer:
(i)Demand
(ii)Supply
(iii)Demand
(iv)Demand
(v)Supply
(vi)Demand
(vii) Demand
HIGH ORDER THINKING SKILL QUESTIONS
Q.1 What is foreign exchange?
Ans. It is the amount of currency reserves of all countries other than the domestic
currency .
Q.2 what does a change from Rs. 52 = $ 1 to Rs. 56 = $ 1 indicate?
Ans. Indian rupee depreciates in terms of $.
Q.3 why are autonomous items called above the line items?
Ans. Because autonomous items are recorded in BOP as first items before
calculating surplus or deficit.

Q.4 Is import of machinery recorded in current account or capital account?

Ans. Since import of machinery is VISIBLE item , it is recorded in current account.
SHORT ANSWER TYPE QUESTIONS: - (3 /4 Marks Each)
1. Why foreign currency/exchange is needed?
Ans. i) To purchase of goods and services from other countries.
ii) To send a gift abroad.
iii) To purchase financial assets in a particular country and
iv) To speculate on the value of foreign currencies.
2. What are the factors responsible for inflow of foreign currency?
Ans. i) foreigners purchasing home country goods and services through exports.
ii) Foreigners investment in home country through joint ventures and through
financial market operation.
iii) Foreign currencies flow into the economy due to currency dealers and
speculators
3. When exchange rate of foreign currency falls its supply also falls.
Explain how?
Ans. When exchange rate falls, exports become less profitable hence supply of
foreign currency through exports falls.
4. When exchange rate of foreign currency falls, its demand rises. Explain
how?
Ans. When exchange rate falls, imports become cheaper, demand for imports rises
and so rises the demand of foreign exchange to purchase more imports.
5. What will be the value of imports, if the net imports are Rs 160 crores
and the value of exports are Rs 400 crores.
Ans. Balance of Trade = Exports- Imports
Imports= Exports Balance of trade= 400-(-160)=560
Or Imports= Exports + net imports= 400+160=560 Ans Rs 560 crores
6. If Balance of payment of a country is Rs (-) 100 crores and total payment
are Rs 500 crores. Find out its total receipts.
Ans. Balance of Payment = Total receipts- Total payments
Total receipts= Total Payment +BOP
=500 + (-100)
=500-100=400 Ans Rs 400 crores

7. Find the primary deficit if fiscal deficit is Rs 15,000 crores and interest
payment is Rs 4,000 crores
Ans:- Primary deficit= Fiscal deficit- Interest Payment
=15,000-4,000
= 11,000 Ans. Rs. 11,000 crores
8. Balance of payments always balances. Discuss it.
Ans. Balance of payments is always balanced. A negative balance on the current
account is equated with positive balance in the capital account. The monetary
authorities may finance a deficit by depleting their reserves of foreign currencies or
by borrowing from the IMF etc. Hence BOP is always in balance.