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Andhra Pradesh BIEAP AP Inter 1st Year Accountancy Study Material 2nd Lesson Accounting Principles Textbook Questions and Answers.

AP Inter 1st Year Accountancy Study Material 2nd Lesson Accounting Principles

Essay Type Questions

Question 1.
What are accounting concepts ? Explain any four accounting concepts in detail.
Answer:
The term concept means an idea or thought. Basic accounting concepts are the fundamental ideas underlying in the theory and practice of financial accounting. The Ifnpdftant accounting concepts are –

1. Business Entity Concept: Business is treated as separate form the proprietor. All the transactions are recorded in the books of business and not in the books of the proprietor. The accounting system gives information only about the business and not its owner. The proprietor is also treated as a creditor for the business.
2. Dual Aspect Concept: Dual aspect concept principle is the basis for Double Entry System of book-keeping. All business transactions recorded in accounts have two aspects : receiving benefit and giving benefit.
   For example, when a business acquires as asset: receiving of benefit. It must pay cash : giving of benefit.
3. Going Concern Concept: According to this concept it is assumed that the business will continue for long time. All transactions are recorded from this point of view. The investors lend money and the creditors supply goods with the expectation that the enterprise would continue for long period of time. Hence financial statements are prepared on a going concern basis and not on liquidation basis.
4. Money Measurement Concept: This concept suggests that accountancy should record only the transactions which can be measured in terms of money. The transactions which cannot be measured in terms of money fall beyond the scope of accountancy.
   For example the events of machinery breakdown is not recorded as it does not have monetary value. However, the expenditure incurred for the repair of the machinery can be measured in monetary value.

Question 2.
What are accounting conventions ? Explain them briefly.
Answer:
Conventions mean customs or traditions. These conventions provide useful guidance in preparing accounts or financial statements. The important accounting conventions are –

1. Convention of Disclosure : Accounting statements should disclose fully and completely and significant information, based on which, decisions can be taken by various interested parties. It involves proper classification and explanations of accounting information which are published in the financial statements.
2. Convention of Materiality : According to this convention only those events should be recorded which have a significant bearing and insignificant things should be ignored. The avoidance of insignificant things will not materially off the records of the business.
3. Convention of Consistency: The accounting practices should be remained same from one year to another year. This is useful to the entrepreneur to compare the financial statements of one year with that of the other years. For example, an organization should not change its method of depreciation every year.
4. Convention of Conservation : According to this convention the accountant has to record the actual financial position. We should be careful in calculating profits. Profits should never be anticipated or exaggerated. But losses should be anticipated and provided for. Example : While taking the value of the closing stock the market cost or actual cost which ever is less is to be taken into the books of accounts.

Short Answer Questions

Question 1.
Explain business entity concept of accounting. (Mar. 2018 – A.P. & T.S.; Mar. ’17 – A.P.; May 17 – T.S.)
Answer:
Business is treated as separate from the proprietor. All the transactions are recorded in the books of business and not in the books of the proprietor. The accounting system gives information only about the business and not its owner. The proprietor is also treated as a creditor for the business.

Question 2.
Explain money measurement concept. (Mar. 2019 – T.S.)
Answer:
This concept suggests that accountancy should record only the transactions which can be measured in terms of money. The transactions which cannot be measured in terms of money fall beyond the scope of accountancy.
For example the event of machinery breakdown is not recorded as it does not have monetary value. However, the expenditure incurred for the repair of the machinery can be measured in monetary value.

Question 3.
Explain convention of conservatism. (Mar. ’17 – T.S.)
Answer:
According to this convention the accountant has to record the actual financial position. We should be careful in calculating profits. Profits should never be anticipated or exaggerated. But losses should be anticipated and provided for.
Example : While taking the value of the closing stock the market cost or actual cost whichever is less is to be taken into the books of accounts.

1. Convention of Disclosure : Accounting statements should disclose fully and completely and significant information, based on which, decisions can be taken by various interested parties. It involves proper classification and explanations of accounting information which are published in the financial statements.
2. Convention of Materiality : According to this convention only those events should be recorded which have a significant bearing and insignificant things should be ignored. The avoidance of insignificant things will not materially off the records of the business.
3. Convention of Consistency: The accounting practices should be remained same from one year to another year. This is useful to the entrepreneur to compare the financial statements of one year with that of the other years. For example, an organization should not change its method of depreciation every year.
4. Convention of Conservation : According to this convention the accountant has to record the actual financial position. We should be careful in calculating profits. Profits should never be anticipated or exaggerated. But losses should be anticipated and provided for.
   Example : While taking the value of the closing stock the market cost or actual cost which ever is less is to be taken into the books of accounts.

Short Answer Questions

Question 1.
Explain business entity concept of accounting. (Mar. 2018 – A.P. & T.S.; Mar. ’17 – A.P.; May 17 – T.S.)
Answer:
Business is treated as separate from the proprietor. All the transactions are recorded in the books of business and not in the books of the proprietor. The accounting system gives information only about the business and not its owner. The proprietor is also treated as a creditor for the business.

Question 2.
Explain money measurement concept. (Mar. 2019 – T.S.)
Answer:
This concept suggests that accountancy should record only the transactions which can be measured in terms of money. The transactions which cannot be measured in terms of money fall beyond the scope of accountancy.
For example the event of machinery breakdown is not recorded as it does not have monetary value. However, the expenditure incurred for the repair of the machinery can be measured in monetary value.

Question 3.
Explain convention of conservatism. (Mar. ’17 – T.S.)
Answer:
According to this convention the accountant has to record the actual financial position. We should be careful in calculating profits. Profits should never be anticipated or exaggerated. But losses should be anticipated and provided for.
Example : While taking the value of the closing stock the market cost or actual cost whichever is less is to be taken into the books of accounts.

Question 4.
Explain convention of consistency.
Answer:
The accounting practices should be remained same from one year to another year. This is useful to the entrepreneur to compare the financial statements of one year with that of other years. For example, an organization should not change its method of depreciation every year.

Question 5.
Write a brief note on accounting standards.
Answer:
Accounting standard is a principle that guides and standardizes accounting practices. The Generally Accepted Accounting Principles (GAAP) are a group of accounting standards that are widely accepted as appropriate to the field of accounting. Accounting standards are necessary so that financial statements are meaningful across a wide variety of businesses; otherwise, the accounting rules of different companies would make comparative analysis almost impossible.

Student Activity

Visit a nearest business organization and observe the book keeping and accounting systems adopted by it.

Andhra Pradesh BIEAP AP Inter 1st Year Accountancy Study Material 1st Lesson Book Keeping and Accounting Textbook Questions and Answers.

AP Inter 1st Year Accountancy Study Material 1st Lesson Book Keeping and Accounting

Short Answer Questions

Question 1.
Explain the advantages and limitations of Accounting.
Answer:
Advantages of Accounting: The following are the main advantages of accounting.

1. Permanent and Reliable Record : Accounting provides permanent record for all business transactions and provides reliable information to different interested parties.
2. Net Result of Business Operations: Accounting provides the final result (Profit or Loss) of business for a given period of time.
3. Ascertainment of Financial Position: It is not enough to know only the profit or loss, but the proprietor requires a full picture of his financial position to plan for the next year’s business.
4. Facility of Comparative Study: Accounting provides the facility of comparative study of the various aspects of the business such as profits, sales, expenses, etc.
5. Control over Assets: In the course of business, the proprietor acquires various assets like building, machinery, furniture, etc. which are well protected by generating records.

Limitations of Accounting: The following are the limitations of Accounting.

1. Records only monetary transactions : Accounting considers monetary transactions only, non-monetary transactions like quality, organization culture, units of production sales, etc. are ignored in accounting.
2. Historical in nature : Accounting considers only historical transactions, i.e transactions which have occurred in the past only recorded in accounting books.
3. Price level changes are not considered: Accounting does not consider price level changes which may occur from time to time, thus, it does not reflect the current position.
4. Does not provide realistic information: While preparing the books of account, subjectivity of the accountant may influence the final results of the business enterprise. This may not provide realistic information which in turn affects the overall results of the business concern.

Question 2.
Distinguish between Book-keeping and Accounting.
Answer:

Question 3.
Explain the steps involved in Accounting process.
Answer:
Accounting process:

1. Identifying: Identifying the business transactions from the source documents.
2. Recording: The next function of accounting is to keep a systematic record of all business transactions, which are identified in an orderly manner, soon after their occurrence in the journal or subsidiary books.
3. Classifying : This is concerned with the classification of the recorded business transactions so as to group the transactions of similar type at one place.
4. Summarizing : It is the process of finding the totals of balances of all accounts so as to prepare trial balance.
5. Reporting : The classified information available from the trial balance is used to prepare – profit and loss account and balance sheet in a manner useful to the users of accounting
   information.
6. Analysing: It establishes the relationship between the items of the profit and loss account and the balance sheet.
7. Interpreting : It is concerned with explaining the meaning and significance of the relationship so established by the analysis. Interpretation should be useful to the users.

Very Short Answer Questions

Question 1.
What is Book-keeping ? (Mar. 2018 – A.P. ; Mar. ’17 – T.S. ; May ’17 – A.P. & T.S.)
Answer:
Book-keeping is the art of recording business transactions in a systematic manner. It covers four activities i.e. identifying the transactions, measuring the identified transactions, recording in a chronological order and classifying the recorded transactions.

Question 2.
Define Accounting. (Mar. 2019, ’17 – A.P.)
Answer:
The American Institute of Certified Public Accountants has defined the Accounting as “the art of recording, classifying and summarizing in a significant manner in terms of money transactions and events which in part, at least of a financial character and interpreting the results thereof”.

Question 3.
What is an Accounting cycle ? (Mar. 2018 – T.S. ; Mar. ’15 – A.P. & T.S.)
Answer:
An accounting cycle is a complete sequence beginning with the recording of transaction and ending with preparation of financial statements. It involves journalizing, ledger posting, balancing, trial balance, preparation of trading, profit and loss account and balance sheet.

Student Activity

1. Goto nearest business organizations and observe the book keeping and accounting systems adopted by them.
2. Observe the accounting procedures adopted by large size or medium size organizations located nearby them.

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 10th Lesson Economic Statistics Textbook Questions and Answers.

AP Inter 1st Year Economics Study Material 10th Lesson Economic Statistics

Essay Questions

Question 1.
What is the relationship between Economics and Statistics? [March 18, 16]
Answer:
There is a close relationship between statistics and economics. In the words of Tugwell “The science of economics is becoming statistical in its method”. All economic laws are pronounced on the basis of statistical facts and figures. The theory of the population of Malthus, the law of family expenditure of Engels, etc., were propounded after statistical tests. Statistics help economics to become an exact science.

In the study of theoretical economics, the application and use of statistical methods are of great importance. Most of the doctrines of economics are based on the study of a large number of units and their analysis. This is done through statistical methods. The Law of demand was formulated because of statistical methods.

The importance of statistics is felt in all branches of knowledge- in accountancy and auditing in banking, in insurance in research, and many fields. Without statistics no branch of knowledge is complete.

Question 2.
Explain the Geometric diagrams. What are Bar diagrams and Pie diagrams?
Answer:
Diagrams are more suitable to illustrate the data which is discrete, while continuous data is better represented by graphs.

BAR DIAGRAM and PIE DIAGRAM come in the category of geometric diagrams.
The bar diagram are 3 types. Simple, Multiple and Component bar diagrams.

Simple Bar Diagrams : Bar diagrams are very commonly used and is better for representation of quantitative data. Bars are simply
corresponding numerical values.
Ex: Maximum temperature recorded in Hyderabad in the 1st six months in a year in a bar diagram.

Multiple Bar Diagram : Multiple bar diagrams are used for comparing two or more sets of data.
Ex : The multiple bar diagram depicts the number of students in a college studying two foreign languages, French and German for the period 1960 – 2010 is given below.

Component Bar Diagram : Component bar diagram charts also called sub-divided bar diagram, are very useful in comparing the sizes of different component parts.
Ex : Enrolment at primary level in a district of Bihar. Boys, girls and total children in the given age group are denoted in the component bar diagram is given below.

Pie – Diagram : This diagram enables us to show the partitioning of total into component parts. It is also called a pie chart.
Ex : Draw the pie digram for following data.

Total area = 16 + 24 + 10 + 8 + 5 = 63
Area changed into Degrees =
Paddy =\(\frac{16 \times 360}{63}\) = 91°
Wheat = \(\frac{24 \times 360}{63}\) = 137°
Maize = \(\frac{10 \times 360}{63}\) = 57°
Jower = \(\frac{8 \times 360}{63}\) = 46°
Millets = \(\frac{5 \times 360}{63}\) = 29°
Total = 360°

Question 3.
Calculate the AM in direct method of the following data.

Answer:

\(\overline{\mathrm{X}}=\frac{\Sigma \mathrm{fx}}{\mathrm{N}}\)
Where N is total frequency
Σfx = 7160; N = 200
\(\overline{\mathrm{X}}\) = \(\frac{7160}{200}\) = 35.8
∴ \(\overline{\mathrm{X}}\) = 35.8

Question 4.
Calculate the A.M. in Direct method.

Answer:

\(\overline{\mathrm{X}}=\frac{\Sigma \mathrm{fx}}{\mathrm{N}}\)
\(\overline{\mathrm{X}}\) = \(\frac{3300}{100}\) = 33
∴ \(\overline{\mathrm{X}}\) = 33

Question 5.
Calculate the A.M. in Deviation method or Shortcut method.

Answer:

Here class interval (C) = 10
Assumed mean = 55
A.M. (or) \(\overline{\mathrm{X}}\) = A + \(\frac{1}{N}\) Σfiμi × C
= 55 + \(\frac{1}{90}\) (-44) × 10
= 55 + (-4.8)
∴ \(\overline{\mathrm{X}}\) = 50.2

Question 6.

Answer:
Calculation of Mean :

\(\overline{\mathrm{X}}\) = \(\frac{\Sigma \text { fixi }}{\mathrm{N}}=\frac{4530}{100}\) = 45.3
∴ \(\overline{\mathrm{X}}\) = 45.3
Calculation of Median :

Here N = 100; \(\frac{\mathrm{N}}{2}\) = \(\frac{100}{2}\) = 50
50^th value included in the cumulative frequency 40-49 class intervals. But here class intervals are unequal. So we can adjust that lower limit is \(\frac{39+40}{2}=\frac{79}{2}\) = 39.5.
F = 31; f = 38, C = 10
Median = L + \(\left[\frac{\frac{N}{2}-F}{f}\right]\) × C
Median = 39.5 + \(\left[\frac{50-31}{38}\right]\) × 10
= 39.5 + \(\left[\frac{19}{38}\right]\) × 10
= 39.5 + 0.5 × 10
= 39.5 + 5
= 44.5
∴ Median = 44.5
Calculation of Mode:

Here the maximum frequency occurs in 40 – 49 class.
f = 38; f₁ = 16; f₂ = 15; C = 10
L = \(\frac{39+40}{2}=\frac{79}{2}\) = 39.5 (Lower boundary of the model class)
Mode = L + \(\left[\frac{f-f_1}{2 f-f_1+f_2}\right]\) × C
= 39.5 + \(\left[\frac{38-16}{2(38)-(16+15)}\right]\) × 10
= 39.5 + \(\left[\frac{22}{76-31}\right]\) × 10
= 39.5 + 0.48 × 10
= 39.5 + 4.5
Mode = 44.38

Short Answer Questions

Solve the problems for the following datas.

Question 1.
Calculate the Median for the following data.

Answer:

Here N = 100 ; \(\frac{\mathrm{N}}{2}=\frac{50}{2}\) = 25
25^th value included in the cumulative frequency 21-30 class intervals.
Lower limit = \(\frac{20+21}{2}=\frac{41}{2}\) = 20.5
F = 15; f = 16; C = 10 N
Median = L + \(\left[\frac{\frac{N}{2}-F}{f}\right]\) × C
Median = 20.5 + \(\left(\frac{25-15}{16}\right)\) × 10
= 20.5 + \(\left(\frac{10}{16}\right)\) × 10
= 20.5 + 0.62 × 10
= 20.5 + 6.25 = 26.75
Median = 26.75

Question 2.
Calculate the Median for the following data.

Answer:

Here N = 125 ; \(\frac{\mathrm{N}}{2}=\frac{125}{2}\) = 62.5
65^th value included in the cumulative frequency 7.6
Therefore 30 – 40 in the median class
65^th value appears in 30 – 40 class.
Lower limit = 30; F = 40; f = 36; C = 10 N
Median = L + \(\left[\frac{\frac{N}{2}-F}{f}\right]\) × C
Median = 30 + \(\left(\frac{62.5-40}{36}\right)\) × 10
= 30 + \(\left(\frac{22.5}{36}\right)\) × 10
= 30 + 0.625 × 10
= 30 + 6.25
= 36.25

Question 3.
Calculate the Mode for the following data.

Answer:

Here the maximum frequency occurs in 59 – 60 class.
L = \(\frac{59+60}{2}=\frac{119}{2}\) = 59.5
f = 31, f₁ = 20; f₂ = 17; C = 10
Mode = L + \(\left[\frac{f-f_1}{2(f)-\left(f_1+f_2\right)}\right]\) × C
= 59.5 + \(\left[\frac{31-20}{2(31)-20+17}\right]\) × 10
= 59.5 + \(\left(\frac{11}{62-37}\right)\) × 10
= 59.5 + \(\left(\frac{11}{25}\right)\) × 10
= 59.5 + 0.44 × 10
= 59.5 + 4.4
= 63.9

Additional Questions

Question 4.
Marks of 10 students 43, 45, 68, 55, 33, 57, 40, 48, 77, 60. Calculate A.M by direct method.
Answer:
\(\overline{\mathrm{X}}=\frac{\Sigma \mathrm{x}}{\mathrm{N}}\)
Where Σx = 526 ; N = 10
∴ \(\overline{\mathrm{X}}\) = 52.6

Question 5.
Calculate A.M from the following data by direct method.

Answer:

\(\overline{\mathrm{X}}=\frac{\Sigma \text { fixi }}{\mathrm{N}}\) (or) \(\frac{\Sigma \mathrm{fx}}{\mathrm{n}}\)
where = Σfixi = 1870; N = 100
\(\overline{\mathrm{X}}=\frac{1870}{100}\) = 18.7

Question 6.
Find Median from the following data.
10, 15, 18, 21, 25, 30, 35
Answer:
Arrange asscending order
10, 15, 48, 21, 25, 30, 35
Median = \(\left(\frac{N+1}{2}\right)^{\text {th }}\) item
= \(\left(\frac{7+1}{2}\right)^{\text {th }}\) item = \(\left(\frac{8}{2}\right)^{\text {th }}\) item = 4^th item
4^th item = 21
∴ Median = 21

Question 7.
Find median from the following data.

Answer:

Where \(\) = 32.5 it lies in the 20 – 30 class interval.
So lower limit = 20; F = 15; f = 18; N = 65; C = 10
Median = L + \(\left[\frac{\frac{N}{2}-F}{f}\right]\) × C
= 20 + \(\left[\frac{32.5-15}{18}\right]\) × 10
= 20 + 9.722 = 29.72
∴ Median = 29.72

Question 8.
Find the mode when median is 125.6 and mean is 128
Answer:
Mode = 3 Median – 2 Mean
= (3 × 125.6) – (2 × 128)
= 376.8 – 256
= 120.8

Very Short Answer Questions

Question 1.
What is meant by Arithmetic Mean ? [March 16]
Answer:
Arithmetic Mean of a statistical data is defined as the quotient of the sum of all, the items or entries divided by the number of items.

Question 2.
Find the A.M. for the data 30, 20, 32, 16, 27. [March 18, 17, 16]
Answer:
\(\overline{\mathrm{X}}=\frac{\Sigma \mathrm{x}}{\mathrm{N}}=\frac{30+20+32+16+27}{5}=\frac{125}{5}\) = 25
∴ \(\overline{\mathrm{X}}\) = 25

Question 3.
Find the Median for the data 10, 20, 15, 29, 35, 42.
Answer:
The values arranged in ascending order
(i.e,) 10, 15, 20, 29, 35, 42
Median = \(\left(\frac{n+1}{2}\right)^{\text {th }}\) item
= \(\left(\frac{6+1}{2}\right)^{\text {th }}\) item
= \(\left(\frac{7}{2}\right)^{\text {th }}\) item = 3.5^th item
= \(\frac{20+29}{2}\) = 24.5

Question 4.
Find the value of Median for the data 19, 1, 3, 17, 6, 12, 11, 8.
Answer:
The values arranged in ascending order
i.e., 1, 3, 6, 8, 11, 12, 17, 19
Median = \(\left(\frac{n+1}{2}\right)^{\text {th }}\) item
= \(\left(\frac{8+1}{2}\right)^{\text {th }}\) item
= \(\left(\frac{9}{2}\right)^{\text {th }}\) item = 4.5^th value
= \(\frac{8+11}{2}=\frac{19}{2}\) = 9.5
∴ Median = 9.5

Question 5.
Find the Mode for the data 17, 6, 19, 14, 8, 6, 12, 15, 6, 10.
Answer:
Mode is 6 is occuring many items i.e., 3

Question 6.
Find the Mode for the data 12, 11, 15, 11, 12 ,12, 15, 12, 9, 12. [March 18]
Answer:
Mode is 12 is occuring many items i.e 5

Question 7.
What is a Pie diagram ? [March 18, 17, 16]
Answer:
It is also called a pie chart. The circle is divided into many parts as there are compo-nents by drawing straight lines from the centre to the circumference.

Question 8.
What is a Bar diagram ?
Answer:
Bars are simply vertical lines, where the lengths of bars are proportional to their corresponding numerical values.

Question 9.
Find the median of the observation – 3,- 5, -8, 0, 2, -10,
Answer:
Arrange data in ascending order – 10, – 8, – 5, – 3, 0, 2
Median = \(\left(\frac{n+1}{2}\right)^{\text {th }}\) item
= \(\left(\frac{6+1}{2}\right)^{\text {th }}\) item
= \(\left(\frac{7}{2}\right)^{\text {th }}\) item = 3.5
= \(\frac{-5+(-3)}{2}=\frac{-8}{2}\) = -4
∴ Median = – 4

Additional Questions

Question 10.
What is mode if data is Bio-modal?
Answer:
Mode = 3 Median – 2 Mean

Question 11.
What is Median ?
Answer:
The median is a measure of central tendency, which appears in the centre of an ordered data. It is aften described as the “middle most” value. It is called a position average.

Question 12.
What is Mode?
Answer:
Mode is most frequently occuring value in data.

Question 13.
What is Simple Bar Diagram ?
Answer:
Bar diagram comprising a group of equi-spaced and equi-width rectangular bars for each class of data.

Question 14.
What is Multiple Bar Diagrams ?
Answer:
Multiple bar diagrams are used for comparing two or more set of data.

Question 15.
What is Component Bar Diagram or Sub-Divided Bar Diagram ?
Answer:
These diagrams are used to represent various parts of the total.

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 9th Lesson Money, Banking and Inflation Textbook Questions and Answers.

AP Inter 1st Year Economics Study Material 9th Lesson Money, Banking and Inflation

Essay Questions

Question 1.
Examine the difficulties of the barter system.
Answer:
Barter system means exchange of goods. This system was followed in old days. But the population and its requirements are increasing, the system became very complicated. The difficulties of barter system are :

1) Lack of coincidence of wants : Under the barter system, the buyer must be willing to accept the commodity which the seller is willing to offer in exchange. The wants of both the buyer and the seller just coincide. This is called double coincidence of wants. Suppose the seller has a good and he is willing a exchange it for rice. Then the buyer must have rice and he must be willing to exchange rice for goat. If there is no such coincidence direct exchange between the buyer and the seller is not possible.

2) Lack of store value : Some commodities are perishables. They perish within a short time. It is not possible to the value of such commodities in their original form under the barter system. They should be exchanged before they actually perish.

3) Lack of divisibility of commodities : Depending upon its quantity and value, it may become necessary to divide a commodity into small units and exchange one or more units for other commodity. But all commodities are not divisible.

4) Lack of common measure of value : Under the barter system, there was no common measure value. To make exchange possible, it was necessary to determine the value of every commodity interms every other commodity.

5) Difficulty is making deferred,payments : Under barter system furture payments for present transaction, was not possible, because future exchange involved some difficulties. For example suppose it is agreed to sell specific quantity of rice in exchange for a goat on a future date keeping in view the recent value of the goat. But the value of goat may decrease or increase by that date.

Question 2.
Explain the functions of money.
Answer:
Money plays a vital role in modem economy. A modem economy is rightly known as monetary economy because of the crucial position that money occupies.

1. According to ‘Robertson’ – “Anything which is widely accepted in payment for goods or it discharges of other kinds of business obligations”
2. According to ‘Seligman’ – “One that possesses general acceptability”.
3. According to Waker’ – “Money is what money does”.

Functions of money :
1. Primary functions :
a) Medium of exchange : Money serves as a medium of exchange. It removes the inconveniences of the barter system in which exchange of goods was possible if only there was double coincidence of wants. But money facilitates exchange of commodities without double coincidence watns. Any commodity can be exchange for money. People can exchange goods and services through the medium of money.

b) Measure of value : Money serves as a measure of the value of goods and services. As common measure of value it has removed the difficulty of the barter system and has made transactions simple and easy. The value of each commodity is expressed in the units of money. We call if the price.

2. Secondary functions : .
a) Store of value : The value of commodities and services can be stored in the form of more. Certain commodities are perishable. If they are exchanged for money before they perish, their value be preserved in .the form of money.

b) Standard of deferred payments : Money serves as a standard of deferred payments. The modern economies most of the business transactions take place on the basis of credit. An individual consumer or a business man may now purchase a commodity and pay for it in future as this function makes it possible to express future payments in terms of money.

c) Transfer of money : Money can be transferred from one person to another at any time at any place.

3. Contingent functions :
a) Measurement and distribution of National income : National income of a country be measured in money by aggregating the value of all commodities. This is not possible in a barter system similarly national income can be distributed to different factors of production making payment them in money.

b) Money equalises marginal utilises / productivities : The consumers can equalize marginal utilities of different commodities purchased by them with the help of money. We know how consumers equalize the marginal utility of the taste rupee they speed on each commodity. Similarly firms can also equalize the marginal productivities of different factors of production and maximize profits.

c) Basis of credit : Credit is created by banks from out of the primary deposits of money supply of credit, in an economy is dependent on the supply of nominal money

d) Liquidity : Money is the most important liquid asset. Interms of liquidity it is superior other assets. Money is centpercent liquid.

Question 3.
Write a note on the supply of money.
Answer:
The term supply of money is related to stock concept. There may be increase or decrease in the money stock over a period of time. Money supply determines the various factors i.e., rate of interest, credit availability, investment, national income and employment. This affects the general price level.
Components of money supply :
1) Currency issue by the Central Bank : Central Bank is the apex bank and enjoys the power of issue of currency. Currency consists of paper notes and coins. In India, RBI is the Central Bank and issue notes in the denominations of 1000, 500, 100, 50, 20, 10, 5 and 2 rupees. The one rupee note and coins are issued by the finance department of the government of India.

2) Demand deposits created by Commercial banks : Bank deposits are also considered as money supply. Commercial banks collect deposits from the public and creates credit out those deposits. Credit in this form is called derived or secondary deposits. This constitute nearly 80% of total money supply.
Monetary aggregates : In India money supply measured in terms of the following monetary aggregates.
M₁ = Currency + demand deposits + other deposits
M₂ = M₁ + time liability portion of saving deposits with banks + certficates of deposits issued by banks + terms deposits maturing within one year.
M₃ = M₂ + term deposits over one year maturity + call term borrowings of banks,
M₁, M₂ and M₃ as monetary measures.

Question 4.
Describe the functions of the commercial banks.
Answer:
Functions of commercial banks :
Primary functions :
a) Accepting deposits : The commercial bank just like any other money lender is doing money lending business bank receives public money in the form of deposits. The deposits mainly are of the following steps.

1) Current deposits : These deposits have two characteristics. One, there are no restrictions with regard to the amount of withdrawl and number of withdrawls. Banks normally do not pay any interest on current account deposits.

2) Savings deposits : The sole aim of banks in receiving these deposits is to promote the habit of thrift among low income groups. They have the following characteristics :

1. two or three withdrawls per week are permited
2. banks pay 4 to 5% interest (nominal) per annum or savings deposits.

3) Recurring deposits: People will deposit their money in these deposits as monthly installments for a fixed period of time. The bank after expiry of the said period will return the total amount with interest thereon. The rate of interest will be higher than the savings deposits.

4) Fixed deposits : Deposits received on fixed accounts are called fixed or time deposits. They are left with the bank for a fixed period. The following are the characteristics.

1. The amount cannot be withdrawn before the expiry of the fixed period.
2. Banks pay high rate of interest than any other deposits.

b) Advancing loans : Commercial banks release funds so collected for productive purposes by way of loans and advances. Commercial bank usually lend money by way of loans, cash credits, overdrafts and by discounting bills of exchange.
1) Cash credit: In this case, the borrower is given a loan. The amount of the loan is deposited in his account in the bank. The loan is not normally paid in cash. The borrower can draw money out of this account as per his needs.

2) Overdraft: It means allowing the depositor to overdraw his account upto a previous agreed limit. Banks allow overdrafts only to those persons who have their accounts in the bank. The overdraft is granted only for short period for customers.

3) Loans : Usually a loan is granted against the securities of assets or the personal security of the borrower bank loans and advances carry a high rate of interest. In addition, banks grant call loans for every short period, term loans for longer period and also grant consumer credit for buying durable goods.

4) Discounting bills of exchange : The banks facilitate trade and commerce by dis-counting the bills of exchange. This is the most popular form of bank lending.

Secondary functions :
a) Agency services : Banks act as agents, correspondents and representatives of their
customer. As an agent a commercial bank collect and pay cheques, drafts, bills and pay insurance premium subscriptions, rent, income tax etc, as per the instruction of their customers, Banks also act as trusties executors and attorneys. .

b) General utility services : Banks provide some general utility services like :

1. Locker facility the safe custody and valuables.
2. Issue traveller’s cheques and drafts
3. Transfer of funds.
4. Acting a referee to the financial standing of customers
5. Issue letters of credit
6. Finance foreign trade by discounts foreign bills of exchange.

Question 5.
Explain the functions of the central bank.
Answer:
Central bank is the apex bank of the banking system of a country. It controls, regulates, monitors all the activities of the banks in the banking system. The following are the functions performed by the central bank.
a) Note issue : In any country central bank alone is authorised to issue the currency notes. It has monopoly power of note issue. It not only issue the currency. It also controls the supply of money in the economy.

b) Banker to government: Central bank renders certain services to the government it acts as a banker, agent and financial advisor to the government. It maintains the accounts of the government funds, receives money and pay money on behalf of the government. It performs all foreign exchange transactions on behalf of the government and maintains the public debt and advises the government on all financial matters.

c) Banker’s bank : Central bank acts as banker’s bank it controls all the transactions of all banks and every bank must maintain a certain minimum cash reserve with central bank.

d) Lender of last resort: It serves as a lender of last resort to all the financial institutions viz. Commercial banks discount houses and other credit institutions. All these institutions approach central bank if they face the problem of liquidation. It also help the banks and other financial institutions by providing loans and advances against certain approved securities and rediscounts the bills on certain terms and conditions.

e) Controller of credit: This is the most important function of central bank. It controls the volume of credit in the economy through various monetary and fiscal policies. It takes some steps to increase or reduce the volume of credit as per the inflationary conditions of the economy. It controls the inflation by reducing the volume of credit and recession by expanding the supply in the economy.

f) Custodian of foreign exchange reserve : Central bank regulates all foreign exchange transactions in a country. It is responsible for exchange rate so it acts against the fluctuations in exchange rates and maintain standard exchange rate.

Question 6.
Describe the role played by the Reserve Bank of India.
Answer:
The Central Bank of our country is Reserve Bank of India. It was established in April 1935, with a share capital of ₹ 5 crores. It was originally owned by private shareholders but was nationalised by the government of India in 1949. It performs all its activities under the Reserve Bank of India Act 1934.

The main aim of. RBI is to achieve the monetary stability and to control the credit system of an economy. It performs the following functions.
1) Note issue : Reserve Bank of India enjoys the monopoly of note issue in the country. It maintains a minimum ₹ 200 crores of gold and foreign exchange reserves of which gold should be ₹ 115 crores. It issue notes in the denominations of ₹ 1,000, ₹ 500, ₹ 100, ₹ 50, ₹ 20, ₹ 10, ₹ 5 and ₹ 2. One rupee note and coins are issued by the finance department of the Government of India. Reserve Bank of India prints all the currency notes in the security press of the Government of India.

2) Banker to Government : Reserve Bank of India acts as the banker, agent and adviser to the Government of India. It receives money and makes payments on behalf of the government and gives temporary advances to the government. It advises the government in all financial matters.

3) Banker’s Bank : Reserve Bank serves as a banker not only to the government but also to the banks. It provides financial assistance to the commercial banks by giving loans and rediscounting the bills of exchange. It helps the banks by acting as a clearing house for settlement of inter bank transactions and controls the supply of money in the economy through cash reserve ratio.

4) Lender of last resort : It acts as lender of last resort by granting loans and advances to the commercial banks against some securities viz., treasury bonds, treasury bills and other approved securities. It also provides financial help to banks by rediscounting the eligible bills of exchange.

5) Custodian of foreign exchange reserves : Reserve Bank of India as a member of the International Monetary fund. It regulates all foreign exchange transactions in the country. It controls and regulates the purchase and sale of foreign exchange through restrictions on exports and imports to maintain the official rate of exchange.

6) Credit controller : Reserve Bank of India controls the volume of credit in the country. It controls the credit through different methods by appropriate monetary or fiscal policies. It announces credit policy for every six months based on the credit needs of the country. Through this it controls the inflation and deflation.

7) Promotional and development functions: Reserve Bank of India inorder to achieve economic development performs certain promotional and developmental functions.
They are :

1. Promoting various financial institutions to provide industrial finance.
2. It takes steps for establishment of banks throughout the country and expansion of their branches.
3. Encourage the financial institution to provide financial help to agriculture and rural credit.

Question 7.
Define inflation. Explain the causes of inflation.
Answer:
Inflation means a rise in the general price level over a long period of time. It occur due to the following reasons.

1. Increase in the aggregate demand of commodities.
2. Inadequate supply of commodites.
3. Increase in the cost of production.

I. The factors that the effect the increase in demand.

1. Heavy pressure of population.
2. Increase in economy’s money supply.
3. More public expenditure towards various welfare schemes.
4. Reduce in rates of direct taxes.
5. Increase in the income levels of individuals.
6. Deficit financing by government.
7. Conspicious spending by the people having black money.
8. Production in direct tax rates.

II. Factors that increase the cost of production :

1. Increase in costs of various factors of production.
2. Increase in tax rates.
3. Increase in the prices of technology.
4. Devaluation of domestic currency.
5. Inefficient management and no control on expenditure.
6. Lack of optimum allocation of resources.
7. Devaluation of domestic currency.

III. Factors that cause inadequate supply :

1. Irregular monsoons, floods, interior seeds in agriculture.
2. Non-availability of scarcity of inputs and raw materials.
3. Under-utilisation of productive capacity.
4. Shortage of investment due to non-availability of institutional credit.
5. Artificial scarcity due to black-marketing.
6. Exports at the cost of domestic supply.
7. Long gestation period of certain industries.

Question 8.
Discuss the impact of inflation.
Answer:
Inflation refers to a persistent upward movement in the general price level rather than once for all rise in it.
The effects of inflation can be divided into two sub-heads.

1. Effects of production
2. Effects of distribution

It will affect all economic activities in the economy.
A) On production :
a) Mild inflation stimulates production and it increases the profit margin of entrepreneurs.
b) High inflation rate hinders production. ;
c) Inflation discourages savings. This affects the capital formation which in turn affects production.

B) On distribution :
Inflation produces a deep impact on the distribution of income and wealth of society. A prolonged period of inflation results in the distribution of wealth in favour of rich and affluent classes of society. The concrete effects of inflation on various groups of society are as follows.

Effects on distribution : Inflation produces a deep impact on the distribution of income and wealth of society. A prolonged period of inflation results in the distribution of wealth in favour of inflation on various groups of society are as follows.
1) Debtors and creditors : During inflation debtors are generally the gainers while the creditors are the losses. The reason is that the debtors had borrowed when the purchasing power of money was high and now return the loans when the purchasing power of money is low due to rising prices.

2) On fixed income groups : Those who get fixed income lose from inflation. Salaried persons people living oh past savings, pensioners, interest earners are the worst suffers during inflation because their income remain fixed.

3) On working class: During inflation working class also suffers worst because wages do not rise as much as the prices of commodities. In addition there is a time lag between the rise in prices and rise in wages. If the trade unions are strong they may get equal increase in money incomes compared to rise in prices.

4) Entrepreneurs : They experience windfall gains as the prices at their stocks suddenly go up. Inflation thus re-distributes income and wealth in such away as to harm the interest of creditors, labours, fixed income groups and favours the businessmen, traders and debtors. By meaning the rich richer and poor poorer, inflation is socially undesirable.

C) Social impact: Economic inequality leads to unequal opportunities in matters of health, education and employment. This results in social injustice.

D) Political effect: Inflation widens social and economic disparities. It leads to for political movements and if government is not responsive. This movement may threaten the stability of governments. .

Short Answer Questions

Question 1.
State any three definitions of money, which definition do you consider better and why ?
Answer:
Money plays a vital role in modem economy. A modem economy is rightly known as monetary economy because at the crucial position that money occupies. In the olden days goods were exchanged for goods. Such system is called barter system. However when economics grew there was a tremendous increase in the wants of the people as well as in the number of transactions then barter system became more difficult, in order to eliminate the difficulties in the barter system money came into existence.

Definition of money: Several economists have defined money in several ways. Some of the prominent definitions are given below.
According to Waker’ – “Money is what money does”.
According to ‘Robertson’ – Money as” anything which is widely accepted in payment for goods or in discharge of other kinds of business obligations”.
According to ‘Seligman’ – Money as “one that possesses general acceptability”.
According to “Crowther” – Money as “anything that is generally acceptable as a medium of exchange and which at the same time acts as a measure and store of value”.

It may be found from the above definitions that the main focus is on general acceptability. Anything that used as money should have the general acceptance of the public as medium of exchange because it is for direct exchange of commodities money is fundamentally required. It acts as a common measure of value. However its suitability as a store of value is equally important. Therefore we can consider Crowther’s definition as relatively more comprehensive. It is elaborate and covers the most important functions of money.

Question 2.
Distinguish between different types of money.
Answer:
Money can be grouped into various items based on the value, material used and the legal status. They are :
1) Commodity money and representative money: Money is classified into commodity money and representative money on the basis of the intrinsic value it possess. If the intrinsic value is equal to the face value of coin is called commodity money and if the value is less than the face value is called representative money.

2) Legal tender money and optional money : On the basis of legality money is divided into legal tender money and optional money. If money is accepted as per law by every one is called legal tender money. If the acceptance is optional and not according to law is called optional money.
Ex: Cheques.

3) Metallic money and paper money : Based on the material used money can be divided into metallic and paper money. If money is made up of metals such as silver, nickle, steel etc., all coins are metallic money and if money is printed on papers is called paper money. ^

4) Standard money and token money: If the face value and intrinsic value are same. The money is called standard money and if the face Value is higher than the intrinsic value is called token money.

5) Credit money : It is also called as bank money. This is created by commercial banks. This refers to the bank deposits that are repayable on demand and can be transferred from one person to other through cheques.

Question 3.
Explain the concept of the legal tender money.
Answer:
Based on the legality money is divided into legal tender money and optional money.
Legal tender money is that money which is accepted by the people as per Jaw while paying the amount for goods and services. This is further divided into two types. They are :

1. Limited legal tender money.
2. Unlimited legal tender money.

1) Limited legal tender money : The money which no persons can be forced to accept beyond a certain limit. The maximum limit for acceptance will be decided by the government.
Ex : 5 paise, 10 paise, 25 paise. The limit in case of these Coins is 25 rupees.

2) Unlimited legal tender money : This money which everyone should accept without any limit in payment of goods and services.
Ex : 1 rupee paper note, 5 rupee coins, 2 rupee coins, 1 rupee and 50 paise coins.

Question 4.
State the contingent functions of money.
Answer:
Money plays a vital role in modem economy.
According to Waker’ – “Money is what money does”.
According to ‘Robertson’ – “Anything which is widely accepted in payment for goods discharge of other kinds of business obligations”.
Contingent functions :
a) Measurement and distribution of National income: National income of a country be measured in money by aggregating the value of all commodities. This is not possible in a barter system similarly national income can be distributed to different factors of production by making payment then in money.

b) Money equalises marginal utilises / productivities : The consumers can equalize marginal utilities of different commodities purchased by them with the help of money. We know how consumers equalize the marginal utility of the taste rupee they speed on each commodity Similarly firms can also equalize the marginal productivities of different factors of production and maximize profits.

c) Basis of credit: Credit is created by banks from out of the primary deposits of money supply of credit, in an economy is dependent on the supply of nominal money.

d) Liquidity : Money is the most important liquid asset. Interms of liquidity it is superior other assets. Money is cent percent liquid.

Question 5.
Explain different hinds of deposits accepted by the commercial banks.
Answer:
Commercial banks pay a very important role in the economic growth of a country. Commercial banks are the most important source of institutional credit in the money market. Banks attract savings from the people and encourage investment in industry, trade and commerce. Bank is a profit seeking business firm dealing in money and credit.

The word bank is derived from the “German” word “bankco” which means joint stock or joint fund. Banking in Britain originated with the lending of money by wealthy individuals to merchants who wished to borrow.

According to ‘Richard Sydney’ sayers – “Banks are institutions whose debts .usually referred to as “Bank deposits” are commonly accepted in final settlement of other people’s debts”.
Accepting deposits : The commercial bank just like any other money lender is doing money lending business. Bank receives public money in the form of deposits. The deposits mainly are of the following types.
a) Current deposits : These deposits have two characteristics.

1. There are no restrictions with regard to the amount of withdrawal and number of withdrawls.
2. Banks normally do not pay any interest on current account deposits.

b) Savings deposits : The sole aim of banks in receiving these deposits is to promote the habit of thrift among low income groups. They have the following characteristics :

1. Two or three withdrawals per week are permitted.
2. Banks pay 4% to 5% interest per annum on savings deposits.

c) Recurring deposits : People will deposit their money in these deposits as monthly installments for a fixed period of time. The bank after expiry of the said period will return the total amount with interest thereon. The rate of interest will be higher than the saving deposits.

d) Fixed deposits : Deposits are fixed accounts are called fixed or time deposits they are left with the bank for a fixed period. The following are the characteristics.

1. The amount cannot be withdrawn before expiry of fixed period.
2. Bank pay high rate of interest than any deposits.

Question 6.
Explain different types of loans and advances paid by the commercial banks.
Answer:
According to “Crowther”- “A bank is a dealer in debts his own and other people”.
Banking means the accepting for the purpose of lending or investment of deposits of money from the public repayable or demand or otherwise and withdrawable by cheque, draft or otherwise.

Advancing loans : Commercial banks refease funds so collected for productive purposes by way of loans and advances. Commercial bank usually lend money by way of loans, cash credit, overdrafts and by discounting bills of exchange. ‘

a) Cash credit: In this case, the borrower is given a loan is deposited in his account in the bank. The loan is not normally paid in cash. The borrower can draw money out of this account as per his needs.

b) Overdraft: It means allowing the depositor to overdraft his account upto a previously agreed limit. Banks allow overdraft only to those persons who have their accounts in the bank. The overdraft is granted only for a short period for customers.

c) Loans : Usually a loan is granted against the securities of assets or personal security of the borrowed bank loans and advances carry a high rate of interest. In addition, banks grant call loans for every short period: Term loans for longer period and also grant consumer credit for buying durable goods.

d) Discounting bills of exchange : The bank facilitates ‘trade and commerce’ by ‘ discounting the bills of exchange. This is the most popular form of bank lending.

Question 7.
Distinguish between the roles of a commercial bank and a central bank with reference to credit.
Answer:
Controlling credit is the most important function of the central bank. It controls the volume of credit in the economy through various monetary and fiscal policies. It takes . some qualitative and quantitative step to increase or reduce the volume of credit as per the conditions of the economy.

It controls the inflation by reducing the volume of credit and controls recession by expanding the supply of credit in the economy.

Commercial bank also provide credit facilities in the form of loans and .advances. Commercial banks release funds so collected for productive purposes by way of loans and advances. Commercial bank usually lend money by way of loans, cash credits, overdrafts and by discounting bills of exchange.
a) Cash credit: In this case, the borrower is given a loan. The amount of the loan is deposited in his account in the bank. The loan is not normally paid in cash. The borrower can draw money out of his account as per his needs.

b) Overdraft: It means allowing the depositor to overdraft his account upto a previously agreed limit. Bank allow overdraft only to those persons who have their accounts in the bank. The overdraft is granted only for short period for customers.

c) Loans : Usually a loan is granted against the securities of assets or the personal security of the borrower bank loans and advances carry a high rate of interest. In addition, bank grant call loans for every short period. Term loans for a longer period and also grant consumer credit for buying durable goods.

d) Discounting bills of exchange : The bank facilitates trade and commerce by discounting th,e bills of exchange. This is the most popular form of bank lending.

Question 8.
Explain why the central bank is called banker’s bank ?
Answer:
The central bank acts as a banker’s bank because of the following functions.
a) Every bank maintained a certain minimum of cash reserves with the central bank as a statutory obligation. The ratio of cash reserve to the deposits of the commercial banks will be prescribed by the central bank.

b) It serves as a lender of last resort and provides financial assistance to the scheduled bank by rediscounting the eligible bills of exchanges and provides loans and advances, against approved securities. This helps the commercial banks to over come the problems of liquidity.

c) It acts as cleaning house for The commercial banks to settle their inter bank accounts. Each and every commercial banks to maintains accounts with the central bank. Because of this central bank transfer funds from one bank to another bank very easily.

Question 9.
What do you understand by lender of last resort’ ?
Answer:
The central bank serves as a lender of last resort to all the financial institutions i.e., commercial banks, discount houses and other credit institutions. These institutions can also approach the central bank when they face the problem of liquidity. The central bank helps the commercial banks by providing loans and advances against some approved securities and also help to rediscount the commercial banks bills subject to certain terms and conditions.

Question 10.
State the objectives of a central bank. [March 18, 17, 16]
Answer:
Central bank is the apex bank of the baning system in a country. It controls, regulates and supervises the activities of the banks in the banking system of a country. The following are the objectives of the central bank.

1. Maintaining the internal value of currency.
2. Preserve the external value of currency.
3. Ensure price stability.
4. Promote economic development.
5. Develop financial institutions.

Question 11.
Write a note on the Reserve Bank of India. [March 18, 16]
Answer:
Reserve Bank of India is the central bank of India. It was established in April 1935, with a share capital of ₹ 5 crores. It was originally owned by private shareholders and was nationalised by the government of India in 1949. It performs all the functions of central bank according to the “Reserve Bank of India Act 1934”. .
The main objectives of Reserve Bank of India are :

1. Regulating the issue of currency notes.
2. Providing guidance to the commercial banks.
3. Controlling the credit system of the economy
4. Achieving the monetary stability in the economy.
5. Implementing the uniform credit policy throughout the country.

Question 12.
Explain any three definitions of inflation.
Answer:
Inflation we mean a general rise in the prices in the ordinary language it is rapid upward movement of prices in a broader sense. The term inflation refers to persistent rise in the general price level over a long period of time.
According to Prof.Hawtrey “Issue of too much currency”
According to ’Dalton’: Defined inflation as “Too much Money is chasing too few goods”.
According to ‘Pigou’: “Inflation exists when money income is expanding more than in proportion to increase in earning activity”.
According to Irving Fisher : “Inflation occurs when the volume of money increases faster than the available supply of goods”.
According to Samuelson : “Inflation denotes a rise in the general level of prices”.

Question 13.
Distinguish between demand – pull and cost – push inflation.
Answer:
It refers to a persistent upward movement in the “general price level rather than once for all rise in it. If results in a decline of the purchasing power. There is no generally accepted definition to inflation.

According to “Hawtrey” is “issue of too much currency”.

According to “Dalton” as “too much money chasing too few goods”.

Demand – pull inflation : The most common cause of inflation is pressure of even increasing aggregate demand for goods and services compared to the rise of aggregate supply. If aggregate demand for goods and services exceeds aggregate supply of goods and services prices rise. This is called “demand – pull inflation”.

Cost – push inflation : As the result of rise in the cost of production of goods and services, prices. This is. called cost – push inflation. It is caused by increase in wage enforced by trade unions through strikes or increase in other factor costs.

On this two types of inflations – cost – push inflation is much more difficult to control than demand – pull inflation the reason is obvious. Any attempt to cutdown wages by the authorities will be met by stiff resistance on the part of the workers.

Question 14.
State the types of inflation. [March 17]
Answer:
Inflation means a general rise in prices. Based on the rate of inflation, it may be divided into four types.

1. Creeping inflation : When rise in the prices is very slow and small, it is called creeping inflation.
2. Walking inflation : This is the second stage of inflation. The inflation rate will be between 2% and 4%.
3. Running inflation : When the rate of inflation is in the range of 4-10% per annum, it is called running inflation.
4. Galloping inflation or hyper inflation : If the inflation rate exceeds 10%, gallop-ing inflation occurs. It may also called hyper inflation.

Question 15.
Explain the effects of inflation on distribution.
Answer:
Effects of inflation : A period of prolonged persistent and continuous inflation affects everyone in the economy it effects production and distribution. Income and employment etc., it is goods so long as it is under control of the economy.The effects of inflation can be discussed under two sub-heads.

1. Effects on production
2. Effects on distribution

Effects on distribution : Inflation produces a deep impact on the distribution of income and wealth of society. A prolonged period of inflation results in the distribution of wealth in favour of inflation on various groups of society are as follows.
1) Debtors and creditors : During inflation debtors are generally the gainers while the creditors are the losses. The reason is that the debtors had borrowed when the purchasing power of money was high and now return the loans when the purchasing power of money is low due to rising prices.

2) On fixed income groups : Those who get fixed income lose from inflation. Salaried persons people living on past savings, pensioners, interest earners are the worst suffers during inflation because their income remain fixed.

3) On working class: During inflation working class also suffers worst because wages do not rise as much as the prices of commodities. In addition there is a time lag between the rise in prices and rise in wages. If the trade unions are strong they may get equal increase in money incomes compared to rise in prices.

4) Entrepreneurs : They experience windfall gains as the prices at their stocks suddenly go up. Inflation thus re-distributes income and wealth in such away as to harm the interest of creditors, labours, fixed income groups and favours the businessmen traders and debtors. By meaning the rich richer and poor poorer, inflation is socially undesirable.

Question 16.
Enumerate the measures for control of inflation. [March 18, 16]
Answer:
To control the inflation the government has taken various steps. They are :

1. Increase the production in the long run.
2. Implementing proper monetary and fiscal policies to reduce the supply of money • and credit.
3. Controlling prices and eliminating black markets.
4. Importing the goods which are scares in supply from outside countries.
5. Introducing rationing and quota system in case of mass consumption of goods.
6. Distribution of goods to all the needy sections of the people.

Very Short Answer Questions

Question 1.
Double coincidence of wants
Answer:
Under Barter system a buyer should be able to find a seller who is not only requires the same commodity but should possess the commodity required by the buyer the want of both the buyer and the seller must coincide. This is called coincidence of wants.

Question 2.
Standard of deferred payments
Answer:
Money serves as a measure of deferred payments. Deferred payments refers to future payments. As such money is helpful not only in current transaction but also in conducting future transaction thus money acts as a bridge from present to the future, i.e., an efficient store of value.

Question 3.
Store of value
Answer:
Money acts par excellence as a store of value money preserves and carries values through time and place it is convenient to store money rather than goods. Money does not come down in value by being stored up like commodities.

Question 4.
Liquidity [March 18, 17, 16]
Answer:
Liquidity means the ease with which one can convert a financial asset into a medium of exchange. Liquidity is greatest for money as an asset because money itself is a medium of exchange. In fact money is the only asset which possess perfect liquidity.

Question 5.
Currency
Answer:
Currency consists of paper notes and coins. Paper notes are. issued by government or the central bank of a country. In India, the Reserve Bank which is the central bank of India issue currency notes at all denominations. Except one rupee notes. The government of India issues them coins are metallic tokens and are produced in the limits of government.

Question 6.
Near money
Answer:
The near money refers to those highly liquid assets which are not accepted as money but then can be easily converted into money within a short period.
Ex : Saving bank deposit, shares, treasury bills, bonds etc.

Question 7.
Credit money
Answer:
This is also called bank money. This is created by commercial banks. This is refers to the bank deposits that are repayable on demand and which can be transferred from one individual to the other through cheques.

Question 8.
Limited legal tender
Answer:
Money which no person can be forced to accept beyond certain limit. The maximum limit for acceptance is decided by the government. In India small coins 5 paise, 10 paise, 25 paise are limited legal tender the maximum limit of ₹ 25.

Question 9.
Token money
Answer:
It is the money or unit of currency whose face value is higher than the intrinsic value. It is not convertible it facilitates transactions and accepted by the public as medium of exchange.

Question 10.
Time deposits
Answer:
Time deposits are deposits that are not payable on demand. They are repayable only after their maturity period. These deposits are called term deposits. They are two types, i) Fixed deposits ii) Recurring deposits.

Question 11.
Recurring deposits
Answer:
These are called fixed deposits but the deposits money is paid not in lumpsum. But every month for various periods from 12 to 120 months.

Question 12.
Demand deposits
Answer:
The deposits which are payable on demand without any prior notice demand deposits they can be transferred from one person to person. All current deposits are demand deposits.

Question 13.
Cash credit
Answer:
Bank give cash credit to business form and industries against current assets. Such as shares, bonds, etc., cash credit is an open credit.

Question 14.
Overdraft [March 18, 17, 16]
Answer:
Overdraft is allowed on current account only the current account holders are given the facility overdraft by which they are allowed to draw an amount above their balances.

Question 15.
Discounting of bills of exchange
Answer:
Bills of exchange are the written undertaking received by the seller from the buyer against the credit transaction. The person one who possesses bill can discount the bill in the bank. If they need money.

Question 16.
Creation of credit [March 18]
Answer:
It means the process of creating credit from the depositor received by the bank from the customers to those who is in need of money in the form of loans and advances.

Question 17.
Clearance house
Answer:
Central Bank acts as a clearing house for the commercial banks to settle their interbank accounts all commercial banks maintain their accounts with the central bank.

Question 18.
Lender of last resort
Answer:
The central bank serves as lender of last resort not only to commercial banks but also other credit institutions they approach central bank when they face the problem of liquidity and rediscounting the bills and taking loans.

Question 19.
Reserve money
Answer:
The amount kept by the banks in the bank to use in the future to face the unfore seen events these reserves will be used by banks to lend loans and reduce the losses in the future.

Question 20.
Reserve Bank of India
Answer:
Reserve Bank of India is the Central Bank of India. It was established in April 1935 with a share capital of ₹ 5 crore. It was nationalised by government of India in 1949 it acts under the Reserve Bank of India 1934.

Question 21.
Meaning of inflation
Answer:
The term inflation refers to persistent rise in the general price level over a long period of time. Money supply increase, money value will be fallen, result in purchasing power will be decline.

Question 22.
Consumer Price Index (CPI)
Answer:
This is the index of prices of a given basket of commodities which are brought by the representative consumer. CPI is expressed in percentage terms.

Question 23.
Wholesale Price Index (WPI)
Answer:
Whole sale price is that price at which goods are traded in bulk. The index for wholesale price is called Wholesale Price Index (WPI).

Question 24.
Demand – Pull inflation
Answer:
Inflation caused by the increase in the aggregate demand for commodities over aggregate supply is called demand – pull inflation. Aggregate demand increases due to increase in the income level of the people.

Question 25.
Cost-push inflation
Answer:
Inflation caused by the rise in cost of production is called cost – push inflation. Cost of production may rise due to the increase in wages forced by the trade unions of government.

Question 26.
Hyper inflation [March 16]
Answer:
Hyper inflation is also known as galloping inflation. If the inflation rate exceeds 10% per annum is called hyper inflation.

Question 27.
Inflation and value of money.
Answer:
Inflation and value of money are important aspects of macro economics. They play a major role in the functioning of the economy and bear large influence on all economic activities affecting the levels of output, income, employment etc.

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 8th Lesson Macro Economic Aspects Textbook Questions and Answers.

AP Inter 1st Year Economics Study Material 8th Lesson Macro Economic Aspects

Essay Questions

Question 1.
Discuss the implications of 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. lt is based on the famous “Law of markets” advocated by J.B. Say. According to this law “supply creates 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)

A) Goods market equilibrium: The 1^st part of Say’s law of markets explains the goods market equilibrium. According to Say “supply creates its own demand”. Say’s law 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 every thing 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. This can be explained by the following diagram.

In the diagram savings and investment are measured on the ‘X’ axis and rate of interest on Y axis. Savings and investments are equal at ‘Oi’ rate of interest. So money market equilibrium can be automatically brought through the rate of interest flexibility.

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. Pigou 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.

According to the classical theory supply of and demand for labour are determined by real wage rate. Demand for labour is the inverse function of the real wage rate. The supply of labour is the direct function of real wage rate. At a particular point real wage rate the supply of and the demand for labour in the economy become equal and thus equilibrium attained in the labour market. Thus there is full employment of labour. This can be ex-plained with the help of diagram.

In the above diagram supply of and demand for labour is measured on the X – axis. The real wage rate is measured on the Y axis. If the wage rate is OW₁, the supply of labour more than the demand for labour. Hence the wage rate falls. If the real wage rate is OW₂, the demand for labour is more than supply of labour. Hence the wage rate rises. At OW, real wage rate the supply and demand are equal. This is equilibrium.
Assumptions:

1. There is no interference of government of the economy.
2. Perfect competition in commodity and labour market.
3. Full employment.
4. Wage flexibility.
5. Money does not matter.
6. Savings and investment depends on the rate of interest.
7. Supply of and demand for labour depends on real wage rate.

Question 2.
Explain the Keynesian theory of employment. [March 18, 17, 16]
Answer:
Keynes theory of employment is the principle of effective demand. He called his theory, general theory because it deals with all levels of employment. Keynes explains that lack of aggregate demand is the cause of unemployment. He used the terms aggregate demand, aggregate supply. It means total. The term effective demand is used to denote that level of aggregate demand which is equal to aggrerate 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 schedule : The aggregate supply schedule shows the various amounts of the commodity that will be offered for sale at a series of price. As the level of output increases with the level of employment. The aggregate supply price also increases with every increase in the level of employment. The aggregate supply curve slopes upwards from left to right. But when the economy reaches the level of the full employment, the aggregate supply curve becomes vertical.

Aggregate demand schedule: The various aggregate demand prices at different level of employment is called aggregate demand price schedule. As the level of employment rises, the total income of the community also rises and therefore the aggregate demand price also increases. The aggregate demand curve slopes upward from left to right.

Equilibrium level of income : The two determinants of effective demand aggregate supply and aggregate demand prices combined schedule is shown in the following table.

The table shows that so long as the demand price is higher than the aggregate supply price. The level of employment 40 lakh workers aggregate demand price is equal to aggregate supply price i.e., 300 crores. So effective demand in the above table is ₹ 300 crores. This can be shown in the following diagrams.

In the diagram X’ axis represents the employment and Y axis represents price. A.S is aggregate supply curve A.D is aggregate demand curve. The point of intersection between the two ‘E₁‘ point. This is effective demand where all workers are employed at this point the entrepreneur’s expectation of profits are maximised. At any other points the entrepreneurs will either incur losses or earn sub-normal profits.

Question 3.
How does Keynes advocate government expenditure to reduce unemployment ? Explain.
Answer:
The role of the state has become almost all pervasive in the economic organisation of the country. Whether it may be developed or underdeveloped country.
The activities undertaken by the modem State in the economic organisation of a country may be discussed under the following heads.

1) The State and Industry: The activities of the State in the industrial sphere may be considered under three groups namely, the regulatory functions, control of monopolies and lastly nationalisation or public ownership.

The state is taking an increasing role in regulating the manner of forming and operating industrial undertakings. The undertakings will probably have to take out licenses from the government before they can start operation. To check the growth of few giant concerns, the state has been forced to adopt measures for fixing prices and other terms of sale of the monopolised products. All the methods of controlling monopolies have ineffective, then the State take over the ownership of the monopolistic concerns.

2) State and Labour : The modem state has also been forced to take a number of steps for protecting the interests of labour. In this respect the state has passed factory laws prohibiting the employment of children and women under certain circumstances, fixing of reasonable hours of work etc.

3) The State and the Social Services : State has adopted schemes of social insurance according tp which all persons get free medical treatment and cash payments during periods of sickness, receive unemployment benefits if they are out of work, enjoy pensions in their oldage or in case of disablement. The widows and orphans also receive pensions from the State. The purpose behind these schemes is to relieve the poverty of the citizens and to provide security against the various risks of life.

4) The State and Foreign Trade : The state interferes with the course of foreign trade for the protection of home industries and for curing deficits in the balance of payments. The deficits in balance of payments will be cured by the State through the system of import control and exchange restrictions.

5) State and Inequalities of Income : It is the duty of the state to take all reasonable steps for the reduction of inequalities of income. Therefore, the state has adopting the system of progressive taxation of incomes, imposing levy of death duties or inherited proper ties at progressive rates and distributing the proceeds of the taxes among the poorer sections of the community.

6) The State and War : The expenses of modem war have forced the state to assume a good deal of control over the economic lifd of a country. If the economic system is to be organised fully for the successful prosecution of the war, it may be necessary for the state to exercise an all – round control over the economy of the country.

7) The State and the Trade Cycles : Both monetary policy and budgetary policy can be utilised by the State to check the course of the trade cycle.

8) The State and Economic Planning : An economic plan is a method of organising and utilising .the available resources of a country for the purpose of fulfilling certain desirable end. The modem state is expected to formulate such an economic plan or plans. It is necessary or desirable for the state to formulate a plan for rapid economic development especially in underdeveloped economies, to secure a better distribution of the national income among all classes of people, for the development of resources of the community so on to ensure full employment for everybody etc. All these activities of the state will increase the public expenditure.

Question 4.
Discuss how the Keynesian theory is an improvement over the classical theory of employment ?
Answer:
Classical theory of employment was stated by Adam Smith, David Ricardo, Robert Malthus etc. It is based on the Say’s law of market. According to this law “Supply creates its own demand”. The classical theory of employment assumed that there is always full employment of labour and other resources.

Infact full – employment is considered to be the normal situation and any lapses from full employment are considered to be abnormal. Even if at any time there is not actual full employment. The classical theory asserts that there is always a tendency towards full employment.

The free play of economic resources itself bring about the fuller utilization of economic resources including labour. Any interference of government in economic activities shall fail to bring about full employment.

Criticism on classical theory: J. M Keynes criticized the basic assumptions of classical theory. According to him the assumptions of classical theory are far from reality.
1) Full employment: According to classicals full employment is a general condition in the economy but for Keynes full employment is a special situation and not a general situation. The 1930’s economic depression proved that the classical assumption of full employment equilibrium was wrong.

2) Automatic adjustment: Classicals believed that the economic forces automatically adjust by them self without interference of the government. But automatic adjustment mecha-nism faild to restore. Full employment during the period of economic depression.

3) Money is neutral: J.M Keynes denounced the classical assumption that money is neutral. He integrated monetary variables with real variable through rate of interest and successfully demonstrated the effect of changes in money supply on real variables.

4) Wage-cut-policy : Classicals suggested the wage cut policy to solve the problem of involuntary unemployment. But according to Keynes it is impossible to cut money wage. The unions always fight for a hike in money wage and never accept a cut in money wage.

5) Savings and investment: According to classicals the saving and investment are the function of interest rate. But Keynes argued that savings is a function of level of income rather than that the rate of interest.

6) Labour supply: The supply of labour depends upon the money wage rate and not on real wage rate because workers suffer from money illusion i.e., they are interested in the amount of money they receive rather than its purchasing power.-

7) Long run analysis : Keynes also criticized the long run analysis of classical by saying that we are all dead in the long run. He emphasised the need for the analysis of short run problems and providing solution for them.

8) According to Keynes existence of perfect competition is also wrong.
Having made such a frontal attract on the classical theory. Keynes offered his own theory in its place. So his theory is treated as an improvement over the classical theory of employment.

Question 5.
Explain the concept of under – employment equilibrium with the help of a diagram.
Answer:
Under employment equilibrium is a situation when all resources are not fully used and same resources are lying idle or under utilised.
In case of under employment, equilibrium increase in aggregate demand brought about by expansionary fiscal and monetary policies will lead to increase in aggregate supply.

Keynesian employment theory states that in general there is unemployment in the economy in the short run that is caused by deficiency of aggregate demand. This can be shown in the side diagram.

Output is shown on X-axis as national income on the Y- axis consumption expenditure (Q and investment I are measured. AS is the aggregate supply curve. E represents the equilibrium point. ON output represents low level employment and to ensure full employment. The output should reach ON₁ level. The aggregate demand helps determine output in the Keynesian approach. AS is upward sloping curve. AD and AS intersects at point A. It implies that a modem market economy can get trapped in an under employment equilibrium. Thus Keynes’s analysis created a revolution in macro economics.

Question 6.
Describe the various methods of redemption of public debt.
Answer:
Redemption of public debt means repayment of public debt. All government debts should be rapid promptly. There are various methods of repayment which may be discussed under the following heads.

1. Surplus budget: 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. Refunding : Refunding implies the issue of fresh bands and securities by government so that the matured loans can be used for repayment of public debt.
3. Annuities : By this method, the government repays past of the public debt every year. Such annual payments are made regularly till the debt is completely cleared.
4. Sinking fund: By this method, the government creates a separate fund called ’Sinking fund’ for the purpose of repaying public debt. This is considered as the best method of redemption.
5. Conversion: Conversion means that the existing loans are changed into new loans before the date of their maturity.
6. Additional taxation : Government may resort to additional taxation so as to raise necessary funds to repay public debt under this method new taxes are imposed.
7. Capital levy: Capital levy is a heavy one time tax on the capital assets and estates.
8. Surplus Balance of payments : This is useful to repay external debt for which foreign exchange is required surplus balance of payment implies exports in excess of imports by which reserves of foreign exchange can be created.

Short Answer Questions

Question 1.
“Supply creates its own demand” comment on the statement. [March 18, 17]
Answer:
Classical theory of employment or the theory of output and employment developed by economists such as Adam Smith, David Ricardo, Robert Malthus etc., it is based on the J.B Say’s law of market’. According to this law “supply creates its own demand”. The classical theory of employment assumes that there is always full employment of labour and other resources.

According to this law the supply always equals to demand it can be expressed as S = D. Whenever additional output is produced in the economy. The factors of production which participate in the process of production. Earn income in the form of rent, wages, interest and profits.

The total income so generated is equivalent to the total value of the additional output produced. Such income creates addition demand necessary for the sale of the additional output. Therefore the question of addition output not being sold does not arise.

Question 2.
Enumerate the assumptions of Classical theory of employment.
Answer:
The classical theory of employment is based on the Say’s law of markets. The famous law of markets, propounded by the J.B Say states that “Supply creates its own demand”.
Assumptions : The Say’s law is based on the following assumptions.

1. There is a free enterprise economy.
2. There is perfect competition in the economy.
3. There is no government interference in the functioning of the economy.
4. The equilibrium process is considered from the long term point of view.
5. All savings are automatically invested.
6. The interest rate is flexible.
7. The wage rate is flexible.
8. There are no limits to the expansion of the market.
9. Money acts as medium of exchange.

Question 3.
Explain the criticism against the classical theory of employment.
Answer:
The classical theory of employment came in for severe criticism from J.M. Keynes. The main points of criticism are as follows :

1. The assumption of full employment is unrealistic. It is rare phenomenon and not a normal features.
2. The wage cut policy is not a practical policy in modem times. The supply of labour is a function of money wage and not real wage. Trade unions would never accept any reduction in the money wage rate.
3. Equilibrium between savings and investment is not brought about by a flexible rate of interest. Infact, saving is a function of income and not interest.
4. The process of equilibrium between supply and demand is not realistic. Keynes commented the self adjusting mechanism doesn’t always operate.
5. Long run approach to the problem of unemployment is also not realistic. Keynes commented, “we are all dead in the long run”. He considered unemployment as a short- run problem and offered immediate solution through his employment theory.
6. It is not correct to say that money is neutral. Money acts not only as a medium of exchange but also as a store of value. Money influences variables like consumption, investment and output.

Question 4.
Explain the wage cut policy.
Answer:
Wage cut policy is one of the assumption of classical theory of employment which was started by “AC Pigou” who defended the classical theory and its full employment assumption. To Pigou and others the wage fund is given. The wage rate determined by dividing the wage fund with the number of workers. Pigou advocated a general cut in money wages in times of depression to restore full employment.

If there is a problem of unemployment in the economy. It is possible to solve this problem by reducing the money wages of the workers. This is known as “wage cut policy”. The given wage fund can offer more employment at a lower wage rate. The classicals believe that involuntary unemployment all involuntary unemployment would disappear.

According to classical theory of the labour supply and its demand depends on real wage rate. Real wage rate indicates the purchasing power of labourers. Because of existence of perfect competition in labour market real wage rate always equals to marginal productivity of labour. Labour supply is positively related to real wage rate and the demand for labour is inversely related to real Wage rate.

Question 5.
Distinguish between aggregate supply price and aggregate demand price.
Answer:
Aggregate supply price : When an entrepreneur gives employment to certain amount of labour. It requires the use of other factors of production or inputs. All these inputs have to be paid remunerations. When all these are added what we get is the value of the output produced or the expenditure incurred to supply employment for a specific number of labourers. By selling the output the entrepreneurs must expect to receive atleast what they have spent. This is known as the “Aggregate supply price” of the output or level of employment. As the level of output increases with the level of employment, aggregate supply price also increases with every increase in the level of employment.

Aggregate demand price : In Keynes theory the aggregate demand determines the level of employment. The aggregate demand price for a given output is the amount of money which the firms expect to receive from the sale of that output. Then aggregate demand will be equal to the sum of consumption (C) investment (I) and Government expenditure (G) for goods and services.
Therefore, Aggregate demand (AD) = C + I + G.
As the level of employment rises, the total income of the community also rises and therefore the aggregate demand, price also increases.

Question 6.
Explain the concept of effective demand.
Answer:
Effective demand means where aggregate demand equals the aggregate supply. When aggregate demand is equal to aggregate supply the economy is in equilibrium. This can be shown in the table.

In the table when the level of employment is 14 lakh workers, aggregate demand price is equal to aggregate supply price i.e ₹ 700 crores. This can be shown in the following diagram.

In the above diagram aggregate demand price curve (AD) and the aggregate supply price curve (AS) interest each other at point E₁. It shows the equilibrium point. The equilibrium has been attained at ON₁ level of employment. It is assumed that ON₁ in the above diagram does not indicate full employment as the economy is having idle factors of production. So it is considered as under-employment equilibrium.

According to Keynes, to achieve full employment an upward shift of aggregate demand curve is required. This can be possible through government expenditure on goods and services supplied in the economy, whenever private entrepreneurs may not show interest to invest. With this the AD₁ curve (C + I) shift as AD₂ (C + I + G) at new point of effective demand E₂, where the economy reaches full employment level i.e., ONE

Question 7.
What are the sources of public Revenue. [March 18, 17, 16]
Answer:
Revenue received by the government from different sources is called public revenue.
Public revenue is classified into two kinds.

1. Tax revenue
2. Non-Tax revenue.

1) Tax Revenue : Revenue received through collection of taxes from the public is called tax revenue. Both the state and central government collect taxes as per their allocation in the constitution.
Taxes are two types.
a) Direct taxes:

1. Taxes on income and expenditure. Ex : Income tax, Corporate tax etc.
2. Taxes on property and capital assests. Ex : Wealth tax, Gift tax etc.

b) Indirect taxes : Taxes levied on goods and services. Ex : Excise duty, Service tax.

2) Non – tax revenue: Government receives revenue from sources other than taxes and such revenue is called non-tax revenue. They are
a) Administrative revenue : Government receives money for certain administrative services. Ex : License fee, Tution fee etc.

b) Commercial revenue : Modern governments establish public sector units to manufacture certain goods and offer certain services. The goods and services are exchanged for the price. So such units earn revenue by way of selling their products. Ex : Indian Oil Corporation, Bharath Sanchar Nigam Ltd, Bharath Heavy Electricals, Indian Railways, State Road Transport Corporations, Indian Air lines etc.,

c) Loans and advances : When the revenue received by the government from taxes and from the above non-tax sources is not sufficient to meet the needs of government expenditure, it may receive loans from the financial institutions operating within the country and also from the public. Modem government also taken loans from international financial institutions.

d) Grants-in-aid : Grants are amount received without any condition of repayment. They are not repaid.
These are two types.

1. General grant,
2. Specific grant.

Question 8.
List out various items of public expenditure. [March 16]
Answer:
Public expenditure is an important constituent of public finance. Modem governments spend money from various welfare activities. The expenditure incurred by the government on various economic activities is called public expenditure.
Governments incur expenditure on the following heads of accounts.

1. Defence
2. Internal security
3. Economic services
4. Social services
5. Other general services
6. Pensions
7. Subsidies
8. Grants to state governments
9. Grants to foreign governments
10. Loans to state governments
11. Loans to public enterprises
12. Loans to foreign governments
13. Repayment of loans
14. Assistance to states on natural calamities etc.

Very Short Answer Questions

Question 1.
Classical economics.
Answer:
The term classical economics refers to the body of economic group which held their influence from the letter half of the 18^th century to the early part of the 20^th century. The most important principle of classicism are personal liberty Private property and freedom of private enterprise.

Question 2.
Laissezf aire
Answer:
According to classicals the role of government in economic activities should be nominal or very less. The free play of economic forces it self bring about the fuller utilization of economic resources including labour. Any interference with the free play of market forces under such circumstances the state shall not interfere in economic matter. It should pursue a policy of laissez fair-a policy of, non-intervention in economic matters.

Question 3.
Say’s law of market [March 16]
Answer:
J.B Say a french economist advocated the famous ‘Law of markets’ on which the classical theory of employment is based. According to this law “supply creates its own demand”. According to this law whenever additional output is created. The factors of production which participate in that production receive incomes equal to that value of that output. This income would be spent either on consumption goods or on capital goods. Thus additional demand is created matching the additional supply.

Question 4.
Market mechanism
Answer:
Market mechanism is the method of solving the central problems of an economy viz., what to produce, how to produce, whom to produce use through the forces of demand and supply. This mechanisms used by a free enterprise capitalist economy.

Question 5.
Full employment [March 17]
Answer:
Full employment is a situation in which all those who are willing to work at the existing wage rate are engaged in work.

Question 6.
Aggregate demand function
Answer:
The schedule showing aggregate demand prices at different levels of employment in the economy is called as aggregate demand function.

Question 7.
Aggregate supply function
Answer:
The schedule showing the aggregate supply price at different levels of employment is called the aggregate supply function.

Question 8.
Effective demand [March 16]
Answer:
Effective demand is that aggregate demand which becomes equal to the aggregate supply. This refers to the aggregate demand at equilibrium.

Question 9.
Difference between revenue account and capital account
Answer:
Revenue account consists of the current transactions and includes value of transactions relating to export import travel expenses, insurance, investment, income etc. The capital account refers to the transactions of capital nature such as borrowing and lending of capital repayment of capital sale and purchase of shares and securities etc.

Question 10.
Difference between internal debt and external debt
Answer:
Internal debt is the debt which is borrowed by a government from the people and institutions with in the country is called internal debt.
External debt is amount borrowed by a government from institutions and government of other countries is called external debt.

Question 11.
Structure of budget
Answer:
Budget is the annual statement showing the estimated receipts and expenditure of the government for a financial year in the budget. The budget estimates and revised estimates of the current financial year and actual expenditure of the preceding financial year are shown.

Question 12.
Deficit budget [March 18]
Answer:
Deficit budget arises when the total expenditure in the budget exceeds the total receipts in the budget technically there are four types of deficit budgets.

1. Revenue deficit
2. Budget deficit
3. Fiscal defict
4. Primary defict

Question 13.
Fiscal deficit
Answer:
Fiscal deficit is the difference between total revenue and total expenditure plus the market borrowings.
Fiscal deficit = (Total revenue – total expenditure) + Other borrowing and other liabilities.

Question 14.
Primary deficit
Answer:
Primary deficit is the fiscal deficit minus the interest payments.

Additional Questions

Question 15.
Wage – cut policy
Answer:
This is the policy advocated by A.C Pigou to reduce unemployment in the economy. It suggests that the wages of the labour should be reduced so that the unemployed can be employed.

Question 16.
Vote on account
Answer:
Vote on account is an interium budget presented for a few months pending presentation of the regular budget.

Question 17.
Surplus budget
Answer:
It refers to the budget in which the total receipts exceed the total expenditure.

Question 18.
Balanced Budget
Answer:
It is the budget in which the total receipts and total expenditure are equal.

Question 19.
Revenue deficit
Answer:
Revenue deficit is the difference between the revenue receipts and the revenue ex-penditure.

Question 20.
Redemption of debt
Answer:
Redemption of public debt means repayment of public debt.

Question 21.
Budget.
Answer:
Budget is the annual statement of the estimated receipts and estimated expenditure of the government for the ensuing financial year.

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 7th Lesson National Income Textbook Questions and Answers.

AP Inter 1st Year Economics Study Material 7th Lesson National Income

Essay Questions

Question 1.
Define National Income and explain the various concepts of National Income.
Answer:
National Income means the aggregate value of all the final goods and services produced in the economy in one year.
Concepts of National Income :
1) Gross National Product (GNP) : It is the total value of all final goods and services produced in the economy in one year.
The main components of GNP are :
a) The goods and services purchased by consumers – C.
b) Investments made by public and private sectors – I.
c) Government expenditure on public utility services – G.
d) Incomes earned through International Trade (x – m).
e) Net factor incomes from abroad.
GNP at market prices = C + I – G + (x – m) + Net factor income from abroad.

2) Gross Domestic Product (GDP) : The market value of the total goods and services produced in a country in one particular period usually in a year is the GDP
GDP = C + I + G

3) Net National Product (NNP) : Firms use continuously machines and tools for the production of goods and services. This result in a loss of value due to wear and tear of fixed capital. The loss suffered by fixed capital is called depreciation. When we substract depreciation from GNP we get NNP
NNP = GNP – depreciation.

4) National Income at factor cost: The cost of production of a good is equal to the rewards paid to the factors which participated in the production process. So the cost of production of a firm is the rent paid land, wages paid labour, interest paid on capital and profits of the entrepreneur.
National Income at factor cost = NNP + Subsidies – Indirect Taxes – Profits of Govt, owned firms.

5) Personal Income: It is the total of incomes received by all persons from all sources in a specific time period. Personal income is not equal to National Income. Because social security payments. Corporate taxes, undistributed profits are deducted from national income and only the remaining is received by persons.
Personal Income = National Income at factor cost – Undistributed profits – Corporate taxes – Social security contributions + Transfer payments.

6) Disposable income : Personal income totally is not available for spending income tax is a payment which must be, deducted to obtain disposable income.
Disposable income = Personal income – Personal taxes
D.I = Consumption + Savings

7) Per capita income : National Income when divided by country’s population. We get per capita income.
Per capita Income = \(\frac{\text { National Income }}{\text { Total Population }}\)
The average standard of living of a country is indicated by per Capita income.

Question 2.
Explain the various methods of calculating National Income. [March 18, 17, 16]
Answer:
There are three methods of measuring National Income.

1. Output method or Product method
2. Expenditure method
3. Income method

‘Carin cross’ says National Income can be looked in any one of the three ways. As the national income measured by adding up everybody’s income by adding up everybody’s output and by adding up the value of all things that people buy and adding in their savings.

1) Output method (Product method) : The market value of total goods and services produced in an economy in a year is considered for estimating National Income. In order to arrive at the value of the product services, the total goods and services produced are multiplied with their market prices. .
Then National Income = (P₁Q₁ + P₂Q₂ + ……….. P_nQ_n) – Depreciation – Indirect taxes + Net income from abroad.
Where P = Price
Q = Quantity
1, 2, 3 n = Commodities & services
There is a possibility of double counting. Care must be taken to avoid this. Only final goods and services are taken to compute National Income but not the raw materials or intermediary goods. Estimation of the National Income through this method will indicate the contribution of different sectors, the growth trends in each sector and the sectors which are lagging behind.

2) Expenditure method : In this method we add the personal consumption expenditure of households, expenditure of the firms, government purchase of goods and services net exports plus net income from abroad.
NI – EH + EF + EG + Net exports + Net income from abroad.
Here National Income = Private final consumption expenditure + Government final consumption expenditure + Net domestic capital formation + Net exports + Net income from abroad
EH = Expenditure of households
EF = Expenditure of firms
EG = Expenditure of Government
Care should be taken to include spending or expenditure made on final goods and services only.

3) Income method : In this method, the incomes earned by all factors of production are aggregated to arrive at the National Income of a country. The four factors of production receive incomes in the form of wages, rent, interest and profits. This is also national income at factor cost.
NI = W + I + R + P + Net income from abroad
NI = National income
W = Wages I = Interest
R = Rent
P = Profits
This method gives us National Income according to distribute shares.

Question 3.
Describe the components of National Income.
Answer:
The total quantity of goods and services produced in the economy in a year is the National Income. The various components of the National Income are :

1. Consumption (C)
2. Gross Domestic Investment (I)
3. Government Expenditure (G)
4. Net foreign Investment (x – m) ‘

1) Consumption : By consumption, we mean the expenditure’ made on goods and services which directly satisfy our wants. Ex : Cloth, food products, education and health services etc. A major portion of the National Income comprises Only consumption goods and services.

Consumption expenditure depends on the level of income. Consumption and savings are the two parts of disposable income. Income which is left after consumption is the saving.

Consumption goods can be perishable or durable. Perishable goods are single use goods. Ex : Food. Durable goods can be used more than once for a longer time.
Ex : Vehicles, fans etc.

2) Gross Domestic Investment : The expenditure made on producer goods by the firms to produce goods and services is the investment expenditure. Ex : Machinery and tools etc. They satisfy wants indirectly. For instance, the plough used for producing rice cannot give us satisfaction directly. Producer goods are most essential for the growth in National Income.

3) Government expenditure : The expenditure incurred on various goods and services by the government is the public expenditure. This is what is meant by government consumption. Government provides roads, schools, medical facilities, irrigation, electricity, infrastructure facilities etc., to the society.
It also provides administrative services, defence services etc. The public expenditure is determined by the nature of economic system.

4) Net foreign Investment: Some goods produced in the economy are exported to other countries. In the same way, some goods which are required in the economy are imported into the country. If the value of exports is more than the value of imports, other countries are indebted to our country. So, it must be added to National Income. If the value of imports is more than exports, that difference must be deducted from National Income.
Exports – Imports = Net foreign investment National Income = C + I + G + (x – m)

Short Answer Questions

Question 1.
What are the factors that determine National Income ? [March 17]
Answer:
National Income is the total market value of all goods and services produced in a country during a given period of time. There are many factors that influence and determine the size of national income country.
a) Natural resources : The availability of natural resources in a country, its climatic conditions, geographical features, fertility of soil, mines and fuel resources etc., influence the size of National Income.
b) Quality and Quantity of factors of production : The national income of a country is largely influenced by the quality and quantity of a country’s stock of factors of production.
c) State of technology : Output and national income are influenced by the level of technical progress achieved by the country. Advanced techniques of production help in optimum utilization of a country’s national resources.
d) Political will and stability: Political will and stability in a country helps in planned economic development and for a faster growth of National Income.

Question 2.
What is National Income at factor cost ? [March 18, 16]
Answer:
The cost of production of good is equal to the rewards paid to the factors which participated in the production process. So the cost of production of a firm is the rent paid to land, wages paid to labour, interest paid on capital and profits of the entrepreneur. These are received by suppliers of factors of production. There is a difference between net National Income at market prices and National Income at factor of cost. Imposition of tax increases the market prices. When these taxes deducted from net National Income, remaining income gets distributed among the factors of production.

Sometimes, the government may offer subsidies to encourage production of certain goods. The market prices of such goods will decrease to that extent. The value of subsidies is not included in net national product. So, it is to be added.
National Income at factor cost = NNP + Subsidies – Indirect taxes.

Question 3.
Mention any three definitions of National Income.
Answer:
National Income is the total market value of all goods and services produced in a country during a given period of time. ,
Several economists have defined National Incomes as follows :
Pigou’s definition : According to Pigou “National Income is that part of the objective income of the community including of course income derived from abroad which can be measured in money”.

Fisher’s definition : “The National dividend or income consists solely of services as received by ultimate consumers, whether from their material or from their human environment.

Marshall’s definition : “The labour and capital of country acting on its natural resources, produce annually a certain net aggregate of commodities, material and immaterial including services of all kinds. This is the net annual income or revenue of a country”.

Kuznet definition : According to Kuznets, National Income is the net output of commodities and services flowing during the year from the country’s productive system into the hands of the ultimate consumers or into the net additional to country’s capital goods”.

Question 4.
What is the relationship between per capita income and population ?
Answer:
There is a close relationship between national income and population. These two together determine the per capita income. If rate of growth of national income is 6% and rate of growth of population is 3% the rate of growth of per capita income will be 3% and it can be expressed as follows.
QPC = Q – QP
QPC = Rate of growth of per capita income
Q = Rate of growth of national income
QP = Rate of growth of population
A rise in the per capita income indicates a rise in standard of living. The rise in per capita income is possible only when the rate of growth of population is less than the rate of growth of that national income.

Additional Questions

Question 5.
Importance of National Income estimates.
Answer:
The importance of national income studies is growing because of several reasons.

1. The national income estimates are very important for preparing economic plans.
2. It is a very important tool for framing economic policies. .
3. It is very useful in making budgetary allocations.
4. It helps us to compare economic growth with other countries.
5. It is essential to calculate per capita incomes in a country and income inequalities.
6. It helps the government in macroeconomic policy making.

Question 6.
Explain circular flow of goods, services and incomes.
Answer:
Income is flow from wealth where as wealth is a stock. In every economy income flows from households to firms and vice versa. Thus the factor market and the product market are closely related to each other.

The process of circular flow of income of income makes to understand that income flows from households, firms and firms to households. The same can be understood from the following diagram.

In this diagram from households to firms shows the spending of households on goods and services produced by firms. The second arrow from firm to households shows the flow of goods and services from firm to households. These two arrows show the goods and services market. The other two arrows in second half of the diagram (lower part) represents the factors of production market.

Very Short Answer Questions

Question 1.
GNP (Gross National Product)
Answer:
It is the total value of all final goods and services produced in the economy in one year.
GNP = C + I + G + (x – m) where
C = Consumption
I = Gross National Investment
G = Government Expenditure
X = Exports
M = Imports
x – m = Net foreign trade.

Question 2.
Per capita Income [March 18, 17, 16]
Answer:
National Income when divided by country’s population, percapita income is obtained.
Per capita Income = \(\frac{\text { National Income }}{\text { Total Population }}\)
The average standard of living of country is indicated by per capita income.

Question 3.
Depreciation
Answer:
Firms use continuously machines and tools for the production of goods and services. This results in a loss of value due to wear and tear of fixed capital. This loss suffered by fixed capital is called depreciation.

Question 4.
Disposable Income
Answer:
Personal income totally is not available for spending. Income tax is payment which must be deducted to obtain disposable income.
Disposable Income = Personal income – Personal taxes
DI = Consumption + savings

Additional Questions

Question 5.
Circular flow of income
Answer:
Flow of income from firms to households and from households to firms.

Question 6.
Subsidies
Answer:
Share of government in price of a commodity.
Ex : Agriculture products.

Question 7.
National Income
Answer:
The total value of all final goods and services produced in the economy in a year.

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 6th Lesson Theory of Distribution Textbook Questions and Answers.

AP Inter 1st Year Economics Study Material 6th Lesson Theory of Distribution

Essay Questions

Question 1.
Define Rent and explain Ricardian theory of Rent.
Answer:
David Ricardo was a 19^th century economist of England, who propounded a systematic theory of rent. Ricardo defined rent as “that portion of the procedure of earth which is paid to the landlords for the use of the original and indestructible powers of soil”. According to Ricardo, rent arises due to differential in surplus occurring to agriculturists resulting from the differences in fertility of soil of different grades of land.

Rica rdiarz theory of rent is based on the principle of demand and supply. It arises in both extensive and intensive cultivation of land. When land is cultivated extensively, rent on superior land equals the excess of its produce over that of the inferior land. This can be explained with the following illustration.

We can imagine that a new island is discovered. Assume a batch of settlers go to that Island. Land in this Island is differ in fertility and situation. We assume that there are three grades of land A, B, and C. With a given application of labour and capital superior lands will yield more output than others. The difference in fertility will bring about differences in the cost of production, on the different grades of land. They first settle on A’ grade land for cultivation of com. A’ grade land yields say 20 quintals of corn with the investment of ₹ 300. The cbst of production per quintal is ₹ 15 (300/20). The price of corn in the market has to cover the cost of cultivation.

Otherwise the farmer will not produce com. Thus the price in the present case should be atleast ₹ 15 per quintal. As time passes, population increases and demand for land also increases. In such a case people have to cultivate next best land, i.e., ’B’ grade land. The same amount of Rs. 300 is spent of ‘B’ grade land gives only 15 quintals of corn as ‘B’ grade land is less fertile. The cost of cultivation on ‘B’ grade land risen to ₹ 20 (300/15) per quintal of corn. If the price of com per quintal in the market is then ₹ 20, the cultivator of ‘B’ grade and will be not cultivated. Therefore, the pride has to be high enough to cover the cost of cultivation on ‘B’ grade land. Hence the price also rises to ₹ 20. There is no surplus on B’ grade land. But on A grade land. But on A grade land, the surplus is 5 quintals or ₹ 100 (5 × 20).

Further, due to growth of population demand for land and corn increased. This necessitates, the cultivation of ‘C’ grade land with ₹ 300 investment cost. It yields only 10 quintals of com. Therefore the per quintal production cost rises to 30 (300/10). Then the price per quintal must be atleast ₹ 30 to cover the cost of production. Otherwise ‘C’ grade land will be withdrawn from cultivation. At price ₹ 30. ‘C grade land yield no surplus or rent. But A grade land yields still layer surplus of 10 quintals or ₹ 300 (10 × 30). But surplus or rent on ‘B’ grade land has 5 quintals or ₹ 150 (5 × 30). But there is no surplus or rent on ‘C’ grade land. It covers just the cost of cultivation. Hence, ‘C’ grade land is a marginal land which earns no rent or surplus.
This can also be explained with the following table.

The essence of Ricardian theory of rent.

1. Rent is a pure surplus.
2. Rent is differential surplus.
3. Rent does., not determine or enter into price.
4. Diminishing returns applies to agricultural production.
5. Land is put to only one use i.e., for cultivation.

Ricardian theory of rent can be explained with the help of diagram.
In the above diagram the shaded area represents the rent or differential surplus. The least fertile land i.e., C does not carry any rent. So it is called marginal land or no rent land.

Question 2.
Explain Marginal Productivity Theory of Distribution.
Answer:
This theory was developed by J.B.Clark. According to his theory, the remuneration of a factor of production will be equal to its marginal productivity. The theory assumes perfect competition in the market for factors of production. In such a market, average cost and marginal cost of each unit of factor of production are the same as they are equal to the price or cost of a factor of production.

For example if four tailors can stitch ten shirts in a day and five tailors can stitch thirteen shirts in a day, then the marginal physical product of the 5^th tailor is 3 shirts. If stitching charge for a shirt is ₹ 100/-, then the marginal value product of three shirts is ₹ 300/-. According to this theory the 5^th person will be remunerated ₹ 300/- marginal physical product is the additional output obtained by using an additional unit of the factor of production. If we multiply the additional output by market price we will get marginal value product or marginal revenue product.

At first stage when additional units of labour are employed the marginal productivity of labourer increases up to certain extent due to economies of scale. If additional units of labour are employed beyond that point the marginal productivity of labour decreases. This can be shown in the following figure.

In the figure OX axis represent units of labour and OY represent price/revenue/cost. At a given price OP the firm will employ OL units of labour where price OP = L. If it employees less than ‘OL’ i.e., OL₁ units MRP will be E₁L₁ which is higher than the price OR If firm employers more than OL units upto OL₂ price is OP is more than E₂L₂. So the firm decreases employment until price = MRP till OL. At that point ‘E’ the additional unit of labour is remunerated equal to his marginal productivity.

Question 3.
What is meant by Real Wages ? And what are the factors that determine Real wages ?
Answer:
The amount of goods and services that can be purchased with the money wages at any particular time is called real wage. Thus real wage is the amount of purchasing power received by worker through his money wage.
Factors determining the real wage :
1. Methods of form of payment: Besides money wages, normally the labourers get same additional facilities provided by their management. Ex : Free housing, free medical facilities etc. As a result this real wage of the worker will be high.

2. Purchasing power of money : An important factor which determines the real wage is the purchasing power of money which depends upon the general price level. A rise in general price level will mean a full in the purchasing power of money, causes decline in real wages.

3. Nature of work: The working conditions also determine the real wages of labourer. Less duration of work, ventilation fresh air etc., result in high real wages, lack of then facilities real wages are low eventhough money wages are high.

4. Future prospects : Real wage is said to be higher in those jobs where there is possibility of promotions hike in wages and vice-versa.

5. Nature of work : Real wages are also determined by the risk and danger involved in the work. If work i$ risky wages of labourer will be low though money wages are high. Ex : Captain in a submarine.

6. Timely payment : If a labourer receives payment regularly and timely the real wages of the labourer is high although his money wage is pretty less and vice-versa.

7. Social prestige : Real wage depends on social prestige. The money wages of Bank officer and judge are equal, but the real wage of a judge is higher than bank officer.

8. Period and expenses of education : Period and expenses of training also affect real wages.

Question 4.
What is meant by wages ? Explain briefly various theories of wages.
Answer:
Wages are a payment made for the services of labour, either mental or physical.
According to Benham “sum of money paid under contract by an employer to a worker for the services rendered”.
Theories of wages:
1. Subsistence theory of wages : This theory was formulated by a group of French Economics known as Physiocrats. This theory is also termed as “Iron Law of wages”. According to this theory, wages will always be at a level to enable the labourer and his family to fulfill the minimum subsistence level. If the wages are raised above the subsistence level, supply of labour will increase. If wages will decrease to the subsistence level, the supply of labour will decrease. Hence wages will always be at the subsistence level.

2. Wage fund theory : This theory developed by J.S.Mill. According to this theory every entrepreneur will keep aside a part of the variable capital to pay wages as the labourers cannot wait for their wages till goods are sold. Such part of variable capital is known as ‘Wages fund” or “Circulating capital”.
Average wage rate = \(\frac{\text { Amount of wage fund }}{\text { Number of labourers }}\)

3. Residual claimant theory of wages : This theory proposed the residual claimant theory of wages. According to Walker is a residual claimant. After paying rent, interest and profit from total revenue, the balance will be paid as wages to labourers.
Wages = Total Revenue – (Rent + Interest + Profit)

4. Taussig’s theory of wages: This theory modified by Taussig. According to Taussig, wages are equal to the discounted marginal product of labour. According to him, the labourer cannot get full value of the marginal productivity. In order to meet the expenditure of labourer in course of production, the employer will have to pay wages in advance. Hence, the employers deducts a certain percentage from the final output inorder to compensate the risk involved in advance payments to the labourers.

5. Modern theory of wages : This theory proposed by Marshall and J.R.Hicks. According to this theory, the wages of labourers are determined by the demand for and supply of labourers wage is determined at that point where the demand and supply of labourer are equal.

Question 5.
What is meant by interest ? Explain briefly various theories of interest.
Answer:
In Economics, interest is regarded as the payment for the use of the service of capital.
Carver said “Interest is the income which goes to capital”.
Theories of interest:
1. Abstinence or Waiting theory of interest: Nassau Senior proposed the Ah f inence theory of interest. According to him capital can be created by postponing consumption. It means when people save, they abstain from consumption. Abstaining from consumption is disagreeable and painful. As lending involves sacrifice, it is necessary to reward the lender in the form of interest.

2. Agio theory of interest or Bohm – Bawerk’s theory: According to Bohm – Bawerk, interest arises because people prefer present goods to future goods of the same kind and quantity. People prefer present enjoyment to future enjoyment. As a result of saving, people lose present enjoyment.
Bohm-Bawerk gave three reasons for the emergence of rate of interest. They are :

1. The demand for goods is greater now than in future as people have different demands for goods in the present than in the future.
2. People under estimate future wants due to lack of imagination to judge the intensity of their future wants, lack of will to resist temptation of satisfying present wants and they think they may not be alive to satisfy wants as future is uncertain.
3. Present goods are considered technically superior over future goods. By consuming goods at present lead to accumulation of productive capital for future. Hence interest is paid as a premium for the postponement of consumption.

3. Productivity theory of interest : According to Classical Economists, capital is demanded because of its productivity. Whenever additional units of capital are used, productivity will increase upto a certain point and later decreases beyond that point. Additional units of capital are not as productive as the earlier units as a result of the law of variable proportions.

According to this theory, rate of interest is just equal to the productivity of capital. Hence, higher the demand for capital, lower will be the rate of interest and vice versa. As per the theory, rate of interest is inversely related to the demand for capital.

4. Loanable funds theory of interest: The lonable funds theory or the neo classical theory was first formulated by Knutt Wicksell. According to this theory, interest is determined by the equilibrium of demand for and supply of loanable funds in the market.

5. Time preference theory : Irvin’g Fisher proposed the time preference theory of ! interest. Fisher’s theory emphasized time preference as a cause of interest. He also considered the role of marginal productivity or “rate of return over cost that determines interest”. Hence, rate of interest is determined by time preference.

6. Keynes’ liquidity preference theory: Keynes proposed a monetary explanation of the rate of interest. According to Keynes, interest is determined by both the demand for and supply of money.
According to Keynes “Interest is the reward paid for paring with liquidity for the specified period”.

7. Supply money: Supply of money refers to the total quantity of money in circulation. Supply of money is fixed or perfectly inelastic at a given point of time. Supply of money is determined by the central bank of a country.

8. Demand for money : People demand money for its liquidity. The desire to hold ready cash is liquidity preference. Liquidity preference is positively related to the rate of interest. People demand money basically for these reasons.

1. Transactions motive
2. Precautionary motive
3. Speculative motive.

Question 6.
What is meant by profit ? Explain briefly various theories of profit.
Answer:
Profit is the reward paid to the entrepreneur for his services as an organizer in the process of production.
Theories of profit:
1. Dynamic theory of profit: This theory was propounded by J.B. Clark. According to Clark “Profit is the difference between the price and cost of production of commodity”. He viewed that profit as a reward for entrepreneurial dynamism. Dynamic changes like increase in population, new method of production etc., result increase in profit. In a static economy due to lack of these changes entrepreneurs receive only wages but not profit. Hence profits are the result of the dynamic changes only.

2. Innovation theory: This theory was developed by Joseph Schumpeter. According to Schumpeter, “profit is the reward paid to the entrepreneur for his inventive skills”. Because of these inventions profits arise as a difference between prices and costs of production.
According to Schumpeter, entrepreneur must break the circular flow by introducing innovations they are :

1. Introduction of new good.
2. Introduction of new method of production.
3. Reorganisation of industry.
4. Opening up of a new market.
5. Discovery of new source of raw materials.

So these innovations, the cost of production remains below its selling price and thus profit arises.
Thus profit is paid to entrepreneur for innovating but not for risk taking.

3. The risk theory of profit: This theory was proposed, by Prof. Hawley. Profits are the reward for an entrepreneur for risk-taking. So the residual part of income after paying all factors of production goes to the entrepreneur for risk taking. Fluctuations in future prices, demand etc., are involved in risk taking.
According to Prof. Hawley those who face risks in business will be able to earn an excess of payment above the actual value of risk in the form of profit.

4. Uncertainty theory of profit: This theory formulated by Prof. Knight. It is a modified version of risk bearing theory of profits. According to him profit as the reward for bearing uninsurable risks and uncertainties. He classified risks into two types.

1. Unforseen insurable risks like fire, theft.
2. Unforseen non insurable risks like changes in prices, demand and supply. These uninsurable risks cannot be calculated.

According to Prof. Knighit, “Profit cannot be treated as the reward for risk taking only for reward for uncertainty bearing”.

5. Walker’s theory of profit: This theory developed by Walker. According to Walker “Profits are a rent paid for the abilities of entrepreneur”. Walker theory states that profits arise due to the differences in efficiency and ability of entrepreneurs. Hence efficient and able entrepreneurs’ are paid profits.

Short Answer Questions

Question 1.
Explain the concept of Distribution.
Answer:
Distribution refers to that branch of economies which analyses how the national income of a community is divided among the various factors of production, distribution then refer to the sharing of the wealth that is produced among factors of production. It is the pricing of factors of production. The distribution of income may be personal or functional economies is concerned with functional distribution. The distinction between them is briefly explained here.

1. Functional distribution : Functional distribution deals with the study of factor incomes. It means the theory of factor pricing. The prices of land, labour, capital and organisation are called rent, wages, interest and profit respectively. Therefore, it is the study and determination of rent, wages, interest and profit. It concern the pattern of distribution of national income as rent, wage, interest and profits. Thus it is not concerned with individuals and their individual income, but with the agents’of production. The study of functional shares has been carried on both at the macro and micro levels.
Micro-distribution: The theory of micro-distribution explains how the prices of factors of production are determined.
Ex : Micro-distribution we study how wage rate of labour is determined.

Macro-distribution : Macro distribution explains the share of a factor of production in the national income.
Ex : The share of labour in the national income.

2. Personal distribution: It refers to the distribution of income or wealth of a country among its people. It studies how income or wealth is distributed among individuals or persons. It studies how much income is earned by an individual, but not how it is earned or in how many forms it is earned. The causes of income inequalities can be known by studying personal distribution.

Question 2.
What are the factors that determine factor prices ? [March 16]
Answer:
The demand and supply of a factor of production determine its price. The demand for a factor of production depends on the following.

1. It depends on the demand for the goods produced by it.
2. Price of the factor determines its demand.
3. Prices of other factors or co-operative factors determine the demand for a factor.
4. Technological changes determine the demand for a factor.
5. The demand for a factor increases due to increase in its production.

Factors that determine the supply of a factor of production.

1. The size of the population and it’s age composition.
2. Mobility of the factor of production.
3. Efficiency of the factor of production.
4. Geographical conditions,
5. Wage also determines the supply of this factor.
6. Income.

Question 3.
Explain the concept of Quasi-rent. [March 17]
Answer:
The concept of Qliasi rent was first introduced by Marshall. According to Marshall, quasi rent is the income derived from machines and other man made appliances of production. Whose supply is inelastic in the short run in relation to their demand. If the demand for these factors increases, their prices will also increase due to their inelasticity of supply in R the short period. The rent or surplus above the factor price will disappear in the long run.

In the above diagram man made appliances are shown in ‘OX’ axis and ‘OY’ axis shown rent SPS is short period supply curve. LPS is long period supply curve. In the above diagram it is observed that rent will disappear in the long run.

Question 4.
Explain the concept of Scarcity rent. [March 18]
Answer:
Marshall explained the concept of scarcity rent on the basis of demand and supply. In general land has indirect demand or derive demand. If there is an explosion of population demand for land increases this result rise in its price. The surplus earned by land above its price is called scarcity rent.

The supply of land is fixed and inelastic. The demand for land will determine the rent by influencing its price. Hence rent arises due to the scarcity in the supply of factors of production.

In the given diagram on ‘OX’ axis represent supply and demand for land. ‘OY axis represents Rent. SL is supply of land. It is perfectly inelastic. When DD curve shifts upward to D₁D₁. So price increases from OR to OR₁. Similarly if demand curve further shifts from D₁D₁ to D₂D₂ rent price further increases from OR₁ to OR₂.

Question 5.
Explain the concepts of Gross interest, Net interest and their components.
Answer:
Gross interest: The payment which the lender receives from the borrower excluding the principal is gross interest. Gross interest includes net interest or pure interest also.
Gross interest include the following four elements :
a) Net interest: Net interest is the reward for the services of the capital alone. Interest paid on government bonds and government loans is the net interest. If capital has mobility. The net interest any where will be the same.

b) Insurance against risk : Lending money as alone to somebody always involves a risk that the borrower may not repay it. These risks are two types :
1. Trade risk
2. Personal risk
In order to cover these risks. The lender charges some extra amount in addition to the net interest.

c) Compensation for inconvenience: Lending may also some inconvenience because the lender lends money only by saving i.e. by restricting his consumption out of income. In addition to this the lender may not get back his money when he requires for his own use.. He thus suffers from certain inconveniences. In order to compensate this sort of inconvenience he charge some extra over and above net interest.

d) Reward for management services : The lender has to maintain a record of all repayments and charges. He has to remind the debtors about the repayment of loan by post or by personal visits. He has maintain an office and clerical staff. Sometimes he has to approach the court also in case of non-payment of loan by the debtor for all these sorts of management work. He deserves some payment.

Question 6.
Explain the components of Gross profits and Net profits.
Answer:
Gross profit is considered as a difference between total revenue and cost of production. The following are the components of gross profit.

1. The rent payable to his own land or buildings includes gross profit.
2. The interest payable to his own business capital.
3. The wage payable to the entrepreneur for his management includes gross profit.
4. Depreciation charges or user cost of production and insurance charges are include in gross profit.
5. Net profits are reward paid for the organiser’s entrepreneurial skills.

Components :

1. Reward for risk bearing : Net profit is the reward for bearing uninsurable risks and uncertainities.
2. Reward for coordination : It is the reward paid for co-ordinating the factors of production in right proportion in the process of production.
3. Reward for marketing services : It is the profit paid to the entrepreneur for his ability to purchase the services of factors of production.
4. Reward for innovations: It is the reward paid for innovations of new products and alternative uses to natural resources.
5. Wind fall gains : These gains arise as a result of natural calamities, wars and artificial scarcity are also include in net profits.

Very Short Answer Questions

Question 1.
Contract rent [March 16]
Answer:
It is the hire charges for any durable good. Ex : Cycle rent, room rent etc. It is a periodic payment made for the use of any material good. The amount paid by the tenant cultivator to the landlord annually may be also called contract rent. Ex. : The rent that a tenant pays to the house owner monthly as per an agreement made earlier or the hiring charges of a cycle ₹ 10 per hour is also contract rent.

Question 2.
Economic rent
Answer:
The ordinary use of the term ‘rent’ means any periodic payment for the hire of anything such as garriages, .buildings etc. Economic rent is the pure rent payable as a reward for utilising the productivity of land. It is derived by subtracting the elements like interest, wages, profits and depreciation from the gross rent 6r contract rent. To David Ricardo; it is surplus over costs or expenses of cultivation.

Question 3.
Scarcity rent
Answer:
Prof. Marshall explained the concept of scarcity rent on the basis of demand and supply. Scarcity rent is the surplus earned by land which has inelastic supply. In general land has indirect demand or derived demand. If there is an explosion of population, demand for land increases resulting in a rise in its price. The surplus earned by land above its price is called scarcity rent.

Question 4.
Quasirent
Answer:
The concept of quasi-rent was first introduced by Marshall. Quasi rent according to Marshall is the surplus earned by instruments of production other than land. It is the income earned from man made factors of production! Such as machinery, buildings, tools etc. This is short term concept.

Question 5.
Transfer earnings [March 18]
Answer:
Transfer earnings refer to the surplus earned by a factor of production is its present use-over its next best use.

Question 6.
Money wages
Answer:
Money ’ ages are the remuneration received by the labourer in the form of money for the physical and mental service rendered by him or her in the production process.
Ex : If a labourer is paid ₹ 30/- per day. ₹ 30/- is the money wage.

Question 7.
Real wages [March 16]
Answer:
Real wage is the purchasing power of money wages in terms of goods and services.

Question 8.
Time wages
Answer:
Time wage is the amount paid for labourers for a fixed period of work i.e. weakly, daily, monthly etc.

Question 9.
Piece wages
Answer:
Piece wage is the amount paid for labourers according to volume of work done by them.

Question 10.
Gross interest
Answer:
The payment which the lender receives from the borrower excluding the principal is gross interest.
Gross interest = Net interest + [Reward for risk taking + Reward for Inconvenience + Reward for management]

Question 11.
Net interest [March 18, 17]
Answer:
Net interest is tjie reward for the service of the capital loan.
Ex : Net interest paid on government bonds and government loans.

Question 12.
Gross profit
Answer:
Gross profit is considered as a difference between total revenue and cost of production.
Gross profit = Net profit + [Implicit rent + Implicit wage + Implicit interest + Depreciation charges + Insurance premium]

Question 13.
Net profit
Answer:
Net profit is the reward paid for the organizer’s entreprenurial skills.
Net profit = Gross profit – [Implicit rent + Implicit wage + Implicit interest + Depreciation charges + Insurance premium]

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 4th Lesson Theory of Production Textbook Questions and Answers.

AP Inter 1st Year Economics Study Material 4th Lesson Theory of Production

Essay Questions

Question 1.
Explain the law of variable proportions. [March 18, 17]
Answer:
The law of variable proportions has been developed by the 19^th century economists David Ricardo and Marshall. The law is associated with the names of these two economists. The law states that by increasing one variable factor and keeping other factors constant, how to change the level of output, total output first increases at increasing rate, then at a diminishing rate and later decreases. Hence this law is also known as the “Law of Diminishing returns”.

Marshall stated in the following words.

“An increase in capital and labour applied in the cultivation of land causes in general less than proportionate increase in the amount of produce raised, unless it happens to coincide with an improvement in the arts of agriculture”.
Assumptions :

1. The state of technology remain constant.
2. The analysis relates to short period.
3. The law assumes labour in homogeneous.
4. Input prices remain unchanged.

Explanation of the Law :
Suppose a farmer has ‘4’ acres of land he wants to increase output by increasing the number of labourers, keeping other factors constant. The changes in total production, average product and marginal product can be observed in the following table.

In the above table total product refers to the total output produced per unit of time by all the labourers employed.

Average product refers to the product per unit of labour marginal product refers to additional product obtained by employing an additional labour.
In the above table there are three stages of production.

1^st stage i.e., increasing returns at 2 units total output increases average product increases and marginal product reaches maximum.
2^nd stage i.e., diminishing returns from 3^rd unit onwards TP increases diminishing rate and reaches maximum, MP becomes zero, AP continuously decreases.
3^rd stage i.e., negative returns from 8^th unit TP decreases AP declines and MP becomes negative.
This can be explained in the following diagram.

In the diagram on ‘OX’, axis shown units labourer and OY’ axis show TP, MP, and AP. 1^st stage TP, AP increases MP is maximum. In the 2^nd stage TP maximum, AP MP is zero. At 3^rd stage TP declines, AP also declines, MP becomes negative.

Question 2.
Explain the law of returns to scale.
Answer:
The law of returns to scale relate to long run production function. In the long run it is possible to alter the quantities of all the factors of production. If all factors of production are increased in given proportion the total output has to increase in the same proportion. Ex : The amounts of all the factors are doubled, the total output has to be doubled increasing all factors in the same proportion is increasing the scale of operation. When all inputs are changed in a given proportion, then the output is changed in the same proportion. We have constant returns to scale and finally arises diminishing returns. Hence as a result of change in the scale of production, total product increases at increasing rate, then at a constant rate and finally at a diminishing rate.
Assumptions :

1. All inputs are variable.
2. It assumes that state of technology remain the same. The returns to scale can be shown in the following table.

The above table reveals the three patterns of returns to scale. In the 1^th place, when the scale is expanded upto 3 units, the returns are increasing. Later and upto 4^th units, it remains constant and finally from 5^th on words the returns go on diminishing.

In the diagram on ‘OX’ axis shown scale of production, on OY’ axis shown total product. RR₁ represents increasing returns R₁S – Constant returns; SS₁ represents diminishing returns.

Question 3.
Distinguish between internal and external economies.
Answer:
Economies of large scale production can be grouped into two types.

1. Internal economies
2. External economies.

1. Internal Economies:
Internal economies are those which arise from the expansion of the plant, size or from its own growth. These are enjoyed by that firm only.
“Internal economies are those which are open to a single factory or a single firm independently of the action of other firms”. – Cairncross
i) Technological Economies : The firm may be running many productive establishments. As the size of the productive establishments increase, some mechanical advantages may be obtained. Economies can be obtained from linking process to another process i.e. paper making and pulp making can be combined. It also used superior techniques and increased specialization.

ii) Managerial Economies : Managerial economies arises from specialisation of management and mechanisation of managerial functions. For a large size firm it becomes possible for the management to divide itself into specialised departments under specialised personnel. This increases efficiency of management at all levels. Large firms have the opportunity to use advanced techniques of communication, computers etc. All these things help in saving of time and improve the efficiency of the management.

iii) Marketing Economies : The large firm can buy raw materials cheaply, because it buys in bulk. It can secure special concession rates from transport agencies. The product can be advertise better. It will be able to sell better.

iv) Financial Economies : A large firm can arise funds more easily and cheaply a small one. It can borrow from bankers upon better security.

v) Risk bearing Economies : A large firm incurs unrisk and it can also reduce risks. It can spread risks in different ways. It can undertake diversifications of output. It can buy raw materials from several firms.

vi) Labour Economies : A big firm employs a large number of workers. Each worker is given the kind of job he is fit for.

2. External Economies :
An external economy is one which is available to all the firms in an industry. External economies are available as an industry grows in size.

1. Economies of Concentration : When a number pf firms producing an identical product are localised in one place, certain facilities become available to all. Ex : Cheap transport facility, availability of skilled labour etc.
2. Economies of Information : When the number of firms in an industry increases collective action and co-operative effort becomes possible. Research work can be carried on jointly. Scientific journal can be published. There is possibility for exchange of ideas.
3. Economies of Disintegration : When the number of firms increases, the firm may agree to specialise. They may divide among themselves the type of products of stages of production. Ex : Cotton industry.

Question 4.
Explain short-run cost structure of a Firm.
Answer:
Costs are divided into two categories i.e.,

1. Short run cost curves
2. Long run cost curves.

In short run by increasing only one factor i.e., (labour) and keeping other factor constant. The short run cost are again divided into two types.

1. General costs
2. Economic costs.
   1. General costs :

i) Money costs : Production is the outcome of the efforts of factors of production like land, labour, capital and organisation. So, rent to land, wage to labour, interest to capital and profits to entrepreneur has to paid in the form of money is called money cost.

ii) Real cost: Adam Smith regarded pains and sacrifices of labour as real cost. So it cannot be measured interms of money.

iii) Opportunity cost: Factors of production are scarce and have alternative uses. The opportunity cost of a factor is the benefit that is foregone from the next best alternative use.

2. Economic costs :
i) Fixed costs : The cost of production which remains constant even the production may be increase or decrease is known as fixed cost. The amount spent by the cost of plant and equipment, permanent staff are treated as fixed costs.

ii) Variable cost: The cost of production which is changing according to changes in the production is said to be variable cost. In the long period all costs are variable costs. It include price of raw materials, payment of fuel, excise taxes etc. Marshall called “Prime cost”.

iii) Average cost: Average cost means cost per units of output. If we divided total cost by the number of units produced, we will get average cost.
AC = \(\frac{\text { Total cost }}{\text { Output }}\)
iv) Marginal cost: Marginal cost is the additional cost of production producing one more unit.
MC = \(\frac{\Delta \mathrm{TC}}{\Delta \mathrm{Q}}\)
v) Total cost: Total cost is the sum of total fixed cost and total variable cost.
TC = FC + VC
The short term cost in relation to output are explained with the help of a table.

In the above table shows that as output is increased in the 1^st column, fixed cost remains constant. Variable costs have changed as and when there are changes in output. To produce more output in the short period, more variable factors have to be employed. By adding FC & VC we get total cost different levels of output. AC falls output increases, reaches its minimum and then rises MC also change in the total cost associated with a change in output. This can be shown in the diagram.

In the above diagram on ‘OX’ axis taken by output and ‘OY taken by costs. The shapes of different cost curves explain the relationship between output and different costs. TFC is horizontal to ‘X’ axis. It indicates that increase in output has no effect on fixed cost. TVC on the other side increases along with level of output. TC curve rises as output increases.

Additional Questions

Question 1.
Explain Production function.
Answer:
Production function is technical concept. It explains the physical relationship between input and output at any period of time. It represents functional relationship between inputs and the amount of output produced.
According to Stigler “Production is the name given to the relationship between rates of inputs of productive services and the rate of output of product”.
The production function can be expressed mathematically as follows.
G_x = f (L, K, R, N, T)
G_x = Output
f = Functional relationship
L = Amount of Labour
K = Amount of Capital
R = Raw material
N = Natural resources or land
T = State of Technology.
Where G_x is dependent variable and is determined by the inputs used, whereas L, K, R, N, T are independent variables.

Question 2.
Explain Law of supply.
Answer:
The law of supply explains the functional relationship between price of a commodity and its quantity supplied. The law of supply can be stated as follows “Other things remaining the same, as the price of a commodity rises its supply is extended and as the price falls its supply is contracted”.

The law of supply can be explained with the help of supply schedule and supply curve.

Supply Schedule : Supply schedule explains various amounts of good that the seller offers for sale at different prices. It represents the functional relationship between price and quantities supplied. There is direct relationship between price and supply. This can be shown in the following schedule.

The above schedule high price i.e, ₹ 5.00 per unit 1000 units are supplied and at ₹ 1 per 200 units are supplied. It means high price indicate high supply and low price indicates low supply. So, it shows the direct relationship between price and supply.

Supply curve :
A supply curve can be drawn with the help of above supply schedule to explain the direct relationship between price and supply.

In the above diagram supply is shown on ‘OX’ axis and price is shown ‘OY axis. SS is supply curve. It slopes upwards from left to right. The slope of supply curve is always positive. Because there is direct relationship between the price and supply.’

Question 3.
Define Factors of production.
Answer:
Factors that help in the production process are called factors of production.
Ex : land, labour, capital and organization
1) Land : Land stands in economics for natural resources. There are nature given resources like soil, earth, water, rainfall, forests, mines, clijnate etc. All these come under land. Land is the productive equipment given by nature. The remuneration to land is called rent.

2) Labour : Labour is man’s effort. It may be physical or mental labour. Any service offered for a price is considered as labour in economics. All services rendered to produce scarce goods come under labour. The remuneration to labour is called wage.

3) Capital : Capital is man made production equipment. Factories, buildings, vehicles, rail-roads, roads, irrigation dam etc., come under capital. The remuneration to capital is interest.

4) Organisation or Entrepreneurship : The entrepreneur or businessmen brings together all the factors of production required for production. He bears the risk is doing so. He coordinates the functions of different factors. Profit is the remuneration for organisation or entrepreneurship.

Question 4.
Define land and explain the characteristics of land.
Answer:
Land stands in economics for natural resources. There are nature given resources like soil, earth, water, rainfall, forests, mines, climate etc., all these come under land. Land is the productive, equipment given by nature. The remuneration to land is called rent. Characteristics of land:

1. Land is a free gift of nature.
2. The supply of land is perfectly inelastic from the point of view of economy.
3. Land cannot be shifted from one place to another place.
4. It does not yield any result unless human effort’s are employed.

Question 5.
Define labour. Explain the characteristics of labour.
Answer:
Labour is man’s effort. It may be physical (or) mental labour. Any’service offered for a price is considered as labour in economics. The remuneration to labour is called wage. Characteristics of labour:

1. Labour is inseparable from the labourer himself.
2. Labour is highly ‘perishable’. It means labour lost cannot store his labour.
3. Labour has a very weak bargaining power.
4. Labour power differs from labourer to labourer of their skills.
5. The supply curve of a labourer is backward bending.

Question 6.
What is supply ? What are the determinants of supply.
Answer:
The supply of a commodity means the total quantity of the commodity that sellers offer to sell at different prices from the stock of that commodity existing at any given time. The supply of commodity depends upon the following factors.
Determinants of supply :

1. Price of the commodity: The supply of the commodity depends upon the price of that commodity. When price falls, supply falls and when price rises, supply also rises. Thus price and supply are directly related.
2. Factor prices : The cost of production of a commodity depends upon the prices of various factors of production.
3. Prices of related goods : The supply of the commodity depends upon the prices of related goods. If the price of a substitute good goes up, the producer will be induced to
4. State of technology: Technological improvements determine supply of a commodity. Progress in technology leads to reduction in the cost of production which will increase supply.
5. Government policy : Imposition of heavy taxes as a commodity discourages its production. Hence production decreases.

Question 7.
Explain the nature of revenue curves untier perfect competition.
Answer:
If competition is perfect in market, the market is known as perfectly competitive market. Due to the existing features the total demand and total supply pf a commodity interact to determine the price in the industry and individual firm. Hence, an individual seller or firm is a price taker but not a price maker in perfect competition, ‘therefore he can sell any quantity at the ruling price. Thus, the demand curve is parallel to X-axis. The nature of Average Revenue (AR) and Marginal Revenue (MR) and their relationship under perfect competition can be better understood from the following schedule.
Revenue Schedule :

The above table indicates that in perfect competition price remains the same irrespective of the number of units sold. Therefore, the total revenue increases at a constant rate. AR and MR are equal. There is no difference among price AR and MR. This can be reveals the following diagram.

In the diagram X-axis represents number of units (output) and Y-axis represents revenue. DP is demand curve.

In diagram, the Average Revenue curve (AR) is horizontal straight line parallel to the X-axis and Marginal Revenue Curve MR coincides with it. Because the seller can sell number of units given the price, the AR curve facing the seller is a horizontal line.

Very Short Answer Questions

Question 1.
Production function [March 18]
Answer:
The production function is the none for the relation between the physical inputs and the physical outputs of a film. Production of a firm, production function explains the functional relationship between inputs and outputs this can be as follows G_x = f (L, K, R, N, T).

Question 2.
Law of supply [March 16]
Answer:
The law of supply explains the functional relationship between price of a commodity and its quantity supplied. The law of supply can be stated as follows. “Other things remaining the same, as the price of a commodity rises its supply is extended and as the price falls its supply is contracted”.

Question 3.
Factors of production
Answer:
Factors that help in the production process are called factors of production.
Ex : land, labour, capital and organization.

Question 4.
Average cost
Answer:
If we divided total cost, by the number of units produced. We will get average cost. Average cost means cost per unit of output.
AC = \(\frac{\mathrm{TC}}{\text { Output }}\)

Question 5.
Marginal cost
Answer:
Marginal cost is the additional cost of production producing one more unit in other words it is the addition made to total cost by producing one more unit of a commodity.
MC = \(\frac{\Delta \mathrm{TC}}{\Delta \mathrm{Q}}\)

Additional Questions

Question 6.
Production
Answer:
Production is the process that converts inputs into output in economies production includes services along with physical goods.

Question 7.
Short period
Answer:
Short period is a period in which a producer is unable to change factors of production to increase output. This relates to law of variable proportions.

Question 8.
Long period
Answer:
Long period is a period in which a producer is unable to change factors of production to increase output. This relates to returns to scale.

Question 9.
Average product
Answer:
It refers to the product per unit of labour it is Obtained by dividing total product by the number of labourers employed.
AP = \(\frac{\mathrm{TP}}{\mathrm{L}}\)

Question 10.
Marginal product
Answer:
It is the additional product by employing an additional labour.
MP = \(\frac{\Delta \mathrm{TP}}{\Delta \mathrm{L}}\)

Question 11.
Fixed factor
Answer:
Fixed factors are those costs which can’t be changed by the producer in the short period.
Ex : Buildings, Machinery etc.

Question 12.
Variable factors
Answer:
The factors of production which are possible to change in relation to a change in output is known as variable factors in the long run all factors of production are variable.
Ex : Labour, Raw materials.

Question 13.
Change in scale of production
Answer:
It refers that output will be increase by increasing inputs in the long period.

Question 14.
Internal economies
Answer:
It refers that when a firm expands output by increasing all inputs.

Question 15.
External economics
Answer:
It refers to one which is available to all the firms in an industry. External economies are available as an industry grows in size.

Question 16.
Supply
Answer:
The quantity of a commodity that a seller is prepared to sell at a particular price and at a particular time is known as supply. The supply curve slopes upwards from left to right.

Question 17.
Supply function
Answer:
It explains the functional relation between supply and the factors of production of a good.

Question 18.
Opportunity cost
Answer:
The opportunity cost of a factor is the benefit i.e, forgone from the next best alternative use.

Question 19.
Fixed cost
Answer:
The cost of production which remains constant even the production may be increase (or) decrease is known as fixed cost.
Ex : Machinery, permanent staff salaries.

Question 20.
Variable cost
Answer:
The cost of production which is changed according to changes in the production is said to be variable cost. In the long period all costs are variable costs it include price of raw materials, wages of labour, power transport charges etc.

Question 21.
Total Revenue
Answer:
Total revenue of a producer depends on the price and the quantity of output sold in the market.
Total Revenue = Price × Quantity of output
TR = P × Q

Question 22.
Average Revenue
Answer:
Average revenue is the revenue per unit of output. Average revenue is obtained by dividing to revenue by the number of unit sold.
AR = \(\frac{\text { TR }}{\mathrm{Q}}\)

Question 23.
Marginal Revenue
Answer:
Marginal revenue is the additional revenue earned by selling one more unit of the product. In other words change in total revenue arising from the sale of an additional unit of output is called marginal revenue.
MR = \(\frac{\Delta \mathrm{TR}}{\Delta \mathrm{Q}}\)

Question 24.
Total Cost
Answer:
Total cost can be obtained by adding total fixed costs and variable costs.

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 2nd Lesson Theory of Consumers Behaviour Textbook Questions and Answers.

AP Inter 1st Year Economics Study Material 2nd Lesson Theory of Consumers Behaviour

Essay Questions

Question 1.
Explain the law of diminishing marginal utility and its limitations. [March 17]
Answer:
Hermann Heinrich Gossen was the first economist to explain the law of diminishing marginal utility in 1854. It is also known as Gossen’s ‘first law’. In 1890 Marshall in his principles of economics developed and popularised this analysis. This law explains the functional relationship between the stock of commodity and the marginal utility of the commodity.

According to Marshall “The additional benefit which a person derives from a given increase of his stock thing diminishes with every increase in the stock that he already has”.

“A consumer increases the consumption of any one commodity keeping constant the consumption of all other commodities the marginal utility of the variable commodity must eventually decline”. Kenneth E.Boulding.

The law says that as we go consuming a commodity satisfaction derives from its additional units goes on diminishes.
Assumptions :

1. Rationality : Consumer is a rational man which means he always tries to get maximum satisfaction.
2. Cardinal measurement of utility : Utility is a cardinal concept, i.e., utility can be measured and compared numerically.
3. Utilities are independent: It implies that utility of any commodity depends as its own quantity
4. Homogeneous : Units of the commodity are similar in quantity, size, taste and colour etc.
5. No time gap : There should not be any time gap between the consumption of one unit and other it.
6. Constant marginal utility : It is assumed that the marginal utility of money remains constant. ’
7. Total & marginal utility : Total utility : Total satisfaction obtained by the consumer from the consumption of a given quantity of commodity.
   TU_n = f(Q_n)
   Where TU_n = Total utility of n commodity,
   f = functional relationship,
   Q_n = Quantity of n commodity.

Marginal utility: Marginal utility is the addition made to the total utility by consuming one more unit of the commodity.
It can be explained as
MU_n = TU_n – TU_n-1
MU_n = Marginal utility of n^th unit
TU_n = Total utility of n^th unit
TU_n-1 = Total utility of n – 1 units.
MU may also be expressed as follows.
Marginal utility is the additional utility derived from the consumption of an extra unit of commodity.
MU = \(\frac{\Delta \mathrm{TU}}{\Delta \mathrm{C}}\)
Where ∆TU = Change in total utility
∆C = Change in no. of units consumed.

Explanation of the law : The law of diminishing marginal utility explains the relation between the quantity of good and its marginal utility. If a person goes on increasing his stock of a thing, the marginal utility derived from an additional unit declines. We show this tendency with an imaginary table given below.

In the table let us suppose that one is fond of apples. As he consumes one apple after another he derives less and less satisfaction. The first unit consumed with atmost pleasure. For the second, the intensity of his desire diminishes. The third will be still less and so on. The total utility increasing until the consumption of fourth unit of good but diminishing rate. Fifth unit of apple gives him maximum total utility. But marginal utility becomes zero. Further consumption of sixth unit TU diminishes and MU becomes negative.

The relationship between total utility and marginal utility is explained in the following three ways.

1. When total utility increases at diminishing rate, marginal utility falls.
2. When total utility is maximum, marginal utility becomes zero.
3. When total utility decreases, marginal utility becomes negative.

This can be shown in the following diagram.

In the diagram on ‘X’ axis measures units of apples and OY axis measures total utility and marginal utility. TU curve represents total utility and MU curve represents marginal utility. TU curve is maximum at 5^th unit where MU curve will become zero. TU curve slopes downwards from 6^th unit, while MU will become negative.

Limitations or Exceptions :

1. Hobbies: This law does not operate in the case of hobbies like collection of stamps, old paintings, coins etc. Greater the collections of a person, greater is his satisfaction. Marginal utility will not diminish.
2. Drunkers : It is pointed out that the consumption of liquor is not subject to the law of diminishing marginal utility. The more a person drinks liquor, the more he likes it.
3. Miser : This law does not apply to money. The more money a person has the greater is the desire to acquire still more of it.
4. Further, this law does not hold good if any change in income of the consumer, tastes and preferences.

Question 2.
Critically examine the law of equi-marginal utility.
Answer:
Law of equi – marginal utility is an important law of consumption. It is called as “Gossen’s second law”, as its formulations is associated with the name of H.H.Gossen.

According to Marshall “If person has a thing which can be put to several uses, he will distribute it among these uses in such a way that it has the same marginal utility in all uses. If it had a greater marginal utility in one use than in another, he would gain by taking away some of it from the second and applying it to the first”.

According to this law the consumer has to distribute his money income on different uses in such a manner that the last rupee spent on each commodity gives him the same marginal utility. Equalisation of marginal utility in different uses will maximise his total satisfaction. Hence this law is known as the “Law of equi-marginal utility”.

The fundamental condition for consumer’s equilibrium can be explained in the following way.
\(\frac{\mathrm{MU}_{\mathrm{x}}}{\mathrm{P}_{\mathrm{x}}}=\frac{\mathrm{MU}_{\mathrm{y}}}{\mathrm{P}_{\mathrm{y}}}=\frac{\mathrm{MU}_{\mathrm{z}}}{\mathrm{P}_{\mathrm{z}}}\) = MU_m
Where MU_x, MU_y, MU_z, MU_m = Marginal utilities of commodities x, y, z, m;
P_x, p_y, p_z = Prices of X, y, z.
This law can be explained with the help of a table. Suppose the consumer is prepared to spend his money income is ₹ 26/- on two goods X and Y. Market prices of two goods are ₹ 4/- & ₹ 5/- respectively. Now the marginal utilities of good x & good y are shown below.

For explaining consumer’s maximum satisfaction and consequent equilibrum position we need to reconstruct the above table by dividing marginal utilities of x by its price ₹ 4/- and marginal utility of y by ₹ 5/-. This is shown in the following table.

In the table it is clear that when consumer purchase 4 units of goods x & 2 units of good y. Therefore, consumer will.be in equilibrium when he is spending (4 × 4 = 16 + 2 × 5 = 10) ₹ 26 on them.
Limitations of the law : The law of equi marginal utility has been subject to certain limitations which are as given below.

1. The law assumes that consumer is a rational man and always tries to get maximum satisfaction. But it is not possible always to compare the utilities derived from different commodities.
2. This law not applicable when goods are indivisible.
3. The law is based on unrealistic assumptions like cardinal measurement of utility and marginal utility of money remains constant. In real world MU of money does not remain constant.
4. This law will not be applicable to complementary goods.
5. Another limitations of this law is that there is no fixed accounting period for the consumer in which he can buy and consume goods.

Question 3.
Explain consumer’s equilibrium with law of equi-marginal utility. [March 18]
Answer:
Law of equi-marginal utility is an important law of consumption. It is called as “Gossen’s with the name of H.H.Gossen. According to Marshall “If person has a thing which can be put to several uses, he will distribute it among these uses in such a way that it has the same marginal utility in all uses. If it had a greater marginal utility in one use than in another, he would gain by taking away some of it from the second and applying it to the first”.

According to this law the consumer has to distribute his money income on different uses in such a manner that the last rupee spent on each commodity gives him the same marginal utility. Equalisation of marginal utility in different uses will maximise his total satisfaction. Hence this law is known as “law of equi-marginal utility”.

Assumptions of the law : The law of equi-marginal utility depends on the following assumptions.

1. This law is based on cardinal measurement of utility.
2. Consumer is a national man always aiming at maximum satisfaction.
3. The marginal utility of money remains constant.
4. Consumer’s income is limited and he is proposed to spent the entire amount on different goods.
5. The price of goods are unchanged.
6. Utility derived from one commodity is independent of the utility of the other commodity.

The fundamental condition for consumer’s equilibrium can be explained in the following way.
\(\frac{\mathrm{MU}_{\mathrm{x}}}{\mathrm{P}_{\mathrm{x}}}=\frac{\mathrm{MU}_{\mathrm{y}}}{\mathrm{P}_{\mathrm{y}}}=\frac{\mathrm{MU}_{\mathrm{z}}}{\mathrm{P}_{\mathrm{z}}}\) = MU_m
Where MU_x, MU_y, MU_x, MU_m = marginal utility of commodities X, Y, Z, m;
P_x, P_y, P_z = prices of x, y, z.
This law can be explained with the help of a table. Suppose the consumer is prepared to spend his money income is ₹ 26/- on two goods x and y. Market prices of two goods are ₹ 4/- & ₹ 5/- respectively. Now the marginal utilities of goods x & y are shown below.

For explaining consumer’s maximum satisfaction and consequent equilibrum position we need to reconstruct the above table by dividing marginal utilities of x its price ₹ 4/- and marginal utility of y by ₹ 5/-. This is shown in the following table.

In the table it is clear that when consumer purchase 4 units of goods x & 2 units of good y. Therefore, consumer will be in equilibrium when he is spending (4 × 4 = 16 + 2 × 5 = 10) ₹ 26 on them.

Consumer’s equilibrium may be shown in the diagram.

Consumer’s equilibrium by using principle of equi-marginal utility

In the diagram marginal utility curves of goods slope downwards i.e. AB & CD taking of the income of the consumer as given, suppose his M>_U of money constant at OE. \(\frac{\mathrm{MU}_{\mathrm{x}}}{\mathrm{P}_{\mathrm{x}}}\) is equal to OE when OG quantity of good X is brought. \(\frac{\mathrm{MU}_{\mathrm{y}}}{\mathrm{P}_{\mathrm{y}}}\) is equal to OE, when OF quantity of good y is purchased. Thus consumer purchasing OG of X and OF of Y. \(\frac{\mathrm{MU}_{\mathrm{x}}}{\mathrm{P}_{\mathrm{x}}}=\frac{\mathrm{MU}_{\mathrm{y}}}{\mathrm{P}_{\mathrm{y}}}\) = MU_m. This is consumer’s equilibrium.

Question 4.
Explain the consumer’s equilibrium using indifference curve.
Answer:
The point where the consumer gets maximum possible satisfaction, where the budget line is tangent to the indifference curve and the MRS is equal to the price ratio of the two goods will be defined as equilibrium of the consumer.
Assumptions :

1. Consumer scale of preferences must remain constant.
2. Money income of thfe consumer must remain constant.
3. The price of two goods must remain unchanged.
4. There should be no change in the tastes and habits of the consumer.
5. The consumer is rational and thus maximises his satisfaction.

Conditions of equilibrium : There are two conditions that must be satisifed for the consumer to be in equilibrium. They are :

1. At the point of equilibrium, the budget / price line must be tangent to the indifference curve.
2. At the point of equilibrium, the consumer’s MRS_xy and the price ratio must be equal.
   i.e„ MRS_xy = \(\frac{P_x}{P_y}\)

This can be shown in the following diagram.

In the diagram ‘AB’ is consumer’s budget or price line. IC, IC₁, IC₂ are indifference curves. In the diagram the consumer is equilibrium OM of x and ON of y. At point E the price line touches to an IC₁. At point ‘S’ consumer will be on ‘O’ lower indifference curve IC and will be getting less satisfaction than at E on IC. IC₂ is beyond the capacity of consumer. So it is outside to the budget line.

Question 5.
Define price line / budget line and explain shifts in the budget line.
Answer:
The budget line or price line shows all possible combinations of two goods that a consumer can buy with the given income of the consumer and prices of the two goods.

The concept of budget / price line will be shown in the following example. Suppose that a consumer has ₹ 150 (income) to buy two goods namely X and Y. Whose prices are ₹ 15 and ₹ 30 each. With the given information now we can draw the budget or price line as shown in the diagram.

In the above diagram ‘AB’ is the ‘budget or price line’. The slope of the line AB represents the ratio of the prices of X and Y in such a manner that 10 of x will be equal to 5 of y.

Shifts in the Budget line : The position of the budget line depends upon size of money income of the consumer. If his income increase and the price of the two commodities remaining the same, the consumer can buy more of both the commodities. On the other hand, if his income decreases, the prices of the two commodities remaining the same the consumer now to reduce his purchase. As a result of changes in the consumer income, there will be shifts in budget line also. The same is shown in the following diagram.

1. When the income of the consumer increase, the budget line moves towards right from the original to AB to A’B’.
2. When the income of the consumer decrease, the budget line moves to the left from the original / initial AB to A”B”.

Change in price line : The slope of the price line depends on the prices of both the commodities there will be a change in the slope of the price line when there is a change in the price or either of the two commodities.
i) Suppose that the price of ‘X’ falls, while the price of Y and money income of the consumer remaining the same.

In the above diagram, the initial price line of AB, before change in the price of X’. Suppose that the price of X’ has fallen and the price of ‘Y’ remaining the same.

ii) Suppose that the price Y falls, while the price of X and money income of the consumer re-maining the same.

In the above diagram, the initial line is AB that is before a change in price of Y.

Short Answer Questions

Question 1.
Difference between cardinal and ordinal utility.
Answer:
The concept of utility was introduce by Benham in 1789. Utility means want satisfying power of a commodity. It is a psychological phenomenon. The measurement of utility, there are two different approaches.

1. Cardinal utility
2. Ordinal utility

1) Cardinal utility : This approach was developed by Alfred Marshall. According to him utility is psychological concept. So it can be measured ‘util’. The numbers 1, 2, 3, 4 etc are cardinal numbers. According to this analysis the utilities derived from consumption of different commodities can be measured in terms of arbitary units, such as 1, 2, 3 … and so on.

2) Ordinal utility : This approach was developed by R.J.D. Allen and J.R.Hicks. According to them utility is psychological concept. So we cannot measure in numerically much less compared. The numbers 1^st, 2^nd, 3^rd, 4^th etc., are ordinal numbers. The ordinal numbers are ranked. It means the utilities obtained by the consumer from different goods can be arranged in a serial order such as 1^st, 2^nd, 3^rd, 4^th etc.

Question 2.
Properties of IC (Indifference curves). [March 18, 17, 16]
Answer:
The important properties of indifference curves are :

1. Indifference curves slopes downwards from left to right there exists negative slope.
2. Indifference curves are convex to the origin because of diminishing marginal rate of substitution.
3. Indifference curves can never intersect each other.
4. Higher indifference curve represent higher level of satisfaction. Indifference curve to the right represents higher satisfaction.

Question 3.
Marginal Rate of Substitution
Answer:
The concept of MRS (Marginal Rate of Substitution) is the basis of indifference curves. The MRS may be defined as the rate at which an individual will exchange successive unity of one commodity for another. This can be explained with the help of following example.

From the table it is clear that consumer has 15 units of good Y and 1 of good X, he is willing to forego 4Y for IX. Here marginal rate of substitution of X for Y is 4 :1 and for 3^rd combination it is 3 : 1 and so on. The MRS xy diminishes as the consumer goes on substituting X for Y.
MRS_xy = \(\frac{\Delta Y}{\Delta X}\)

Question 4.
Indifference Map
Answer:
A set of indifference curves drawn for different income levels is called as “indifference map”. In other words indifference map is the locus of various indifference curves various levels of satisfaction to the consumer.

From the above diagram it is clear that an indifference map of IC₁, IC₂, IC₂. Each curve shows a certain level of satisfaction to the consumer: The different indifference curves are always arranged and numbered in ascending order.

As are moves from IC₁ to IC₃ on an indifference map, the IC labelled higher number (IC₃) is preferred to the IC labelled lower number (IC₁).

Question 5.
Price Line.
Answer:
The budget / price line shows all possible combinations of two goods that a consumer can buy, with given income of the consumer and prices of the two goods. But which particular combination of two goods on IC he can get depends on two factors.

1. Consumer’s money income
2. Prices of two goods.

The concept of budget / price line will be shown in the following diagram.

In the above diagram PL is Budget line. If consumer spend his total income on good X, he could get L. Any point outside the given price line H will beyond the capacity of consumer, K is under spending Capacity.

The concept of price line or budget line can be known the following example. Suppose the consumer has ₹ 5/- to buy two goods say X and Y prices of X and Y are ₹ 1/- and 0.50 paisa. Then the following are the opportunities available before him.

1. If consumer spends his total amount of ₹ 5 on X only he gets 5 units of X and none of Y.
2. If he spends whole of his money i.e., ₹ 5 on Y only he gets 10 units of Y and none of X.
3. If consumer wants to have both X & Y. Therefore he can move within OAB of price line.

Additional Questions

Question 6.
Explain the importance of law of equi-marginal utility.
Answer:
The law of equi-marginal utility states that a consumer will be in equilibrium when the marginal utility of the various commodity are equal.
Importance :

1. Basis of consumer expenditure : It is basis for consumers expenditure and guide the consumers while allocating resources.
2. In the field of production : This law is useful to the producer and it explains how a producer maximises his profits and reduces cost of production.
3. Exchange : In all our exchanges, this law works, for exchange is nothing but substitution of one thing for another.
4. Public Finance : This law helps the government in the allocation of scarce resources and also the government levied taxes on the basis of this principle.
5. Price determination : This principle has an important bearing on the determination of value.

Question 7.
Explain superiority of the indifference curve technique.
Answer:

1. It is an analysis of multi-goods model.
2. It does not assume marginal utility of money remains constant.
3. It analyses income effect, price effect and substitution effect.
4. The assumption of ordinal measurement of utility made by indifference curve is less restrictive and more realistic.

Question 8.
What are the important assumptions of indifference techniques ?
Answer:
An indifference curve represents satisfaction of a consumer from two commodities. An IC curve can defined as the locus of points each representing a different combination of two goods yielding the same level of satisfaction.
Assumptions :

1. Rationality: It is assumed that the consumer tries to obtain maximum satisfaction from his expenditure.
2. Scale of preference : Consumer is able to arrange the available combinations of goods according to scale of preference.
3. Ordinal utility : It assumes ordinal utility approach. So utility measurable only ordinal terms i.e., 1^st, 2^nd, 3^rd ………… etc.
4. Diminishing marginal rate of substitution : It is the rate at which a consumer is willing to substitute commodity to another. So that this satisfaction remains the same.
5. Consistency : Consumer’s choices have to consistent. It means if consumer prefers A to B and B to C his choice reflects his rationality.
6. Completeness : The consumer’s scale of preferences is to complete that he is able to choose any one of the two combinations of commodities presented to him.

Very Short Answer Questions

Question 1.
Utility
Answer:
The want satisfying power or capacity of a commodity or service is known as utility. It is the basis of consumer’s demand for a commodity.

Question 2.
Cardinal utility [March 17]
Answer:
Alfred Marshall developed cardinal utility analysis. According to this analysis the utilities derived from consumption of different commodities can be measured in terms of arbitary units called utils. 1, 2, 3, 4 are called cardinal numbers.

Question 3.
Ordinal utility
Answer:
This was developed by J.R.Hicks, Allen. Utility is subjective and measurement of utility in numerical terms is not possible. We can observe the preference one for a good more than for another. Ordinal numbers such as 1^st, 2^nd, 3^rd ………….. etc. The ordinal numbers are ranked.

Question 4.
Scale of preferences
Answer:
Guides the consumer in his purchases. It reflects his tastes and preferences.

Question 5.
Price Line [March 16]
Answer:
It shows all possible combinations of two goods that a consumer can buy, with the given income of the consumer’s and prices of the two goods.

Question 6.
MRS
Answer:
The additional amount of one product required to compensate a consumer for a small decrease in the quantity of another, per unit of the decrease.

Additional Questions

Question 7.
Total utility
Answer:
Total utility is the total amount of utility which a consumer derives from a given stock of a commodity.
TU_n = f(Q_n)

Question 8.
Marginal utility
Answer:
Marginal utility is the additional utility obtained from the consumption of additional unit of the commodity.
MU_n = TU_n – TU_(n-1)
(or)
MU = \(\frac{\Delta \mathrm{TU}}{\Delta \mathrm{Q}}\)

Question 9.
Consumers equilibrium
Answer:
The term equilibrium implies a position of rest or changelessness. A consumer attains equilibrium only when he secures maximum satisfaction out of his expenditure. In distributing a commodity various uses, the consumer will secure maximum satisfaction if the marginal utility of the commodity equalised in all its uses.
\(\frac{\mathrm{MU}_{\mathrm{x}}}{\mathrm{P}_{\mathrm{x}}}=\frac{\mathrm{MU}_{\mathrm{y}}}{\mathrm{P}_{\mathrm{y}}}\) ………… and ao on.

Question 10.
Indifference curve
Answer:
It represents the satisfaction of a consumer from two goods of various combinations. It is drawn on the assumption that for all possible combinations of the two goods on an indifference curve, the satisfaction level remains the same.

Question 11.
Iso-utility curve
Answer:
Iso-utility curve is also known as indifference curve or the curve of equal utility. The situation where consumers yield the same level of total satisfaction at various combinations of the commodities called Iso-utility curve.

Question 12.
Indifference schedule
Answer:
It is a table representing the various combinations of goods which give equal satisfaction to the consumer. An indifference curve is drawn on the basis of an “indifference schedule”.

Question 13.
Indifference map
Answer:
A set of indifference curves drawn for different income levels is called indifference map.

From the above diagram it is clear that an indifference map of IC₁, IC₂, IC₃. Each curve shows a certain level of satisfaction to the consumer.

Andhra Pradesh BIEAP AP Inter 1st Year Economics Study Material 1st Lesson Introduction Textbook Questions and Answers.

AP Inter 1st Year Economics Study Material 1st Lesson Introduction

Essay Questions

Question 1.
Discuss Wealth definition.
Answer:
Adam Smith was the first person to give a precise definition of Economics and separate this study from other social sciences. Adam Smith is considered as ‘Father of Economics’. He defined it in his famous book Wealth of Nations’, as “An enquiry into the nature and causes of wealth of nations”. Most of the economists in the 19th century held this view.

J.B. Say states that “The aim of political economy is to show the way in which wealth is produced, distributed and consumed”. The other economists who supported this definition are J.B. Say, J.S.Mill, Walker and others.
The main features of Wealth definition :

1. Acquisition of wealth is considered as the main objective of human activity.
2. Wealth means material things.
3. Human beings are guided by self-interest, whose objective is to accumulate more and more wealth.

Criticism : The wealth definition was severely criticised by many writers due to its defects.

1. Economists like Carlyled and Ruskin pointed out that economics must discuss ordinary man’s activities. So they called it as a ‘Dismal Science’.
2. Adam Smith’s definition, wealth was considered to consist of only material things and services are not included. Due to this the scope of economics is limited.
3. Marshall pointed out wealth is only a means to an end but not an end in itself.
4. This definition concentrated mainly on the production side and neglected distributed side.

Question 2.
Explain Welfare definition.
Answer:
Alfred Marshall tried to remedy the defects of wealth definition in 1890. He shifted emphasis from production of wealth to distribution of wealth.

According to Marshall “Political economy or Economics is a study of mankind in the : ordinary business of life. It examines that part of individual and social action which is most closely connected with the attainment and with the use of material requisites of well-being. Thus Economics is on one side, a study of wealth and on the other and more important side, a part of study of man”.

Edwin Cannan defined it as “The aim of political economy is the explanation of the general causes on which the material welfare of human beings depends”.

In the words of Pigou “The range of enquiry becomes restricted to that part of social welfare that can be brought directly or indirectly into relation with the measuring rod of money”.

The main features of Welfare definition :

1. Economics as a social science is concerned with man’s ordinary business of life.
2. Economics studies only economic aspects of human life and it has no concern with the social, political and religious aspects of human life. It examines that part of individual and social action which is closely connected with acquisition and use of material wealth for promotion of human welfare.
3. According to Marshall, the activities which contribute to material welfare are considered as economic activities.
4. He gave primary importance to man and his welfare and to wealth as means for the promotion of human welfare.

Criticism:

1. Robbins criticised Marshall’s economics is a ‘social science’ rather than a human science, which includes the study of actions of every human being.
2. Marshall’s definition mainly concentrated on the welfare derived from material things only. But non – materialistic goods which are also’ very important for the well being of the people. Hence, it is incomplete.
3. Critics pointed out that quantitative measurement of welfare is not possible. Welfare is a subjective concept and changes according to time, place and persons.
4. According to Marshall, economics deals with those activities of men which will promote human welfare. But production of alcohol and drugs do not promote human welfare. Hence the scope of economics is limited.
5. Another important criticism is that it is not concerned with the fundamental problem of scarcity of resources.
6. According to Robbins the economic problem arises due to unlimited wants and limited resources. These factors are ignored in this definition.

Question 3.
Explain how Robbings definition is superior to the welfare definition.
Answer:
Lionel Robbin’s of London School of Economics introduced the ‘Scarcity’ definition of Economics, in his book.

‘An Essay on the nature and significance of Economic Science’.

According to Robbin’s “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. Scarcity of resources is the central idea in Robbin’s definition.
Main features of Robbin’s definition :

1. Unlimited wants or ends
2. Means are scarce or limited
3. Means have alternative uses
4. Problem of choice.

Welfare definition: According to Marshall “Economics is on one side a study of wealth and on the other and more important side a part of study of man.” Marshall in his definition gave more importance to man than wealth.

Marshall defined “Political economy or Economics is a study of mankind in the ordinary business of life, it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of well-being.

Main features of welfare definition :

1. He assumed that Economics must be a science which is study of man kind in the ordinary business of life.
2. Economics is concerned with real man influenced by human considerations and it has no concern with the political, social and religious aspects of life.
3. Wealth is a means for promoting human welfare, i 4) The main emphasis of Marshall is on material welfare and the immaterial aspects are ignored.

Superiority of Robbin’s definition over Marshall’s definition :

1. According to Marshall “Economics Studies the activities of those people who live in society”. But Robbin’s says that Economics studies, all human activities whether they promote human welfare or not.
2. According to Marshall “The scope of Economics is limited. But Robbin’s the scope of Economics is wide”.
3. Robbin’s definition has universal applicability. Because it is applicable to all types of societies.
4. Robbin’s definition of Economics is neutral between ends. He made economics a positive science. It does not pass value judgements.

Question 4.
Define Prof. Samuelson’s growth definition.
Answer:
Robbin’s definition does not take into consideration the dynamic problem of economic growth. As the time passes the scarcity of means ends, targets choices undergo a change. The inherent defect of Robbins definition has been rectified by Paul Samuelson in his definition of Economics.

Prof. Paul Samuelson, a Nobel Prize winner of 1970 provided a new definition of economics in which he introduced time element and it is dynamic in nature. Therefore his definition is known as growth oriented definition.

According to Samuelson “Economics is the study of how people and society choosing with or without the use of money, to employ scarce productive resources that could have alternative use to produce various commodities and distribute them for consumption. Now or in the future among various persons and groups in society.
Important features of the definition :

1. Scarcity : Like Robbins, Samuelson emphasises the scarcity of resources, unlimited wants and the alternative uses for the means.
2. Dynamism : Samuelson’s definition is dynamic. He talks about production, distribution and consumption in the present and also in the future.
3. Wide Scope : This definition widen the scope of Economics. It deals with problems of choice in a dynamic society.
4. Economic growth : He gave importance to economic growth the future consumption is safeguard by productive investment which leads to economic growth.

Thus Samuelson definition of economics is considered to be the most satisfactory definition of economics as it clearly states.

Question 5.
Distinguish between “Micro” and “Macro Economics”.
Answer:
Modem economic theory divided it into two branches, namely (i) Micro Economics (ii) Macro Economics. Ragnar Frisch was the first economist to use the words “Micro and Macro” in economic theory in 1930.

Micro Economics : The term “Micro Economics” is derived from the Greek word MIKROS’ which means small. Thus micro economics is the theory of small. It was developed by classical economists like Adam Smith, J.B.Say, J.S.Mill, Ricardo, Marshall etc. It studies about individual units or behaviour of that particular units like individual income, price, demand etc. Micro Economics is also known as partial analysis. If main, concentrates on the determination of prices of commodities and factors of production. It is also known as “Price theory”. According to K.E. Boulding Micro Economics is the study of particular firms, particular households, individual prices, wages, incomes individual industries and particular commodities.

Shapiro says “Micro Economics has got relation with small segments of the society.
Macro Economics : The term Macro Economics is derived from the Greek word ‘MAKROS’ which means large. Thus Macro Economics is the study of economic system as a whole. It was developed by J.M. Keynes. It studies aggregates in the economy like national income, total consumption, total saving and total employment etc. It is also known as Income and Employment theory.

According to Boulding “Macro Economics studies National Income not Individual income, general price level instead of individual prices and national output instead of individual output. Macro Economics also studies the economic problems like poverty, unemployment, economic growth, development etc. It is also deals with the theory of distribution.

The difference between Micro Econoinics and Macro Economics : Micro and Macro Economics are interrelated to each other. Inspite of close relationship between the two branches of economics, fundamentally they differ from each other.

Micro Economics

1. The word micro derived from the greek word ‘ Mikros’ means “small”.
2. Micro Economics is the study of individual units of the economy.
3. It is known as Price theory.
4. Micro Economics explains price determination both commodity and factor markets.
5. Micro Economics is based on price mechanism which depends on demand and supply.

Macro Economics

1. The word macro derived from the greek word ‘Makros’ which means large”.
2. Macro Economics is the study of economy as a whole.
3. It is known as Income and Employment theory.
4. Macro Economics deals with national income, total employment, general price level and economic growth.
5. Macro Economics based on aggregate demand. and aggregate supply.

Short Answer Questions

Question 1.
Free goods and Economic goods.
Answer:
Free goods

1. Free goods are nature’s gift.
   Ex : Air, Sunshine etc.
2. Their supply is abundant.
3. They do not have price.
4. These goods don’t have cost of production.
5. Free goods have only value in use.
6. These goods are not included in National Income.

Economic goods

1. Economic goods are man made.
   Ex: Book, Pen etc.
2. Supply is always less than their demand.
3. These goods command price.
4. Economic goods have cost of production.
5. Economic goods have both use value and exchange value.
6. Economic goods are included in National Income.

Question 2.
Characteristics of Wants. [March 18, 17, 16]
Answer:
Human wants are starting point of all economic activities. They depend on social and economic conditions of individuals.
Characteristic features of wants :
1) Unlimited wants : Human wants are unlimited. There is no end to human wants. When one want is satisfied another want takes its place. Wants differ from person to person, time to time and place to place.

2) A particular want is satiable : Although a man cannot satisfy all his wants, a particular want can be satisfied completely in a period of time.
Ex: If a person is thirsty he can satisfy it by drinking a glass of water.

3) Competition : Human wants unlimited. But the means to satisfy them are limited of scarce. Therefore they complete with each other in priority of satisfaction.

4) Complementary: To satisfy a particular want we need a group of commodities at the same time.
Ex: Writing need is satisfied only when we have pen, ink and paper together.

5) Substitution : Most of our wants can be satisfied by different ways.
Ex : If we feel hungry, we take some food and satisfy this want.

6) Recurring : Many wants appear again and again thought they are satisfied at one point of time.

7) Habits : Wants change into habits, which cannot be given up easily.
Ex : Smoking cigarettes for joke results into a habit if it is not controlled.

8) Wants vary with time, place and person : Wants go on changing with the passage of time. They are changing from time to time, place to place and person to person. Human wants are divided into 1. Necessities, 2. Comforts and 3. Luxuries.

Question 3.
Various types of utility.
Answer:
The want satisfying capacity of a commodity at a point of time is known as utility.
Types of utility:
1) Form utility: Form utilities are created by changing the shape, size and colour etc., of a commodity so as to increase its want satisfying power.
Ex : Conversion of a wooden log into a chair.

2) Place utility : By changing the place some goods acquire utility.
Ex : Sand on the sea shore has no utility. If it is brought out and transported to market, it gains utility. This is place utility.

3) Time utility : Time utilities are created by storage facility.
Ex : Business men store food grains in the stock points in the off season and releases them to markets to meet high demand and obtained super normal profits.

4) Service utility : Services also have the capacity to satisfy human wants.
Ex: Services of Lawyer, Teacher, Doctor etc. These services directly satisfy human wants.
Hence they are called as service utilities.

Question 4.
Jacob Viner’s definition. [March 18, 17, 16]
Answer:
Jacob Viner’s-definition of Economics is considered as modem definition of Economics. He is an American economist known for his short run and longrun cost curve analysis. According to Jacob Yiner “Economics is what economists do”.
The problems of the economy are :

1. What to produce and in what quantities : The economy has to decide whether to produce consumer goods and capital goods. These decisions are influence by individuals as well as government.
2. How to produce these goods : A decision has to be made whether to use labour intensive or capital intensive techniques.
3. For whom to produce these goods and services: It is concerned with the distribution of income and wealth among different sections of the society.
4. How efficient the productive resources are in use : This refers to the efficiency of economic system.
5. Whether the available resources are fully utilised : If resources are fully utilised that it can provide more employment opportunities.
6. Is the economy growing or static over a period of time.

Question 5.
Various economic investigations.
Answer:
According to Peterson “The term method refers to the techniques and producers used by economists for both construction and verification economic principles. There are plainly two methods used by the economists for conducting economic investigations. They are :

1. Deductive method
2. Inductive method.

1. Deductive method : This method is also known as the analytical and abstract method. The method of studying phenomenon by taking same assumptions and deducing conclusions from those assumptions is known as the deductive method. It proceeds from general to the particular or from universal to the individual. This was advocated by economists belonging to the classical school. There are four steps involved in drawing inference through deductive method. They are :

1. Selecting the problem
2. Formulating assumptions
3. Formulating hypothesis
4. Verifying the hypothesis.

The law of diminishing marginal utility is one law derived using this deductive method.
Merits of deduction:

1. It is less expensive and less time consuming.
2. It analyses complex economic phenomena and bring exactness to economic generalizations.
3. It helps in laying down basic principles of human behaviour.

Inspite of the above stated advantages, it is not free from limitations. It is based on unrealistic assumptions with little empirical content.

2. Inductive method : This method is also known as Historical, Empirical, Concrete, Ethical or Realistic. This method was strongly advocated and made use of by economists belonging to the historical school. This method proceeds from a part to the whole from particular to general or from the individual to the universal.
The following are the important steps involved in deriving economic generalisations through inductive method.

1. Selection of the problem
2. Collection of data
3. Observation
4. Generalisation

Merits of induction method :

1. It is nearer to reality and therefore expected to depict reality.
2. This method involves less chances of mistakes.

Inspite of several advantages it has its own defects. This method is expensive and consuming. It can be used by those who possess skill and competance in handling ex data.

Additional Questions

Question 6.
What is meant by Micro Economics ? Discuss its importance.
Answer:
The tehn ‘Micro Economics’ is derived from the greek word ‘MIKROS’ which means ‘small’. Thus Micro Economics deals with individual units like individual demand, price, supply etc. It was popularised by Marshall. It is also called as ‘Price Theory’ because it explains pricing in product market as well as factor market.
Importance :

1. Micro Economics provides the basis for understanding the working of the economy as a whole.
2. This study is useful to the government to frame suitable policies to active economic growth and stability.
3. This study is applicable to the field of international trade in the determination of exchange rates.
4. Micro Economics provides an analytical tool for evaluating the economic policies of the government.
5. It can be used to examine the condition of economic welfare and it suggests ways and means to bring about maximum social welfare.

Question 7.
What is meant by Macro Economics ? Discuss its importance.
Answer:
The term Macro Economics is derived from the greek word ‘MAKROS’ which means large. It was developed by j.M.Keynes. Macro Economics deals with economic system as a while like national income, aggregate demand, aggregate supply, general price level etc. It is also known as ‘Income and Employment’ theory.
Importance :

1. Macro Economics study is more useful to the government for formulation and execution of policies for achievement of maximum social benefit.
2. It helps in understanding the problems of unemployment poverty, inflation etc, and suggests has to solve them.
3. It gives us a picture of the working of the economy as a whole;
4. The study of Macro Economics is helpful in analysing the causes of business cycles and in providing-remedies.
5. Macro Economics includes economic growth and suggests how developing countries can use their resources to maximise their growth.
6. Macro Economic study is useful for making international comparisons in terms of average national income.

Question 8.
Explain the circular flow of income with suitable diagram.
Answer:
Income is a flow over a period of time. Income flow is of circular in character. Where beginning and end cannot be traced. National output originates in private and public sectors. It moves to the households. The household is the basic consuming unit in economic life. In every economy income flows from households to firms and vice versa. Thus the factor market and the product market are closely related to each other.

The circular flow of income can be explained with the help of the following diagram.

According to the above diagram, it is clear that the factor market and commodity market are closely related to one another.

The households supply the resource services and receives in returm payment interms of money. Thus money flows from producing units to households. The household exchange that money for goods and services they want. As a result the money flows from households to firms. Thus there is a circular flow of income and output.

Question 9.
Explain the differences between Consumer goods and Capital goods.
Answer:
Anything that can satisfy a human want is called a good. Goods can be classified into two types namely,

1. Free goods
2. Economic goods.

Further the economic goods divided into two types namely :

1. Consumer goods
2. Capital goods or Producer goods.

1) Consumer goods: A consumer good is an economic good or commodity purchased by households for final consumption. Thus these goods satisfy human wants directly.
Ex : Foods, books etc.
Consumer goods further divided into two types.
a) Perishable goods
b) Durable goods
a) Perishable goods : They lose their value in single use.
Ex : Milk, fruits etc.
b) Durable goods: These goods which yields service over period of time. Hence utility from these goods can be derive’d for a long time.
Ex : T.Vs & Computers.

2) Producer or Capital goods: Goods which are used in the production of other goods -lied producer or capital goods. They satisfy human wants indirectly.
Ex : Machines, buildings etc.
Differences between Consumer goods and Capital goods.
Consumer goods

1. These goods satisfy human wants directly. Ex: Milk, fruits etc.
2. They have direct demand.
3. These are the goods of first order.
4. They are net used in the production process of other goods.
5. They yield utility to the owners of these goods.

Capital goods

1. These goods satisfy human wants indirectly. Ex: Machines, raw-materials.
2. They have indirect or derived demand.
3. These are the goods of second order.
4. These are used in the production process of other goods.
5. They yield income to the owners of these goods.

Very Short Answer Questions

Question 1.
Economic goods
Answer:
Economic goods are man-made, they have cost of production and price. They are limited in supply. They have both value in use and value in exchange.
Ex : Pen, Book etc.

Question 2.
Capital goods
Answer:
Goods which are used in the production of other goods are called producer or capital goods. They satisfy human wants indirectly.
Ex : Machines, tools, buildings etc.

Question 3.
Intermediary goods [March 17]
Answer:
Goods which are under the process of production and semi finished goods are known as intermediary goods.
Ex : Cotton and fibre etc.

Question 4.
Wealth [March 18, 16]
Answer:
Wealth means stock of assets held by an individual or institution that yields has the potential for yielding income in some form. Wealth includes money, shares of companies, land etc. Wealth has three properties. 1. Utility 2. Scarcity 3. Transferability

Question 5.
Income
Ans. Income is a flow of satisfaction from wealth per unit of time. In every economy income’ flows from households to firms and vice versa. Income can be expressed in two types.

1. Money income which is in terms of money.
2. Real income which is in terms of goods and services.

Question 6.
Utility [March 16]
Answer:
Utility is the wants satisfying capacity of goods and services. It is a subjective concept. No one can measure it in mathematical terms.

Question 7.
Exchange value
Answer:
Exchange value is the purchasing power of one commodity to another. All economic goods have exchange value.

Question 8.
Price [March 18, 17]
Answer:
The price of anything is its value measured in terms of money.
Ex: A commodity is exchanged for 50 rupees then the price of commodity is 50 rupees.

Question 9.
Choice problem
Answer:
The choice problem is the central problem of Economics. The problems of the economy “What to produce ? How to produce” ? The problem of choice between commodities and the problem of choice of production techniques respectively.

Question 10.
Deductive Method
Answer:
Deductive method is the process from general to particular or from the universal to the individual.

Question 11.
Inductive method
Answer:
It is the process from particular to general or from the individual to the universal.
Economic statistics : It refers to the functional relationship between the two variables whose values are related to the same point. This concept was introduced by J.S. Mill.

Question 13.
Economic dynamics
Answer:
J.S. Mill introduced this concept in Economics. It refers to the analysis where the functional relationship is established between relevant variables whose values belong to different point of time.

Question 14.
Partial equilibrium
Answer:
It was popularised by Marshall. It exists when an equilibrium relates to a single variable.

Question 15.
General equilibrium
Answer:
This concept was popularised by Leon Walras. General equilibrium exists when an equilibrium relates to number of variables or even the economy as a whole.

Question 16.
Micro Economics
Ans. The word ‘Micro’ derived from Greek word ‘Mikros’ which means ‘small’. It was developed by Marshall. It is the study of the individual units like individual demand, price, supply etc.

Question 17.
Macro Economics
Answer:
The word ‘Macro’ derived from Greek word ‘Makros’ which means large. It was developed by J.M. Keynes. It studies aggregates or economy as a whole like national income, employment, general price level etc. It is also called “Income and Employment” theory.