Test: Class 12 (Macroeconomics) Economy NCERT Based - 1 - UPSC MCQ

• Non-monetary exchanges: Many activities in an economy are not evaluated in monetary terms. For example, the domestic services women perform at home are not paid for. The exchanges which take place in the informal sector without the help of money are called barter exchanges.

• In barter exchanges, goods (or services) are directly exchanged against each other. But since money is not being used here, these exchanges are not registered as part of economic activity.

• In developing countries, where many remote regions are underdeveloped, these kinds of exchanges do take place, but they are generally not counted in the GDPs of these countries. This is a case of underestimation of GDP. Hence, GDP calculated in the standard manner may not give us a clear indication of the productive activity and well-being of a country.

• CPI (and analogously WPI) may differ from GDP deflator because

1. The goods purchased by consumers do not represent all the goods which are produced in a country. GDP deflator takes into account all such goods and services.

2. CPI includes prices of goods consumed by the representative consumer, hence it includes prices of imported goods. GDP deflator does not include prices of imported goods.

3. The weights are constant in CPI – but they differ according to the production level of each good in GDP deflator.

• Some countries have made an attempt to move towards an economy which uses less cash and more digital transactions.

• A cashless society describes an economic state whereby financial transactions are not connected with money in the form of physical bank notes or coins but rather through the transfer of digital information (usually an electronic representation of money) between the transacting parties.

• In India the government has been consistently investing in various reforms for greater financial inclusion. During the last few years’ initiatives such as Jan Dhan accounts, Aadhar enabled payment systems, e –Wallets, National financial Switch (NFS) and others have strengthened the government resolve to go cashless.

• Today, financial inclusion is seen as a realistic dream because of mobile and smartphone penetration across the country.

• The demand for money tells us what makes people desire a certain amount of money. Since money is required to conduct transactions, the value of transactions will determine the money people will want to keep: the larger is the quantum of transactions to be made, the larger is the quantity of money demanded.

• Since the quantum of transactions to be made depends on income, it should be clear that a rise in income will lead to a rise in demand for money.

• Also, when people keep their savings in the form of money rather than putting it in a bank which gives them interest, how much money people keep also depends on the rate of interest. Specifically, when interest rates go up, people become less interested in holding money since holding money amounts to holding less of interest-earning deposits, and thus less interest received.

Therefore, at higher interest rates, money demanded comes down.

• Commercial banks are the other type of institutions which are a part of the money-creating system of the economy.

• In the following section we look at the commercial banking system in detail. They accept deposits from the public and lend out part of these funds to those who want to borrow.

• The interest rate paid by the banks to depositors is lower than the rate charged from the borrowers. This difference between these two types of interest rates, called the ‘spread’ is the profit appropriated by the bank.

• All the people of the economy increase the proportion of income they save (i.e. if the mps of the economy increases) the total value of savings in the economy will not increase – it will either decline or remain unchanged.

• This result is known as the Paradox of Thrift – which states that as people become thriftier they end up saving less or the same as before. This result, though sounds apparently impossible, is actually a simple application of the model we have learnt. Let us continue with the example.

• Suppose at the initial equilibrium of Y = 250, there is an exogenous or autonomous shift in peoples’ expenditure pattern – they suddenly become more thrifty.

• Full employment level of income is that level of income where all the factors of production are fully employed in the production process. Recall that equilibrium attained at the point of equality of Y and AD by itself does not signify full employment of resources.

• Equilibrium only means that if left to itself the level of income in the economy will not change even when there is unemployment in the economy. The equilibrium level of output may be more or less than the full employment level of output.

• If it is less than the full employment of output, it is due to the fact that demand is not enough to employ all factors of production.

• This situation is called the situation of deficient demand. It leads to decline in prices in the long run. On the other hand, if the equilibrium level of output is more than the full employment level, it is due to the fact that the demand is more than the level of output produced at full employment level.

• This situation is called the situation of excess demand. It leads to rise in prices in the long run.

• Aggregate demand for final goods consists of ex ante consumption, ex ante investment, government spending etc.

• The rate of increase in ex ante consumption due to a unit increment in income is called marginal propensity to consume. For simplicity we assume a constant final goods price and constant rate of interest over a short run to determine the level of aggregate demand for final goods in the economy.

• We also assume that the aggregate supply is perfectly elastic at this price. Under such circumstances, aggregate output is determined solely by the level of aggregate demand. This is known as the effective demand principle.

An increase (decrease) in autonomous spending causes aggregate output of final goods to increase (decrease) by a larger amount through the multiplier process.

• Change in investment: we have assumed that investment is autonomous. However, it just means that it does not depend on income. There are a number of variables other than income which can affect investment. One important factor is availability of credit: easy availability of credit encourages investment.

• Another factor is interest rate: interest rate is the cost of investible funds, and at higher interest rates, firms tend to lower investment.

• Although the budget document relates to the receipts and expenditure of the government for a particular financial year, the impact of it will be there in subsequent years.

• There is a need therefore to have two accounts- those that relate to the current financial year only are included in the revenue account (also called revenue budget) and those that concern the assets and liabilities of the government into the capital account (also called capital budget).

• There are two major differences. One, the benefits of public goods are available to all and are not only restricted to one particular consumer. For example, if a person eats a chocolate or wears a shirt, these will not be available to others.

• It is said that this person’s consumption stands in relation to the consumption of others. However, if we consider a public park or measures to reduce air pollution, the benefits will be available to all.

• One person’s consumption of a good does not reduce the amount available for consumption for others and so several people can enjoy the benefits, that is, the consumption of many people is not ‘rivalrous’.

• Out of private income, what finally reaches the households is known as personal income and the amount that can be spent is the personal disposable income.

• The government sector affects the personal disposable income of households by making transfers and collecting taxes.

• It is through this that the government can change the distribution of income and bring about a distribution that is considered ‘fair’ by society. This is the redistribution function.

• The overall level of employment and prices in the economy depends upon the level of aggregate demand which depends on the spending decisions of millions of private economic agents apart from the government.

• These decisions, in turn, depend on many factors such as income and credit availability. In any period, the level of demand may not be sufficient for full utilisation of labour and other resources of the economy.

• Since wages and prices do not fall below a level, employment cannot be brought back to the earlier level automatically. The government needs to intervene to raise the aggregate demand.

• On the other hand, there may be times when demand exceeds available output under conditions of high employment and thus may give rise to inflation. In such situations, restrictive conditions may be needed to reduce demand. The intervention of the government whether to expand demand or reduce it constitutes the stabilisation function.

• Revenue receipts are those receipts that do not lead to a claim on the government. They are therefore termed non-redeemable.

• They are divided into tax and non-tax revenues. Tax revenues, an important component of revenue receipts, have for long been divided into direct taxes (personal income tax) and firms (corporation tax), and indirect taxes like excise taxes (duties levied on goods produced within the country), customs duties (taxes imposed on goods imported into and exported out of India) and service tax Other direct taxes like wealth tax, gift tax and estate duty (now abolished) have never brought in large amount of revenue and thus have been referred to as ‘paper taxes’.

• The redistribution objective is sought to be achieved through progressive income taxation, in which higher the income, higher is the tax rate. Firms are taxed on a proportional basis, where the tax rate is a particular proportion of profits. With excise taxes, necessities of life are exempted or taxed at low rates, comforts and semi-luxuries are moderately taxed, and luxuries, tobacco and petroleum products are taxed heavily.

• Non-tax revenue of the central government mainly consists of interest receipts on account of loans by the central government, dividends and profits on investments made by the government, fees and other receipts for services rendered by the government.

• Cash grants-in-aid from foreign countries and international organisations are also included.