(ii) Indifference curve should be convex to the point of origin at equilibrium point or we can say MRS is declining.
The point where these two conditions are fulfilled simultaneously represents eqm. for the consumer because that relates to the highest indifference curve that consumer can reach within his available budget. It can be shown with the help of the following diagram: It is clear from the figure that ‘Q’ is the only eqm. point where both the conditions of eqm. are fulfilled. Where the consumer buys ‘OM’ of X Commodity and ‘OH’ of Y Commodity. Any other point-like and Q2 cannot be considered as an optimum point because they lie on a lower indifference curve IC. Any point lying on IC3 like ‘Q3’ is beyond the reach of the consumer and no eqm. condition is satisfied.

Thus on Price line AB, ‘Q’ is on the highest IC, that gives maximum satisfaction to the consumer. At point ‘Q’ both the conditions of eqm. are satisfied.

Question 6.
(a) Discuss two contingent functions of money.
(b) Explain the role of the Reserve Bank of India with respect to:
(i) Custodian of foreign exchange.
(ii) Promotional and developmental functions.
(c) Discuss how the exchange rate is determined under a flexible exchange rate system.
(a) Facilitates Credit: Money facilitates the functioning of credit instruments such as cheques, promissory notes, bills of exchange, etc. Such credit instruments facilitate the transfer of value from one person to another.
Liquidity: Money is the most liquid form of all the assets and wealth. Gold, silver, land, cheques are not as liquid as money. If the need arises, then these assets need to be converted into money, but on the other hand, money need not be converted into any other form as it is readily acceptable. Apart from being liquid, money also provides a guarantee of liquidity/solvency to other forms of wealth and assets. This implies that money can be converted into any type of asset and on another hand, any type of asset can be converted into money.

(b)

(i) Reserve Bank keeps a close watch on the external value of its currency and undertakes exchange management control. All the foreign currency received by the citizens has to be deposited with the reserve bank and if citizens want to make payment in foreign currency, they have to apply to reserve bank. It also keeps gold and billion reserves.
(ii) Promotional and developmental functions: The RBI has been a promoter since its inception. Various promotional and developmental functions of RBI are:

• By encouraging commercial banks to expand their branches in semi-urban and rural areas, the reserve bank helps:
To reduce the dependence of the people in these areas on the defective unorganized sector of indigenous bankers and money lenders. To develop the banking habits of the people.
• By establishing the Deposit Insurance Corporations.
• Through the Institutions like Unit Trust of India, the Reserve Bank helps to mobilize saving in the country.
• Since its inception, Reserve Bank is making efforts to promote institutional agricultural credit by developing cooperative credit institutions.
• It also helps to promote the process of industrialization in the country by setting up specialized institutions for industrial finance.
• It also takes measures for developing the bill market in the country.

(c) The flexible exchange rate is determined by the interaction of the forces of demand and supply.
The equilibrium exchange rate is determined at a level where the demand for foreign exchange is equal to the supply of foreign exchange. This will be clear from As seen in the diagram, demand and supply of foreign exchange are measured on the X-axis whereas the rate of foreign exchange on the Y-axis. DD is the downward sloping demand curve of foreign exchange and SS is the upward-sloping supply curve of foreign exchange. Both the curves intersect each other at point ‘E The equilibrium exchange rate is determined at OR and the equilibrium quantity is determined at OQ.

Any exchange rate (other than OR) is not the Equilibrium Exchange Rate
(i) If the exchange rate is more than equilibrium rate.
If the exchange rate rises to OR2, then demand for foreign exchange will fall to OQ2 and supply will rise to OQ1. It will be a situation of excess supply. As a result, the exchange rate will fall till it again reaches the equilibrium level of OR.

(ii) If the exchange rate is less than the equilibrium rate.
If the exchange rate falls to OR1, then demand will rise to OQ1 and supply will fall to OQ2. It will be a case of excess demand. It will push up the exchange rate until it reaches OR.

Question 7.
(a) Explain how public expenditure can be used as a tool to attain economic stability.
(b) Differentiate between degressive taxation and regressive taxation.
(c) Explain the various components of the budget.
(a) Public expenditure helps to attain economic stability in following ways:
Production and Employment:
It depends on:
The capability of the people to work, save and invest.
The will of the people to work, save and invest.
Transfer the resources to different uses and regions.

Government Expenditure and Economic Stability: The activities of the market economy are never alike. Sometimes, there is brisk in economic life while on other occasions, the business life faces sluggish behaviour. Thus after 1930‘s Great Depression, the economist is stressing upon economic stabilization. According to Keynes, economic crisis rose because AD was less than AS and lower MPC along with lower MEC played their role. Therefore, he stressed upon increasing consumption and investment for the sake of economic stability.

Public Expenditure and Economic Growth: The public expenditure can be used to remove unequal income distribution. The facilities of health, education and communication can be made available. All such means that government expenditure can be used for economic growth and development. Moreover, because of government expenditure, the incomes of the people through the multiplier process will increase. When income will increase, the saving will also increase, which can be used for investment. This shows that an increase in government expenditure can play a vital role in the economic growth of the country.

(b)

 Degressive Taxation Regressive Taxation It is a type of tax in which people with high incomes pay less tax as a percentage of their income than those people with low income. It is a tax imposed in such a manner that the tax rate decreases as the number of taxation increases. Those tax take place when a tax is just vaguely progressive. For e.g., when the speed of development is not sufficiently spiky. In terms of individual income and wealth, a regressive tax imposes a greater burden on the poor than on the rich. Those tax might take place when the uppermost proportion is laid down for that particular kind of revenue on which it is projected to put forth most weight, and from this position onwards, taxes are implied rationally on upper-income groups and decreasingly on lesser incomes, declining to zero on poorest income group. These taxes tend to reduce the tax -incidence of people with higher ability to pay tax, as they shift the incidence disproportionately to those with lower ability to pay.

(c) Components of Budget: The budget has two broad components
(1) Revenue budget
(2) Capital budget.
(1) Revenue budget includes revenue receipts and expenditure of the government.
(a) Revenue Receipts: It refers to those receipts of the government which neither create a liability nor leads to a reduction in assets.
Tax Revenue: It consists of the proceeds of taxes and other duties levied by the government.
Non Tax Revenue: It includes receipts from sources other than tax.
(b) Revenue Expenditure:

• It refers to all those expenditures of the government which do not result in the creation of physical assets.
• Capital Budget includes capital receipts and expenditure of the government.
• Capital Receipts: It is defined as any receipts of the government which either create liability or reduce assets.
• Capital Expenditure: An expenditure which either creates assets or reduce liabilities.

Question 8.
(a) Discuss the mechanism of investment multiplier with the help of a numerical example.
(b) Distinguish between marginal propensity to consume and marginal propensity to save. What is the relationship between the two?
(c) Explain the determination of the equilibrium level of output with the help of saving and investment curves. If savings exceed planned investment, what changes will bring about equality between them?
(a) Increase in investment in an economy generates a multiplier effect on its national income. The extent of multiplier effect (and therefore, the extent of the total increase in income) depends on the marginal propensity to consume (MPC). Higher the MPC, greater would be the multiplier effect and vice-versa.
Illustration: Let us assume that Increase in investment = ₹ 100 crore
MPC = 0.90
$\begin{array}{l}{\mathrm{K}=\frac{\Delta \mathrm{Y}}{\Delta \mathrm{I}}} \\ {\mathrm{K}=\frac{1}{1-\mathrm{MPC}}} \\ {\mathrm{K}=\frac{1}{1-0.90}=2}\end{array}$
Putting value of K in equation (ii)
\begin{aligned} 10 &=\frac{\Delta Y}{100} \\ 1000 &=\Delta Y \end{aligned}

(b) APC can be > 1 in situation when C > Y

 Average Propensity to Consume (APC) Marginal Propensity to Consume (MPC) 1. It refers to the ratio of consumption expenditure (C) to the corresponding level of income (Y) at a point of time. APC = C/Y 2. When income increases APC falls but at a rate less than that of MPC. 1. It refers to the ratio of change in consumption expenditure (DC) to change in total income (DY) over a period of time. MPC = DC/DY 2. When income increases, MPC falls but at a rate more than that of APC.

(c) Saving-Investment Approach (S-1 Approach)
According to this approach, the equilibrium level of income is determined at a level, when planned saving (S) is equal to planned investment (I).

In Fig, Investment curve (I) is parallel to the X-axis because of the autonomous character of investments. The Saving curve (S) slopes upwards showing that as income rises; saving also rises.
The economy is in equilibrium at point ‘E’ where saving and investment curves, intersect each other.
At point ‘E\ ex-ante saving is equal to ex- ante investment.
OY is the equilibrium level of output corresponding to point E.

When Saving is more than Investment
If planned saving is more than planned investment, i.e., after point ‘E’ in Fig., it means that households are not consuming as much as the firms expected them to. As a result, the inventory rises above the desired level.
To clear the unwanted increase in inventory, firms would plan to reduce the production till saving and investment become equal to each other.

When Saving is less than Investment
If planned saving is less than planned investment, i.e. before point ‘E’ in Fig., it means that households are consuming more and saving less than what the firms expected them to. As a result, planned inventory would fall below the desired level.
To bring the inventory back to the desired level, firms would plan to increase the production until saving and investment become equal to each other.

Question 9.
(a) How can personal disposable income be derived from private income?
(b) Explain any three precautions which should be taken while estimating national income by income method.
(c) Calculate national income and operating surplus from the following data:

 (i) Government final consumption expenditure 800 crores (ii) Net factor income earned from abroad -110 crores (iii) Private final consumption expenditure 900 crores (iv) Net domestic capital formation 200 crores (v) Profits 220 crores (vi) Rent 90 crores (vii) Net exports -25 crores (viii) Interest 100 crores (ix) Net indirect taxes 165 crores

(a) Personal disposable income is that part of personal income which is available to the households for disposal as like.
Personal Disposable Income – Personal Tax Payments – Non-tax Payments.

(b)

(i) Only factor incomes which are earned by rendering productive services are included. All types of transfer income are excluded.
(ii) Sale and purchase of secondhand goods are excluded since they are not part of the production of the current year. Likewise, sale proceeds of shares and bonds are not included.
(iii) Imputed rent of owners occupied dwellings and value of production for self-consumption are included but the value of self-consumed services is not included.

(c) Operating surplus = Rent + Interest + Profit = 90 + 100 + 220 = 410
National Income = Government final consumption expenditure + Private final consumption expenditure + Net domestic capital formation + Net exports + Net factor income earned from abroad
National Income = 800 + 900 + 200 + (- 25) + (-110) = 1900+ (-135) = 1765

-: End of ISC Economics 2014 Class-12 Solved Paper :-

Thanks