Economics MACRO ECONOMICS NATIONAL INCOME

Solution

MACRO ECONOMICS NATIONAL INCOME AND DI Section A 1. (i) Indian Economy is a developing economy. There occur several non-monetary transactions. In rural India, people exchange some goods with other goods or exchange goods with services without involving money. Money Value of such transactions is excluded from GDP. Thus GDP is not a true index of all the transactions of a nation. (ii) National Income GDP MP= Private final consumption expenditure + Government final consumption expenditure + Net domestic capital formation + Net exports = 400 crore + 100 crore + 50 crore + (–) 20 crore GDP MP= Rs. 530 crore

NNP FC= GDP MP - Net Factor Income to abroad - Net indirect taxes ( Indirect Taxes - Subsidy ) - Depreciation = 530 crore - 10 crore - (30 crore - 5 crore) - 20 crore = 475 crore 2. (i) Treatment of the following items while estimating the national income of India: a. It will not be included in national income because it is the non-factor payment as it is considered that the general government borrows only for consumption purposes. b. Not included, because it is capital gain and has nothing to do with production. c. It will be included because it is the final consumption expenditure by the government. d. It is included in the national income because it adds to the production of goods though it is used for self- consumption. (ii) Net Value Added at Market Price by Firm Y = Sales + Change in stock (Closing Stock - Opening Stock) – Purchase of intermediate products – Consumption of fixed capital = 300 thousand + (–) 10 thousand (200 thousand - 210 thousand) – 150 thousand – 20 thousand = 120 thousand Rupees. 3. (i) Activities or transactions that are not included from Gross National Product measurement are: Purely Financial Transaction: Buying and selling of security: - Because it does not rather add to any production services. Government transfer payments:- Because it is a one-sided payment made by the Government. Transfer of used (Second hand) goods: - Because it is already counted at the time of production and hence it will lead to double counting. Non- market goods and services: - Because it is not bought and sold into the market and thus it is not included. The value of leisure: - Because leisure does not refer any productive services. (ii) Gross Value Added at Factor Cost by Firm X = Sales + Change in stock (Closing stock – Opening stock) + Subsidy – Purchase of intermediate products = 2000 thousand + (80 thousand – 120 thousand) + 160 thousand – 1200 thousand = 2000 thousand – 40 thousand + 160 thousand – 1200 thousand = 920 thousand 4. (i) Yes, the concept of Green GNP can be followed. a. Green GNP measures national income or Output adjusted for the depletion of natural resources and degradation of the environment. b. It will help to attain sustainable use of the natural environment and equitable distribution of benefits of development. A large number signifies greater Sustainability.

(ii) NDP FC = Compensation of the employees + Mixed Income of the self employed + Operating surplus Compensation of Employees = Wages + Employer's Contribution = 800+200= 1000 Mixed Income of Self Employed = 1000 Operating Surplus = Rent + Royalty + Interest + Profit

1 / 8 [email protected], 9935145789 =1400+200+1500+500=3600 NDP FC =1000+1000+3600 = Rs 5600 crore GDP FC = NDP FC + Depreciation = 5600 + 70 = Rs 5670 Crore 5. (i) a) This Expenditure by the Govt. is not included in National income as it is transfer Payment and does not correspond to the flow of goods and services b) This Expenditure will help people to get their lives back on track. It will add to their consumption expenditure. Also, if some expenditure is incurred to rebuild their houses, it will add to the capital formation in the city. (ii) GVA MP of Sector A= Sales + Change in stocks - Purchase of raw material by A = 5000 + (250 - 500) - 2500 = Rs 2250 crore GVA MP of Sector B = Sales + Change in Stocks - Purchase of raw material by B = 10000 - 1000 - 3000 = Rs 6000 crore 6. (c) Negative savings Explanation: '-a' denotes autonomous savings.So, these are done at zero level of income. 7. (d) Consumption expenditure Explanation: It is a linear consumption function where 'C' represents consumption expenditure. 8. (d) MPC Explanation: Since, we know that C = a + by --- (i) dc = MPC also, dy Diffenciating (i) w.r.t y, we get dc = b dy b = MPC 9. (b) 4000 Explanation: Here, MPC = 0.8 K = 1 = 1 = 5 1−0.8 0.2 Δy = 5 ΔI Δy = 5ΔI --- (i) 1 Also, = 5 1− ΔC Δy Δy = 5 Δy−Δc Δy = 5(Δy − Δc) --- (ii) from (i) and (ii) we get, 5ΔI = 5(Δy − Δc) 1000 = 5000 − Δc --- using (i) Δc = 4000

10. (c) Infinity Explanation: Since, multiplier is a function of MPC, so when MPC is maximum, K must be maximum. K = 1 Thus, 1−1 = infinity. 11. (b) 1.0 Explanation: Referring to the formula of investment multiplier below, if MPS=1, K=1. It means when consumption is zero or all income is saved, then there is no investment hence ,no change in income. K = 1 = 1 = 1 1− dC 1−MPC 1−MPS dY

2 / 8 [email protected], 9935145789 12. (a) 5 Explanation: K=1/1-mpc = 1/1-0.8 =1/0.2 =5 13. (b) S= -a+(1-b)Y Explanation: S=-b+(1-b)Y, where 1-b implies marginal propensity to save. 1 14. (b) MPS 1 Explanation: MPS 15. (d) The level of income (Y) Explanation: Saving is a function of income. S=f(Y). So, APS=S/Y=f(Y)/Y. 16. (a) MPC Explanation: 'bY 'denotes induced consumption where 'b' denotes marginal propensity to consume. 17. (a) The value of consumption exceeds the value of income Explanation: APC=C/Y APC>1 when C>Y. 18. (d) MPC Explanation: Since, MPS =1-b =1-MPC. Hence, 'b' must be MPC.

19. (c) Autonomous consumption expenditure Explanation: Here, 'a' is a constant which denotes autonomous consumption.This consumption is not induced by income changes. 20. (c) 0.25 Explanation: MPS=1-MPC MPS= 1-0.75. (given) =0.25 21. (a) AD. Explanation: Because , AD=C+I+G+(X-M). So, clearly AD is a function of G. 22. (b) 0.0 Explanation: APC=C/Y=1000/1000=1 Thus, APS= 1-APC=1-1=0. 23. (b) Rs. 5000 Explanation: K=1/1-MPC=1/1-0.8=1/0.2=5. It means that income will multiply five times the initial income. So, New income= 5×1000=5000. 24. (d) Increase in savings per unit increase in the income. Explanation: Slope of saving function implies rate of change of saving with respect to income. 25. (a) Disposable income. Explanation: Because savings are started when first taxes are deducted from income. 26. Equilibrium level of income : 1. Equilibrium level of income is determined at a point, where ex-ante or planned saving is equal to planned investment. 2. This is because, in equilibrium:Aggregate Supply = Aggregate Demand or Consumption + Saving = Consumption + Investment, or Saving = Investment or AS = AD or C + S= C + I or S = I Diagrammatic presentation:

3 / 8 [email protected], 9935145789 In the diagram given, E is the point where S= I, hence, the point at which the economy is in equilibrium. OY is the equilibrium level of National Income. When S > I: When savings are greater than investment in an economy, it refers to AD < AS. There will be a rise in inventory stock and prices will start to fall. The producers would now plan lesser output to clear their stocks. This would mean, lesser income in the economy. Lesser income implies lesser saving. The process would continue till S = I. When S < I: If investments are more than savings, it means that AS < AD Stocks would reduce and prices will start to rise. The producers will increase their production to stand benefited from such a condition and this will lead to an increase in investments. The process would continue till S = I. 27. i. Induced Investment: a. Induced investment is positively related to the level of income in an economy. At higher level of income, consumption expenditure tends to increase. Increased consumption expenditure or level of demand raises expected profitability of the producer who accordingly are induced to make greater investment. b. Induced investment curve has a positive slope showing direct relationship between income and investment. ii. Autonomous Investment : An investment which is not influenced by expected profitability or level of income is called autonomous investment. In fact, it is an investment expenditure incurred by the government with a view to promoting the level of aggregate demand in the economy when AD falls short of AS, resulting in fall in prices and rise in unemployment. The govt. intends in push up the level of AD by way of its autonomous investment. Autonomous investment is independent of the level of income. It is also profit and income inelastic.

28. 1. Underemployment equilibrium refers to a situation when equilibrium is attained i.e. aggregate demand is equal to aggregate supply below full employment level or when resources are not fully employed.

2. In the above diagram full employment level of national income is attained at point E, but due to deficient demand, aggregate demand shifts downward from AD to AD0 and a new equilibrium is attained at point

4 / 8 [email protected], 9935145789 E1: which is below full employment level. The aggregate demand shifts downward because of the following reasons. 1. Decrease in household consumption demand due to fall in the propensity to consume. 2. Decrease in private investment demand because of fall in credit facilities. 3. Decrease in public (government) expenditure. 4. Decrease in export demand. 5. Decrease in money supply or a decrease in disposable income. 3. In order to achieve full employment equilibrium deficiency of demand must be corrected through additional investment expenditure. In the diagram deficiency of AD = AB. Thus, AB amount of additional investment is required to reach the level of full employment. 29. In the Keynesian model, the determination of income and employment depends on the level of Aggregate Demand (AD) and Aggregate Supply (AS). The point where AD = AS, i.e. Aggregate Demand equals the Aggregate Supply is known as an equilibrium point. As represented in the given graph, Aggregate Demand curve 'AD' cut Aggregate Supply curve 'AS' at point 'E' (i.e equilibrium point). When AD is greater than AS, the flow of goods and services in the economy tends to be less than their demand. The existing stocks of the producers would be sold out. To rebuild the desired stocks, the producers would plan greater production. AS would increase to become equal to AD. In the given graph, at P' level of income, AD exceeds AS because of this prices will rise and the existing stocks of the producers will be sold out. The Probability of increased profits will induce the producers to expand their production leading to an increase in the level of Aggregate Supply, till both converge at point E i.e. equilibrium restored back.

30. i. Open market operations refer to the sale and purchase of securities by the central bank. Deficient demand refers to AD falling short of AS at full employment. In this situation the central bank buys securities in the open market and makes payment to the sellers. The money flows out of the central bank and ultimately reaches the commercial banks as deposits. This raises the lending capacity of the banks. People can borrow more. This will raise AD. ii. Bank rate is the rate of interest which the central bank charges on the loans given to commercial banks. In case of deficient demand central banks can reduce the hank rate. This forces the commercial banks to reduce lending rate. Since borrowing becomes cheaper people borrow more. AD rises. 31. The process of investment multiplier is as under: 1. It can be illustrated with the help of a simple example. We know that one man’s expenditure is another man’s income. 2. Suppose, the government of a country spends Rs 100 crore on building roads. National income of the country automatically rises by Rs 100 crore in Round 1. 3. Now suppose MPC is 0.5, people working in the investment industry will spend Rs 50 crore on new consumption goods. 4. The consumer goods industry will have an extra income of Rs 50 crore. Assume the MPC for the whole society is 0.5, people working in this consumer goods industry would again spend 50% of their additional income of Rs 50 crore (which works out to be 25 crores) on more consumer goods. 5. These Rs 25 crore will, thus, become the income for others. This will continue until the total increase in income becomes k times the increment of investment. 6. The process of income generation has been shown in the following table: Round Number Increase in Investment ((ΔI) Increase in Income (ΔY) Increase in Consumption

5 / 8 [email protected], 9935145789 Δ(C)

1 100 100 = ΔI 50(100×0.5)

2 50 = b ΔI 25(50×0.5)

3 25 = b2 ΔI 12.5(25×0.5)

4 12.5 = b3 ΔI 6.25(12.5×0.5)

5 6.25 = b4 ΔI 3.125(6.25×0.5)

6 3.125 = b5ΔI 1.56(3.125×0.5)

7 1.56 = b6 ΔI 0.78(1.56×0.5)

- - - -

Total increase in Income = 200 crore

2 3 4 Change in income (ΔY ) = ΔI + bΔI+b ΔI + b ΔI + b ΔI + … … 2 3 4 ΔY = ΔI [1 + b + b + b + b + … ...] The term in square bracket is of the form of the sum of an infinite geometric progression series and can be written as, 2 3 4 = 1 = 1 = 2 1 + b + b + b + b + ...... 1−b[MPC] 1−0.5 On the assumption that MPC for the community as a whole is 0.5, the initial investment of Rs.100 crore would generate an additional income of Rs.200 crore. The size of investment multiplier here is 2. 32. In an economy, the equilibrium level of income and employment is determined when Aggregate Demand (AD) is equal to Aggregate Supply (AS) According to Keynes, Aggregate Supply may be assumed to be perfectly elastic in an economy where full employment of resources is yet to be achieved. Accordingly, Aggregate Demand becomes the principal determinant of equilibrium level of income. In the following graph, AD represents Aggregate Demand curve and 45° line is the line of reference, representing Aggregate Supply (AS) Equilibrium level of income Y is determined at point E, where AD = AS.

i. AD > AS: When AD is greater than AS, the flow of goods and services in the economy tends to be less than their demand. The existing stocks of the producers will be sold out. To rebuild the desired stocks, the producers will plan greater production. AS will increase to become equal to AD. ii. AD < AS: When AD is less than AS, the flow of goods and services in the economy tends to exceed their demand. As a result, some of the goods will remain unsold. To clear unwanted stocks, the producers would plan a cut in production. Consequently, AS will reduce to become equal to AD. This is how AS adapts itself to AD.

Income Consumption Saving Investment AD AS 33. (Rs.) (Y) (Rs.) (C) (Rs.) (S) (Rs.) (I) (C + I) (C + S)

6 / 8 [email protected], 9935145789 0 60 -60 40 100 0

100 140 -40 40 180 100

200 220 -20 40 260 200

300 300 0 40 340 300

400 380 20 40 420 400

500 460 40 40 500 500

600 540 60 40 580 600

700 620 80 40 660 700 34. (i) Meaning: Aggregate demand refers to the total demand for final goods and services in the economy. Since aggregate demand is measured by total expenditure of the community on goods and services, therefore, aggregate demand is also defined as ‘total amount of money which all sectors (households, firms, government) of the economy are ready to spend on the purchase of goods and services.

Components of AD:

The main components of aggregate demand (aggregate expenditure) in a four sector economy are: 1. Household (or private) consumption demand. (C) 2. Private investment demand. (I) 3. Government demand for goods and services. (G) 4. Net export demand. (X-M) Thus, AD = C + I + G+(X-M) Note: All the variables represent planned (ex-ante) and not actual (ex-post).

¯¯¯¯ (ii) Autonomous Consumption, (C) = Rs 200 Marginal Propensity to Consume, MPC (b) = 0.75 Investment, (I) = Rs 6,000 We know that Income (Y) = C + I ¯¯¯¯ and C = C + b(Y ) ¯¯¯¯ ∴ Y = C + b(Y) + I ⇒ Y = 200 + 0.75Y + 6000 ⇒ Y - 0.75Y = 6200 ⇒ 0.25Y = 6200 ⇒ Y = 6.200 = 6,200 × 100 0.25 25 = Rs 24800 ∴ Equilibrium level of income will be Rs 24800. 35. i) Given, I = Rs. 3,000 and C = 200+ 0.9 Y For equilibrium,Income (Y) = Consumption (C) + Investment (I) Y = C + I Y = (200 + 0.9 Y) + 3000 Y - 0.9 Y = 3200 or 0.1 Y = 3200 Y = 3,200 or 0.1 or National income (Y) = Rs. 32,000 ii) Given,I = Rs. 3,000 and C = 200+ 0.9 Y Again, for equilibrium,Income (Y) = Consumption (C) + Investment (I) Y = C + I or 32,000 = C + 3,000 [Y = 32000, calculated in (i) ]

7 / 8 [email protected], 9935145789 or C = 32,000-3,000 or Consumption expenditure (C) = Rs. 29,000

8 / 8 [email protected], 9935145789