Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 9th Lesson Theory of Employment and Public Finance Class 11 Textbook Exercise Questions and Answers.
Theory of Employment and Public Finance Class 11 Questions and Answers AP Inter 1st Year Economics 9th Lesson
I. Multiple Choice Questions (1 Mark)
Question 1.
Which of the following is not an assumption of classical theory of employment ?
(1) Full employment
(2) Laissez faire economy
(3) Perfect competition
(4) Short period
Answer:
(4) Short period
Question 2.
A point where aggregate demand equals to aggregate supply is called:
(1) Direct Demand
(2) Indirect Demand
(3) Effective Demand
(4) Derived Demand
Answer:
(3) Effective Demand
Questionn 3.
Which of the following is not considered as public revenue ?
(1) Direct taxes
(2) Indirect taxes
(3) Goods and Services tax
(4) Transfer payments
Answer:
(4) Transfer payments
Question 4.
If revenue receipts are Rs. 800 cr., capital receipts are Rs. 500 cr., borrowings and other liabilities are Rs. 400 cr., and total expenditure is Rs. 1200 cr., then Fiscal Deficit is
(1) Rs. 100 cr.
(2) Rs. 500 cr.
(3) Rs. 300 cr.
(4) Rs. 400 cr.
Answer:
(3) Rs. 300 cr.
Question 5.
GST comes under which type of tax in the government budget ?
(1) Indirect tax
(2) Corporate tax
(3) Direct tax
(4) Income tax
Answer:
(1) Indirect tax
II. Fill in the Blanks (1 Mark)
Question 1.
The minimal interference of the government in economic activities is known as …………… .
Answer:
Laissez – Faire
Question 2.
In ……………. budget, the total receipt and total expenditure are equal.
Answer:
Balanced Budget
Question 3.
The ratio of change in Income to change in investment is called …………….. .
Answer:
Investment multiplier
Question 4.
Fiscal Deficit minus Interest payments is equal to …………….. .
Answer:
Primary deficit
Question 5.
If borrowings and other liabilities are added to the budget deficit, we get ………… .
Answer:
Fiscal deficit
III. Answer the following questions in one word. (1 Mark)
Question 1.
In which year, Goods and Services Taxes (GST) was introduced in India ?
Answer:
01-07-2017
Question 2.
The ratio of change in consumption to the change in Income is known as:
Answer:
Marginal Propensity to Consume (MPC)
Question 3.
“Supply creates its own demand”, stated by ?
Answer:
JB. Say
Question 4.
The slope of consumption function is equal to:
Answer:
Marginal Propensity to Consume (MPC)
Question 5.
The relationship between initial increment in investment and total income is called:
Answer:
Multiplier
IV. Briefly explain the following concepts in two to three sentences. (2 Marks)
Question 1.
Laissez Faire
Answer:
Laissez-faire is an economic theory dating back to the 18th century that opposes any government intervention in business affairs. It suggests that businesses and the overall economy function best when the government avoids regulating or controlling the market, allowing market forces to operate freely. This approach is a cornerstone of free-market capitalism.
Question 2.
Say’s law of markets
Answer:
The classical theory of employment is based on “Say’s Law of Markets”. The fa-mous law of markets, propounded by J.B. Say states that, “Supply creates its own demand”. The law is generally interpreted as supply always equals demand or it can be expressed as S = D.
Question 3.
Consumption function
Answer:
Consumption is a function of income, denoted as C = f (Y) (where C is consumption and Y is income). It means consumption depends on the level of income. As income rises, consumption also increases but not in the same proportion. The increase in consumption is usually less than the increase in income. It is because of the propensity to consume. It means the tendency on the part of the consumers to spend their income.
Question 4.
Marginal propensity to save
Answer:
It refers to the proportion of an increase in disposable income that a household saves rather than uses for consuming goods and services. MPS varies by income level and is typically higher at higher incomes. Symbolically,
MPS = \(\frac{\Delta \mathrm{S}}{\Delta \mathrm{Y}}\)
where ∆S is change in Savings and ∆Y is change in income.
Question 5.
Paradox of Thrift
Answer:
The paradox of thrift was developed by British economist J.M. Keynes. If all the people of the economy increase the proportion of income they save (i.e., if the MPS of the economy increases) the total value of savings in the economy will not increase – it will either decline or remain unchanged. This result is knoWn as the Paradox of Thrift. This theory states that as people become more thrifty, overall savings may actually decline or remain unchanged.
Question 6.
Goods and Services Tax
Answer:
1. Goods and Services Tax is the biggest tax reform in the country since Inde-pendence. GST was introduced in India on 1st July 2017. The motto of the GST is “One Nation, One Tax, One Market”.
2. It is applicable throughout the country with one rate for one type of goods/ services. GST replaced large number of taxes on goods and services levied by central and state/UT governments.
Question 7.
Marginal propensity to consume
Answer:
MPC refers to the ratio of change in consumption expenditure to the change in the income. If the MPC increases, consumption increases more and the aggregate demand can be increased Symbolically,
MPS = \(\frac{\Delta \mathrm{C}}{\Delta \mathrm{Y}}\)
where ∆C is change in consumption and ∆Y is change in income.
Question 8.
Effective demand
Answer:
Effective demand is nothing but the level of aggregate demand that is equal to the aggregate supply. In other words, effective demand is the total money spent on consumer goods and investment goods in the economy.
Question 9.
Deficit Budget
Answer:
This refers to a budget in which the total expenditure exceeds the total revenue. This means the government is spending more money than it is earning through taxes, fees, and other revenue streams. To cover this shortfall, governments often need to borrow money, leading to an increase in the national debt.
Question 10.
Fiscal Deficit
Answer:
Fiscal Deficit is the difference between Government’s total expenditure and its total receipts excluding borrowings and other liabilities. In other words, Fiscal Deficit is the sum of budget deficit and market borrowings arid other liabilities. Fiscal deficit = Revenue Receipts + Capital Receipts (excluding borrowings and other liabilities) – Total expenditure.
Question 11.
FRBM act
Answer:
The enactment of the FRBM A, in August 2003, marked a turning point in fiscal reforms, binding the government through an institutional framework to pursue a prudent fiscal policy. The Act mandates the central government to take appropriate measures to reduce fiscal deficit to not more than 3 percent of GDP and to eliminate the revenue deficit.
Question 12.
Balance of Trade and Balance of Payments
Answer:
Balance of Trade: It is a statement showing the total value of exports and imports of goods over a specific period of time. Invisible items (services) are not included in Balance of trade.
Balance of Payments: The Balance of Payments (BOP) is a systematic record of all economic transactions between the residents of one country and the residents of the rest of the world in a year. The balance of payments always balance in an accounting sense.
Question 13.
Fixed exchange rate
Answer:
Under fixed exchange rate regime, a country’s central bank or government declares the value of its currency relative to another country’s currency or a basket of currencies. E.g.: Fixing the value of Rs. 85 per US dollar.
In order to maintain the exchange rate at the pre-determined level, the central bank intervenes in the foreign exchange market.
Question 14.
Floating exchange rate
Answer:
Under floating exchange rate regime, the equilibrium value of the exchange rate of a country’s currency is market – determined (i.e., the demand for and supply of currency relative to other currencies determine the exchange rate). Under this system, there is no interference on the part of the government or central bank of the country in the determination of exchange rate.
Question 15.
Devaluation and Depreciation
Answer:
- Devaluation: Devaluation is a deliberate downward adjustment in the value of a country’s currency relative to another currency, a group of currencies or standard.
- Depreciation: Depreciation is a decrease in a currency’s value (relative to other major currency benchmark) due to market forces under a floating exchange rate and not due to any government or central bank policy actions.
V. Write the answers briefly for the following questions. (4 Marks)
Question 1.
State the assumptions of the classical theory of employment.
Answer:
The classical theory of employment is based on the following assumptions.
- There is a free enterprise economy.
- The economy operates under conditions of perfect competition.
- There is no government interference in the economy, and price mechanism is allowed to work freely.
- The equilibrium is viewed from the long-term perspective.
- It is assumed that all savings are automatically converted into investment.
- Both interest rates and wage rates are flexible, adjusting to restore equilibrium.
- There are no constraints on market expansion.
- Money acts as a medium of exchange and does not influence output and em-ployment.
Question 2.
“Supply creates its own demand”. Explain this statement.
Answer:
The classical theory of employment is based on “Say’s Law of Markets”.
The famous law of markets, propounded by J.B. Say states that, “Supply cre-ates its own demand”. The law is generally interpreted as supply always equals demand or it can be expressed as S = D.
Whenever additional output is produced in the economy, the factors of pro-duction which participate in the process of production, earn income in the form of rent, wages, interest and profit.
The total income so generated is equivalent to the total value of the output produced. Such income creates additional demand necessary for the sale of the additional output. Therefore, the question of the additional output not being sold does not arise. Hence, supply always equals demand.
Question 3.
What are the sources of public revenue ?
Answer:
Public Revenue refers to the revenue received by the government from different sources.
Sources of public revenue : Public revenue is broadly classified into two kinds :
i) Tax revenue and
ii) Non-tax revenue.
i) Tax revenue: Tax revenue refers to the income collected by the government through taxes imposed on public. Both the central government and the state governments collect taxes as per their allocation in the constitution. Broadly taxes are divided into two categories :
a) Direct Taxes:
- Taxes on income and expenditure. E.g.: Personal income tax, corporate tax.
- Taxes on property and capital assets. E.g.: Wealth tax, gift tax, estate duty.
b) Indirect taxes:Taxes le vied on goods and services are called indirect taxes. E.g.: Customs duty, GST.
ii) Non tax revenue: Government receives revenue from sources other than taxes and such revenue is called the non tax revenue.
Sources of Non- tax revenue: These sources are broadly classified as follows :
a) Administrative revenue: Government receives money for certain administrative services. E.g.: License fee, tuition fee, penalities.
b) Commercial revenue: Modern governments establish public sector units to manufacture certain goods and offer certain services. So such units earn revenue by way of selling their products. E.g.: BSNL, IOC, BHEL etc.
c) Loans and advances: When the tax revenue is insufficient to meet the government expenditure, the government may borrow loans from the financial institutions operating within the country or from the public. It may also obtain loans from foreign governments or international financial institutions such as IMF, IBRD.
d) Grants-in-aid: Grants are amounts received without any obligation to re payment. State governments often receive these from the central government, which in turn may receive these from foreign governments or any international funding agencies.
Question 4.
List out the various items of public expenditure.
Answer:
The expenditure incurred by the government on various economic activities is called the public expenditure. They spend a lot of money not only on defence, law and order but also on creating infrastructural facilities, public services and welfare schemes.
Generally, public expenditure incurred for the following services.
- Defence
- Internal security (Police)
- Economic services (agriculture, industry, power, transport, communications, science &. technology etc.)
- Social services (Education, health, broadcasting etc.)
- Other general services (tax collection, external affairs etc.)
- Pensions
- Subsidies
- Grants to state governments
- Grants to foreign governments
- Loans to state governments
- Loans to public enterprises
- Loans to foreign governments
- Repayment of loans (principal amount, interest and debt management)
- Assistance to states on natural calamities etc.
Question 5.
Write a note on Goods and Services Tax (GST).
Answer:
1. Goods and Services Tax is the biggest tax reform in the country since Independence. GST was introduced in India on 1st July 2017. The motto of the GST is “One Nation, One Tax, One Market”.
2. It is applicable throughout the country with one rate for one type of goods/ services. GST replaced large number of taxes on goods and services levied by central and state/UT governments.
3. Some of the major taxes like excise duty, service tax, central sales tax, VAT etc, are replaced by GST. Under GST, there are six standard rates applied they are 0%, 3%, 5%, 12%, 18% and 28% on supply of all goods and services across the country. GST is applicable to most of the goods and services.
4. However, the following will not come under the preview of GST.
- Petroleum crude,
- High-speed diesel,
- Motor spirit (Petrol),
- Natural gas,
- Alcoholic liquids for human consumption.
5. Objective: GST aimed at reducing the cost of business operations and the cas-cading effect of various taxes on consumers. GST also reduced the overall cost of production, which will make Indian product/ services more competitive in domestic and international markets.
Question 6.
Distinguish between Revenue account and Capital account in the Budget.
Answer:
A. Revenue Account: The Revenue Budget deals with the day-to-day expenses of running the government. Revenue Account consists of the Revenue Receipts of Government and the revenue expenditure.
- Revenue Receipts: Revenue receipts are those receipts that do not lead to a claim on the government. They are therefore termed non-redeemable.
- Revenue Expenditure: Revenue expenditure is expenditure incurred for the normal functioning of the government departments and various services, such as interest payments, subsidies, and pensions.
B. Capital account: The Capital Budget focuses on long-term investments and asset creation. Capital Account consists of capital receipts and payments.
- Capital Receipts: These include market loans and borrowings. Market loans
are raised from the public by floating bonds and securities. Borrowings include loans raised from the Reserve Bank of India and financial institutions by selling. - Capital Expenditure: Capital expenditure refers to the government spending that results in the creation of physical or financial assets or the reduction in financial liabilities. This includes expenditure on the acquisition of land, buildings, machinery.
Question 7.
Explain the Investment multiplier.
Answer:
- The concept of the Investment multiplier was introduced by J.M. Keynes. The Investment multiplier is an important in Keynesian theory, which explains how an economy’s income and employment are determined.
- The multiplier refers to the phenomenon where a change in investment or expenditure lead to a proportionately larger change (or multiple change) in the national income.
- Multiplier explains how many times the aggregate income increases as a result of an increase in investment.
- When the level of investment increases by an amount say ∆I, the equilibrium level of income will increase by some multiple amounts ∆Y.
- Thus, the multiplier expresses the relationship between an initial increment in investment and the resulting increase in aggregate income.
- In other words, the ratio of change in income (∆Y) to change in investment (∆I) is called the investment multiplier.
Thus, k = \(\frac{ ∆Y }{ ∆I }\)
Where, k = Multiplier, ∆Y = Change in Income, ∆I = Change in Investment
Question 8.
Define Foreign Exchange Rate. Explain the types of foreign exchange rate.
Answer:
Foreign Exchange Rate : Foreign Exchange (FX) rate is the price of one currency expressed in terms of units of another currency and represents the number of units of one currency that exchanges for a unit of another.
Types of Exchange rates ; There are two major types of exchange rate regimes at the extreme ends, namely
a) Floating (Flexible) exchange rate regime
b) Fixed (Non-Floating) exchange rate regime
a) Floating exchange rate regime: Under floating exchange rate regime, the equilibrium value of the exchange rate of a country’s currency is market-determined (i.e., the demand for and supply of currency relative to other currencies determine the exchange rate). Under this system, there is no interference on the part of the government or central bank of the country in the determination of exchange rate.
b) Fixed exchange rate regime: Under fixed exchange rate regime, a country’s central bank or government declares the value of its currency relative to another country’s currency or a basket of currencies. E.g.: Fixing the value of Rs. 85 per US dollar. In order to maintain the exchange rate at the pre-determined level, the central bank intervenes in the foreign exchange market.
Question 9.
Explain the Difference between current account and capital account in Balance of Payments.
Answer:
Tablee
VI. Write an essay on the following questions. (8 Marks)
Question 1.
Elucidate the classical theory of employment.
Answer:
The theory of output and employment developed by economists such as Adam Smith, David Ricardo, Malthus is known as classical theory. It is based on the famous “Law of markets” advocated by J.B. Say. According to this law “supply ere ates its own demand”. The classical theory of employment assumes that there is always full employment of labour and other resources. The classical economists ruled out any general unemployment in the long run. These views are known as the classical theory of output and employment.
The classical theory of employment can be three dimensions.
A. Goods market equilibrium → Say’s market law
B. Money market equilibrium → Say’s market law
C. Equilibrium of the labour market (Pigou wage – cut policy)
Assumptions of classical theory of employment:
The classical theory of employment is based on the following assumptions.
- There is a free enterprise economy.
- The economy operates under conditions of perfect competition.
- There is no government interference in the economy, and price mechanism is allowed to work freely.
- The equilibrium is viewed from the long-term perspective.
- It is assumed that all savings are automatically converted into investment.
- Both interest rates and wage rates are flexible, adjusting to restore equilibrium.
- There are no constraints on market expansion.
- Money acts as a medium of exchange and does not influence output and employment.
A) Goods market equilibrium:
The 1st part of Say’s law of markets explains the goods market equilibrium. According to J.B. Say “supply creates its own demand”. Say’s taw states that supply always equals demand. Whenever additional output is produced in the economy, the factors of production which participate in the process of production.
The total income generated is equivalent to the total value of the output produced. Such income creates additional demand for the sale of the additional output. Thus there could be no deficiency in the aggregate demand in the economy for the total output. Here everything is automatically adjusting without need of government intervention.
The classical economists believe that economy attains equilibrium in the long run at the level of full employment. Any disequilibrium between aggregate demand and aggregate supply equilibrium adjusted automatically. This changes in the general price level is known as price flexibility.
B) Money market equilibrium:
The goods market equilibrium leads to bring equilibrium of both money and labour markets. In goods market, it is assumed that total income spent the classical economists agree that part of the income may be saved. But the savings is gradually spent on capital goods. The expenditure on capital goods is called investment. It is assumed that equality between savings and investment is brought by the flexible rate of interest.
C) Labour market equilibrium:
According to the classical economists, unemployment may occur in the short run. This is not because the demand is not sufficient but due to increase in the wages forced by the trade unions. A.C. Pigow suggests that reduction in the wages will remove unemployment. This is called wage – cut policy. A reduction in the wage rate results in the increase in employment.
Question 2.
Describe the Keynesian theory of employment with the help of diagram.
Answer:
Classical Economists consider full employment as general phenomenon in long run. Keynes argued that full employment was a rare phenomenon and in general there would always be less than full employment at equilibrium in an economy. According to Keynesian theory, the level of employment is determined by two factors: 1. Aggregate demand, 2. Aggregate supply.
Keynes theory of employment is the principle of effective demand. He called his theory, general theory because it deals with aH levels of employment. The term effective demand is used to denote that level of aggregate demand which is equal to aggregate supply.
According to Keynes where, aggregate demand and aggregate supply are intersected at that point effective demand is determined. This effective demand will determine the level of employment.
Aggregate Supply (AS): The term aggregate supply refers to the total supply of all commodities produced by all entrepreneurs together in the economy at a particular level of employment. As employment increases, aggregate supply also increases. The AS curve slopes upwards from left to right.
The AS curve starts at origin which means that aggregate supply is zero at zero employment. It increases with increase in employment but becomes vertical and parallel to the y-axis at full employment level which means that it cannot be increased further.
Aggregate Demand (AD): When commodities are produced, the households and entrepreneurs receive income. Households spend their income on consumption goods which is called consumption expenditure (C), while the entrepreneurs spend their income on capital goods which is called investment expenditure (I). Together, the total expenditure is called “Aggregate Demand.”
AD = C + I
Aggregate Demand increases as employment increases. So, AD curve also slopes upwards from left to right. It maybe observed that the AD curve starts above the origin on Y-axis. It means that even in the absence of employment, there will be some minimum consumption expenditure. Households use their past savings or borrow money to spend on essentials.
Equilibrium:
Aggregate supply and aggre gate demand are not equal at all levels of employment. Initially aggregate demand will be more than aggregate supply and at some level of employment they become equal and at further employment levels aggregate supply will be more than aggregate demand. It may be seen in that AS Curve and AD curve intersect at point ‘E’ which indicates equilibrium at OYu level of employment. ‘E’ indicates effective demand which refers to that level of aggregate demand which is equal to the aggregate supply.
It may also be observed that the AS curve becomes vertical at 0Yf level of full employment. At that level output cannot be increased. It maybe observed that there is equilibrium at OYu level of employment which is less than the full employment 0Yf. This equilibrium is referred to as low-level employment or underemployment equilibrium. Keynes considers this as general situation.
Question 3.
Explain various methods of redemption of public debt.
Answer:
Public debt refers to borrowings by a government, either from domestic or foreign sources.
Public debt is classified into two categories :
1. Internal debt: Internal debt is the borrowing from domestic sources such as banks, financial institutions and private individuals.
2. External debt: External debt is the borrowing by the government from the sources outside the country are called external debt. A government can raise external debt from the governments of other countries, international financial institutions such as World Bank and International Monetary Fund (IMF).
Redemption of public debt refers to the repayment of borrowings by the government. Internal debt can be repaid in the domestic currency, but to repay external debt, foreign exchange is necessary.
Methods of redemption of public debt:
The following are the methods of redemption of public debt.
1. Surplus budget: The surplus budget means having public revenue in excess of public expenditure. If the government plans for a surplus budget, the excess revenue may be utilized to repay public debt.
2. Surplus balance of payments: This is useful to repay external debt for which foreign exchange is required. A surplus in the balance of payments implies exports in excess of imports by building up foreign exchange reserves.
3. Refunding: Refunding implies the issue of fresh bonds and securities by the government, so that the matured loans can be used for repayment of public debt.
4. Sinking fund: In this method, the government creates a separate fund called ‘sinking fund’ for the purpose of repaying public debt. A part of the public revenue is deposited into this fund every year public debt is repaid from the sinking fund. This is considered as the best method of redemption.
5. Terminable Annuities: This method is similar to a sinking fund. Under this method, the government repays part of the public debt every year by issuing terminable annuities to the bond holders. Such annual payments are made regularly until the debt is completely cleared.
6. Conversion: Conversion means that the existing loans are converted into new loans before the date of their maturity. This method is advantageous when the rate of interest on new loans is less than that on the existing loans.
7. Additional taxation : The government may impose additional taxes to raise funds for debt repayments. Under this method new taxes are imposed.
Question 4.
Describe various components of a budget.
Answer:
Budget is the annual statement showing the estimated receipts (revenue) and esspeftdttateof the gawenawant for a financial year (April 1st – March 3rd). The word ‘Budget’ was derived from the French word “Bougette” which means “small leather bag”.
Components of Budget: The government budget consists of two main components: Revenue Budget and Capital Budget. They are presented as revenue account and capital account in the budget documents. Each consists of receipts and expenditure as shown below.
I. Revenue Budget:
a) Revenue Receipts: Revenue receipts are those receipts that do not lead to a claim on the government. They are therefore termed non-redeemable. They are divided into tax and non-tax revenues, tax revenues are divided into direct taxes and indirect taxes. Non-tax revenue consists of interest receipts, dividends aad profits on government investments.
b) Revenue Expenditure: Revenue expenditure is expenditure incurred for purposes other than the creation of physical or financial assets of the central government, ft relates to those expenses incurred for the normal functioning of the government departments and various services, such as interest payments, subsidies, and pensions.
II. Capital Budget:
a) Capital Receipts: These include market loans and borrowings. Market loans are raised from the public by floating bonds and securities. Borrowings include loans raised from the Reserve Bank of India and financial institutions by selling Treasury Bilk. The government may also receive loans from World Bank and IMF.
Another source is small savings such as National Savings Certificates, provident fund etc. The government also receives money by way of loans or from the sale of its assets. Loans will have to be returned to the agencies from which they have been borrowed. Thus, capital receipts liabilities for the government.
b) Capital Expenditure: Capital expenditure refers to the government spending that results in the creation of physical or financial assets or the reduction in financial liabilities. This includes expenditure on the acquisition of land, buildings, machinery, equipment, investment in shares, and loans and ad-vances by the central government to state and union territory governments.