Economics cbse board_solution_2011-12 (1)

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Economics cbse board_solution_2011-12 (1)

  1. 1. Studymate Solutions to CBSE Board Examination 2011-2012 Series : SMA/1 Code No. 58/1/1 Candidates must write the Code onRoll No. the title page of the answer-book.  Code number given on the right hand side of the question paper should be written on the title page of the answer-book by the candidate.  Please check that this question paper contains 8 printed pages.  Please write down the Serial Number of the questions before attempting it.  15 minutes time has been allotted to read this question paper. The question paper will be distributed at 10.15 a.m. From 10.15 a.m. to 10.30 a.m., the student will read the question paper only and will not write any answer on the answer script during this period. ECONOMICS[Time allowed : 3 hours] [Maximum marks : 100]General Instructions:1. All questions are compulsory.2. Marks for questions are indicated against each.3. Questions numbered 1 to 5 and 17-21 are very short-answer questions carrying 1 mark each. They are required to be answered in one sentence each.4. Questions numbered 6 to 10 and 22-26 are short-answer questions carrying 3 marks each. Answer to them should not normally exceed 60 words each.5. Questions numbered 11 to 13 and 27-29 are also short-answer questions carrying 4 marks each. Answer to them should not normally exceed 70 words each.6. Questions numbered 14 to 16 and 30-32 are long-answer questions carrying 6 marks each. Answer to them should not normally exceed 100 words each.7. Answer should be brief and to the point and the above word limit be adhered to as far as possible. -(1)-
  2. 2. STUDYmate SECTION-A1. Give meaning of an Economy?Ans. An economy is a system which provides people with the means to work, and earn a living. In the words of A.J. Brown, “An economy is a system by which people get a living and satisfy their wants”.2. What is Market Demand?Ans. Market Demand is the demand of all the individuals taken together in a market at a given price during the given period of time.3. What is the behaviour of average fixed cost as output increases? TFCAns. Average fixed cost declines as output increases. Since AFC  and TFC constant Q with increase in output therefore AFC declines.4. What is the behaviour of average revenue in a market in which a firm can sell more only by lowering the price?Ans. Average revenue falls in a market in which a firm can sell more only by lowering the price i.e. under imperfect competition.5. What is a price taker firm?Ans. A perfectly competitive firm is a price taker firm which takes the price from the market that is determined by forces of demand and supply.6. What is opportunity cost? Explain with the help of a numerical example.Ans. Opportunity cost is defined as the cost of next best alternative opportunity foregone. The opportunity cost of any commodity is the amount of other good which has been given up in order to produce that commodity. Eg : If a person is working in a bank and gets 2 job offers. 1 as a bank executive @ ` 30,000 and other as journalist @ ` 35,000. In this case the opportunity cost of being a journalist is ` 30,000.7. Given price of a good, how does a consumer decide as to how much of that good to buy?Ans. Given price of a good, a consumer decides on the basis of the following conditions. MUx 1. MU = price, i.e., MU  Px m 2. Total gain falls as more is purchased after equilibrium. If MU x (money) > Px, consumer keeps on consuming more units. When he consumes more unit, the additional utility derived from consuming x keeps on falling. He keeps on consuming till MUx (money) = Px. -(2)-
  3. 3. STUDYmate If MUx (money) < Px, he will decrease the consumption of x. When he decreases the consumption of x, the marginal utility of x will increase. He will keep on decreasing consumption of x till MUx(money) = Px. Thus, MUx(money) = Px is the condition for consumer’s equilibrium in a simple commodity case.8. Draw Average Variable Cost, Average Total Cost and Marginal Cost Curves in a single diagram.Ans. ATC MC AVC Cost (Rs.) M2 M1 O X Units of Output9. An individual is both the owner and the manager of a shop taken on rent. Identify implicit cost and explicit cost from this information. Explain.Ans. (i) Explicit cost refers to the actual payment made to outsiders for hiring services of the factors of production. These include wages paid to the employees, rent paid for hired premises, cost of raw materials, interest on loans etc. (ii) Implicit cost: Implicit cost refers to the cost of self supplied factors. For example interest on self invested capital, rent of own land, salary for the services of entrepreneur, etc. In the above example rent is an explicit cost as it is paid by the owner of the shop. Imputed value of salary he could have earned as a manager working in some other organisation is the Implicit cost.10. Explain the implication of large number of buyers in a perfectly competitive market. OR Explain why are firms mutually interdependent in an oligopoly market.Ans. A Large Number of Buyers and Sellers: (a) There are so many buyers and sellers that no individual buyer or seller can not influence the price of the commodity in the market. (b) Any change in the output supplied by a single firm will not affect the total output of the industry. (c) To an individual producer the price of the commodity is given. He can sell whatever output he produces at the given price, i.e., an individual seller is a price-taker. -(3)-
  4. 4. STUDYmate Market Firm D S P d = p = AR = MR P Price Price S D O X Output O Output (d) Implication: The perfectly competitive firm is then a ‘price-taker’ and can sell any amount of the commodity at the established price. OR Interdependence: (a) The most important characteristic feature of oligopoly is interdependence among its firms. The number of sellers is small in this market and each of these firms contributes a significant portion of the total sale. (b) As a result when any one of them undertakes any measure to promote its sale, it directly affects other firms and they also immediately react. (c) Hence every firm decides its policy after taking into consideration the possible reactions of its rival firms. (d) Thus, every firm is affected by the activities of other firms and it affects others also. This is the interdependence of firms.11. Define an indifference curve. Explain why an indifference curve is downward sloping from left to right.Ans. Indifference curve refers to the graphical representation of various alternative combinations of the goods, which provide same level of satisfaction to the consumer. Indifference Schedule Combinations Good X Good Y Marginal Rate of Substitution A 1 8 - B 2 4 4Y : 1X C 3 2 2Y : 1X D 4 1 1Y : 1X The consumer is indifferent between the combinations A, B, C, D. Therefore joining these points on the curve, we get an indifference curve. good Y 8 A 7 6 5 4 B 3 2 C 1 D IC good X 1 2 3 4 -(4)-
  5. 5. STUDYmate The indifference curve slopes down wards from left to right i.e. It is negatively sloped. This is because when consumer increases consumption of X, he must reduce consumption of Y to keep the utility level unchanged. [IC doesn’t touch either axis because the assumption of IC curve is that he consumes both the goods].12. When price of a good is ` 7 per unit a consumer buys 12 units. When price falls to ` 6 per unit he spends ` 72 on the good. Calculate price elasticity of demand by using percentage method. Comment on the likely shape of demand curve based on this measure of elasticity.Ans. Q P TE 12 `7 12 `6 72 Working Notes P × Q = TE 6 × Q = 72 72 Q  12 6 q p ed = ( )  p q 0 7 =   1 12 =0 OR 0Ans. Percentage change in quantity =  100 12 1 Percentage change in price =  100 7 0 ed = =0 14.28 The likely shape of demand curve is perfectly inelastic. It is || to y axis.13. What does the Law of Variable Proportions show? State the behaviour of total product according to this law. OR Explain how changes in prices of other products influence the supply of a given product.Ans. The law of variable proportion show the impact on output when units of variable factor are increased, keeping fixed factors constant in the short run. The law states, ‘if more and more units of a variable factor are employed with fixed factors, total physical product (TPP) increases at an increasing rate in the beginning, then increases at a diminishing rate and finally starts falling. -(5)-
  6. 6. STUDYmate Three phases of production Land No. of TPP APP MPP (Acre) labourers (quintal) (quintal) (quintal) 1 0 0 0 – 1 1 2 2 2  Phase I 1 2 6 3 4 1 3 12 4  6 1 4 16 4 4 1 5 18 36 2 Phase II  1 6 18 3  0 1 7 14 2 –4  Phase III 1 8 8 1 –6   Phase I : Stage of increasing returns TPP increases at an increasing rate. Y N M TPP TPP O X Q1 Q2 Unit of variable factor Phase I Phase II MPP R X O Q1 Q2 MPP Unit of variable factor MPP keeps rising between O to Q1 level of output and reaches its maximum where this stage ends. Phase II : Stage of Diminishing returns TPP increases at a diminishing rate till it reaches its maximum point (N). MPP is falling but remains positive. Phase III : Stage of negative returns TPP starts declining. As a result TPP curve starts sloping downward as depicted in figure. So phase III is called the phase of negative returns. MPP becomes negative (–) and its curve goes below x-axis. OR -(6)-
  7. 7. STUDYmateAns. Prices of Other Goods: (a) As resources have alternative uses, the quantity supplied of a commodity depends not only on its price, but also on the prices of other commodities. (b) Increase in the prices of other goods makes them more profitable in comparison to the given commodity. (c) As a result, the firm shifts its limited resources from production of the given commodity to production of other goods. For example, increase in the price of wheat (other good) will induce the farmer to use land for cultivation of wheat in place of rice (given commodity). (d) Decrease in price of other good will shift the supply curve to the right. Y Y S1 S S S1 Price (in Rs.) Price (in Rs.) Supply curve shifts Supply curve shifts towards left due to towards right due to P increase in prices P decrease in prices of other goods of other goods S1 S S S1 X X O Q1 Q O Q Q1 Supply (in units) Supply (in units) Increase in the Prices of other Goods Decrease in the Prices of other Goods14. Explain how do the following influence demand for a good: (i) Rise in income of the consumer. (ii) Fall in prices of the related goods.Ans. (i) These are two types of goods based on how demand changes due to change in income of the consumer (i) Normal goods (ii) Inferior goods Normal Goods: Normal goods are those goods the demand for which increases with increase in income of the consumer. In case of normal goods, income effect is positive. With increase in income of the consumer demand curve of normal goods will shift rightward from D1 to D2. Increase in income of the consumer D1 D2 K1 K2 Price P1 D1 D2 0 T1 T2 Quantity Demanded Inferior Goods: Inferior goods are those goods the demand for which decreases as income of the consumer rises. Thus, in case of inferior goods, income effect is negative. -(7)-
  8. 8. STUDYmate Example: When income of the consumer increases, demand of coloured TV increases while that of black and white TV decreases therefore colored TV is a normal good while black and white TV is an inferior good. The demand curve (figure 1) for inferior goods will shift leftward with increase in income from D1 to D2. D2 D1 K2 K1 Price P1 D2 D1 0 T2 T1 Quantity Demanded (i) There are two types of related goods (a) Substitute goods (b) Complimentary good (ii) (a) Fall in price of the substitute goods (Tea & Coffee) : - If price of coffee decreases, consumer will tend to substitute some coffee in place of tea or he will demand less tea even when its price is constant. Figure below illustrate this situation. Initially the consumer was buying OT1 of tea (=P1K1), now he is buying OT2 (=P1K2) of tea even when price of tea is constant (=OP1). This is a situation of leftward shift in demand curve. D2 D1 K2 K1 Price P1 D2 D1 0 T2 T1 Quantity Demanded (b) Fall in prices of complementary good (Car and Petrol) :If price of petrol decreases, people will have the tendency to buy more cars, even when price of car is constant. This is a situation of increase in demand or rightward shift in demand curve. Initially P1K1 (=OT1) cars were purchased. As price of petrol decreases, P1K2 car are purchased even when price of car is constant. Accordingly, demand curve shifts rightward from D1 to D2 D1 D2 K1 K2 Price P1 D1 D2 0 T1 T2 Quantity Demanded -(8)-
  9. 9. STUDYmate15. Explain the conditions of a producer’s equilibrium in terms of marginal cost and marginal revenue. Use diagram.Ans. According to this approach, the producer is at equilibrium when the marginal revenue (MR) is equal to the marginal cost (MC) and marginal cost curve cuts the marginal revenue curve form below. Thus the two conditions are 1. MC = MR 2. MC curve should cut the MR curve from below MR is the addition to total revenue from the sale of one more unit of output and MC is the addition to total cost for increasing the production by one unit. the basic aim of every producer is to maximize the profit. For this, a firm compares its MR with its MC. As long as the addition to revenue is greater than the addition to cost, it is profitable for a firm to continue producing more units of output. Y Revenue and Cost MC R K (in Rs.) P AR = MR Producer’s equilibrium O X Q1 Q Output (in units) In the diagram, output is shown on the X-axis and revenue and costs on the Y-axis. The marginal cost (MC curve is U-shaped and P = MR = AR. MC = MR at two points R and K in the diagram but profits are maximised at point K, correspoidning to OQ level of output. Between OQ1 and OQ levels of output, MR exceeds MC, therefore firm will not stop at point R but will continue to produce to take advantage of additional profit. Thus, equilibrium will be at point K. where both the conditions are satisfied. Two other situations may exist (a) MR > MC. At output level less than OQ, MR > MC, this implies that the firm is earning profit on the last unit of output. The marginal profit provides an incentive to the firm to increase production and move towards OQ units of output. Therefore when MR > MC, the firm increases output to maximise its profit. (b) MR < MC At output level more than OQ, MR < MC. This implies that the firm is making a loss on its last unit of output. Hence, in order to maximise profit, a rational producer decreases output as long as MC > MR. Thus the firm moves towards producing OQ units of output.16. Market for a good is in equilibrium. There is simultaneous “increase” both in demand and supply of the good. Explain its effect on market price. OR Market for a good is in equilibrium. There is simultaneous “demand” both in demand and supply of the good. Explain its effect of market price. -(9)-
  10. 10. STUDYmateAns. Initially, the equilibrium is determined at E0 where the demand curve D0D0 and the supply curve S0S0 intersect each other. OQ0 is the equilibrium quantity and OP0 is the equilibrium price. The effect of increase in both demand and supply on equilibrium price and equilibrium quantity can be better understood under three different cases: Case 1: Increase in Demand = Increase in Supply (a) In the figure, increase in demand is proportionately equal to the increase in supply. So, the (rightward) shift in demand curve from D 0D 0 to D 1D 1 is proportionately equal to the (rightward) shift in supply curve from S0S0 to S1S1. (b) The new equilibrium is determined at E1. As both demand and supply increase in the same proportion, equilibrium price remains the same at OP0, but equilibrium quantity rises from OQ0 to OQ1. Increase in Demand = Increase in Supply Y S0 D1 D0 S1 Price (in Rs.) E0 P E1 D1 S0 D0 S1 O X Q0 Q1 Quantity demanded & supplied (in units) Case 2: Increase in Demand>Increase in Supply (a) From figure, it is clear that increase in demand is proportionately more than the increase in supply. Hence, the (rightward) shift in demand curve from D0D0 to D1D1 is proportionately more than the (rightward) shift in supply curve from S0S0 to S1S1. (b) The new equilibrium is determined at E 1. As the increase in demand is proportionately more than the increase in supply, equilibrium price rises from OP0 to OP1 and equilibrium quantity rises from OQ0 to OQ1. Increase in Demand > Increase in Supply Y S0 D1 S1 D0 Price (in Rs.) P1 E1 P E0 D1 S0 D0 S1 O X Q0 Q1 Quantity demanded & supplied (in units) -(10)-
  11. 11. STUDYmate Case 3: Increase in Demand < Increase in Supply (a) In the figure, increase in demand is proportionately less than the increase in su ppl Th eref y. ore, th e ( gh tw ard) sh i t i dem an d cu rve f ri f n rom D 0D0 to D1D1 is proportionately less than the (rightward) shift in supply curve from S0S0 to S1S1. Increase in Demand < Increase in Supply Y D0 D1 S0 S1 Price (in Rs.) P0 E0 P1 E1 S0 D0 D1 S1 O X Q0 Q1 Quantity demanded and supplied (in units) (b) The new equilibrium is determined at E 1. As the increase in demand is proportionately less than the increase in supply, equilibrium price falls from OP0 to OP1 whereas, equilibrium quantity rises from OQ0 to OQ1. Conclusion: (i) Equilibrium price may remain same, may increase or may decrease. (ii) Equilibrium quantity always falls. ORAns. Initially, the equilibrium is determined at E0, where the demand curve D0D0 and the supply curve S0S0 intersect each other. OQ0 is the equilibrium quantity and OP0 is the equilibrium price. The effect of decrease in both demand and supply on equilibrium price and equilibrium quantity can be better analysed under three different cases: Decrease in Demand = Decrease in Supply Y D1 D0 S1 S0 Price (in Rs.) E1 P0 E0 S1 S0 D1 D0 O X Q1 Q0 Quantity demanded and supplied (in units) -(11)-
  12. 12. STUDYmate Case 1: Decrease in Demand = Decrease in Supply (a) In diagram, decrease in demand is proportionately equal to the decrease in supply. So, the (leftward) shift in demand curve from D0D0 to D1D1 is proportionately equal to the (leftward) shift in supply curve from S0S0 to S1S1. (b) The new equilibrium is determined at E1. As demand and supply decrease in the same proportion, equilibrium price remains the same at OP0, but equilibrium quantity falls from OQ0 to OQ1. Case 2: Decrease in Demand > Decrease in Supply (a) In figure that decrease in demand is proportionately more than the decrease in supply. The (leftward) shift in demand curve from D0D0 to D1D1 is proportionately more than the (leftward) shift in supply curve from S0S0 to S1S1. (b) The new equilibrium is determined at E 1. As the decrease in demand is proportionately more than the decrease in supply, equilibrium price falls from OP0 to OP1 and equilibrium quantity falls from OQ0 to OQ1. Decrease in Demand > Decrease in Supply Y D0 S1 S0 D1 Price (in Rs.) P0 E0 E1 P1 D0 S1 S 0 D1 O X Q1 Q0 Quantity demanded & supplied (in units) Case 3: Decrease in Demand < Decrease in Supply (a) In a diagram decrease in demand is proportionately less than the decrease in supply. So, the (leftward) shift in demand curve from D 0D 0 to D 1D 1 is proportionately less than the (leftward) shift in supply curve from S0S0 to S1S1. (b) The new equilibrium is determined at E 1. As the decrease in demand as proportionately less than the decrease in supply, equilibrium price rises from OP0 to OP1 whereas, equilibrium quantity falls from OQ0 to OQ1. Decrease in Demand < Decrease in Supply Y S1 D D0 S0 1 Price (in Rs.) P0 E0 E1 P1 S1 D0 D1 S0 O X Q1 Q0 Quantity demanded & supplied (in units) -(12)-
  13. 13. STUDYmate Conclusion: (i) With simultaneous decrease in demand and supply equilibrium price may remain same, may decrease or may increase. (ii) Equilibrium quantity always falls. SECTION-B17. Define stock variable.Ans. Stock variable refers to that variable, which is measured at a particular point of time. Stock variables are not measured over a period of time.18. Define capital goods.Ans. Capital goods are those final goods which help in production of other good and services. Capital goods are used in future for productive purposes and have expected life time of several years.19. What are demand deposits.Ans. Demand deposits refers to those deposits which are repayable by the banks on demand. They are chequeable deposits. Demand deposits do not carry any interest.20. Define a Tax.Ans. Tax is a compulsory payment imposed by the government on people and companies to meet its expenditures.21. Give meaning of managed floating exchange rate.Ans. Managed floating rate system refers to a system in which foreign exchange rate is determined by market force and central bank is a key participant to stabilize the currency in case of extreme appreciation or depreciation.22. Calculate Gross Value Added at Factor Cost (i) Units of output sold (units) 1,000 (ii) Price per unit of output (`) 30 (iii) Depreciation (`) 1,000 (iv) Intermediate cost (`) 12,000 (v) Closing stock (`) 3,000 (vi) Opening stock (`) 2,000 (vii) Excise (`) 2,500 (viii) Sales tax (`) 3,500Ans. GVOmp = Sales +  stock = 1000 × 30 + (3000 – 2000) = 30000 + 1000 = 31000 (`) -(13)-
  14. 14. STUDYmate Intermediate cost = ` 12000  GVAfc = GVOmp – Intermediate cost – Net Indirect Taxes = 31000 – 12000 – (3500 + 2500) = 19000 – 6000 = 13000 (`)23. Explain the significance of the ‘Store of Value’ function of money.Ans. M on ey as a store of val e u (i) Money as a store of value helps people to transfer their purchasing power from present to future. Money is a way to store wealth. (ii) They do this as they know that money will be acceptable at any time in future for buying any commodity which they desire. Also money provides security to individuals to meet contingencies, unpredictable emergencies and to pay future debts. (iii) Under Barter system, it was difficult to use goods as a store of wealth due to perishable nature of some goods and high cost of storage.24. Outline the steps taken in deriving saving curve from the consumption curve. Use diagram.Ans. We know that income (Y) is the sum total of consumption (C) and savings (S) as income is either consumed or saved. It means, consumption and saving curves are complementary curves. Consumption Curve (i) We can derive saving curve from the Y consumption curve. Let us understand this with Consumption (` Crores) Y the help of diagram. As seen in the diagram, CC C=Y is the consumption curve and the 45° line (OY) (Break-Even Point) represents income. Consumption, at zero level (Zero saving) C of income, is equal to OC (autonomous consumption. The amount of saving is indicated E c by vertical distance between consumption curve 45° and income line. So savings, at zero level of O X Income (` Crores) income, will be OS (= – OC). It means, the saving Y curve will start from point S on the negative Y- Saving Curve axis. Saving (` Crores) (ii) CC intersects OY at point E (Break-even point) where savings are zero. It means, saving curve will intersect the X-axis (point K) at the income S=0 (Break-Even Point) S level where the consumption curve and 45° line intersect each other. O X (iii) Beyond point E (Break even point) consumption K is less than income therefore savings are positive S Income (` Crores) is saving curve is above the x-axis. As income measures, saving also increases. -(14)-
  15. 15. STUDYmate25. Find national income from the following Autonomous consumption = ` 100 Marginal propensity to consume = 0.80 Investment = ` 50Ans. c = ` 100 MPC(b) = 0.80 I = ` 50 At equilibrium, National Income (Y) = C + I = c + bY + I = 100 + 0.8Y + 50 0.2 Y = 150 1500 Y = = 750 (`) 0.2  National Income = ` 75026. Distinguish between Revenue Expenditure and Capital Expenditure in a government budget. Give examples. OR Explain the role of Government budget in allocation of resources.Ans. Comparison between Revenue Expenditure & Capital Expenditure Revenue Expenditure Capital Expenditure Revenue expenditure neither creates Capital expenditure either creates an any asset nor reduces any liability asset or reduces a liability. Revenue expenditure is incurred on Capital expenditure is incurred for the normal functioning of acquisition of assets, granting of loans government departments and on the and advances and repayment of provisions for various services borrowings. Revenue expenditure is recurring in However, capital expenditure is non- nature i.e. an expenditure is made recurring in nature. by the government on its day-to-day activities. Some examples of revenue Examples of capital expenditures (i) expenditures are: Payment of Loan to states and Union territories; salaries, pensions, interests, (ii) expenditure on building roads, expenditure on administrative flyovers, factories, purchase of services, defence services, health machinery etc; (iii) repayment of services, grants to state, education borrowings. etc. OR Reallocation of Resources: The role of government budget in allocation of resources. (a) The government aims to reallocate resources according to economic and social priorities through its budgetary policy. (b) Government encourages the production of certain commodities by giving -(15)-
  16. 16. STUDYmate subsidies or tax reliefs. For e.g. government encourages the use of’ khadi products’ by providing subsidies. (c) Government can discourage the production of harmful goods like liquor or cigarettes, by imposing heavy excise duties or taxes.27. Giving reason explain how should the following be treated in estimating national income. (i) Expenditure of fertilizers by a farmer. (ii) Purchase of tractor by a farmer.Ans. (i) Expenditure of fertilizers by a farmer is not a part of National Income because it is intermediate consumption. (ii) Purchase of tractor by a farmer is included in National Income because it is gross domestic capital formation.28. Explain the components of Legal Reserve Ratio OR Explain ‘bankers’ bank, function of Central bank.Ans. Legal Reserve Requirements (Increase in CRR and SLR): It refers to the minimum percentage of total deposits (time and demand deposits) required to be kept by the commercial banks with themselves and with the central bank. It is a very quick and direct method for controlling the credit creation power of commercial banks. Legal reserve has two components: (i) Cash Reserve Ratio (CRR): It refers to the minimum precentage of total deposits required to be kept by commercial banks with the central bank. To curb excess demand, the central bank increases this ratio and, therefore, cash reserve of commercial banks get reduced. This forces the commercial banks to contract credit. (ii) Statutory Liquidity Ratio (SLR): It refers to the minimum percentage of total deposits which the commercial banks are required to maintain with them. To reduce the flow of cerdit in the economy, central bank increases this ratio and, thereby, reduces credit availability. OR Banker’s Bank and Supervisor (i) Custodian of Cash Reserves: The central bank is a reservoir of the cash reserves of commercial banks. Commercial banks maintain a certain proportion (Cash Reserve Ratio, i.e. CRR) of their demand and time deposits with the central bank as reserve. (ii) Lender of the Last Resort: When commercial banks fail to meet their financial requirements from other sources, they can approach the central bank which gives loans and advances as lender of the last resort. The rate, at which the central bank advances loans to commercial banks, is known as bank rate. Central bank assists these banks through discounting of approved securities and bills of exchange. The direct lending to commercial banks by central bank is referred to as the ‘lender of the last resort’ function of a central bank. (iii) Supervisor: A central bank supervises the functioning of commercial banks. It makes rules regarding licensing, management, branch expansion, liquidation, etc. It also undertakes periodic inspection of banks. -(16)-
  17. 17. STUDYmate29. Explain ‘revenue deficit’ in a Government budget? What does it indicate?Ans. Revenue deficit: It refers to the excess of total revenue expenditure of the government over its total revenue receipts. Revenue deficit = Revenue expenditures – Revenue receipts Implication (i) It signifies that the government’s current expenses are greater than current income. The bulk of these expenses is interest payment, wages for government employees and defence personnel. (ii) Government makes up this deficit from capital receipts i.e., through borrowings or disinvestment. It means, revenue deficit either leads to an increase in liability (in the form of borrowings) or reduces the assets (through disinvestment). (ii) Use of capital receipts for meeting the extra consumption expenditure leads to an inflationary situation in the economy. Higher borrowings increase the future burden in term of loan amount and interest payments.30. Find out (a) National income and (b) net national disposable income (` crore) (i) Factor income from abroad 15 (ii) Private final consumption expenditure 600 (iii) Consumption of fixed capital 50 (iv) Government final consumption expenditure 200 (v) Net current transfers to abroad (–) 5 (vi) Net domestic fixed capital formation 110 (vii) Net factor income to abroad 10 (viii) net imports (–) 20 (ix) Net indirect tax (x) Change in stocks (–) 10Ans. (a) NDPMP = (ii) + (iv) + (vi) + (x) – (viii) = 600 + 200 + 110 + (–10) – (–20) crores = 920 crores NNPFC (NI) = NDPMP + NFIA – Net Indirect Taxes = 920 + (–10) – 70 = 840 crores (b) Net National Disposable Income = NDPMP + NFIA – Net Current transfers to abroad = 920 + (–10) – (–5) crores = 915 crores31. Explain the concept of ‘excess demand’ in macroeconomics. Also explain the role of ‘open market operation’ in correcting it. OR Explain the concept of ‘deficient demand’ in macroeconomics. Also explain the role of Bank Rate in correcting it. -(17)-
  18. 18. STUDYmateAns. Excess Demand: Excess demand refers to a situation where the current aggregate demand is greater than the aggregate demand that is required to achieve full employment of resources. Excess demand gives rise to the inflationary gap. Y E ADc Aggregate demand A ADf F Inflationary gap 45° O Yf Y Income (i) In the figure, the economy achieves full employment level of income at OYf. (ii) Given the current aggregate demand curve of ADc, this implies that the current level of aggregate demand (corresponding to full employment income) is AYf. (iii) Here, aggregate demand AY f is more than the output produced FY f. When aggregate demand is more than output, it leads to a reduction in the levels of planned inventory stock with producers. This motivates producers to produce more output to reach the desired levels of stock, in turn increasing output, income and the associated levels of employment. (iv) The economy, therefore, achieves equilibrium at point E with the equilibrium level of income being OY. However, this level of real income is not possible in the case of excess demand. (v) Since resources are fully employed, production levels at point E are the same as those at point F, i.e., OYf level. Hence, there is only an increase in the nominal value of income in the economy, with no increase in the real output. Open Market Operations (Sale of securities): Open market operation refers to sale and purchase of securities (mainly government securities) in the open market by the central bank. It directly influences the level of money supply in the economy. When there is an inflationary situation, the central bank offers securities for sale. It, not only withdraws a part of money supply, but also reduces the capacity of commercial banks to create credit. OR Deficient Demand: Deficient demand refers to a situation where the current aggregate demand falls short of the aggregate demand that is required to achieve full employment of resources. Deficient demand leads to an equilibrium level of income that is less than full employment level of income. Deficient demand gives rise to the deflationary gap. Deflationary Gap measures the extent to which the current aggregate demand falls short of the aggregate demand that is required to achieve a full employment of resources. (i) In the figure, the economy achieves full employment level of income at OYf. (ii) Given the current aggregate demand curve ADc, this implies that the current level of aggregate demand (corresponding to full employment income) is AYf. (iii) This aggregate demand AYf is less than output FYf. In a situation when aggregate demand is less than output, it leads to a build-up of unplanned inventory stock with producers. (iv) This leads to deflationary pressures in the economy as producers reduce stock -(18)-
  19. 19. STUDYmate to desired levels. As a result there is a reduction in output, income and the associated employment levels. Aggregate demand (v) The economy, therefore, achieves Y equilibrium at point E with the ADf F equilibrium level of income being OY ADc and not OYf. The equilibrium level of A E Deflationary gap income OY is termed as under employment equilibrium. 45° O Y Yf Income Bank Rate (Decrease in Bank rate): Bank rate refers to the rate at which the central bank lends money to commercial banks as the lender of last resort. In order to expand credit to meet the deficient demand, the central bank should follow a ‘cheap money policy’. For this purpose, it reduces the bank rate. It leads to fall in the market rate of interest which induces people to borrow more funds. It ultimately leads to increase in the aggregate demand.32. Explain the distinction between autonomous and accommodating transactions in balance of payments. Also explain the concept of balance of payments ‘deficit’ in this context.Ans. Non Autonomous/ Autonomous Accommodating items Autonomous items refer to those Accommodating items refer to the international economic transactions transactions that are undertaken in which take place due to some order to maintain the ‘balance’ in the economic motive (such as profit BOP account. maximisation). Such transactions are independent These are compensating capital of the state of BOP account. For transactions which are meant to correct example, if an MNC is making the disequilibrium in autonomous items investment in India with the aim of of balance of payments. earning profit, then such a transaction is independent of the country’s BOP situation. These items are also known as ‘above These items are also known as ‘below the line items’ the line items’ For example, if there is a current account deficit in the BOP, then this deficit is settled by capital inflow from abroad. Autonomous transactions take place Generally, the sources used to meet a on both, current and capital, deficit in the BOP are accommodating accounts. On the current account items (i) Foreign exchange reserves; merchandise export and imports of (ii) Borrowings from IMF or foreign goods are autonomous transactions. monetary authorities. On the capital account, receipts and repayments of long-term loans by private individuals are autonomous transactions. -(19)-
  20. 20. STUDYmate Meaning of Balance of Payment Deficit: A deficit in the BOP occurs when during the year the autonomous inflow of foreign exchange falls short of autonomous outflow. i.e. Autonomous payments > Autonomous receipts Suppose the autonomous inflow of foreign exchange during the year is $1000, while the total outflow is $1100. It means that there is a deficit of $100. To meet the shortfall, one option before the country is to borrow from abroad. ×·×·×·×·× -(20)-
  21. 21. STUDYmate Studymate Solutions to CBSE Board Examination 2011-2012 Series : SMA/1 Code No. 58/1/2 UNCOMMON QUESTIONS ONLY SECTION-A6. What is ‘Marginal Rate of Transformation’? Explain with the help of an example.Ans. Marginal Rate of Transformation of a particular good along PPC is the amount of a particular good which is sacrificed to increase the production of the other good by 1 unit. It is also called MOC (Marginal Opportunity Cost). Production Amount of Amount of MRT possibilities (X) Butter (Y) Guns (Thousand kgs) (Thousands) A 0 21 – B 1 20 1:1 C 2 18 2:1 D 3 15 3:1 E 4 11 4:1 F 5 6 5:1 G 6 0 6:1 Units of one good sacrified G Y MRT  More units of other good produced  B  X9. A producer borrows money and opens a shop. The shop premises is owned by him. Identify the implicit and explicit cost from this information. Explain.Ans. (i) Explicit cost refers to the actual payment made to outsiders for hiring services of the factors of production. (ii) Implicit cost: Implicit cost refers to the cost of self supplied factors. Interest paid on borrowed money will be explicit cost where as the imputed rent of the shop premises is implicit cost.11. Define Marginal Rate of Substitution. Explain why is an indifference curve convex?Ans. It is the rate at which the consumer is willing to sacrifice one good to obtain one more unit of the other good. Quantity of the good sacrificed  MRSxy = Quantity of the good obtained Y = X Indifference curve is convex as MRSxy keeps on decreasing due to law of diminishing marginal utility. As a consumer consumes more of X, the additional utility derived -(21)-
  22. 22. STUDYmate from every successive unit keeps on declining. Indifference Schedule Combinations Good X Good Y Marginal Rate of Substitution A 1 8 - B 2 4 4Y : 1X C 3 2 2Y : 1X D 4 1 1Y : 1X  He is willing to sacrifice less units of Y to obtain additional units of X as shown in the schedule [Initially he is willing to sacrifice 4 units of X, then 2 units and soon]12. A consumer buys 10 units of a good at a price of ` 9 per unit. At price of ` 10 per unit he buys 9 units. What is price elasticity of demand? Use expenditure approach. Comment on the likely shape of demand curve on the basis of this measure of elasticity.Ans. P Qty Expenditure 9 10 90 10 9 90 As per the expenditure approach, when, with a change in price (rise or fall) the total expenditure remains unchanged, demand is unitary elastic. (Here ed = 1) Since, in the above example, with the change in price, there is no change in total expenditure, so ed = 1. The shape of demand curve, i.e., will be rectangular hyperbola. SECTION-B22. Calculate Net Value Added at Factor Cost: (i) Consumption of fixed capital (`) 600 (ii) Import duty (`) 400 (iii) Output sold (units) 2,000 (iv) Price per unit of output (`) 10 (v) Net change in stocks (`) (–) 50 (vi) Intermediate cost (`) 10,000 (vii) Subsidy (`) 500Ans. NVAFC Sales = qt × mp GVOMP = Sales + Net Change in stock = 2,000 × 10 = 20,000 – 50 = 20,000 = 19,950 GVAmp = GVOmp – Intermediate consumption = 19,950 – 10,000 = 9,950 NVAFC = GVAmp – Consumption of fixed capital – Net indirect tax = 9,950 – 600 – (400 – 500) -(22)-
  23. 23. STUDYmate = 9950 – 500 = ` 9,45025. Find ‘investment’ from the following National income = ` 500 Autonomous Consumption = ` 100 Marginal propensity to consume = 0.75Ans. y = 500 c = 100 MPC = 0.75 C = c  by = 100 + 0.75 × 500 = 100 + 375 = 475 At equilibrium Y = C + I  I=Y–C I = National Income – Consumption = 500 – 475 = ` 2527. Giving reason explain how should the following be treated in estimating national income. (i) Payment of bonus by a firm (ii) Payment of interest on a loan taken by an employee from the employer.Ans. (i) Payment of bonus by a firm will be included in national income as it is a part of compensation of employees. (ii) Payment of interest on a loan taken by an employee from the employer will not be included in the national income accounting as it is assumed that the loan is taken for consumption purpose and therefore treated as a transfer income.30. Find out (a) Net Product at Market Price and (b) Gross National Disposable (` crore) (i) Net current transfers from abroad (–) 10 (ii) Wages and Salaries 1,000 (iii) Net factor income to abroad (–) 20 (iv) Social security contributions by employers 100 (v) Net Indirect Tax 80 (vi) Rent 300 (vii) Consumption of fixed capital 120 (viii) Corporation Tax 50 (ix) Dividend 200 (x) Undistributed profits 60 (xi) Interest 400 -(23)-
  24. 24. STUDYmateAns. (a) NDPFC = Wages & salaries + social security by employers + Rent + corporation tax + dividend + undistributed profits + interest = 1,000 + 100 +300 + 50 + 200 + 60 +400 = 2,110 crores NNPMP = NDPFC + NFIA + NIT = 2,110 + 20 + 80 = 2210 crores (b) GNDI = GNPMP + Net current transfer from ROW = NNPMP + consumptio of fixed capital + Net current transfer from ROW = 2,210 + 120 + (– 10) = 2320 crores ×·×·×·×·× -(24)-
  25. 25. STUDYmate Studymate Solutions to CBSE Board Examination 2011-2012 Series : SMA/1 Code No. 58/1/3 UNCOMMON QUESTIONS ONLY SECTION-A6. State reasons why does an economic problem arise?Ans. Scarcity of resources is the basic reason for existence of economic problems in all economies. There would have been no economic problem, if resources were not scarce. The scarcity arises due to the following reasons: (i) Unlimited Human Wants: Human wants are never ending i.e. they can never be fully satisfied. Human wants also differ in priorities. That is why, people are able to allocate resources in order to satisfy some of their wants. (ii) Limited resources which have alternative uses: Resources are not only scarce, but they can also be put to various uses. Thus, one has to make a choice if the resources have alternate uses. For example, LPG cylinder is used not only for cooking, but also for running cars, gas welding etc.9. A producer invests his own savings in starting a business and employs a manager to look after it. Identify implicit and explicit costs from this information. Explain.Ans. (i) Explicit cost refers to the actual payment made to outsiders for hiring services of the factors of production. (ii) Implicit cost: Implicit cost refers to the cost of self supplied factors. Imputed value of the interest that a producer would have earned on his savings will be implicit cost and salary paid to the manager will be the explicit cost.11. Define an indifference map. Explain why an indifference curve to the right shows higher utility level.Ans. A set of indifference curves representing various levels of satisfaction is known as indifference map. Infinite number of indifference curves showing different levels of satisfaction can be drawn as shown in the diagram. The higher indifference curve (I2) has higher utility (I1). Good Y B Y2 A Y1 I2 I1 O X1 X2 Good X This is based on the assumption of ‘monotonic preferences’. Monotonic preferences means that a consumer always prefers the combination which -(25)-
  26. 26. STUDYmate has either more of both goods or more of at least one good and no less of the other goods. As a consumer moves to higher indifference curves, he is able to have more of both the goods for eg. At point A, he can have OX and OY, but at point B, he can have more of both X and Y i.e. OX2 and OY2. Thus he prefers to be on I2 than I1. Since, as consumption increases, his utility also increases  We conclude that higher indifference curve has higher utility.12. A consumer buys 20 units of a good at a price of ` 5 per unit. He incurs an expenditure of ` 120 when he buys 24 units. Calculate price elasticity of demand using the percentage method. Comment upon the likely shape of demand curve based on this information.Ans. P Q TE 5 20 5 24 120 q 4  100  100 q 20 ed = ( )  ( ) 20  ( ) = p 0 0  100  100 p 5 Working Note: TE = P × Q 120 = P × 24 120 P= =5 24 Hence, the likely shape of demand curve is parallel to the x-axis, i.e., perfectly elastic. SECTION-B22. Find Net Value Added at Market Price: (i) Output sold (units) 800 (ii) Price per unit of output (`) 20 (iii) Excise (`) 1600 (iv) Import duty (`) 400 (v) Net change in stocks (`) (–)500 (vi) Depreciation (`) 1000 (vii) Intermediate cost (`) 8000Ans. GVOmp = Sales + Change in stock = Quantity × Price + Change in stock GVOmp = 800 × 20 + (–500) = 15500 (`) Intermediate cost = 8000 (`) GVAmp = GVOmp – Intermediate cost = 15500 – 8000 = 7500 (`) NVAmp = GVAmp – Depreciation = 7500 – 1000 = 6500 (`) -(26)-
  27. 27. STUDYmate25. Find consumption expenditure from the following: Autonomous consumption = 100 (`) Marginal propensity to consume = 0.70 National Income = 1000 (`)Ans. c = ` 100 MPC(b) = 0.70 Y = ` 1000 Consumption Expenditure (C) = c + bY = 100 + 0.70 × 1000 = 100 + 700 = 800 (`)27. Giving reason explain how should the following be treated in estimating national income: (i) Interest paid by banks on deposits by individuals. (ii) National debt interestAns. (i) Interest paid by banks on deposits by individuals will be included in national income as it is a factor income. (ii) National debt interest will not be included in national income as it is assumed that government borrows for consumption purpose, therefore it is treated as a transfer.30. Find out (a) Gross National Product at Market Price and (b) Net Current Transfers from abroad: (` crore) (i) Net Indirect tax 35 (ii) Private final consumption expenditure 500 (iii) Net national disposable incomre 750 (iv) Closing stock 10 (v) Government final consumption expenditure 150 (vi) Net domestic fixed capital formation 100 (vii) Net factor income to abroad (–)15 (viii) Net imports 20 (ix) Opening stock 10 (x) Consumption of fixed capital 50Ans. (a) NDPMP = (ii) + (v) + (vi) + (iv – ix) – (viii) = 500 + 150 + 100 + (10 – 10) – 20 crores = 730 crores GNPMP = NDPMP + (x) – (vii) = 730 + 50 – (–15) = 795 crores -(27)-
  28. 28. STUDYmate (b) Net National Disposable Income = NNPMP + Net current transfers from abroad 750 = 730 – (–15) + Net Current transfers from abroad 750 = 745 + Net Current transfers from abroad  Net current transfers from abroad = ` 5 crores ×·×·×·×·× -(28)-

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