Government Budget and Economy - Class 12 Economics - Chapter 5 - Notes, NCERT Solutions & Extra Questions
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Extra Questions - Government Budget and Economy | Macroeconomics | Economics | Class 12
Inflation is which type of phenomenon?
A) Regional
B) Practical
C) Theoretical
D) Global
The correct answer is Option D: Global.
Inflation is a global phenomenon. This can be illustrated by historical events such as the notable rise in global crude oil prices in 1973, followed by a staggering 130% increase in prices by the Organisation of Petroleum Exporting Countries in 1980, which led to inflated costs for crude oil imports worldwide.
Fiscal Policy is related to:
a) Money supply in the economy
b) Regulation of the banking system
c) Planning for economic development
d) Government's Revenue and Expenditure
The correct option is D) Government's Revenue and Expenditure.
Explanation:
Fiscal policy is primarily concerned with the government's revenue and expenditure in the economy. It involves how the government earns (through taxes and other means) and spends money to influence the economic activities of a country.
Government collects tax money from people to:
A. earn income
B. provide services to people
C. control people
D. make profits
The correct answer is B. provide services to people.
The primary function of tax collection by the government is to provide services to the public. This includes responsibilities such as maintaining health services, ensuring access to clean drinking water, and constructing and repairing roads, among many other essential services.
Whose resignation results in the resignation of the entire Council of Ministers?
A) 10 Cabinet Ministers
B) The Prime Minister
C) The Finance Minister
D) The Home Minister
The correct answer is B) The Prime Minister.
When the Prime Minister resigns, it leads to the resignation of the entire Council of Ministers. This is because the Prime Minister holds the central executive authority, and their resignation symbolizes the loss of majority support in the legislature, leading the entire government to resign.
Q. Which of the following can be a part of the Finance bill but not a part of the Appropriation bill?
The abolition of Commodity Transaction tax.
The amendments to the Income Tax Act 1961.
The expenditure charged on the consolidated fund of India.
Select the correct answer using the codes given below:
A) 1 and 2 only
B) 2 and 3 only
C) 1 and 3 only
D) 1, 2 and 3
The correct option is A (1 and 2 only)
Explanation:
Statements 1 and 2 are correct: The primary purpose of the Finance Bill is to implement the government's financial policies for the upcoming fiscal year. It adheres to all conditions applicable to a Money Bill, including those specified in Article 110 (1)(a) of the Constitution. The Finance Bill encompasses proposals like the abolition or modification of taxes delineated in the budget. It is also the instrument through which amendments to laws such as the Income Tax Act 1961 are enacted, thus adjusting the financial laws according to the budgetary proposals.
Statement 3 is incorrect: The Constitution mandates that no funds can be withdrawn from the Consolidated Fund of India without proper legislative appropriation. The Appropriation Bill facilitates this by legalizing all expenditure, including those charged on the fund, which is pre-approved without further debate. Hence, changes affecting the amount or destination of such expenditure are not permissible in the Appropriation Bill, making its scope different from that of the Finance Bill which can introduce new tax laws or modify existing ones without direct impact on the appropriations.
Thus, only Statements 1 and 2 can be part of a Finance Bill and not part of an Appropriation Bill, confirming option A as the correct answer.
Why should revenue deficit be curbed?
Revenue deficit occurs when the government's unproductive expenditure (such as costs related to subsidies, law and order, and defence) exceeds its tax and non-tax revenue. This situation primarily contributes to the fiscal deficit without significantly enhancing the flow of goods and services in the economy.
Resorting to borrowing or disinvestment are common strategies to manage a revenue deficit. Borrowing increases the national debt, which can have long-term economic repercussions. On the other hand, disinvestment involves transferring assets from the public sector to the private sector, marking a shift from social welfare to profit maximization.
Given these implications, it is clear that curbing the revenue deficit is essential to maintain economic stability and prioritize social welfare.
India, as of today, is deeply \qquad with financial difficulties, but the Government has taken a pledge to set everything right within five years.
A Saturated
B Engrossed
C Swamped
D Vexed
(E) Ruined
The correct answer is C) Swamped.
Swamped implies being overwhelmed or overburdened, which closely fits the context of the sentence:
India, as of today, is deeply swamped with financial difficulties, but the Government has taken a pledge to set everything right within five years.
This usage highlights that India is heavily burdened by financial issues, consistent with the typical usage of 'swamped' to describe being inundated or overwhelmed, often in a way that is difficult to manage.
Read these sentences to find out whether there is any grammatical mistake/error in them. The error, if any, will be in one part of the sentence. Mark the part with the error as your answer. If there is no error, mark 'No error' as your answer. (Ignore the errors of punctuation, if any.)
A. The two most important numbers
B. Which the mandarins of an
C. Economy have to watch
D. Are inflation and unemployment (E) No error
The correct answer is E. No error.
The sentence presented is grammatically correct in all its parts. Each segment correctly follows the rules of English syntax and grammar, resulting in a coherent and well-structured sentence. Therefore, the appropriate choice is 'No error'.
Open market operations of the RBI
A) Increases the total stock of government securities in the economy
B) Reduces the total stock of government securities in the economy
C) Changes the proportions of government securities held by various players
D) Leads to no changes in the government securities holding
Correct Answer: C
Explanation:
Open Market Operations (OMO), conducted by the Reserve Bank of India (RBI), involve the buying and selling of government securities in the open market. This strategy is used by the RBI to adjust the liquidity in the banking system. When the RBI purchases government securities, it injects money into the banking system, thereby promoting economic growth. Conversely, selling government securities withdraws money from the banking system, helping to control inflation. This process changes the proportions of government securities held by various players in the economy, hence the correct option is C.
You won a lottery worth Rs. 20,000. You spent Rs. 2,850 on your shopping and Rs. 450 on eating. Find the amount of money left with you.
Solution
From the lottery winnings of Rs. 20,000, the expenditures were as follows:
- Rs. 2,850 on shopping
- Rs. 450 on eating
The total amount spent can be calculated by summing these expenditures: $$ 2850 + 450 = 3300 $$
Thus, the total expenditure is Rs. 3,300.
To find out the amount remaining, subtract the total expenditure from the total winnings: $$ 20000 - 3300 = 16700 $$
Therefore, the amount left with you after the expenditures is Rs. 16,700.
There is no difference between GDP at market price and GDP at factor cost in a two-sector economy including household sector and producer sector.
A) True
B) False
The correct answer is A) True.
The difference between GDP at market price and GDP at factor cost primarily arises due to net indirect taxes, which is calculated as:
$$ \text{Net Indirect Taxes} = \text{Indirect Taxes} - \text{Subsidies} $$
In a two-sector economy consisting only of the household sector and the producer sector, there is no involvement of the government sector. Consequently, taxes and subsidies, which are typically introduced by the government, do not exist in this scenario. Hence, without these fiscal elements, the GDP at market price equals GDP at factor cost, affirming the statement as true.
What are the different documents presented in the full budget?
Demands for Grants
Vote on account
Finance Bill
Select the correct answer using the codes given below:
Only 1 and 2
Only 2 and 3
Only 1 and 3
All of the above
The correct option is C - Only 1 and 3
When a full budget is presented, it typically includes various documents. Among them, the most critical ones are:
Annual Financial Statement
Demands for Grants
Receipts Budget
Expenditure Budget
Finance Bill
The Vote on account is specifically meant for an interim approval allowing government expenditure for a limited period, rather than representing a comprehensive financial statement that includes policy changes and fiscal details. Thus, it does not count as part of the standard documents of a full budget like the Annual Financial Statement or the Finance Bill.
Therefore, the documents Demands for Grants and Finance Bill are the relevant parts of a full budget, making the correct answer Only 1 and 3.
Why do you think privatization helps improve the position of the economy?
A. Increased efficiency
B. More equitable
C. Cheaper products
D. Less corruption
The correct options are:
A. Increased efficiency
D. Less corruption
Privatization aligns with the principles of free-market economics, which endorse minimal government intervention. This process often leads to increased efficiency in business operations as private companies are driven by profit motives and competitive pressures. Additionally, it can contribute to less corruption as privatization reduces the opportunities for corrupt practices by decreasing the interface between government officials and the allocation of resources.
Consider the following statements:
Policy cut motion - The amount of the demand should be reduced by Rs. 100.
Economy cut motion - The amount of demand should be reduced by a specific amount.
Token cut motion - The amount of the demand should be reduced to Re 1.
Which of the above is/are correctly matched?
A) 1 only B) 2 only C) 1 and 3 only D) All of the above
The correct answer is B) 2 only.
Explanation of the motions:
Policy Cut Motion: This motion reflects disapproval of the policy underlying a demand for grant. It suggests that the amount of the demand should be reduced to ₹1, indicating symbolic opposition without a specific financial implication beyond this nominal reduction.
Economy Cut Motion: This motion suggests that there could be an economy in the proposed expenditure, aiming for a specific reduction amount. It may propose either a lump sum reduction or the omission or reduction of specific items within the grant.
Token Cut Motion: This motion addresses a specific grievance directly related to the government's responsibility. It suggests reducing the demand by ₹100 to express the grievance without significantly impacting the budget.
Choice B is correct as only the definition of the Economy Cut Motion is matched correctly with its description.
A TV is valued at ₹30,000. If its value falls by 5% per year, what will be its value after 2 years?
A Rs 27,075
B Rs 37,075
C Rs 27,080
D Rs 27,085
The correct answer is A Rs 27,075. Here is the step-by-step calculation:
Initial Value of the TV ($P$): $$ P = ₹30,000 $$
Annual Depreciation Rate ($r$): $$ r = -5% $$
Period of Time ($n$), here it is 2 years: $$ n = 2 $$
Formula to calculate the value after $n$ years, considering a depreciation rate: $$ A = P \left(1 + \frac{r}{100}\right)^n $$
Filling in the known values: $$ A = 30,000 \left(1 + \frac{-5}{100}\right)^2 = 30,000 \left(\frac{95}{100}\right)^2 $$
Perform the calculation: $$ A = 30,000 \times \frac{95}{100} \times \frac{95}{100} = 27,075 $$
Therefore, the value of the TV after two years is ₹27,075.
Britain gained the most from the Industrial Revolution before the war, but after the war its economy was in shambles. Select the reason for this:
A. It lost its grip over all the colonies.
B. It spent most of the money and materials on the war.
C. It borrowed a lot of money from the USA.
D. Unemployment increased due to a decrease in demand.
The correct reasons are:
B. It spent most of the money and materials on the war.
C. It borrowed a lot of money from the USA.
D. Unemployment increased due to a decrease in demand.
Britain, once a robust economy before the war, faced a severe economic downturn post-war. The country had accumulated substantial external debts by borrowing heavily from the USA to finance the war efforts. Moreover, a significant amount of national resources were allocated to the war, which left the economy depleted. As production scaled back after the war, unemployment rates soared due to reduced demand, exacerbating the economic crisis.
$38745 + 26944 + 53217$ ?
(A) 218906
(B) 125906
(C) $\mathbf{1 1 8 9 0 6}$
(D) $\mathbf{1 1 7 9 0 6}$
(E) None of these
To solve the problem $38745 + 26944 + 53217$, we need to calculate the sum of those three numbers:
First, add $38745$ and $26944$, which equals: $$ 38745 + 26944 = 65689 $$
Then, add $65689$ to $53217$: $$ 65689 + 53217 = 118906 $$
Thus, the total sum is 118906. Therefore, the correct option is (C) $\mathbf{118906}$.
What measures do experts suggest be taken to ensure targeted economic growth?
A Lowering of interest rates to help industries hit by recession.
B Prolonged financial support for basic input industries.
C Incentives to Indian companies to invest in infrastructure.
D Formulation of policies and their implementation in factor markets.
E Stringent implementation of licensing system.
The correct answer is D: Formulation of policies and their implementation in factor markets.
Formulation of policies and their implementation in factor markets can ensure targeted economic growth, as indicated in the last paragraph of the passage.
The officialdom, shocked and frightened by the general unrest, expanded local relief efforts, hoping to moderate the depression's severity and to re-establish social order.
A. The officialdom, shocked and frightened by the general unrest, expanded local relief efforts, hoping to moderate the depression's severity and to re-establish social order.
B. Officialdom, shocked and frightened by the general unrest, expanded local relief efforts, and hoped to moderate the depression's severity and to re-establish social order.
C. The officialdom, shocked and frightened by the general unrest, expanded local relief efforts, and hoped to moderate the depression's severity and to re-establish social order.
D. The officialdom, shocked and frightened by the general unrest, expanded local relief efforts, moderated the depression's severity, and re-established social order.
The correct answer is Option A: The officialdom, shocked and frightened by the general unrest, expanded local relief efforts, hoping to moderate the depression's severity and to re-establish social order.
Option A is the only grammatically correct choice. It effectively uses the modifiers "shocked and frightened" which are well placed near their subject, "The officialdom". This option accurately connects the actions and intentions – expanding local relief efforts with the hope of moderating the depression's severity and re-establishing social order – in a cohesive manner.
A) What are the difficulties in the construction of the consumer price index? B) An enquiry into the budgets of middle class families in a certain city gave the following information:
Expenses On | Food (30%) | Fuel (10%) | Clothing (20%) | Rent (15%) | Other (20%) |
---|---|---|---|---|---|
Price in 2004 (₹) | 1500 | 250 | 750 | 300 | 400 |
Price in 1995 (₹) | 1400 | 200 | 500 | 200 | 250 |
What is the cost of living index of 2004 as compared to 1995?
A) Difficulties in Constructing the Consumer Price Index
Variation in Retail Prices: Retail prices can vary significantly from shop to shop, place to place, and even consumer to consumer. Hence, index numbers created using these prices might not be universally applicable across different locations or for different demographic groups.
Unstable Quality of Commodities: Many commodities included in the index may have unstable qualities that change over time. These variations can introduce inaccuracies when comparing the cost of living over time.
Different Expenditure Ratios: The ratio of expenditure on various commodities can differ across time periods and among different individuals. This discrepancy complicates the construction of accurate cost of living indices.
Thus, cost of living indices will vary depending on the region, demographic group, or community in question.
B) Cost of Living Index Calculation for 2004 as Compared to 1995
Given the following data:
Expenses On | Food (30%) | Fuel (10%) | Clothing (20%) | Rent (15%) | Other (20%) |
---|---|---|---|---|---|
Price in 2004 (₹) | 1500 | 250 | 750 | 300 | 400 |
Price in 1995 (₹) | 1400 | 200 | 500 | 200 | 250 |
To find the cost of living index, we use the formula:
$$ \textbf{Price Relatives} \ (R) = \left( \frac{P_{1}}{P_{0}} \right) \times 100 $$
Commodity | 1995 $(P_0)$ | 2004 $(P_1)$ | Price Relatives $(R)$ | Weights $(W)$ | RW |
---|---|---|---|---|---|
Food | 1400 | 1500 | 107.14 | 35 | 3749.9 |
Fuel | 200 | 250 | 125 | 10 | 1250 |
Clothing | 500 | 750 | 150 | 20 | 3000 |
Rent | 200 | 300 | 150 | 15 | 2250 |
Others | 250 | 400 | 160 | 20 | 3200 |
$\Sigma W = 100$ | $\Sigma RW = 13449.9$ |
To calculate the Cost of Living Index for 2004:
$$ \text{Cost of Living Index} = \frac{\Sigma RW}{\Sigma W} = \frac{13449.9}{100} = 134.499 $$
Thus, the Cost of Living Index is 134.499, indicating a 34.499% increase in prices in 2004 compared to 1995.
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Ask Chatterbot AINCERT Solutions - Government Budget and Economy | Macroeconomics | Economics | Class 12
Explain why public goods must be provided by the government.
Public goods must often be provided by the government due to their distinct characteristics:
-
Non-excludability: Public goods are non-excludable, meaning that it is not feasible to prevent individuals from using them even if they do not pay for them. For example, once a public park is established, or a national defense system is in place, it is not practical to exclude people from benefiting from these services.
-
Non-rivalrous consumption: The use of public goods by one individual does not diminish the availability of these goods for consumption by others. For instance, the utilization of a street light or a public broadcast does not prevent others from enjoying the same light or information.
These characteristics lead to the free-rider problem, where individuals would not voluntarily pay for the public good because they can benefit from it without contributing financially. This results in the potential for these goods to be underproduced or not produced at all if left to private markets.
Government intervention is therefore essential to ensure the provision of such goods since the market may fail to provide them due to the lack of profit incentive stemming from their non-excludable and non-rival nature.
Distinguish between revenue expenditure and capital expenditure.
Revenue Expenditure vs Capital Expenditure
-
Revenue Expenditure:
- Definition: These are expenditures incurred by the government for its operational needs and routine functions, such as salaries, subsidies, and interest payments.
- Purpose: Primarily for the normal functioning of government departments and services.
- Asset Creation: Does not result in the creation of any physical or financial assets.
- Impact on Financial Health: It generally covers expenses that maintain the existing system or status quo within the economy.
-
Capital Expenditure:
- Definition: Expenditures that result in the creation of physical or financial assets or reduce liabilities. Examples include spending on infrastructure like roads, schools, hospitals, etc.
- Purpose: For creating long-term assets that provide benefits over a number of years.
- Asset Creation: Results in the creation of assets or the reduction of liabilities.
- Impact on Financial New values added: Boosts the productive capacity of the economy and potentially enhances future economic growth.
Key Differences: The main difference lies in the nature and impact of the spending. Revenue expenditure maintains current operations and services, while capital expenditure is investment-oriented, aimed at building and maintaining assets that have long-term benefits.
‘The fiscal deficit gives the borrowing requirement of the government’. Elucidate.
The statement "The fiscal deficit gives the borrowing requirement of the government" means that the fiscal deficit quantifies the total amount that the government needs to borrow in order to cover its expenses when its total expenditure exceeds its revenue from non-borrowing sources.
Fiscal Deficit is calculated as:
$$ \text{Fiscal Deficit} = \text{Total Expenditure} - (\text{Revenue Receipts} + \text{Non-debt Creating Capital Receipts}) $$
Here:
- Total Expenditure includes all types of government spending.
- Revenue Receipts include taxes and other forms of revenue.
- Non-debt Creating Capital Receipts are receipts which do not lead to a debt increase, such as profits from investments.
If the government has a fiscal deficit, it indicates a shortfall in funds which must be financed through borrowing. This makes the fiscal deficit a crucial indicator of the amount of money the government needs to borrow in a given financial year, impacting the country's debt level and economic stability.
Give the relationship between the revenue deficit and the fiscal deficit.
The retest deficit and the fiscal deficit are closely related but measure different aspects of a government's budget.
-
Revenue Deficit: It represents the excess of the government's revenue expenditure over its revenue receipts. It indicates that the government is dissaving, implying the use of resources from other sectors to finance part of its consumption expenditure.
-
Fiscal Deficit: It is the difference between the total expenditure of the government and its total receipts excluding borrowings. It represents the total borrowing needs of the government, including both consumption and investment expenditures.
The relationship is such that the revenue deficit is a component of the fiscal deficit. The fiscal deficit is essentially the sum of the revenue deficit and the net of capital expenditure minus non-debt creating capital receipts. Therefore, if the revenue deficit is significant, it suggests that a large portion of the government's borrowing is used to cover its operational expenses rather than for investment, reflecting a more consumption-oriented use of borrowed funds.
Mathematically:
$$ \text{Fiscal Deficit} = \text{Revenue Deficit} + (\text{Capital Expenditure} - \text{Non-debt Creating Capital Receipts}) $$
Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes (that is lump-sum taxes minus transfers) is 100 and consumption is given by C = 100 + 0.75Y (a) What is the level of equilibrium income? (b) Calculate the value of the government expenditure multiplier and the tax multiplier. (c) If government expenditure increases by 200, find the change in equilibrium income.
To solve this, we'll break down the problem into three parts as requested: finding the equilibrium income, calculating the government expenditure multiplier and tax multiplier, and determining the change in equilibrium income if the government expenditure increases by 200.
Part (a): Equilibrium Income
The Keynesian cross model equation for aggregate demand $AD$ in an economy is: [ AD = C + I + G ] where
- ( C ) is consumption,
- ( I ) is investment,
- ( G ) is government expenditure.
Given,
- ( C = 100 + 0.75Y ),
- ( I = 200 ),
- ( G = 150 ),
- ( T = 100 ).
We adjust for taxes by updating the consumption function: [ C = 100 + 0.75(Y - T) ]
Substituting ( T ): [ C = 100 + 0.75(Y - 100) ] [ C = 100 + 0.75Y - 75 ] [ C = 25 + 0.75Y ]
Now, setting $AD$ equals to output ( Y ): [ Y = 25 + 0.75Y + 200 + 150 ]
Part (b): Government Expenditure Multiplier and Tax Multiplier
-
Government Expenditure Multiplier: It’s the ratio of a change in the level of output (or income) to a change in government expenditures: [ \frac{1}{1 - MPC} ] where MPC is the marginal propensity to consume.
-
Tax Multiplier: It’s derived similarly but includes a negative sign because taxes decrease disposable income: [ -MPC \times \text{Government Expenditure Multiplier} ]
Part (c): Change in Equilibrium Income with an Increase in G
Given (\Delta G = 200) and using the government expenditure multiplier, we apply: [ \Delta Y = \text{Multiplier} \times \Delta G ]
Let's calculate these values using the information provided.
Results
(a) Equilibrium Income: The equilibrium level of income ( Y ) is calculated to be ( 1500 ).
(b) Value of the Government Expenditure Multiplier: The government expenditure multiplier is [ \frac{1}{1 - 0.75} = 4 ] The Tax Multiplier is: [ \frac{-0.75}{1 - 0.75} = -3 ]
(c) Change in Equilibrium Income with an Increase in G of 200: The change in equilibrium income ( \Delta Y ) due to an increase in government expenditure ( \Delta G = 200 ) is: [ \Delta Y = 4 \times 200 = 800 ]
Thus, a $200 increase in government spending would result in an $800 increase in equilibrium income.
Consider an economy described by the following functions: C = 20 + 0.80Y, I = 30, G = 50, TR = 100 (a) Find the equilibrium level of income and the autonomous expenditure multiplier in the model. (b) If government expenditure increases by 30, what is the impact on equilibrium income? (c) If a lump-sum tax of 30 is added to pay for the increase in government purchases, how will equilibrium income change?
Answers:
(a) Equilibrium Level of Income and Autonomous Expenditure Multiplier
- Equilibrium Income ($Y^*$): The equilibrium level of income for the economy is $780$.
- Autonomous Expenditure Multiplier: The autonomous expenditure multiplier is $5$. This multiplier indicates that for each unit increase in autonomous expenditure, output (income) increases by five units.
(b) Impact of an Increase in Government Expenditure by $30$
- The increase in equilibrium income due to a $30$ increase in government expenditure, given the multiplier of $5$, is $150$. Hence, if government expenditure increases by $30$, the new equilibrium income will be higher by $150$.
(c) Effect of Funding the Expenditure Increase with a Lump-sum Tax of $30$
- Since the increase in government spending is exactly offset by the lump-sum tax, the increase in income from the increased government expenditure is $150$. However, the lump-sum tax would decrease disposable income and consumption, reducing the total increase in equilibrium income to zero. Thus, the balanced budget multiplier is $1$, leading to no net change in the equilibrium income.
In the above question, calculate the effect on output of a 10 per cent increase in transfers, and a 10 per cent increase in lump-sum taxes. Compare the effects of the two.
To calculate the effects on output of a 10% increase in transfers and a 10% increase in lump-sum taxes, we need to understand and use the multiplier effects described in the fiscal policy framework presented in your text.
Scenario 1: Effect of a 10% Increase in Transfers
Using the formula for the change in equilibrium income due to a change in transfers: $$ \Delta Y = \frac{c}{1-c} \Delta TR $$
Given a marginal propensity to consume ($c$) of $0.8$, the multiplier effect of transfers is then: $$ \frac{c}{1-c} = \frac{0.8}{1-0.8} = 4 $$
Now assuming that the original amount of transfer payments is $T_{0}$, a 10% increase is $0.1 T_{0}$. The change in output ($\Delta Y$) due to the 10% increase in transfers will be: $$ \Delta Y = 4 \times 0.1 T_0 = 0.4 T_0 $$
Scenario 2: Effect of a 10% Increase in Lump-Sum Taxes
Using the formula for the change in equilibrium income due to a change in lump-sum taxes: $$ \Delta Y = -\frac{c}{1-c} \Delta T $$
Given that $c = 0.8$, the tax multiplier effect is: $$ -\frac{c}{1-c} = -\frac{0.8}{1-0.8} = -4 $$
For a 10% increase in lump-sum taxes from an original tax amount $T$, the increase in taxes is $0.1 T$. The change in output will be: $$ \Delta Y = -4 \times 0.1 T = -0.4 T $$
Comparison
- Increase in Transfers: The output increases by $0.4 T_0$.
- Increase in Taxes: The output decreases by $0.4 T$.
This implies that a 10% increase in transfer payments stimulates the economy by an equal magnitude but in a positive direction as compared to a 10% increase in taxes, which contracts the economy. Consequently, fiscal policies involving increases in transfers are more stimulative under the same magnitude changes compared to increases in taxation.
We suppose that C = 70 + 0.70Y D, I = 90, G = 100, T = 0.10Y (a) Find the equilibrium income. (b) What are tax revenues at equilibrium income? Does the government have a balanced budget?
(a) Equilibrium Income ($Y^{*}$) is calculated using the formula $Y = C + I + G + (T - cT)$ where $C = 70 + 0.70Y_D$ (with $Y_D$ being the disposable income $Y - T$), $I = 90$, $G = 100$, and $T = 0.10Y$. Solving for $Y$, we find:
$$ Y = 70 + 0.70(Y - 0.10Y) + 90 + 100 = \frac{26000}{37} \approx 702.70 $$
(b) Tax Revenues at the equilibrium income are:
$$ T = 0.10 \times 702.70 \approx 70.27 $$
Government Budget Analysis:
- Total government spending $G = 100$.
- Tax revenue = $70.27$.
Since the tax revenues are less than the government spending, we conclude that the government has a deficit budget, not a balanced budget.
Suppose marginal propensity to consume is 0.75 and there is a 20 per cent proportional income tax. Find the change in equilibrium income for the following (a) Government purchases increase by 20 (b) Transfers decrease by 20.
(a) An increase in government purchases by 20 will result in an increase in equilibrium income by 50. (b) A decrease in transfers by 20 will result in a decrease in equilibrium income by 60.
Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier.
The tax multiplier is smaller in absolute value than the government expenditure multiplier due to the way each influences aggregate demand.
-
Government Expenditure Multiplier:
- An increase in government spending directly adds to aggregate demand and has a one-to-one immediate effect on aggregate demand before considering the multiplier process.
- The multiplier formula is: $$ \Delta Y = \frac{1}{1-c} \Delta G $$ Here, ( c ) is the marginal propensity to consume.
-
Tax Multiplier:
- A decrease in taxes increases disposable income, which in turn affects consumption, hence aggregate demand, but it does so indirectly and less potently.
- The multiplier works through changes in disposable income but influences consumption only by the fraction ( c ) (the marginal propensity to consume).
- The formula for the tax multiplier is: $$ \Delta Y = \frac{-c}{1-c} \Delta T $$
- Because of the ( c ) factor moderating the impact of tax changes, the tax multiplier has a smaller absolute value than the government spending multiplier.
Thus, government spending directly and fully impacts aggregate expenditure immediately, resulting in a larger multiplier. Tax changes affect consumption indirectly and are moderated by ( c ), making their absolute multiplier effect smaller.
Explain the relation between government deficit and government debt.
Government deficit and government debt are closely related concepts in fiscal policy:
-
Government Deficit: This occurs when a government's expenditures exceed its revenues during a particular period, typically a fiscal year. Deficits are a flow variable; they represent the amount by which spending exceeds income in a given period.
-
Government Debt: This is the accumulation of past deficits. It is a stock variable, representing the total amount of money that the government owes at a given point in time. Each year's deficit adds to the stock of debt because the government needs to borrow funds to cover the shortfall between its expenditures and revenues.
In short, deficits add to the stock of debt. Every year that a government runs a deficit, it increases its debt, as it needs to source additional funds (through borrowing) to meet its spending obligations.
Does public debt impose a burden? Explain.
Public debt can be viewed as a burden under certain conditions but not necessarily always. Here are the key considerations:
-
Intergenerational Burden: Public debt may impose a burden on future generations who will bear the cost of paying taxes to service the debt. This reduces their disposable income and may affect consumption and savings rates.
-
Crowding Out Effect: Government borrowing can lead to higher interest rates, making it more expensive for the private sector to borrow and invest. This could reduce private investment, potentially slowing economic growth.
-
Utility of Debt: If the government uses the borrowed funds for productive investments (like infrastructure or education) that boost economic growth, the debt can be less burdensome. These investments can increase future productivity and tax revenues, helping to offset the cost of the debt.
-
Economic Stability: Excessive public debt can lead to financial instability or crisis, especially if the debt must be financed by foreign borrowing.
However, under the theory of Ricardian equivalence, it is argued that borrowing and taxation are equivalent—suggesting that rational taxpayers anticipate future taxes to pay off debt and therefore save more, potentially offsetting the effects of government dissaving through borrowing.
In summary, whether public debt is a burden depends on its size, use, and the economic context. Misuse or excessive accumulation can indeed be burdensome, especially if not matched by corresponding economic growth.
Are fiscal deficits inflationary?
Fiscal deficits can be inflationary, especially when the government increases spending or cuts taxes, leading to an increase in aggregate demand. If the production capacity cannot cope with this augmented demand, prices may rise, contributing to inflation. However, this effect can be mitigated if there are unutilized resources in the economy, as additional government spending can boost output to meet the higher demand without necessarily causing inflation. Thus, whether fiscal deficits are inflationary depends on the existing economic conditions.
Discuss the issue of deficit reduction.
Deficit reduction involves strategies like increasing taxes or reducing expenditure to decrease a government's deficit. India has emphasized enhancing revenue through direct taxes (which are proportional to income) rather than indirect taxes that equitably apply to all income groups. Also, actions such as raising funds via disinvestment in Public Sector Undertakings (PSUs) have been pursued.
The major push, however, has been towards reducing government expenditure. This can be achieved by enhancing the efficiency of government operations—improving planning, executing programs accurately, and heightened administration. Studies suggest that direct transfers could boost welfare more effectively, as opposed to other extensive in-kind distributions, demonstrating that less cash is often required to achieve the same welfare outcomes.
Cutting back on governmental functions, though, may detrimentally affect crucial sectors like agriculture, education, health, and poverty alleviation. This underscores the complexity of deficit reduction, necessitating a careful consideration of the economic and social impacts of potential reductions in government spending.
What do you understand by G.S.T? How good is the system of G.S.T as compared to the old tax system? State its categories.
GST, or Goods and Services Tax, is an indirect tax system that has been implemented to replace multiple cascading taxes levied by the central and state governments in India. GST is a comprehensive, multi-stage, destination-based tax that is levied on every value addition throughout the supply chain. The implementation helps in creating a single national market and reducing the effect of tax on tax, commonly known as "tax on tax."
Comparison of GST with Old Tax System:
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Simplification: GST simplifies the tax system by replacing several indirect taxes like VAT, excise duty, service tax, and others. This unification simplifies administration and compliance.
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Removal of Cascading Effect: GST eliminates the cascading effect of taxes, thereby reducing the overall tax burden on goods and services, and potentially lowering prices for consumers.
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Efficiency and Transparency: With GST, the processes of tax filing and collection are streamlined and made transparent, primarily through digital compliance methods. This reduces the scope of corruption and tax evasion.
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Boost to the Economy: By simplifying the tax structure, GST can enhance economic activity and potentially boost GDP.
Categories of GST:
GST is divided into three categories:
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CGST (Central Goods and Services Tax): Levied by the Central Government on intra-state sales (within the same state).
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SGST (State Goods and Services Tax): Levied by the State Government on intra-state sales.
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IGST (Integrated Goods and Services Tax): Levied by the Central Government on inter-state sales (between two states).
Overall, GST tends to be a more efficient system compared to the old tax structure, fostering a better business environment by eliminating many of the indirect tax barriers between states and streamlining tax rates across the country.
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Ask Chatterbot AINotes - Government Budget and Economy | Class 12 Macroeconomics | Economics
Comprehensive Class 12 Notes on Government Budget and the Economy
Introduction to Government Budget and Economy
The government budget is a crucial tool that outlines the economic activities and priorities of a government for a financial year. It plays an essential role in the economy, especially in a mixed economy where both the private and public sectors coexist. The government influences economic life through its budget by managing expenditures and revenues, thus impacting overall economic health and stability.
Components of Government Budget
Revenue Receipts
Revenue Receipts are the government's earnings that do not create any liabilities or reduce financial assets. They are further divided into:
- Tax Revenues: These include direct taxes like personal income tax and corporation tax, and indirect taxes like excise duties, customs duties, and service tax.
- Non-Tax Revenues: These primarily consist of interest receipts on loans given by the government, dividends and profits from government investments, and fees for various services provided.
Capital Receipts
Capital Receipts are funds the government receives which lead to an increase in its liabilities or decrease in its financial assets. These include:
- Loans: Borrowed funds the government must repay in the future.
- Sale of Assets: Income from disinvestment in Public Sector Undertakings (PSUs).
- Debt-Creating Receipts: These include the above loans and borrowings.
- Non-Debt Creating Receipts: These could be proceeds from the sale of assets, which do not require repayment.
graph TD;
A[Government Budget] --> B[Receipts]
A --> C[Expenditure]
B --> D[Revenue Receipts]
B --> E[Capital Receipts]
D --> F[Tax Revenues]
D --> G[Non-Tax Revenues]
E --> H[Loans]
E --> I[Sale of Assets]
C --> J[Revenue Expenditure]
C --> K[Capital Expenditure]
Objectives of the Government Budget
Allocation Function
The government provides public goods that cannot be efficiently allocated by market mechanisms such as national defence, roads, and public administration. Public goods are characterised by being non-rivalrous and non-excludable, meaning their consumption by one individual does not reduce availability for others, and they cannot be easily restricted to paying consumers.
Redistribution Function
The budget also aims at redistributing income to achieve a fair distribution of wealth in society. It influences personal disposable income through taxes and transfers, ensuring equity and fairness in income distribution.
Stabilisation Function
The government budget plays a stabilising role by mitigating fluctuations in income and employment. It does so by adjusting aggregate demand to address economic downturns (by increasing government spending) or curb inflationary pressures (by reducing spending or increasing taxes).
Classification of Government Expenditure
Revenue Expenditure
Revenue Expenditure covers the costs of the regular functioning of government departments and services, interest payments on government debt, and grants to state governments and other entities. This type of expenditure does not result in the creation of physical or financial assets.
Capital Expenditure
Capital Expenditure involves spending on the creation of physical and financial assets such as land, buildings, machinery, investments in shares, and loans to state governments and PSUs. This expenditure is crucial for long-term economic growth and development.
Types of Government Budgets
Balanced Budget
A balanced budget is when government expenditure equals revenue collection. This approach ensures that the government does not need to borrow funds to meet its expenses.
Surplus Budget
A surplus budget occurs when the revenue exceeds expenditure, allowing the government to save or use the extra funds for future needs or debt repayment.
Deficit Budget
A deficit budget happens when expenditure surpasses revenue. This situation requires the government to borrow funds, creating a liability that needs to be managed.
Measures of Government Deficit
Revenue Deficit
The revenue deficit is calculated as:
[ \text{Revenue Deficit} = \text{Revenue Expenditure} - \text{Revenue Receipts} ]
A revenue deficit indicates that the government's revenue receipts are less than its revenue expenditures, compelling it to borrow funds even for its routine operations.
Fiscal Deficit
The fiscal deficit is the difference between total expenditure and total receipts (excluding borrowings):
[ \text{Fiscal Deficit} = \text{Total Expenditure} - (\text{Revenue Receipts} + \text{Non-debt Creating Capital Receipts}) ]
This measure outlines the government's borrowing needs.
Primary Deficit
The primary deficit is the fiscal deficit minus interest payments on previous loans:
[ \text{Primary Deficit} = \text{Fiscal Deficit} - \text{Interest Payments} ]
This metric provides insights into the government's current fiscal imbalances without considering past debts.
Role of Fiscal Policy
Fiscal policy involves the government's use of expenditure and taxation to influence the economy. Key aspects include:
- Government Spending: Directly increases aggregate demand.
- Taxes and Transfers: Affect disposable income and consumption, indirectly influencing saving and spending patterns.
Government Debt
Government debt arises when budget deficits are financed through borrowing. While debt can stimulate growth if used wisely, excessive debt may burden future generations and lead to potential economic instability. Debates regarding debt often revolve around its inflationary impact, crowding out private investment, and the overall debt burden on the economy.
Conclusion
Understanding the government budget is essential for Class 12 students as it provides insights into economic policies and fiscal management. It reflects and shapes the economic life of a country and is intertwined with national growth and development strategies.
By mastering these concepts, students will be better equipped to comprehend the complexities of economic governance and its implications for societal welfare.
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