Calculate National Income and Personal Disposable Income:
|(ii)||Private final consumption expenditure||600|
|(v)||Government final consumption expenditure||100|
|(vii)||Net domestic fixed capital formation||70|
|(viii)||Net indirect tax||60|
|(x)||Change in stocks||(-) 10|
|(xii)||Net factor income to abroad||10|
Computation of National Income:
National Income = Private final consumption expenditure + Government final consumption
expenditure + (Net domestic fixed capital formation + depreciation + change in stock) -
net imports - depreciation - Net Indirect Taxes - Net factor income to abroad
National income = 600 + 100 + (70 + 14 - 10) - 20 - 14 - 60 – 10
or National income = Rs 670 crore
Computation of Disposable income:
Personal Disposable Income = Private income - Undistributed profits - Corporation tax –Personal tax
or, Personal Disposable Income = 650 - 30 - 50 – 80
or, Personal Disposable Income = Rs 490 crore
Explain the concept of Inflationary Gap. Explain the role of Repo Rate in reducing this gap.
Explain the concept of Deflationary Gap and the role of 'Open Market Operations' in reducing this gap.
Inflationary gap is also referred to as excess demand. When aggregate demand is greater than aggregate supply, at full employment level in the economy, it is referred to as inflationary gap or excess demand. This situation actually results in an increase of prices, that is inflation.
Graphically, it is represented by the vertical distance between the actual level of aggregate demand (ADE) and the full employment level of output (ADF).
In the figure, EY denotes the aggregate demand at the full employment level of output and FY denotes the actual aggregate demand. The vertical distance between these two represents inflationary gap. That is,
FY – EY = FE (Inflationary Gap)
In the figure, AD1 and AS represent the aggregate demand curve and aggregate supply
curve respectively. The economy is at full employment equilibrium at point “E”, where AD1 intersects AS curve. At this equilibrium point, OY represents full employment level and EY is aggregate demand at the full employment level of output.
Suppose that the actual aggregate demand for output is FY, which is higher than EY. This implies that actual aggregate output demanded by the economy FY is more than the potential (full employment) aggregate output EY. Thus, the economy is facing surplus demand. This situation is termed as excess demand. As a result of the excess demand, inflationary gap arises. The inflationary gap is measured by the vertical distance between the actual aggregate demand for output and the potential (or full employment level) aggregate demand. In other words, the distance between FY and EY, i.e. FE represents the inflationary gap.
Repo rate refers to the rate at which the central bank lends to the commercial bank. In case of inflationary gap, the central bank would increase repo rate. An increase in the repo rate increases the cost of borrowings for the commercial banks. This discourages the demand for loans and borrowings. Thereby, the consumption expenditure falls, and hence aggregate demand falls.
Deflationary gap is otherwise called as deficit demand. It is a situation where aggregate demand is less than aggregate supply at the level of full employment. Graphically, it is represented by the vertical distance between the aggregate demand at the full employment level of output (ADF) and the actual level of aggregate demand (ADE). In the figure below, EY denotes the aggregate demand at full employment level of output and CY denotes the actual aggregate demand. The vertical distance between these two represents deflationary gap.
EY – CY = EC (Deflationary Gap)
In the figure, AD1 and AS represent the aggregate demand curve and aggregate supply curve. The economy is at full employment equilibrium at point “E”, where AD1 intersects at AS curve. At this equilibrium point, OY represents the full employment level of output and EY is the aggregate demand at the full employment level of output.
Let us suppose that the actual aggregate demand for output is only CY, which is lower than EY. This implies that actual aggregate output demanded by the economy CY falls short of the potential (full-employment) aggregate output EY. Thus, the economy is facing a deficiency in demand. This situation is termed as deficit demand. As a result of the deficit demand, deflationary gap arises. The deflationary gap is measured by the vertical distance between the potential (or full employment level) aggregate demand and the actual aggregate demand for output. In other words, the distance between EY and CY,
i.e. EC represents the deflationary gap.
To correct deflationary gap, the central bank purchases the securities in the market through Open market operations (OMO). It refers to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system. Through OMO, the flow of money is increased and subsequently enhancing the purchasing power of the people. The higher purchasing power increases the aggregate demand.
Where will sale of machinery to abroad be recorded in the Balance of Payments Accounts? Give reasons.
Sale of machinery to abroad (exports) will be recorded as positive item in the current account of BOP.
Current account refers to an account which records all the transactions relating to export and import of goods and services and unilateral transfers during a given period of time. Current account contains the receipts and payments relating to all the transactions of visible items, invisible items and unilateral transfers. Those transactions that result in a inflow of foreign exchange in the country are recorded as positive items in the current account of BOP. On the other hand, those items that lead to an outflow of foreign exchange from the country are recorded as negative items in the current account of BOP. Therefore, as sale of machinery abroad leads to an inflow of foreign exchange in the country it will be recorded as a positive item in the current account of BOP.
Explain the 'bank of issue' function of the central bank.
Explain 'Government's Bank' function of central bank.
The central bank is the bank of issue. It has the monopoly of note issue. Notes issued by it circulate as legal tender money. It has its issue department which issues notes and coins to commercial banks. Coins are manufactured in the government mint but they are put into circulation through the central bank.
However, the currency issued by the central bank is its monetary liability. In other words, the central bank is obliged to back the currency issued by it by assets of equal value such as gold coins and bullions, foreign exchange. In addition to issuing currency to the general public, the central bank also issues currency to the central government of the country.
Central banks act as bankers, fiscal agents and advisers to their respective governments. As a banker to the government, the central bank keeps the deposits of the central and state governments and makes payments on behalf of governments. But it does not pay interest on governments deposits. It buys and sells foreign currencies on behalf of the government. It keeps the stock of gold of the government. Thus it is the custodian of government money and wealth. As a fiscal agent, the central bank makes short-term loans to the government for a period not exceeding 90 days. It floats loans, pays interest on them, and finally repays them on behalf of the government. Thus it manages the entire public debt. The central bank also advises the government on such economic and money matters as controlling inflation or deflation, devaluation or revaluation of the currency, deficit financing, balance of payments, etc.
Giving reason, explain how the following should be treated in estimation of national income:
(i) Expenditure by a firm on payment of fees to a chartered accountant
(ii) Payment of corporate tax by a firm
(iii) Purchase of refrigerator by a firm for own use
(i) The services of chartered accountant hired by the firm should not be included in the estimation of national income. This is because it forms a part of the firm’s intermediate consumption.
(ii) Corporate profits already form part of national income. Hence Payment of corporate tax is not included in the national income as it is a mere transfer payment from the firm to the government.
(iii) Purchase of refrigerator by a firm for own use will be included in the national income as it is regarded as final consumption expenditure.
A consumer consumes only two goods X and Y both priced at Rs. 3 per unit. If the consumer chooses a combination of these two goods with Marginal Rate of Substitution equal to 3, is the consumer in equilibrium? Give reasons. What will a rational consumer do in this situation? Explain.
A consumer consumes only two goods X and Y whose prices are Rs. 4 and Rs. 5 per unit respectively. If the consumer chooses a combination of the two goods with marginal utility of X equal to 5 and that of Y equal to 4, is the consumer in equilibrium? Give reason. What will a rational consumer do in this situation? Use utility analysis.
At the point of consumer equilibrium, the following equality should be met:
MRS = Px/Py
MRS = 3 (given)
Px/Py= 3/3 = 1
Thus, MRS is greater than the price ratio.
In order to reach the equilibrium point, a rational consumer would increase the consumption of good X and decrease that of good Y.
According to the utility approach, a consumer reaches an equilibrium where the following equality is met.
MUx/Px = MUY/Py
MUx/Px =5/4 (given)
MUY/Py = 4/5
So MUx/Px is greater than MUY/Py . Thus a rational consumer has to increase the consumption of good X and decrease that of good Y in order to reach equilibrium.
An economy is in equilibrium. Calculate national income from the following:
Autonomous consumption (C) = 100
Marginal propensity to save (S) = 0.2
Investment expenditure (I) = 200
Autonomous consumption (C) = 100
Marginal propensity to save (S) = 0.2
Therefore MPC (c) = 1 - MPS = 1 - 0.2 = 0.8
Investment expenditure (I) = 200
Y = C+I at equilibrium = C+cY +I
Hence, Y-0.8Y = 300
0.2Y = 300
So, Y = 300/.2 = 1,500
Government of India has recently launched 'Jan-Dhan Yojna' aimed at every household in the country to have at least one bank account. Explain how deposits made under the plan are going to affect national income of the country.
With the Jan Dhan Yojna a greater number of individuals are brought under the ambit of banking system. Those individuals who earlier did not have savings account now have access to banking facilities and have opened savings account with the commercial banks.
In this way, the commercial banks are able to tap greater savings which in turn can be used to lend loans for investment purposes. Thus, the yojna indirectly helps in increasing the investment and production in the economy which in turn would help in improving the national income.
Explain the role the government can play through the budget in influencing allocation of resources.
Allocation of resources is one of the important objectives of government budget. In a mixed economy, the private producers aim towards profit maximisation, while, the government aims towards welfare maximisation. The private sector always tend to divert resources towards areas of high profit, while, ignoring areas of social welfare. In such a situation, the government through the budgetary policy, aims to reallocate resources in accordance with the economic (profit maximisation) and social (public welfare) priorities of the country. Government can influence allocation of resources through:
(i) Tax concessions or subsidies:
To encourage investment, government can give tax concession, subsidies etc. to the producers. For example, Government discourages the production of harmful consumption goods (like liquor, cigarettes etc.) through heavy taxes and encourages the use of ‘Khaki products’ by providing subsidies.
(ii) Directly producing goods and services:
If private sector does not take interest, government can directly undertake the production.