Suggestions On Economics-2 PDF

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Suggestions on economics
5-marks questions:
MONEYTARY ECONOMICS:
1. ****What do you mean by bank rate and open market

operation?
Answer: pages BBECO-6
2. *****Define M1, M2, M3 and M4/OR, Define the components of
money.
Answer: pages BBECO-7
3. Define Money. What are the main functions of Money?
Answer: pages BBECO-7-8
4. Define inflation and write down the major causes of inflation.
Answer: refer notes provided.
5. ***State the major functions of RBI.
Answer: refer notes provided.
6. *****Explain the concept of Black money.
Answer:
In India, Black money refers to funds earned on the black
market, on which income and other taxes have not been
paid. The total amount of black money deposited in foreign
banks by Indians is unknown. Some reports claim a total
exceeding US$50 trillion are stashed in
Switzerland's.[1] Other reports, including those reported by
Swiss Bankers Association and the Government of
Switzerland, claim that these reports are false and fabricated,
and the total amount held in all Swiss banks by citizens of
India is about US$2 billion.
ADDRESS: MANINDRA BHAWAN: IA-27/SECTOR:III/SALTLAKE CITY/KOLKATA:700097.LAND

MARK: TANK NO:13/SALTLAKE STADIUM.
Indian corporates invariably under invoice their exports and

over invoice their imports from tax heaven countries such
as Singapore, UAE, Hong Kong, etc. Thus the promoters of
the public limited companies who hold rarely more than 10%
of share capital, earn black money abroad at the cost of
majority share holders and tax income to the Indian
government.
Politicians, political parties and corrupt higher officials of
government and its institutions take bribes from foreign
companies and park/invest the money abroad in tax havens
for transferring to India when needed. Many times locally
earned bribes/funds/collections are also routed abroad
through hawala channels for evading from Indian tax
authorities and consequent legal implications.
The Vodafone tax case is a glaring example where foreign
multinational companies also evade tax payments in India by
making transactions with shell companies registered in tax
haven countries.
15 marks questions:
7. ***Explain Fisher’s quantity theory of money. Highlight the
limitations to this theory.
Answer:
The quantity theory of money states that the quantity of
money is the main determinant of the price level or the
value of money. Any change in the quantity of money
produces an exactly proportionate change in the price level.
In the words of Irving Fisher, “Other things remaining

unchanged, as the quantity of money in circulation increases,
the price level also increases in direct proportion and the
value of money decreases and vice versa.” If the quantity of
money is doubled, the price level will also double and the
value of money will be one half. On the other hand, if the
quantity of money is reduced by one half, the price level will

also be reduced by one half and the value of money will be
twice.
Fisher has explained his theory in terms of his equation of

exchange:
PT=MV+ M’ V’
Where P = price level, or 1 IP = the value of money;
M = the total quantity of legal tender money;
V = the velocity of circulation of M;
M’ – the total quantity of credit money;
V’ = the velocity of circulation of M;
T = the total amount of goods and services exchanged for

money or transactions performed by money.
This equation equates the demand for money (PT) to supply

of money (MV=M’V). The total volume of transactions
multiplied by the price level (PT) represents the demand for
money.
According to Fisher, PT is SPQ. In other words, price level (P)

multiplied by quantity bought (Q) by the community (S)
gives the total demand for money. This equals the total
supply of money in the community consisting of the quantity
of actual money M and its velocity of circulation V plus the
total quantity of credit money M’ and its velocity of
circulation V’. Thus the total value of purchases (PT) in a
year is measured by MV+M’V’. Thus the equation of
exchange is PT=MV+M’V’. In order to find out the effect of

the quantity of money on the price level or the value of

money, we write the equation as
P= MV+M’V’
Fisher points out the price level (P) (M+M’) provided the
volume of tra remain unchanged. The truth of this
proposition is evident from the fact that if M and M’ are
doubled, while V, V and T remain constant, P is also doubled,
but the value of money (1/P) is reduced to half.
Fisher’s quantity theory of money is explained with the help

of Figure 65.1. (A) and (B). Panel A of the figure shows the
effect of changes in the quantity of money on the price level.
To begin with, when the quantity of money is M, the price
level is P.

When the quantity of money is doubled to M2, the price level

is also doubled to P2. Further, when the quantity of money is
increased four-fold to M4, the price level also increases by
four times to P4. This relationship is expressed by the curve P
= f (M) from the origin at 45°.
In panel В of the figure, the inverse relation between the
quantity of money and the value of money is depicted where
the value of money is taken on the vertical axis. When the
quantity of money is M1 the value of money is HP. But with
the doubling of the quantity of money to M2, the value of
money becomes one-half of what it was before, 1/P2. And
with the quantity of money increasing by four-fold to M4, the
value of money is reduced by 1/P4. This inverse relationship
between the quantity of money and the value of money is
shown by downward sloping curve 1/P = f (M).
Assumptions of the Theory:
Fisher’s theory is based on the following assumptions:
1. P is passive factor in the equation of exchange which is

affected by the other factors.
2. The proportion of M’ to M remains constant.
3. V and V are assumed to be constant and are independent

of changes in M and M’.
4. T also remains constant and is independent of other

factors such as M, M, V and V.
5. It is assumed that the demand for money is proportional

to the value of transactions.
6. The supply of money is assumed as an exogenously

determined constant.
7. The theory is applicable in the long run.

8. It is based on the assumption of the existence of full

employment in the economy.
Criticisms of the Theory:

The Fisherian quantity theory has been subjected to severe
criticisms by economists.
1. Truism:
According to Keynes, “The quantity theory of money is a
truism.” Fisher’s equation of exchange is a simple truism
because it states that the total quantity of money (MV+M’V’)
paid for goods and services must equal their value (PT). But
it cannot be accepted today that a certain percentage
change in the quantity of money leads to the same
percentage change in the price level.
2. Other things not equal:

The direct and proportionate relation between quantity of
money and price level in Fisher’s equation is based on the
assumption that “other things remain unchanged”. But in
real life, V, V and T are not constant. Moreover, they are not
independent of M, M’ and P. Rather, all elements in Fisher’s
equation are interrelated and interdependent. For instance,
a change in M may cause a change in V.
Consequently, the price level may change more in proportion

to a change in the quantity of money. Similarly, a change in
P may cause a change in M. Rise in the price level may
necessitate the issue of more money. Moreover, the volume
of transactions T is also affected by changes in P. When
prices rise or fall, the volume of business transactions also
rises or falls. Further, the assumptions that the proportion M’
to M is constant, has not been borne out by facts. Not only
this, M and M’ are not independent of T. An increase in the
volume of business transactions requires an increase in the
supply of money (M and M’).
3. Constants Relate to Different Time:

Prof. Halm criticises Fisher for multiplying M and V because
M relates to a point of time and V to a period of time. The
former is a static concept and the latter a dynamic. It is
therefore, technically inconsistent to multiply two non-
comparable factors.
4. Fails to Measure Value of Money:

Fisher’s equation does not measure the purchasing power of
money but only cash transactions, that is, the volume of
business transactions of all kinds or what Fisher calls the
volume of trade in the community during a year. But the
purchasing power of money (or value of money) relates to
transactions for the purchase of goods and services for
consumption. Thus the quantity theory fails to measure the
value of money.
5. Weak Theory:
According to Crowther, the quantity theory is weak in many
respects. First, it cannot explain ’why’ there are fluctuations
in the price level in the short run. Second, it gives undue
importance to the price level as if changes in prices were the
most critical and important phenomenon of the economic
system. Third, it places a misleading emphasis on the
quantity of money as the principal cause of changes in the
price level during the trade cycle.
8. *****Explain fully the functions of commercial bank. Mention

the credit –creation process of commercial bank. What are
its limits?
Answer: refer notes..
9. ****Highlight the recent condition of Indian money market.
Provide some guidelines to improve the condition of money
market.
Answer: refer pages from Organizer: BBECOII-2

NATIONAL INCOME:
5-marks questions:
10. ****Explain the four factors determining the size of

national income.
Answer: refer pages from Organizer: BBECO-II-29/30.
11. ***Distinguish between the GDP and GNP?
Answer: refer pages from Organizer:BBECO-II-30
12. **Define national income. State the difficulties in measuring

the national income.
Answer: refer notes….
15-marks question:
13.****What do you mean by personal income. How does it

differ from personal disposable income? State the different
methods of measuring the national income.
Answer: refer notes:
Very imp: please go through all the numerical on national

income these are very important as 15-marks questions….
PUBLIC FINANCE:
5-marks questions:
14. *What is the main source of revenue of Central government?
Answer: refer Organizer: BB ECO-II-42
15. ****Define deficit financing.

Meaning
Deficit financing is a method of meeting government deficits

through the creation of new money. The deficit is the gap
caused by the excess of government expenditure over its
receipts. The expenditure includes disbursement on revenue as
well as on capital account.
The receipts similarly comprise revenues on current account as

well as capital account. Creation of new money to meet the
deficit in use for a long time. But it has now being given up.
Instead a new scheme called ways and Means Advances is
being ushered in with effect from April 1997. Under this system
the government can get only temporary loans to overcome the
mismatch between its receipts and expenditures.
Purpose of Deficit Financing:

In India, the deficit financing resorted mainly to enable the
government to obtain the necessary resources for the plans.
The levels of outlay laid down are of an order which cannot be
met only by taxation and borrowing from the public.
The gap in resources is made up partly through external

assistance, but when external assistance is not enough to fill
the gap; deficit financing has to be resorted to. The targets of
production and employment in the plans are fixed primarily
with reference to what is considered as the desirable rate of
growth for the economy.
Advantages of Deficit Financing:

When the Government resorts to deficit financing, it usually
borrows from the Reserve Bank. The interest paid to the
Reserve Bank actually comes back to the Government in the
form of profits.

Through deficit financing, resources are used much earlier than

they can be otherwise. The development is accelerated. This
technique enables the Government to get resources without
much opposition.
Defects of Deficit Financing:

The defects of deficit financing are:
(i) It leads to increase in inflationary rise of prices of goods and
services in the country.
(ii) Inflationary forces created by deficit financing are

reinforced by increased credit creation by banks.
(iii) Investment caused by inflation may not be of the pattern

sought under the plan. It normally changed.
(iv) If as a result of deficit financing inflation goes too far, it

becomes self-defeating.
16.***** Distinguish between the fiscal and monetary policy.
Answer:
Difference Between Fiscal Policy and Monetary Policy
The economic position of a country can be monitored,

controlled and regulated with the sound economic policies. The

fiscal and monetary policies of the nation are the two measures,
which can help in bringing stability and developing
smoothly. Fiscal policy is the policy relating to government
revenues from taxes and expenditure on various
projects. Monetary Policy, on the other hand is mainly
concerned with the flow of money in the economy. It is quite
troublesome to understand the two terms, as the objectives of
both the policies are same, but their ways to achieve those
objectives are different. Here, in this article we provide you all
the differences between the fiscal policy and monetary policy.
Comparison Chart
BASIS FOR FISCAL MONETARY

COMPARISON POLICY POLICY
Meaning The tool The tool

used by the used by
government the central
in which it bank to
uses its tax regulate
revenue and the money
expenditure supply in
policies to the
affect the economy is
economy is known as
known as Monetary
Fiscal Policy. Policy.
Administered Ministry of Central

by Finance Bank
Nature The fiscal The

policy change in
changes monetary
every year. policy
depends
on the
economic
status of

BASIS FOR FISCAL MONETARY

COMPARISON POLICY POLICY
the nation.
Related to Government Banks &

Revenue & Credit
Expenditure Control
Focuses on Economic Economic

Growth Stability
Policy Tax rates Interest

instruments and rates and
government credit
spending ratios
Political Yes No
influence
17. ****What is fiscal policy? Discuss the various elements of

fiscal policy. How it differs from monetary policy.
OR, ****What is monetary policy? Discuss the various elements of

monetary policy. How it differs from fiscal policy.
Answer : to Q.17.
In economics and political science, fiscal policy is the use of

government revenue collection (mainly taxes)
and expenditure (spending) to influence the
economy.[1] According to Keynesian economics, when the
government changes the levels of taxation and governments
spending, it influences aggregate demand and the level of
economic activity. Fiscal policy can be used to stabilize the
economy over the course of the business cycle.[2]
The two main instruments of fiscal policy are changes in the level,
composition of taxation, and government spending in various
sectors. These changes can affect the
following macroeconomic variables, amongst others, in an
economy:
 Aggregate demand and the level of economic activity;

 Savings and Investment in the economy
 The distribution of income
There are four key components of Fiscal Policy are as follows:
 Taxation Policy
 Expenditure Policy
 Investment & Disinvestment policy
 Debt / surplus management policy
Taxation Policy
. The government gets revenue from direct and indirect taxes.

Via its fiscal policy, government aims to keep the taxes as much
progressive as possible. Further, judicious taxation decisions are
very important for economy because of two reasons: Higher than
usual tax rate will reduce the purchasing power of people and will
lead to an decrease in investment and production. Lower than
usual tax rates would leave more money with people to spend
and this would lead to inflation. Thus, the government has to
make a balance and impose correct tax rate for the economy.
Expenditure policy:
Expenditure policy of the government deals with revenue and

capital expenditures. These expenditures are done on areas of
development like education, health, infrastructure etc. and to pay
internal and external debt and interest on those debts.
Government budget is the most important instrument embodying
expenditure policy of the government. The budget is also used for
deficit financing i.e. filling the gap between Government spending

and income.
Investment and disinvestment policy:
Optimum levels of domestic as well as foreign investment are

needed to maintain the economic growth. In recent years, the
importance of FDI has increased dramatically and has become an
instrument of integrating the domestic economies with global
economy.
Debt/Surplus Management policy:
Debt / Surplus Management If the government received more

than it spends, it is called surplus. If government spends more
than income, then it is called deficit. To fund the deficit, the
government has to borrow from domestic or foreign sources. It
can also print money for deficit financing.
Answer to Q.17/OR…
Monetary policy is the process by which the monetary authority

of a country controls the supply of money, often targeting an
inflation rate or interest rate to ensure price stability and general
trust in the currency.
Instruments of Monetary Policy:

The instruments of monetary policy are of two types: first,
quantitative, general or indirect; and second, qualitative, selective
or direct. They affect the level of aggregate demand through the
supply of money, cost of money and availability of credit. Of the
two types of instruments, the first category includes bank rate
variations, open market operations and changing reserve
requirements. They are meant to regulate the overall level of
credit in the economy through commercial banks. The selective
credit controls aim at controlling specific types of credit. They
include changing margin requirements and regulation of

consumer credit. We discuss them as under:
Bank Rate Policy:

The bank rate is the minimum lending rate of the central bank at
which it rediscounts first class bills of exchange and government
securities held by the commercial banks. When the central bank
finds that inflationary pressures have started emerging within the
economy, it raises the bank rate. Borrowing from the central bank
becomes costly and commercial banks borrow less from it.
The commercial banks, in turn, raise their lending rates to the

business community and borrowers borrow less from the
commercial banks. There is contraction of credit and prices are
checked from rising further. On the contrary, when prices are
depressed, the central bank lowers the bank rate.
It is cheap to borrow from the central bank on the part of

commercial banks. The latter also lower their lending rates.
Businessmen are encouraged to borrow more. Investment is
encouraged. Output, employment, income and demand start
rising and the downward movement of prices is checked.
Open Market Operations:

Open market operations refer to sale and purchase of securities in
the money market by the central bank. When prices are rising
and there is need to control them, the central bank sells securities.
The reserves of commercial banks are reduced and they are not
in a position to lend more to the business community.
Further investment is discouraged and the rise in prices is

checked. Contrariwise, when recessionary forces start in the
economy, the central bank buys securities. The reserves of
commercial banks are raised. They lend more. Investment, output,
employment, income and demand rise and fall in price is checked.

Changes in Reserve Ratios:

This weapon was suggested by Keynes in his Treatise on Money
and the USA was the first to adopt it as a monetary device. Every
bank is required by law to keep a certain percentage of its total
deposits in the form of a reserve fund in its vaults and also a
certain percentage with the central bank.
When prices are rising, the central bank raises the reserve ratio.
Banks are required to keep more with the central bank. Their
reserves are reduced and they lend less. The volume of
investment, output and employment are adversely affected. In
the opposite case, when the reserve ratio is lowered, the reserves
of commercial banks are raised. They lend more and the
economic activity is favorably affected.
Selective Credit Controls:

Selective credit controls are used to influence specific types of
credit for particular purposes. They usually take the form of
changing margin requirements to control speculative activities
within the economy. When there is brisk speculative activity in
the economy or in particular sectors in certain commodities and
prices start rising, the central bank raises the margin requirement
on them.
The result is that the borrowers are given less money in loans
against specified securities. For instance, raising the margin
requirement to 60% means that the pledger of securities of the
value of `. 10,000 will be given 40% of their value, i.e. `. 4,000 as
loan. In case of recession in a particular sector, the central bank
encourages borrowing by lowering margin requirements.
$$$.... for difference please refer to question no:16.

18.**Examine carefully the characteristics of Indian tax structure.
What steps have been taken to improve it and with what effect?

Answer : refer Organizer from pages: BBECO-II-49/50-51
19. ****Write short notes on the following:-[5 marks each]
(a) Public expenditure

(b) Goals of monetary and fiscal policy
(c) Progressive and regressive taxation
(d) Burden of public debt
(e) VAT/value added tax
Answer: (a): Public expenditure
Public expenditure is spending made by the government of a

country on collective needs and wants such as pension,
provision, infrastructure, etc.[1] Until the 19th century, public
expenditure was limited as laissez faire philosophies believed that
money left in private hands could bring better returns. In the 20th
century, John Maynard Keynes argued the role of public
expenditure in determining levels of income and distribution in
the economy. Since then government expenditures has shown an
increasing trend.
Causes of growth of public expenditure:

There are several factors that have led to enormous increase in
public expenditure through the years:
1) 'Defense Expenditure due to modernization of defense
equipment by navy, army and air force to prepare
the country for war or for prevention causes-for-growth-of-
public-expenditure.
2) Population growth: It increases with the increase in population,
more of investment is required to be done by government on
law and order, education, infrastructure, etc. investment in
different fields depending on the different age group is required.
3) Welfare activities- welfare, mid-day meals, pension provisions
etc.
 Provision of public and utility services-provision of basic public

goods given by government (their maintenance and installation)
such as transportation.
 Accelerating economic growth- in order to raise the standard of
living of the people.
 Price rise- higher price level compels government to spend
increased amount on purchase of goods and services.[6]
 Increase in public revenue- with rise in public revenue
government is bound to increase the public expenditure.
 International Obligation- maintenance of socio economic
obligation, cultural exchange etc. (these are indirect expenses
of government)
4) Wars and social crises - fighting amongst people and
communities, severe and prolonged drought or unemployment,
earthquake, hurricanes or tornadoes may lead to increase in
public expenditure of a country. This is because it will involve
governments to re-plan and allocate resources to finance the
reconstruction.
5) Creation of super national organizations - E.g. the United
Nations, NATO, European community and other multinational
organizations that are responsible for the provision of public
goods and services on an international basis, have to be financed
out of funds subscribed by member states, thereby adding to
their public expenditure.
6) Foreign Aid - Acceptance by the richer industrialized countries
of their responsibility to help the poor developing countries has
channeled some of the increased public expenditure of the donor
country into foreign aid programmes.
7) Inflation - This is the general rise in price level of goods and
services. It increases the cost of all activities of the public sector
and thus a major factor in growth in money terms of public
expenditure.
(b)Objectives or Goals of Monetary Policy:

The following are the principal objectives of monetary policy:
1. Full Employment:
Full employment has been ranked among the foremost objectives
of monetary policy. It is an important goal not only because
unemployment leads to wastage of potential output, but also
because of the loss of social standing and self-respect.
2. Price Stability:
One of the policy objectives of monetary policy is to stabilise the
price level. Both economists and laymen favour this policy
because fluctuations in prices bring uncertainty and instability to
the economy.
3. Economic Growth:
One of the most important objectives of monetary policy in recent
years has been the rapid economic growth of an economy.
Economic growth is defined as “the process whereby the real per
capita income of a country increases over a long period of time.”
4. Balance of Payments:
Another objective of monetary policy since the 1950s has been to
maintain equilibrium in the balance of payments.
Goals of fiscal policy:
The major objectives of fiscal policy are as follows:

 Full employment: It is very important objective of fiscal policy.
Unemployment reduces the level of production, and hence the
level of economic growth. It also creates many problems to the
unemployed people in their day-to-day life. So, countries try to
remove unemployment and attain full employment. Full
employment refers to that situation, where there is no involuntary
unemployment in the economy. To attain this objective,
government tends to:
 Increase its spending
 Lower the personal income taxes

 Lower the business taxes, or
 Employ a combination of increasing government spending and
decreasing taxes
However, in practice, it is difficult to achieve full employment. As

the factor markets are not perfect, factor units may lose their jobs
and may not get the new jobs immediately.
 Price stability: Both sharp rise and sharp fall in general price level
are not desirable. It is because sharp rise in prices makes many
goods and services unaffordable to the consumers whereas sharp
fall in prices discourages the producers to produce goods and
services. So, price stability is desirable. However, it should be
noted that the principle that general price level should be
reasonably stable is generally accepted, the determination of
exact trends which are most satisfactory from the stand point of
welfare of society is difficult. There are following three alternative
points of view regarding the price stability.
 Economic growth: It is also an important objective of fiscal policy.
By means of higher rate of economic growth, the problem of
unemployment can also be solved. However, it may create some
problems in the maintenance of price stability. The developed
countries, like USA, UK, Japan, etc. give attention to the
relationship of actual growth rate to the potential growth rate
permitted by the consumption – saving ratio, technological
considerations and other factors. The less developed countries
give emphasis to the increase in the potential growth rate as well
as the relationship of the actual and potential growth rate.
 Resource allocation: Resource allocation refers to assigning the
available resources of the economy to the specific uses chosen
among many possible and competing alternatives. It gives answer
to what to produce and how to produce-questions of the economy.
Fiscal policy should ensure the optimum allocation of the
resources. It should divert the resources from unproductive
sectors to the productive sectors of the economy. It is the long-
run objective of the government. The emphasis of the
government upon the full employment, price stability and

economic growth should not overshadow the resource allocation
goal.
 Increase in Savings: This policy is also used to increase the rate
of savings in the country. In the developing countries rich class
spends a lot of money on luxuries. The government can impose
taxes on them and can provide the basic necessities of life to
the poor class on low rate. In this way by providing incentives,
savings can be increased.
 Equal Distribution of Wealth: Fiscal policy is very useful for the
achievement of equal distribution of wealth. When the wealth is
equally distributed among the various classes then their
purchasing power increases which ensures the high level of
employment and production.
 Control Inflation: Fiscal policy is very useful weapon for
controlling the rate of inflation. When the expenditure on non
productive projects is reduced or the rate of taxes are increased
then the purchasing power of the people reduces.
 Reduce the Regional Disparity: In the less-developing countries,
the regional disparity is found. Some areas are more developed
while the others are less developed. Government provides the
infrastructure facilities in less developed areas. The tax holiday
incentive is also provided in these areas which is very useful in
increasing the per capita income.
 Check Rapid Increase in Consumption: Fiscal policy is also used
to check the rapid increase in the consumption will be high then
the rate of saving will be low and consequently rate of investment
will be low. So one country cannot improve its economic condition
without increasing the investment.
(c) Progressive and regressive taxation:

Regressive Taxes
Under a regressive tax system, individuals and entities with low

incomes pay a higher amount of that income in taxes compared
to high-income earners. Rather than implementing a tax liability
based on the individual or entity's ability to pay, the government

assesses tax as a percentage of the asset that the taxpayer
purchases or owns.
For example, a sales tax on the purchase of everyday products

or services is assessed as a percentage of the item bought and is
the same for every individual or entity. However, a sales tax of
7% has a greater burden on lower-income earners than it does on
the wealthy because the ability to pay is not taken into
consideration. Regressive taxes include real estate property taxes,
state and local sales taxes as well as excise taxes on
consumables such as cigarettes, gasoline, airfare or alcohol.
Progressive Taxes
The current federal income tax is a progressive tax system, in

that the proportion of tax liability rises as an individual or entity's
income increases. Tax burdens are meant to be more of an
imposition to wealthy, high-income earners than they are to low-
or middle-class individuals.
Under a progressive tax system, taxes assessed on income and

business profits are based on a progressive or increasing tax rate
schedule. Marginal tax rates under a progressive tax system are
often higher than the average tax rates that are paid. Estate
taxes are another example of progressive taxes, as a greater
burden is placed on wealthy individuals.

Proportional Taxes
A proportional tax system, or a flat tax system,

assesses the same tax rate to taxpayers regardless of
income or wealth. It is meant to create equality
between marginal tax rate and average tax rate paid.
Under a proportional tax system, individual taxpayers
pay a set percentage of their income regardless of
total income earned.
For example, an income tax of 10% that does not

increase or decrease as income rises or falls results in
a proportional tax. In this example, an individual who
earns `.20,000 annually pays `.2,000 under a
proportional tax system, while someone who earns
`.200,000 each year pays `.20,000 in taxes. Some
specific examples of proportional taxes include per
capita taxes, gross receipts taxes and occupational
taxes.
(d) Burden of public debt:

Burden of Public Debt
If the debt is taken for productive purposes, for e.g., for irrigation,
transportation, railway, roads, information technology, human
skill development, etc., it will not mean any burden. Infact, they
will confer a benefit. But if the debt is unproductive it will
impose both money burden and real burden on the economy.
(a) Burden of internal debt: Internal debt involves a series of

transfers of wealth within the country, i.e., from lender to
government and then later on at the time of redemption from
government to lender. Money is thus transferred from one
section of the community to other sections. In this case the
money burden on the economy is zero.

But there may be real burden on the community. In order to

repay the interest and the principal amount of the debt, the
government has to levy taxes. What the taxpayers pay the
lenders receive. The lenders are generally rich people and tax
burden is fall on poor especially in the case of indirect
taxes. The net result may be that the wealth is transferred from
poor to rich. This is the loss of economic welfare.
(b) Burden of external debt: External debt also involves a series

of transfer of wealth from the foreign lender to the borrowing
country, and when it is repaid the transfer is in the opposite
direction. As the borrowing country paid interest to the foreign
lenders, a direct money burden is fall on the whole community.
The community is also suffered from real burden of external

debts. Government has to cover the amount of interest to be
paid to the foreign lender by heavily taxing the income of the
community. As a result the production, consumption and
distribution of income is badly affected. Moreover, the foreign
lender has direct involvement in the economic activities of the
country.
Value added tax:
What is Value Added Tax or VAT?

VAT is a kind of tax levied on sale of goods and services when
these commodities are ultimately sold to the consumer. VAT is an
integral part of the GDP of any country.
While VAT is levied on sale of goods and services and paid by
producers to the government, the actual tax is levied from
customers or end users who purchase these. Thus, it is an indirect

form of tax which is paid to the government by customers but via

producers of goods and services.
VAT is a multi-stage tax which is levied at each step of production

of goods and services which involves sale/purchase. Any person
earning an annual turnover of more than `.5 lacs by supplying
goods and services is liable to register for VAT payment. Value
added tax or VAT is levied both on local as well as imported goods.
Features of Value Added Tax in India:
 Similar goods and services are taxed equally. So a similar
television from all brands will be taxed the same
 VAT is levied at each stage of production and hence makes the
taxation process easier and more transparent
 VAT reduces chances of tax evasion and fosters compliance
 Encourages transparency in sale of goods and services at the
tiniest level
Calculation of VAT:
VAT is actually calculated as the difference between input tax and
output tax.
VAT = Output Tax – Input Tax
Where output tax is the tax received by the seller for sale of his
goods and services and input tax is the tax paid by the seller for
raw materials required to manufacture his goods and services.
VAT Example:
Suppose Ram owns a restaurant and spends `.50,000 towards
obtaining raw materials. Input tax is 10%, so input tax becomes
10% of `.50,000 = `.5,000
Now after selling the food made by using the purchased raw
materials, Ram was able to make `.1,00,000. Supposing 10%
output tax, output tax becomes `.10,000
So, final VAT payable by Ram comes out to be `.10,000 – `.5,000
= `.5,000
INTERNATIONAL TRADE:
Short answer type questions:[5-marks each]
20.*****Mention any two functions of WTO. How far the

membership of India in WTO would be beneficial for the county?
Answer: BB ECOII-57 FROM ORGANIZER….
21.*****Distinguish between BOP and BOT.
Answer:
BALANCE OF TRADE VS BALANCE OF PAYMENT OR BOT VS BOP
(What is the difference between Balance of Payment and Balance of Trade)
Basis of Balance of Payment

Balance of Trade
Difference (BOP)
(BOT)
Balance of Payment is
defined as the 'flow of
Balance of Trade cash between domestic
1. Definition is defined as country and all other
'difference foreign countries'. It
between export includes not only import
and import of and export of goods and
goods and services but also
services' includes financial
capital transfer.
BOP = BOT + (Net

BOT = Net Earning on foreign
2. How Is It Earning investment i.e.
Calculated? on Exports - Net payments made to
payment made for foreign investors) +
imports Cash Transfer + Capital
Account +or -
Balancing Item
or
BOP = Current Account
+ Capital Account + or
- Balancing item
( Errors and omissions)

Balance of Payment will

be favourable, if the
If export is more country has surplus in
3. When is it current account for
than
considered
import, at that paying your all past
as Favourable
time, BOT will be loans in her capital
or
favourable. If account.
Unfavourable?
import is more
than export, at that Balance of payment will
time, BOT will be be unfavourable,
unfavourable. if country has current
account deficit and it
took more loan from
foreigners. After this, it
has to pay high interest
on extra loan and this
will make BOP
unfavourable.
To Buy goods and

4. Solution of To stop taking of
services
being Unfavo loan from foreign
from domestic
urable countries.
country.
Following are
main factors which Following are main
5. Factors affect BOT factors which affect
a) cost of BOP
production a) Conditions of foreign
b) availability of lenders.
raw materials b) Economic policy of
c) Exchange rate Govt.
d) Prices of goods c) all the factors of BOT
manufactured at
home
23.****Enumerate the main effects of exports on Devaluation.
Answer:
Refer notes on Devaluation
24.***What is managed float of a country?

Answer: refer pages from Organizer: BBECO-II-61
15-marks question:
25.*****Define BOP. List and explain the items that are included
in BOP account.
Answer:
A statement that summarizes an economy’s transactions with
the rest of the world for a specified time period. The balance of
payments, also known as balance of international payments,
encompasses all transactions between a country’s residents and
its nonresidents involving goods, services and income; financial
claims on and liabilities to the rest of the world; and transfers
such as gifts. The balance of payments classifies these
transactions in two accounts – the current account and the
capital account. The current account includes transactions in
goods, services, investment income and current transfers, while
the capital account mainly includes transactions in financial
instruments. An economy’s balance of payments transactions and
international investment position (IIP) together constitute its set
of international accounts.
Components of Balance of Payments: (1) Current Account; (2)

Capital Account!
(1) Current Account:
Current account refers to an account which records all the
transactions relating to export and import of goods and services
and unilateral transfers during a given period of time.
Current account contains the receipts and payments relating to all

the transactions of visible items, invisible items and unilateral
transfers.
Components of Current Account:

The main components of Current Account are:
1. Export and Import of Goods (Merchandise Transactions or
Visible Trade):
A major part of transactions in foreign trade is in the form of

export and import of goods (visible items). Payment for import of
goods is written on the negative side (debit items) and receipt
from exports is shown on the positive side (credit items). Balance
of these visible exports and imports is known as balance of trade
(or trade balance).
2. Export and Import of Services (Invisible Trade):

It includes a large variety of non- factor services (known as
invisible items) sold and purchased by the residents of a country,
to and from the rest of the world. Payments are either received or
made to the other countries for use of these services.
Services are generally of three kinds:

(a) Shipping,
(b) Banking, and
(c) Insurance.
Payments for these services are recorded on the negative side

and receipts on the positive side.
3. Unilateral or Unrequited Transfers to and from abroad (One

sided Transactions):
Unilateral transfers include gifts, donations, personal remittances
and other ‘one-way’ transactions. These refer to those receipts
and payments, which take place without any service in return.
Receipt of unilateral transfers from rest of the world is shown on
the credit side and unilateral transfers to rest of the world on the
debit side.
4. Income receipts and payments to and from abroad:

It includes investment income in the form of interest, rent and
profits.

Current Account shows the Net Income:

Current Account records all the actual transactions of goods and
services which affect the income, output and employment of a
country. So, it shows the net income generated in the foreign
sector.
Difference between Balance of Trade and Current Account:

Balance of Current
Basis Trade (BOT) Account
Balance of Current
trade Account
includes records both
only visible visible and
Components: items. invisible items.
It is a
narrow
concept as
it is only a
part of It is a wider
current concept and it
Scope: account includes BOT.
Balance on Current Account:

In the current account, receipts from export of goods, services
and unilateral receipts are entered as credit or positive items and
payments for import of goods, services and unilateral payments
are entered as debit or negative items. The net value of credit
and debit balances is the balance on current account.
1. Surplus in current account arises when credit items are more

than debit items. It indicates net inflow of foreign exchange.
2. Deficit in current account arises when debit items are more

than credit items. It indicates net outflow of foreign exchange.

Components of Current Account:

Net Credit
Credit Items Debit Items (Credit – Debit)
1. Visible
Trade Net Exports of
Exports of Imports of goods (Balance
goods: goods of Trade)
2. Invisible
Trade
Exports of Imports of Net Exports of
services: services services
3. Unilateral
Transfers
Transfer Transfer Net Transfer
Receipts: Payments Receipts
4. Income
Receipts &
Payments
Income Income Net Income
Receipts: Payments Receipts
Current
Receipts Current
Current Account
(1+2+3+4) Payments Balance
(2) Capital Account:

Capital account of BOP records all those transactions, between
the residents of a country and the rest of the world, which cause a
change in the assets or liabilities of the residents of the country or
its government. It is related to claims and liabilities of financial
nature.

Capital Account is used to:

(i) Finance deficit in current account; or
(ii) Absorb surplus of current account.
Capital account is concerned with financial transfers. So, it does

not have direct effect on income, output and employment of the
country.
Components of Capital Account:

The main components of capital account are:
1. Borrowings and landings to and from abroad: It includes:
A. All transactions relating to borrowings from abroad by private
sector, government, etc. Receipts of such loans and repayment of
loans by foreigners are recorded on the positive (credit) side.
B. All transactions of lending to abroad by private sector and

government. Lending abroad and repayment of loans to abroad is
recorded as negative or debit item.
2. Investments to and from abroad: It includes:

A. Investments by rest of the world in shares of Indian companies,
real estate in India, etc. Such investments from abroad are
recorded on the positive (credit) side as they bring in foreign
exchange.
B. Investments by Indian residents in shares of foreign companies,

real estate abroad, etc. Such investments to abroad be recorded
on the negative (debit) side as they lead to outflow of foreign
exchange.
3. Change in Foreign Exchange Reserves:

The foreign exchange reserves are the financial assets of the
government held in the central bank. A change in reserves serves
as the financing item in India’s BOP. So, any withdrawal from the
reserves is recorded on the positive (credit) side and any addition

to these reserves is recorded on the negative (debit) side. It must

be noted that ‘change in reserves’ is recorded in the BOP account
and not ‘reserves’.
Balance on Capital Account:

The transactions, which lead to inflow of foreign exchange (like
receipt of loan from abroad, sale of assets or shares in foreign
countries, etc.), are recorded on the credit or positive side of
capital account. Similarly, transactions, which lead to outflow of
foreign exchange (like repayment of loans, purchase of assets or
shares in foreign countries, etc.), are recorded on the debit or
negative side. The net value of credit and debit balances is the
balance on capital account.
A. Surplus in capital account arises when credit items are more

than debit items. It indicates net inflow of capital.
B. Deficit in capital account arises when debit items are more

than credit items. It indicates net outflow of capital.
In addition to current account and capital account, there is one

more element in BOP, known as ‘Errors and Omissions’. It is the
balancing item, which reflects the inability to record all
international transactions accurately.
Net Credit
Credit Items Debit Items (Credit – Debit)
1.
Borrowings
and
lending’s to
and from
abroad
Borrowings Landings to Net Borrowings
from abroad: abroad from abroad

2.
Investments
from abroad Net
Investments Investments Investments
from abroad: to abroad from abroad
3. Change in
Foreign
Exchange
Reserves.
Decreases in Increases in Net change in

foreign foreign foreign
exchange exchange exchange
reserves: reserves reserves
Capital
Receipts Capital
Capital Account
(1+2+3): Payments Balance
Balance on Current Account Vs. Balance on Capital Account:

Balance on current account and balance on capital account are
interrelated.
A. A deficit in the current account must be settled by a surplus on

the capital account.
B. A surplus in the current account must be matched by a deficit

on the capital account.
26. ****Explain the comparative cost Advantage theory of

International trade. How a country will gain from such trade?
Answer:
Refer notes
27.****Explain the concept of absolute cost advantage theory.

Discuss the economic effect of imposition of tariff and quota.
Answer: For part A refer notes…..
Let's first review what tariffs and quotas are and then discuss the
effects they can have on imported goods and the prices we pay.
A tariff is a tax imposed on imports, which are goods coming into
a country. The tax may range from a few percent of the cost of
the good to well over 100% of the cost of the good! This tax is
ultimately passed on to consumers, resulting in higher prices.
A quota sets a numerical limit on how much of a product can be
imported into a country. This helps to protect producers of
domestic products from facing too much competition and
ultimately going out of business. Ultimately, quotas benefit and
protect the producers of a good in a domestic economy, though
the consumers end up paying more if the domestically produced
goods are priced higher than imports.
There are many reasons that tariffs and quotas may be used. The
most common reasons are often geared towards protecting newer
or inefficient domestic industries that are seen as important to
the American economy and the production of jobs. The
government view is that by protecting these domestic industries,
we can maintain jobs through increased sales of domestic goods.
This ultimately can lead to higher tax revenue collected.
If we didn't protect some of our firms, other countries could dump
thousands of products on our country at extremely low prices and
potentially hurt many of our domestic businesses. Now, let's
explore in more detail the effects of tariffs and quotas.
Tariff Effects
The additional tax, or tariff, on imported goods can discourage
foreign countries or businesses from trying to sell products in a
foreign country. The additional taxes make the foreign import
either too expensive or not nearly as competitive as it would be if

the tariff didn't exist. This can lead to fewer choices of goods and
a lower quality for consumers. The amount of chocolate, fruits
and vegetables, and automotive parts you have to choose from
are all subject to the effects of tariffs.
Domestic producers benefit by ultimately facing reduced
competition in their home market, which leads to lower supply
levels and higher prices for consumers. When a consumer does
purchase a higher-priced imported good with a tariff imposed on
it, the consumer now has less money to spend on other things.
These forces consumers to either buy less of the imported good
or less of some other good, ultimately lowering the purchasing
power of consumers. It is important to remember that although
consumers may pay higher prices because of tariffs and have
limited options, the potential benefit is that domestic sales of
goods can increase, ultimately leading to higher domestic sales
and more jobs for companies inside the country.
Quota Effects. The numerical limits imposed on imported goods
through quotas ultimately leads to higher prices paid by
consumers. Essentially, the import quota prevents or limits
domestic consumers from buying imported goods. The
import quota reduces the supply of imports.
28.*****Write short notes on the following:

a) IMF
b) Tariff & Quota
c) Devaluation
d) Asian Development Bank
e) Devaluation vs Depreciation
f) Gains from trade
ECONOMIC DEVELOPMENT AND WELFARE:

29.***State the indicators of economic development. Why is
planning needed in under-development economics. What do you
mean by “Vicious Circle of Poverty”.
Answer:
Refer Organizer: pages: BBECO:II-82…and BBECO-II-86


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PREPARED BY: ARINDAM DEY; PRIVATE TUTOR: FOR BBA[h]/MBA/MBA

ENTRANCE TEST/BCOM[h]/OTHER PROFESSIONAL COURSES.

1. ****What do you mean by bank rate and open market

ADDRESS: MANINDRA BHAWAN: IA-27/SECTOR:III/SALTLAKE CITY/KOLKATA:700097.LAND

Indian corporates invariably under invoice their exports and

In the words of Irving Fisher, “Other things remaining

quantity of money is reduced by one half, the price level will

Fisher has explained his theory in terms of his equation of

Where P = price level, or 1 IP = the value of money;

M = the total quantity of legal tender money;

V = the velocity of circulation of M;

M’ – the total quantity of credit money;

V’ = the velocity of circulation of M;

T = the total amount of goods and services exchanged for

This equation equates the demand for money (PT) to supply

According to Fisher, PT is SPQ. In other words, price level (P)

ADDRESS: MANINDRA BHAWAN: IA-27/SECTOR:III/SALTLAKE CITY/KOLKATA:700097.LAND

the quantity of money on the price level or the value of

Fisher’s quantity theory of money is explained with the help

ADDRESS: MANINDRA BHAWAN: IA-27/SECTOR:III/SALTLAKE CITY/KOLKATA:700097.LAND

When the quantity of money is doubled to M2, the price level

1. P is passive factor in the equation of exchange which is

2. The proportion of M’ to M remains constant.

3. V and V are assumed to be constant and are independent

4. T also remains constant and is independent of other

5. It is assumed that the demand for money is proportional

6. The supply of money is assumed as an exogenously

7. The theory is applicable in the long run.

ADDRESS: MANINDRA BHAWAN: IA-27/SECTOR:III/SALTLAKE CITY/KOLKATA:700097.LAND

8. It is based on the assumption of the existence of full

Criticisms of the Theory:

2. Other things not equal:

Consequently, the price level may change more in proportion

3. Constants Relate to Different Time:

4. Fails to Measure Value of Money:

8. *****Explain fully the functions of commercial bank. Mention

ADDRESS: MANINDRA BHAWAN: IA-27/SECTOR:III/SALTLAKE CITY/KOLKATA:700097.LAND

10. ****Explain the four factors determining the size of

Answer: refer pages from Organizer: BBECO-II-29/30.

11. ***Distinguish between the GDP and GNP?

Answer: refer pages from Organizer:BBECO-II-30

12. **Define national income. State the difficulties in measuring

13.****What do you mean by personal income. How does it

Answer: refer notes:

Very imp: please go through all the numerical on national

14. *What is the main source of revenue of Central government?

Answer: refer Organizer: BB ECO-II-42

15. ****Define deficit financing.

Deficit financing is a method of meeting government deficits

The receipts similarly comprise revenues on current account as

Purpose of Deficit Financing:

The gap in resources is made up partly through external

Advantages of Deficit Financing:

ADDRESS: MANINDRA BHAWAN: IA-27/SECTOR:III/SALTLAKE CITY/KOLKATA:700097.LAND

Through deficit financing, resources are used much earlier than

Defects of Deficit Financing:

(ii) Inflationary forces created by deficit financing are

(iii) Investment caused by inflation may not be of the pattern

(iv) If as a result of deficit financing inflation goes too far, it

16.***** Distinguish between the fiscal and monetary policy.

Difference Between Fiscal Policy and Monetary Policy

The economic position of a country can be monitored,