2nd PUC Economics Model Question Paper 2 with Answers

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Karnataka 2nd PUC Economics Model Question Paper 2 with Answers

Time: 3.15 Hours
Max Marks: 100

Part – A

I. Choose the correct answer, each question carries one mark: ( 1 × 5 = 5 )

Question 1.
Traditionally, the subject matter of economics has been studied under the following broad branches.
(a) Micro and macro economics
(b) Positive and normative
(c) Deductive and inductive
(d) None of the above
Answer:
(a) Micro and macro economics

Question 2.
The demand for these goods increases as income increases
(a) Inferior goods
(b) Giffen goods
(c) Normal goods
(d) None of the above
Answer:
(c) Normal goods

Question 3.
In a perfect competition each firm produces and sells
(a) heterogeneous products
(b) homogeneous products
(c) luxury goods
(d) necessary goods
Answer:
(b) Homogeneous products

Question 4.
Measuring the sum total of all factor payments will be called
(a) Product method
(b) Expenditure method
(c) Income method
(d) None of the above
Answer:
(c) Income Method

Question 5.
Taxes on individual and firms are
(a) Direct taxes
(b) Indirect taxes
(c) Fixed taxes
(d) Non tax revenues
Answer:
(a) Direct taxes

II. Fill in the blanks each carries one mark): ( 1 × 5 = 5 )

Question 6.
An equation xy = c gives us _______ hyperbola.
Answer:
Rectangular

Question 7.
Marginal product and average product curves are _____ in shape.
Answer:
Inverse U

Question 8.
Savings is that part of income that is _______ .
Answer:
Not consumed.

Question 9.
_______ is a mixture of a flexible and fixed exchange rate system.
Answer:
Managed floating exchange rate

Question 10.
Financial year runs from ______ to ______ in India.
Answer:
1st April to 31st March

III. Match the following: ( 1 × 5 = 5 )

Question 11.

A	B
1. Positive Economics	(a) Gross Domestic Product
2. Unitary elasticity’of demand	(b) Trade in goods
3. GDP	(c) |ed| = 1
4. Circulation of coin	(d) Functioning of Mechanism
5. Balance of Trade	(e) Government of India

Answer:
1 – (d)
2 – (c)
3 – (a)
4 – (e)
5 – (b).

IV. Answer the following questions in a sentence/word. ( 1 × 5 = 5 )

Question 12.
What is market economy?
Answer:
A market economy also known as capitalistic economy is that economy in which the economic decisions are undertaken on the basis of market mechanism by the private entrepreneurs. It functions on demand and supply conditions. Example, USA.

Question 13.
Expand MRS.
Answer:
Marginal Rate of Substitution.

Question 14.
Write the meaning of cost function of the firm.
Answer:
The cost function of the firm describes the least cost of producing each level of output, given prices of factors of production and technology. It deals with the output and prices of factors of production.

Question 15.
Give the meaning of managed floating.
Answer:
The managed floating exchange rate system is the mixture of a flexible exchange rate system and a fixed exchange rate system. Here, the central banks intervene to buy and sell foreign currencies in an attempt to moderate exchange rate movements whenever they feel that such actions are appropriate.

Question 16.
What are public goods?
Answer:
Public goods are the goods and services provided by the Government and which cannot be provided by the market mechanism. Example, roads, defence, etc.

Part – B

V. Answer any NINE of the following questions FOUR sentences each. ( 9 × 2 = 18 )

Question 17.
Mention the central problems of an economy.
Answer:
The central problems of an economy are as follows:

• What goods are to be produced and in what quantities?
• How the goods are to be produced?
• For whom the goods are to be produced?

Question 18.
Give the meaning and formula of price elasticity of demand.
Answer:
Price elasticity of demand is a measure of the responsiveness of the demand for a good to changes in its price. Price elasticity of demand for goods is defined as the percentage change in demand for the goods divided by the percentage change in its price. Price elasticity of demand for goods is measured with the help of following formula.

Question 19.
Mention the types of returns to scale.
Answer:
The types of returns to scale are:

• Constant Returns to Scale.
• Increasing Returns to Scale.
• Decreasing Returns to Scale.

Question 20.
Write the meanings of normal profit and super normal profit.
Answer:
The minimum level of profit that is needed to keep a firm in the existing business is called as normal profit.
Profit that a firm earns over and above the normal profit is called as super normal profit.

Question 21.
How wage is determined in the labour market?
Answer:
The wage rate is determined at the point where the labour demand and supply curves intersect.
This is shown in the following diagram:

In the above diagram, hours of labour is measured in X axis and w age is measured in Y axis. S_L is labour supply curve and D_L labour demand curve. With an upward sloping supply curve and downward sloping demand curve, the equilibrium wage rate is determined at the point where these two curves intersect (point E). That means, the wage rate is determined at that point where the labour that the households wish to supply is equal to the labour that the firms wish to hire.

Question 22.
What is price ceiling? Give example
Answer:
The government imposed upper limit on the price of goods or service is called price ceiling.
Example: price ceiling on necessary items like selected medicines, kerosene, wheat etc.

Question 23.
What is price floor? Give example.
Answer:
The Government imposed lower limit on the price that may be charged for a particular good or service is called price floor. Example: agricultural price support programmes and minimum wage legislation.

Question 24.
Write the equation of GVA at market prices.
Answer:
GVA at Market prices = GVA at basic prices + Net product taxes.

Question 25.
What is time deposit?
Answer:
These are the deposits in which money deposited is fixed for a period of time and cannot be withdrawn before stipulated time. High rate of interest is paid. Interest rate depends on the duration of money deposited.

Question 26.
Write the formula of MPC.
Answer:
It is the change in consumption per unit change in income. Its formula is MPC = “C/”Y = c

Question 27.
Give the meaning of paradox of thrift.
Answer:
The paradox of thrift is a situation where, if all the people of the economy increase their savings, the total value of savings in the economy will not increase but it either decreases or remains constant. That means, the people become more thrifty and they end up saving less or same as before.

Question 28.
Why the proportional income tax acts as automatic stabilizer?
Answer:
The proportional income tax, acts as an automatic stabilizer because, it makes disposable income and consumer spending less sensitive to fluctuations in GDP. When GDP rises, disposable income also rises but by less than the rise in GDP because a part of it is siphoned off as taxes. This helps to limit the upward fluctuation in consumption spending.

During a recession when GDP falls, disposable income falls less sharply and consumption does not drop as much as it otherwise would have fallen, had the tax liability been fixed. This reduces the fall in aggregate demand and stabilizes the economy.

Question 29.
What is the difference between current account and capital account?
Answer:
The difference between current account and capital account is as follows:
Current account:

• It is the record of trade in goods and services and transfer of payments.
• It is the record of all international transactions of assets.

Capital account:

• It consists of factor and non-factor incomes apart from gifts, remittances and grants.
• It includes money, stocks, bonds, government debt etc.

Question 30.
Write the meaning of balanced, surplus and deficit BOT.
Answer:

• Balance of trade is said to be in balance, when exports of goods are equal to the imports of goods i.e., balanced balance of trade.
• Surplus balance of trade arises if country’s exports of goods are more than its imports.
• Deficit balance of trade arises if a country’s imports of goods are more than its exports.

Part – C

VI. Answer any SEVEN of the following questions TWELVE sentences each.  ( 4 × 7 = 28 )

Question 31.
Briefly explain the central problems of an economy.
Answer:
An economic system or economy is a mechanism where the scarce resources are channelized on priority to produce goods and services. These goods and services produced by all the sectors of the economy determine the national income.

Generally, human wants are unlimited and resources to satisfy them are limited. If there was a perfect match between human wants and availability of resources there would have been no scarcity, no problem of choice and no economic problems at all. So, one has to select the most essential want to be satisfied with limited resources. In economics, this problem is called ‘Problem of Choice’.

The problem of choice arising out of limited resources and unlimited wants is called economic problem. Every economy whether developed or underdeveloped, Capitalistic or socialistic or mixed economy, there will be three basic economic problems viz., What to produce. How to produce and For whom to produce. Let us discuss in detail.

(a) What to Produce i.e., what is to be produced and in what quantities:: Every country has to decide which goods are to be produced and in what quantities. Whether more guns should be produced or more foodgrains should be grown or whether more capital goods like machines, tools, etc., should be produced or more consumer goods (electrical goods, daily usable products etc.) will be produced.

What goods to be produced and in what quantity depends on the economic system of the country’. In socialistic economy, the Government decides and in capitalistic economy market forces decide and in mixed economy both the Government and market forces provide solutions to this problem.

(b) How to Produce i.e., how are goods produced?: There are various alternative techniques of producing a product. For example, cotton cloth can be produced with either handloom or power looms. Production of cloth with handloom requires more labour and production with power loom use of more machine., and capital. It involves selection of technologc to produce goods and services.

There are two types of techniques of production viz., (a) Labour intensive technology and (b) Capital intensive technology. The society has to decide whether production be based on labour intensive or capital intensive techniques. Obviously, the choice of technology would depend on the availability of different factors of production (land, labour, capital) and their relative prices (rent, wages, interest).

(c) For whom to produce i.e., for whom are the goods to be produced: Another important decision which an economy has to take is for whom to produce. The economy cannot satisfy all wants of all the people. Therefore, it has to decide who should get how much of the total output of goods and services. The society has to decide about the shares of different groups of people- poor, middle class and the rich, in the national output.

Thus, every economy faces the problem of allocating the scarce resources to the production of different possible goods and services and of distributing the produced goods and services among the individuals within the economy. The allocation of scarce resources and the distribution of the final goods and services are the central problems of any economy.

Question 32.
Explain the differences between normal and inferior goods with examples.
Answer:
Normal goods

• These are the goods for which the demand increases with the increase in the income of consumer.
• Example for normal goods are food, clothes, electronic goods, luxury goods etc.
• There is positive relationship between income and demand.
• Here the demand curve shifts towards right if the income of consumer increases.

Inferior goods:

• These are the goods for which the demand decreases with the increase in the income of consumer.
• Example for inferior goods are low quality of goods like unbranded products.
• There is inverse relationship between income and demand.
• Here the demand curve shifts towards left if the income of consumer increases.

Question 33.
Explain the long run costs.
Answer:
In the long run, all inputs are variable. There are no fixed costs, The total cost and the total variable cost coincide in the long run. There are two types of long run costs. They are as follows:

(a) Long Run Average Cost (LRAC): The long run average cost is the cost per unit of output produced. It is obtained by dividing the total cost by the output produced. It can be calculated as follows:
LRAC = TC/q
Where TC is Total cost and ‘q’ is quantity of output produced.

(b) Long Run Marginal Cost: The long run marginal cost is the change in total cost per unit of change in output. When output changes in discrete units, then, if we increase production from q₁ – 1 to qt units of output, the marginal cost of producing q₁ – 1 unit will be measured as follows:
LRMC = (TC at q₁ units) – (TC at q₁ – 1 units) or LRMC = TC_n – TC_n-1

Question 34.
Explain the working of the economy of a capitalist country.
Answer:
Capitalist economy can be defined as an economy in which most of the economic activities have the following characteristics:

• There is private ownership of means of production.
• Production takes place for selling the output.
• There is sale and purchase of labour service at a price called wage rate.

In a capitalist country production activities are mainly carried out by capitalist enterprises. A typical capitalist enterprise has one or several entrepreneurs. Entrepreneurs are those who exercise control over major decisions and bear a large part of the risk associated with the firm. They may themselves supply the capital needed to run the enterprise or they may borrow the capital.

To carry out the production they also need natural resources. They need the most important element of human labour to carry out production. This is called as labour. After producing output with the help of land, labour and capital, the entrepreneur sells the product in the market to earn money called revenue. Part of the revenue is paid out as rent for land, interest for capital and wage for labour and keeps the rest of the revenue as profit.

Profits are often used by the producers in the next period to buy new machinery or to build new factories, so that production can be expanded. These expenses which raise productive capacity are examples of investment expenditure.

Question 35.
Explain the examples of planned accumulation and acumulation of inventories.
Answer:
Inventories are the unsold goods, unused raw materials or semi-finished goods which a firm
carries from a year to the next year. Change in inventories may be planned or unplanned. A planned change in inventories is the change in the stock of inventories which has occurred in a planned way. The planned accumulation and decumulation of inventories are explained with example as follows:

Suppose a firm wants to increase the inventories from 200 T shirts to 400 T shirts during the year. Expecting sales of 2000 T shirts during the year, the firm produces 2000 + 200 = 2200 T shirts. If the sales are actually 2000 T shirts, the firm ends up with a rise of inventories. The new stock of inventories is 400 T shirts, which was planned by the firm. This is planned accumulation of inventories.

On the other hand, if the firm had wanted to reduce the inventories from 200 to 50, the it would produce 2000 – 150 = 1850 T shirts. This is because it pians to sell 150 T shirts out of the inventory of 200 T shirts it started with. Then the inventory at the end of the year becomes 200 – 150 = 50 T shirts, which the firm wants. If the sales turn out to be 2000 T shirts as expected by the firm, the firm will be left with the planned reduced inventory (decumulation) of 50 T Shirts.

These are the two instances of planned accumulation and planned decumulation of inventories.

Question 36.
Write a note on legal definitions of money.
Answer:
The total stock of money in circulation among the public at a particular point of time is called money supply. The legal definitions of money are defined as follows:
(a) M₁ = CU + DD (CU currency notes held by the public; DD is net demand of the public held by the banks.
(b) M₂ = M₁ + Savings deposits with Post office savings banks.
(c) M₃ = M₁ + Net time deposits of commercial banks.
(d) M₄ = M₃ + Total deposits with post office savings organizations.
M₁ and M₂ are narrow money. M₃ and M4 are broad money.

Question 37.
Explain the multiplier mechanism.
Answer:
The production of final goods employs factors like labour, capital, land and entrepreneurship. In the absence of indirect taxes or subsidies, the total value of the final goods output is distributed among different factors of production – wages to labour, interest to capital, rent to land etc.

The remaining part is profit to entrepreneur. Thus the sum of aggregate factor payments i.e., National Income, is equal to the aggregate value of the output of final goods.

Example, if the value of the extra output 10 is distributed among various factors of production, the income of the economy also goes by 10. When income increases by 10, consumption expenditures goes up by 10, since people spend 0.9 (marginal propensity to consume) fraction of their additional income on consumption. Hence, in the next round, aggregate demand in the economy goes up by 0.9(10) and there again emerges an excess demand equal to 10 and so on. This can be represented in the following table.

According to the above table, the increment in equilibrium value of total output exceeds the initial increment in autonomous expenditure. The ratio of the total increment in equilibrium value of final goods output to the initial increment in autonomous expenditure is called investment multiplier of the economy. The investment multiplier can be expressed as follows:
ΔY/ΔA = 1 / 1 – c = 1/S where ΔY is the total increment in final goods output and c = mpc (marginal propensity to consume). Here, the size of the multiplier depends on the value of c. As and when c increases, the multiplier also increases.

Question 38.
Briefly explain the revenue deficit and fiscal deficit.
Answer:
If the Government’s expenditure exceeds its revenue, it is called budget deficit. The budget deficit includes Revenue Deficit and Fiscal Deficit.

(a) Revenue Deficit: The revenue deficit refers to the excess of Government’s revenue expenditure over revenue receipts. That means –
Revenue Deficit = Revenue Expenditure – Revenue Receipts.

The revenue deficit includes only such transactions that affect the current income and expenditure of the government. When the government incurs a revenue deficit, it implies that the government is dis-saving and is using up the savings of the other sectors of the economy to finance a part of its consumption expenditure.

(b) Fiscal Deficit: It is the difference between the government’s total expenditure and its total receipts excluding borrowing. That is:-
Gross Fiscal Deficit = Total Expenditure – (Revenue receipts + non-debt creating capital receipts)

The non-debt creating capital receipts are those receipts which are not borrowings and, therefore, do not give rise to debt. Examples are recovery of loans and the proceeds from the sale of public sector undertakings.

The fiscal deficit has to be financed through borrowing. It indicates that the total borrowing requirements of the government from all sources. Therefore, from the financing side, Gross fiscal deficit = net borrowing at home + borrowing from RBI + borrowing from abroad. The net borrowing at home includes the directly borrowed from the public through debt instruments and indirectly from commercial banks through Statutory Liquidity Ratio.

In fact, revenue deficit is a part of fiscal deficit. A large share of revenue deficit in fiscal deficit indicates that a large part of borrowing is being used to meet its consumption expenditure needs rather than investment.

Question 39.
Briefly explain the effect of an increase in demand for imports in the foreign exchange market with the help of a diagram.
Answer:
Foreign exchange market is the market in which national currencies are traded for one another. The major participants in the foreign exchange market are commercial banks, foreign exchange brokers and other authorized dealers and monetary authorities.

Foreign exchange rate is the price of one currency in terms of another currency. Different countries have different methods of determining their currency’s exchange rate. It can be determined through flexible exchange rate, fixed exchange rate or managed floating exchange rate.

The flexible exchange rate is determined by the market forces of demand and supply. Here the exchange rate is determined at that point where the Rupees demand curve intersects with the supply curve.

If the demand for foreign goods and services increases, the demand curve shifts upward and right to the original demand curve. This can be graphically represented as follows:

The increase in demand for imports, results in a change in the exchange rate. The initial exchange rate is E₁ = 60. which means that we need to exchange Rs.60 for one dollar. At the new equilibrium, the exchange rate becomes E₂ = 70, which means that we need to pay more rupees for a dollar.

The increase in the price of dollars due to rise in demand for imports indicates that the value of rupees in terms of dollars has fallen and the value of dollar in terms of rupees has increased.

Question 40.
Write the chart of the Government budget.
Answer:

Question 41.
Write the chart of components of current account.
Answer:

Part – D

VII. Answer any FOUR of the following questions TWENTY sentences each. ( 4 × 6 = 24 )

Question 42.
Give the meaning and formula of price elasticity of demand and explain the elasticity along the linear demand curve.
Answer:
Price elasticity of demand is a measure of the responsiveness of the demand for goods to changes in its price. Price elasticity of demand for goods is defined as the percentage change in demand for the goods divided by the percentage change in its price. Price elasticity of demand for a goods is measured with the help of following formula.

Here, ΔQ stands for change in quantity, ΔP is change in price, ‘p’ is initial price and ‘Q’ is initial quantity.

Elasticity along a Linear Demand curve:
The linear demand curve is q = a – bp. Note that at any point on the demand curve, the change in demand per unit change in the price Δq = -b
ΔP
The price elasticity of demand is different at different points on the linear demand curve which is shown in the following diagram:

In the above diagram, \(\left|e_{D}\right|\) = ∞ depicts price elasticity is perfectly elastic, \(\left|e_{D}\right|\) < 1 depicts the demand is less responsive to a price change; \(\left|e_{D}\right|\) = 1 depicts that the change in demand is equal to a change in price, \(\left|e_{D}\right|\) > 1 shows that the demand is more responsive to a price change and \(\left|e_{D}\right|\) = 0 depicts that there is no change in quantity demanded due to a change in price. So, price elasticity of demand is different at different points on the linear demand curve.

Question 43.
Explain the various short run costs with the help of a table.
Answer:
The various short run costs are Total Cost, Total Fixed Cost, Total Variable Cost, Average Cost, Average Fixed Cost, Average Variable Cost, and Marginal Cost. The following table shows the various types of short run costs:
The TFC, TVC, TC, AFC, AVC, AC and MC is shown in table as follows:

(a) Total Fixed Cost (TFC): It refers to the total money expenses incurred on all the fixed factors in the short run. TFC remains constant at all levels of output. Therefore the total fixed cost curve is horizontal straight line to OX axis above the origin which indicates that it is never zero.
TFC = TC – TVC

(b) Total Variable Cost (TVC): It refers to the total money expenses incurred on the variable factor inputs in the short-run. Total variable cost is the direct cost of the output because it increases along with the output and remains zero when the output is zero. So, the TVC curves starts from the origin and rises sharply in the beginning, gradually in the middle and stretch again sharply in the end the nature of this slope is in accordance with the law of variable proportion.
TVC = TC – TFC

(c) Total Cost (TC): It is the aggregate money expenditure incurred by the firm on all the factors to produce a given quantity of output. TC varies in the same proportion as total variable cost because the total fixed cost is constant. The TC curve slope upwards from left to right, above the origin, indicating that, it includes total fixed cost and total variable cost.

(d) Average Fixed Cost (AFC): It is the fixed cost per unit of output. In other words, it is average expenses incurred on a single unit of output produced. AFC and output are inverse relation, i.e. AFC will be higher when the output level is less and as the output goes on increasing AFC starts reducing, when it is represented in the diagram AFC curve will have a negative slope which falls very stiffly in the beginning and later on becomes parallel to the X axis.

The Average Fixed Cost is obtained by dividing Total Fixed Cost by Output.
AFC = TFC/Output

(e) Average Variable Cost (AVC): It is a variable cost for per unit of output. It can be calculated by dividing total variable cost by the total units of output. When this cost is graphically represented, we get a ‘U’ shaped AVC, which shows that the cost will be less as the number of units produced increase, this is because as the number of variable inputs are added in a fixed plant the efficiency will increase and vice versa.
AVC = TVC/Output or AVC = AC-AFC

(f) Average Cost (AC): It is the cost per unit of output produced. It is obtained by dividing total cost by the total output produced i.e. AC = TC/Q or it is also obtained by adding AFC and AVC. If the AC is graphical represented we get U shaped curve because of the operation of law of variable proportions. The short run AC curve is also called as ‘Plant Curves’ because it indicates the optimum utilization of a given plant (Industry) capacity.

(g) Marginal Cost (MC): It is an additional cost incurred to produce an additional output. In other words it is the net additions to the total cost when one more unit of output is produced.
MC = TC_n – TC_n-1
(where TC_n = Total Cost of ‘n’ selected unit of output and TC_n-1 is Total cost of previous output).

Question 44.
Explain the market equilibrium with the fixed number of firms with the help of diagram.
Answer:
Under perfect competition, market is said to be in equilibrium when quantity demanded is equal to the quantity supplied. Here, with the help of market demand curve and market supply curve we will determine where the market will be in equilibrium when the number of firms is fixed.

This can be illustrated with the help of the following diagram:

The given diagram illustrates equilibrium for a perfectly competitive market with a fixed number of firms. SS is market supply curve and DD is market demand curve. The market supply curve SS shows how much of the commodity firms would wish to supply at different prices and the demand curve DD tells us how much of the commodity, the consumer would be willing to purchase at different prices.

At point E. the market supply curve intersects the market demand curve which denotes that quantity demanded is equal to quantity supplied. At any other point, either there is excess supply or there is excess demand.

OP is the equilibrium price and OQ is the equilibrium quantity. If the price is P₁ the market supply is q₁ and market demand is q₄. Therefore, there is excess demand in the market equal to q₁q₄ Some consumers who are either unable to obtain the commodity at all or obtain it in insufficient quantity’ will be willing to pay more than P₁. The market price would tend to increase.

All other things remaining constant, when the price increases the demand falls and quantity supplied rises. The market moves towards equilibrium where quantity demanded is equal to quantity supplied. It happens at P where supply decisions match demand decisions.

If the price is P₂, the market supply – q₃. will exceed the market demand q₂ which leads to excess supply equal to q₂q₃ Some firms will not be able to sell quantity’ they want to sell. Therefore, they will lower their price. All other things remaining constant, when the price falls, quantity demanded rises and quantity supplied falls to equilibrium price P where the firms are able to sell their desired output as market demand equals market supply at P. So, the P is the equilibrium price and the corresponding quantity q is the equilibrium quantity.

Question 45.
Requirement of reserves acts as a limit to money (credit) creation. Explain.
Answer:
The RBI decides a certain percentage of deposits which every bank must keep as reserves. This is done to ensure that no bank is over lending. This is a legal requirement and is binding on the banks. This is called the CRR (Cash Reserve Ratio).

Apart from the CRR. banks are also required to keep some reserves in liquid form in the short term. This ratio is called SLR (Statutory Liquidity Ratio). The statutory requirement of the reserve ratio acts as a limit to the amount of credit that banks can create.

For example, let us assume that Canara Bank starts with a deposit of Rs. 1000 made by Mr.X. The reserve ratio is 20%. Thus Canara Bank has Rs.800 (1000 – 200 = 800.i.e.,20% of 1000 is deducted) to lend and the bank lends out of Rs.800 to Mr.Y, which is shown in the bank’s deposits in the next round as liabilities, making a total of Rs. 1800 as deposits. Now Canara bank is required to keep 20% of 1800 i.e.. 360 as cash reserves. The bank had started with Rs.1000 as cash. Since it is required to keep only Rs.360 as reserves it lends Rs.640 (1000 – 360 = 640). The bank lends out Rs.640 to Mr.Z. This in turn show s up in the bank, as deposits. The process keeps repeating itself till all the required reserves become Rs. 1000. The required reserves will be Rs.1000 only when the total deposits become Rs.5000. This is because, for deposits of Rs.5000, cash reserves would have to be Rs. 1000 (20% of 5000 = 1000)

The process is illustrated in the following table:

In the above table, the first column lists each round. The second column depicts the total deposits with the bank at the beginning of each round. 20% of these deposits need to be deposited with the RBI as required reserves (3rd column). What the bank lends in each round gets added to the deposits with the bank in the 2nd round. 4th column indicates the loans made by the banks.

Question 46.
Discuss the paradox of thrift.
Answer:
The paradox of thrift is a situation where, if all the people of the economy increase their savings, the total value of savings in the economy will not increase but it either decreases or remains constant. That means, the people become more thrifty’ and they end up saving less or same as before.

Suppose, at the initial equilibrium of Y = 250, there is an autonomous shift in people’s expenditure pattern- they suddenly become more thrifty. This may happen due to a new information regarding an imminent war or some other disaster, which makes people more conservative about their expenditures. Hence the MPS (marginal propensity to save) of the economy increases or the MPC (marginal propensity to consume) from 0.9 to 0.6. At the initial income of Ad₁ =Y₁ =250, this sudden decline in MPC will imply a decrease in aggregate consumption spending and aggregate demand by an amount equal to (0.9 – 0.6) x 250 = 75.

This can be regarded as an autonomous reduction in consumption expenditure to the extent that the change in marginal propensity consume is occurring from some exogenous cause and is not a consequence of changes in the variables of the model.

As aggregate demand decreases by 75, it falls short of the output Y₁ =250 and there will be excess supply equal to 75 in the economy. Stocks will pile up in warehouses and producers decide to cut the value of production by 75 in the next round to restore equilibrium in the market which further leads to reduction in factor payments in the next round and hence reduction in income by 75. As income decreases people reduce consumption proportionately and aggregate demand goes down again by (0.6)² 75. The process goes on as follows:
75 + (0.6) 75 + (0.6)² 75 + ……..∞. The total reduction in output turns out to be: 75/1 – 0.6

The paradox of thrift can be explained in the following diagram.

As per the above diagram, when A changes the line shifts upwards or downwards in parallel. When C changes, however, the line swings up or down. An increase in marginal propensity to save or a decline in marginal propensity to consume reduces the slope of the AD (Aggregate Demand) line and it swings downwards. The above diagram depicts the paradox of thrift – downwards swing of AD line.

Question 47.
‘The fiscal deficit gives borrowing requirements of the government’. Elucidate.
Answer:
Fiscal deficit is the difference between the government’s total expenditure and its total receipts
excluding borrowing. It can be expressed as follows:
Gross fiscal deficit = Total expenditure – (Revenue receipts + non-debt creating capital receipts)
The non-debt creating capital receipts are those receipts which are not borrowings and do not give rise to debt. For example, recovery of loans and the proceeds from the sale of Public sector undertakings. The fiscal deficit will have to be financed through borrowing. Thus, it indicates the total borrowing requirements of the government from all sources. From the financing side the fiscal deficit can be expressed as follows:
Gross Fiscal Deficit = Net borrowing at home + borrowing from RBI + Borrowing from abroad

The net borrowing at home includes that directly borrowed from the public through debt instruments (small savings schemes) and indirectly from commercial banks through statutory liquidity ratio.

The gross fiscal deficit is a very important variable in judging the financial health of the public sector and the stability of the economy. Further, revenue deficit is a part of fiscal deficit (i.e., Fiscal Deficit = Revenue Deficit + capital expenditure-non-debt creating capital receipts). A large share of revenue deficit in fiscal deficit indicates that a large part of borrowing is being used to meet its consumption expenditure needs rather than investment.

Question 48.
Write a short note on the gold standard.
Answer:
The gold standard was prevailing from 1870 to 1914. All currencies were defined in terms of gold; indeed some were actually made of gold. Each participant country committed to guarantee the freely convertibility of its currency into gold at a fixed price. That means a domestic currency which was freely convertible at a fixed price into another asset acceptable in international payments. This also made it possible for each currency to be convertible into all others at a fixed price.

Exchange rates were determined by its worth in terms of gold. For example, if one unit currency A was worth one gram of gold, one unit of currency B was worth two grams of gold, currency B would be worth twice as much as currency A. Economic agents could directly convert one unit of currency B into two units of currency A, without having to first buy gold and then sell it. The rates would fluctuate between an upper and a lower limit, these limits being set by the costs of melting, shipping and recoining between the two currencies. To maintain the official parity each country needed an adequate stock of gold reserves. All countries on the gold standard had stable exchange rates.

Many problems caused the gold standard to break down periodically. Moreover, world price levels were at the mercy of gold discoveries. This can be explained by looking at the crude quantity theory’ of money, M=KPY, according to which, if output (GNP) increased at the rate of 4 percent per year, the gold supply would have to increase by 4 percent per year to keep prices stable. With mines not producing this much gold, price levels w ere falling all over the world in the late 19th century, giving rise to social unrest.

For a period, silver supplemented gold introducing ‘bi-metallism’. Also, fractional reserve banking helped to economize on gold. Paper currency was not entirely backed by gold; typically countries held one-fourth gold against its paper currency.

VIII. Answer any TWO of the following project-oriented questions. ( 2 × 5 = 10 )

Question 49.
Find the missing products of the following table.

Answer:

Question 50.
Prepare a budget on monthly income and expenditure of your family.
Answer:
The budget is a financial statement which includes anticipated income and anticipated expenditure. An imaginary monthly income and expenditure of a family is given below:

This family has surplus budget as its income is more than expenditure.

Question 51.
Name the currencies of any five countries of the following
USA, UK, Germany, Japan, China, Argentina. I AM, Bangladesh, Russia.
Answer:

Countries	Currency
USA	US dollars
UK	British Pound
Germany	Euro
Japan	Japanese Yen
China	Chinese Yuan
Argentina	Argentine Peso
UAE	UAE Dirham
Bangladesh	Bangladeshi Taka
Russia	Russian Ruble

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