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S.Y.J.CSYJC (XII) - ECONOMICSPRELIMINARY TEST PAPER - 2

Q.1 (A) Fill in the blanks using proper alternatives given in the brackets :[5]

1. The demand for car and petrol is an example of _____ demand. (joint / composite / competitive / indirect)

2. The objective of a seller in monopoly market is ______ maximisation. (loss / profit / negative profit / zero profit)

3. The demand for salt is ______ (elastic / inelastic / infinite elastic / unitary elastic)

4. Output method is also known as Product method and ________ method. (pricing / supply / inventory / bulk)

5. _____ observed that when the price of inferior goods decreases, the demand for such goods also decreases. (Ragnar Firsch / Adam Smith / Sir Robert Giffen / Dr. Alfred Marshall)

(B) Match the correct pairs : [5]

Group ‘A’ Group ‘B’1. Increase in Supply2. A.P.C3. Factors of production4. Lord Keynes5. Perfect Competition

a. General theory of Employment, Interest and Money

b. Rightward shift in supply curvec. Homogeneous productd. C ÷ Ye. Indirect Demandf. Joint Demand

1-b, 2-d, 3-e, 4-a, 5-c(C) State whether the following statements are true or false : [6]

1. Concept of elasticity of demand is useful for finance minister.True2. Total cost is the total expenditure incurred by a firm.True3. Price discrimination is possible under monopoly.True4. There is no need of advertisement in monopolistic

competition.False5. Better transport facility increases supply at the same time.True6. When two or more commodities can be used alternatively to satisfy

one single want, then such goods are said to be substitutes of to each other.True

Q.2 (A) Define/ Explain the following concepts : (Any three) [6]1. Autonomous consumption

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SOLUTIONSTime : 3 Hrs.

Marks : 80


S.Y.J.Ca. It is the expenditure which has to be incurred in order to

sustain life.b. It is basically the expense incurred for minimum food,

clothing, shelter, expenditure for religious purpose, etc.c. This expenditure has to be incurred irrespective of the

income.d. If a person has no income, he may beg, borrow or steal in

order to collect money to spend for these basic necessities.e. Since, this consumption expenditure is not dependent on

income, it is called autonomous consumptionexpenditure.2. Effective Demand

a. Effective demand is the actual expenditure incurred by all people on all types of goods and services in an economy during a given period of time.

b. Expenditure of a person is income for another.c. Thus, the flow of expenditure determines the flow of income.d. Therefore, Effective Demand = Total Expenditure = Total

Income = Total Output.e. According to Lord Keynes, the effective demand determines

the level of income, output and employment in the country. f. The level of effective demand is determined by the

intersection of Aggregate Demand Function (ADF) and Aggregate Supply Function (ASF).

3. Service utilitya. The want satisfying power of a commodity is called ‘utility.’ b. Service utility is created when any service is provided by any

person to other person or group of people.c. Eg.: (i) Professor taking lectures in a coaching class.

(ii) An advocate giving legal advice to his clients.4. Cash Reserve Ratio

a. Commercial banks have to keep a certain percentage of the total demand and time deposits as cash reserve with the central bank.

b. This percentage is called as cash reserve ratio (CRR).c. CRR has an effect on the volume of credit and interest rates.d. During inflation the central bank increases the CRR and it

decreases the CRR during deflation.5. National Income

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S.Y.J.Ca. National income is defined as the monetary value of all goods

and services produced in a country during a given period of time, generally a year.

b. The computation of national income is important from the point of view of the economy as it is an indicator of the economic health of the nation.

c. It has been defined by Alfred Marshall as follows: “The labour and capital of a country acting on its natural resources produce annually a certain net aggregate of commodities, material and immaterial including services of all kinds. This is the true net income or revenue of the country or national dividend.”

6. Slicing Methoda. Micro Economics is an in-depth study of behaviour of

individual units like suppliers, consumers, firms, household, etc.

b. It slices the aggregate (i.e. total) into small units.c. Thus, it is known to follow slicing method.

(B) Give reasons or explain the following concepts : (Any three) [6]1. Macro economics is different from Micro economics.

a. The term “Macro” is derived from Greek word ‘Makros’ which means large or aggregate (total).

b. Prof. K.E. Boulding defined Macro-Economics as follows: “Macro-Economics deals not with individual quantities as such, but with the aggregates of these quantities, not with the individual incomes but with the national income, not with the individual prices but with the price level, not with individual output but with the national output.”

c. Macro-economics is a study of aggregates covering the entire economy such as total employment, national income, national output, total investment, total savings, total consumption, aggregate supply, aggregate demand, etc.

d. It is aggregative economics. It does not involve study of individual units.

e. Thus Macro-Economics is different from Micro-Economics.2. Agricultural goods are exceptions to the law of supply.

a. When the proportionate change in supply for a commodity is less than a proportionate change in its price, it is called as relatively inelastic supply.

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S.Y.J.Cb. The production of agricultural commodities depends on

natural conditions. c. If the natural conditions are unfavourable, then the supply

cannot be increased even if there is an increase in price.d. On the other hand, certain agricultural commodities are

perishable in nature. So, the supply of such goods cannot be decreased if the price decreases.

e. It can be observed that agricultural commodities have less reaction to a change in price.

f. Therefore, the supply of agricultural commodities is said to be relatively inelastic.

3. Illegal income is not included in National Income.a. National income refers to the monetary value of goods and

services produced in a country, during a given period of time, generally a year.

b. Illegal income refers to income received from illegal activities like kidnapping, extortion, smuggling, gambling, etc.

c. It actually fits in the term “monetary value of services produced in the country during the year.”

d. However, since it is very difficult to determine the illegal income generated in the country during the year.

e. Therefore, illegal income is not included in national income.4. Utility is a subjective concept.

a. “Subjectivity” means changing from one person to another.b. A product may give utility to one person but the same product

may not give as much utility to another.c. Therefore, utility is a subjective concept as the utility of a

commodity differs from person to person on account of differences in tastes, preference, habits, surroundings, age, occupation, etc.

5. Cash Reserve Ratio (CRR) affects the lending capacity of bank.

a. Commercial banks have to keep a certain percentage of the total demand and time deposits as cash reserve with the central bank. This percentage is called as Cash Reserve Ratio (CRR).

b. Only the balance amount is available to the banks for lending activities.

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S.Y.J.Cc. During inflation, the central bank increases the CRR. As a

result, the commercial bank has to keep a higher amount as reserve with central bank and the amount available for lending is reduced.

d. During recession, the central bank decreases the CRR. As a result, the commercial bank has to keep a lesser amount as reserve with central bank and the amount available for lending is increased.

e. Thus, CRR affects the lending capacity of the banks.6. The demand for medicines is inelastic.

a. When there is no change in demand inspite of a change in price, it is called as perfectly inelastic demand.

b. In short, a change in price has no effect on quantity demanded.

c. Medicines are required to save life of a person. A person cannot postpone or reduce his consumption because he will not be able to survive if he does that.

d. A change in price generally does not have any effect on demand of medicines.

e. Therefore, demand for medicines is inelastic.Q.3 (A) Distinguish between the following : (Any three) [6]

1. Commercial bank and Central bank

Commercial Bank Central Bank1. The commercial bank is a

bank which conducts the business of banking with an intention to earn profit.

1. The central bank is an apex monetary & banking authority and occupies a pivotal position in the banking structure of the country.

2. The main motive of the commercial bank is to earn profit from the business of banking.

2. The main motive of central bank is to safeguard the financial and economic stability of the country.

3. Commercial banks create credit in the economy.

3. Central bank controls credit in the economy.

4. It is a banker to general public.

4. It is banker to the government and banker’s bank.

5. There are several commercial banks in the country.

5. There is only one central bank in the country.

2. Slicing method and Lumping method5


S.Y.J.CSlicing Method Lumping Method

1. When the aggregate is sliced into small units for the purpose of study of behaviour of each unit in depth, it is called as slicing method.

1. When the lumping method is used, the economy is not split up into small slices but it is studied in big lumps as it is.

2. Micro-Economics uses Slicing method.

2. Macro-Economics uses Lumping method.

3. It gives a worm’s eye view of the economy.

3. It gives a bird’s eye view of the economy.

4. It studies in-depth individual units like households, firm, consumer, individual wages, prices, incomes, particular commodities, etc.

4. It is used to study large aggregates covering the entire economy such as total employment, national income, national output, total investment, total savings, total consumption, aggregate supply, aggregate demand.

3. Standard coins and Token coins

Standard Coins (Full-bodied Coins)

Token Coins

1. Standard coins are those coins where the face value and intrinsic value is the same.

1. Token coins are those coins where the face value is higher than intrinsic value.

2. The coins which were made of gold and silver were standard or full-bodied coins.

2. The coins which are made of cheap metals like copper, nickel, etc. are token coins.

3. These coins are rarely used. 3. All money coins in circulation today are token coins.

4. They are minted for higher denomination.

4. They are minted for small denomination.

4. Revenue budget and Capital budget

Revenue Budget Capital Budget1. It consists of the revenue

receipts of the government and the allocation of the same towards various revenue expenditures.

1. It consists of the capital aspect of government budget.

2. The following are two parts of 2. The following are the two parts

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S.Y.J.Crevenue budget:

i. Revenue receiptsii. Revenue expenditure

of capital budget:i. Capital receiptsii. Capital expenditure

3. Revenue receipts and revenue expenditure are recurring in nature.

3. Capital receipts and capital expenditure are non-recurring in nature.

5. Output method & Income method of measuring national income

Output Method Income Method1. Under this method, national

income is obtained by adding the value of goods and services produced in an economy during the year.

1. Under this method, national income is obtained by adding the income received by and accrued to all persons & enterprises in the country during a year.

2. This method is also known as product method or inventory method.

2. This method is also known as factor cost method.

3. NI = GDP (MP) + (X-M) +(R-P) – Depreciation – Indirect Taxes + Subsidies.

3. NI + Rent + Wages + Interest + Profit + Mixed Income + (X-M) + (R-P).

4. This method is widely used in underdeveloped countries.

4. This method is more popular in advanced developed countries.

5. In India, this method is used for agriculture, mining and manufacturing sectors.

5. In India, this method is used for the service sector.

6. Utility and Satisfaction

Utility Satisfaction1. Utility refers to the want

satisfying power of a commodity.

1. Satisfaction is the happiness derived by the consumer after consuming a commodity.

2. Utility is pre-consumption. 2. Satisfaction is post-consumption.3. Utility is assumed satisfaction. 3. Satisfaction is actually realized.4. All commodities have utility. 4. Commodities like medicines,

textbooks, karela (vegetable) etc. have utility but the users may not derive any satisfaction on using it.

(B) Write short notes on : (Any two) [6]

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S.Y.J.C1. Features of Perfect Competition

A. Large number of sellers: There are many potential sellers in a perfectly competitive market. The number of sellers is so large that a single seller is not in a position to influence the price of a commodity. The sellers accept the price which is determined on the basis of market forces of supply and demand. Hence, in perfect competition, sellers are said to be ‘price takers.’

B. Large number of Buyers: There are also a large number of buyers. Just like the seller, even a single buyer is not in a position to influence the price because individual demand is a small fraction of market demand. The buyer is also a ‘price taker’ in a perfectly competitive market.

C. Free entry and exit: In perfect competition, there are no entry barriers in the market. Thus, a new firm can freely enter the market and conduct their business. Similarly, any firm can quit the market at their will.E.g.: If Mr. Arun wants to start his own coaching class, he can do so without any permission or license or approval from any association or person. Thus, we can say that there are no barriers to entry.

D. Free from government intervention: A perfectly competitive market is free from government intervention i.e. there is no tax, no control mechanism or any other interference with respect to production, distribution from the government.

E. Perfect knowledge of market conditions: In perfect competition, the buyers and sellers are completely aware of the price of the commodity and other market conditions. Thus, no seller can change a higher price from the consumer or suffer a loss himself by selling at a lower price.

F. Perfect mobility of factors of production: In perfect competition, the factors of production i.e. capital, land, labour have perfect mobility i.e. occupational or geographic. As a result, each factor is optimally utilized and also producer does not face any problem in production. Supply of products is not affected.

G. Homogeneous product: All the firms in the perfectly competitive market sell the same product. Same means exactly identical in terms of size, shape, taste, colour, weight, etc. Thus, commodities have perfect substitute for each other.

H. Single price: The buyers and sellers are price takers in a perfectly competitive market. There is only one single price

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S.Y.J.Cprevailing in the market. It is determined by the forces of demand and supply. In perfect competition, industry is price maker and firm is price taker.

I. Transport cost is constant: In perfect competition, it is assumed that all firms are located close to each other and are equidistant from the place of production. Hence, the transport cost is constant for them. Thus, no firm is affected by transport costs and hey can continue to charge a single rate for the commodity.

2. Features of labourA. Labour is inseparable from the body of the labourer:

The labourer and his labour (i.e. his work) cannot be separated. Therefore, the labourer has to be physically present when work is to be performed.

B. Active and human factor of production: Labour is a human and living factor of production. Therefore, it is active. Other factors of production are passive and they become productive only after labour is applied on them.

C. Bargaining power of labour is less: A single labourer has limited bargaining power and hence he may be exploited. Therefore, labourers collectively form labour unions which bargain with the management for better working conditions and higher wages.

D. Restricted mobility: Labour is a human factor of production. The labourer gets emotionally attached to the place he lives in. He has a family and other social attachments in that place. Therefore, a labourer may be hesitant to move to another place. Thus, Labour cannot be said to be a perfectly mobile factor of production.

E. Supply for labour is inelastic: Supply of labour cannot be increased immediately in the short run even if higher price (wage) are paid for the same. Therefore, in the short run, supply of labour is relatively inelastic. However, over a long term period, supply of labour can be increased.E.g.: If Ratan Tata starts the production plant of NANO in Maharashtra, he will not be able to get hundreds of labourers in a short span. His entire labour strength will be built over a period of time.

F. Efficiency of labour: Every worker may have different skill sets, intellect, physical strength, educational background,etc. Therefore, the efficiency of one worker may be different from another. Thus, labour is a heterogeneous factor. Infact, it is so

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S.Y.J.Cheterogeneous that even one labourer who is efficient today may be less efficient tomorrow.

G. Perishable in nature: Labour is perishable in nature. If a labourer is absent for a day then that day’s labour is lost forever. His work cannot be stored and used when the labourer is absent.E.g.: If a professor is not able to conduct a lecture on some day because of a sore throat then those lecture hours lost are lost forever. His lecture will have to be rescheduled for a future date.

H. Labourer sells his labour and not himself: The labourer sells his labour (i.e. work) in return of wages. He does not sell himself. Therefore, the employer has a right only on the labour but not on the labourer.

3. Price determination under perfect competitionPerfect competition can be explained as a market structure where there are a large number ofsellers selling a homogeneous product to a large number of buyers. The number of sellers and buyers is so large that a single buyer or seller is not in a position to influence the price of the product.Under perfect competition, there is a single ruling market price which is called as equilibrium price. This equilibrium price is determined by the free market forces of demand and supply. Equilibrium price is basically the price at which demand and supply is the same.According to Marshall, demand and supply are like two blades of a pair of scissors. Just as cutting of cloth is not possible with the use of one blade, the equilibrium price of a commodity cannot be determined either by the forces of demand or by supply alone. Both determine the price together.The same can be explained with the help of the following schedule:

Price Per Unit(in Rs.)

Quantity demanded

(Units)

Quantity supplied(Units)

54

100200

500400

3 300 30021

400500

200100

As per the above table, when the price of the commodity is Rs. 5, the quantity demanded is 100 units and quantity supplied is 500

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S.Y.J.Cunits. The consumers are demanding less because they feel that the commodity is over-priced whereas the sellers are supplying more as profit is maximum for them at this price level.When the price is Rs.2 per unit, the demand is 400 units because at this price level the consumers find the commodity cheap whereas the seller is supplying only 200 units as they are earning less or no profits at that price level.However, when the price is Rs.3, the demand and supply are equal i.e. 300 units. Thus, Rs.3 shall be the equilibrium price.DIAGRAMMATIC REPRESENTATION

In the above diagram, the Y-axis represents the price whereas the X-axis represents the quantity demanded/supplied. OP is the equilibrium price and OQ is the equilibrium quantity demand and supplied.The demand curve DD is a downward sloping curve indicating inverse relationship between price and demand. The supply curve SS is an upward sloping curve indicating a direct relationship between price and supply. They intersect each other at point E which is the equilibrium point. At this point, the equilibrium price is Rs 3 and the equilibrium quantity demanded and supplied is 300 units.

4. Types of capital.According to Bohm Bawark, an Austrian economist, “Capital is a produced means of production.”Capital can be classified in the following four groups:1) On the basis of Ownership

Private CapitalThe capital owned by individuals or private organisation is called private capital.E.g.: Plant and Machinery of Reliance Industries Ltd. , air conditioners in a coaching class, a laptop owned by a sharebroker.

Public or Social Capital11


S.Y.J.CThe capital owned by government or local bodies is called as public or social capital.E.g.: Aircrafts owned by Air India Ltd. (owned by government) , government schools, railways, etc.

National CapitalThe capital that is owned by the whole nation is called national capital. It is the sum total of private and public capital.

2) On the basis of durability Fixed Capital

Fixed capital refers to that capital which is used again and again in production process for a long period of time. They enjoy longer life and depreciate slowly. They are durable in nature.E.g.: Machinery, Building, Computers, etc.

Circulating / Working / Variable CapitalWorking Capital refers to that capital which is used only once in the production process. It gets completely consumed once it is used.E.g.: Raw materials, fuel, spare parts, etc.

3) On the basis of use Sunk Capital

The capital that can be used for specific or single purpose only is called Sunk Capital. E.g.: Benches in a college, railway lines, printing machines, etc.

Floating CapitalThe capital which can be used for multi purpose is called as Floating Capital.E.g.: Computers, Fuel, Vehicles, etc.

4) On the basis of nature Real Capital

All physical goods used in production of goods and services directly are called Real CapitalE.g.: Machine, Building, Raw materials, etc.

Money CapitalIn simple terms, cash invested or re-invested in business is called money capital. Money capital does not contribute in production directly but it can be used to acquire real capital.

Q.4 Write short answers for the following questions : (Any three) [12]1. What are the features of ‘macro-economics’?

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S.Y.J.CAccording to Prof. K.E.Boulding, “Macro Economics deals not with the individual quantities as such, but with the aggregates of these quantities, not with the individual incomes but with national income, not with the individual prices but with the price level, not with individual output but with the national output.”The following are the features of macro-economics:(BILL GATES)i. Bird’s eye-view of the economy: Macro Economics does not

study the various parts of the economy individually but it studies the economy as a whole. It gives a bird’s eye view of the economy.

ii. It is a dynamic science: Macro Economics studies the changes in the aggregate economic variables and analyses dynamic nature of the economy. It also helps to study the progress of the economy over a period of time.

iii. Lumping method: Macro Economics deals with macro variables and macro quantities like aggregate demand, aggregate supply, national output, etc. Unlike Micro Economics, it does not split up the economy into small slices but studies in big lumps. Thus, it uses lumping method.

iv. Lays focus on Macro-Economic problems: Macro Economics theory deals with the problems of the whole economy such as:a. Are all the resources being utilized properly?b. Is the productive capacity increasing (i.e. growth)?c. Is the balance of payment in the country favourable?d. Is there stability in prices of commodities?

v. General equilibrium analysis: Macro Economics analysis is based on “General Equilibrium analysis”. It studies a number of economic variables at a time. It does not ignore the inter-dependence between variables like Micro Economics. It studies the functional relationship and interdependence between the economic variables.E.g.: Macro Economics explains how equilibrium is achieved between aggregate demand and aggregate supply and how it determines price level, income and employment in the economy.

The Macro Economic approach assumes “everything depends on everything else.” i. Analyzes and formulates government policies (Policy

oriented): Macro Economics is a policy-oriented science. It studies the economy as a whole. Therefore, it is useful for the formulation and implementation of various monetary and fiscal policies of the government to promote economic growth and maximize public welfare.

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S.Y.J.Cii. Theory of income and employment: Macro Economics is also

known as theory of income and employment or simply as income analysis. It basically explains what determines level of national income and employment in the country and what causes fluctuation in them.

iii. Explains interdependence of variables: Macro Economics studies the functional relationship nd interdependence between economic variables. It explains the impact that the change in one variable will have on the other variables.E.g.: It explains how change in level of investment in the economy will change the level of output, employment, income and will finally lead to economic growth.

iv. Study of aggregates: Macro Economics deals with the study of the economy as a whole. It is a study of aggregates covering the entire economy such as total employment, national income, national output, total investment, total savings, total consumption, aggregate supply, aggregate demand, etc.

2. Explain the types of investment expenditure?Investment Expenditure refers to the use of savings for the purpose of capital formation. Capital formation refers to an addition to the country’s physical stock i.e. new factory, machinery, raw materials, finished goods, work-in-progress (i.e. semi finished goods) etc. This is over and above the replacements that are made to the existing capital goods due to their wear to tear.The following are the types of investment expenditure:i. Gross Investment: It refers to the entire expenditure incurred on

acquiring a new capital asset like building, plant, machinery, etc. without deducting depreciation on existing capital.

ii. Net Investment: It refers to entire expenditure incurred on acquiring a new capital asset like building, plant, machinery, etc. after deducting depreciation on existing capital assets. .Net Investment = Gross Investment – Depreciation؞

iii. Autonomous Investment: This investment is not dependent on income, profit and rate of interest. This investment is not made with profit motive. It is influenced by government’s fiscal & monetary policies, size of population, change in the level of income, technological changes, etc. Autonomous Investment is generally made by the government with a view to maximize public welfare. Investment by the government for infrastructure, communication, irrigation projects, railways etc. can be called as autonomous investment.

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S.Y.J.Civ. Induced Investment: This investment is completely dependent on

income, profit and rate of interest. This investment is made with profit motive. It is influenced by change in price level, change in income level, interest rate, consumption pattern, savings, supply of money, availability of credit, etc.Induced Investment is generally made by business firms, entrepreneurs, industrialists, etc.

v. Financial Investment: It refers to investment in financial asses like shares, bods, securities, debentures, etc. It does not directly help in production of goods and services. However, the business firm which issue such shares and debentures, collects the money and invests it in capital assets to increase production.

vi. Real Investment: It refers to the investments done for the purchase of capital goods like building, machinery, raw materials, etc. It directly helps in production of goods and services.

3. Explain the features of monopoly?Monopoly refers to the form of a market where the supply of the commodity is under the control of single seller or producer. Monopoly is derived from a Greek word “monopolus”Mono = singlePoly = sellerAccording to Chamberlin, “A monopoly refers to a single firm, which has control over the supply of a product, which has no close substitute.”Basically, monopoly gets created due to absence of competition. No other producer/seller produces or sells a product which is a close substitute to the commodity. Therefore, the seller is a price maker and not a price taker. E.g.: Indian Railways.The following are the features of Monopoly:i. Price Maker: In monopoly, the seller himself fixes the price. He has

complete control over the supply and there is also no close substitute to the product. Hence, he can charge any price for the product. Therefore, in a monopoly, the seller is the price maker.

ii. Entry Barriers: In a monopoly, the seller has complete control over the market. He does not allow any other firm selling the same or a substitute product in the market. For this purpose, he sets various economical, technological and legal barriers to entry.

iii. No Close Substitute: The product that is sold by the seller in a monopoly is unique to him. There is no close substitute available for that product in the market.

iv. Price Discrimination Among Buyers: The monopolist charge different prices to different buyers for the same product. He may

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S.Y.J.Ccharge very high price to the rich and charge normal prices to others. Thus, he increases his profits.

v. No Distinction Between Industry and Firm: In a monopoly, there is no distinction between a firm and industry because there is only one firm producing and selling the product. Therefore, that monopolist firm itself is the industry. E.g.: Idea, Airtel, Vodafone, Aircel, etc. from the telecom industry or we can say that these are the firms in the telecom industry. If Airtel was the only firm providing telecom service, then Airtel itself would be the telecom industry.

vi. Profit Maximization: The monopolist is a price maker and he sets the price with the motive of maximizing his profit. He may control the supply at times o that he can create shortage and increase the prices. Thus, he continues to earn super normal profits.

vii. Control Over Market Supply: The monopolist has a complete control over the supply of the commodity. He is the sole producer or seller of the commodity. There is no other seller selling the same commodity or even a close substitute. He does not allow any other producer or seller to enter the market.

viii. Single Seller: In a monopoly, there is a single producer or seller in the market. The monopolist faces no competition from any other producer or seller.

4. What are the primary functions of commercial bank?The two important primary functions of commercial bank are as follows:1) Accepting Deposits : Accepting deposits is the basic and most

important function of the bank. The banking business originated on the basis of this function. Bank accept money deposits from its account holders and pay interest on this amount. Commercial banks accept the following types of deposits:a. Demand Deposits: As the name suggests, demand deposits

are deposits made by the customer in the bank which can be withdrawn on demand. The customers need not wait for any specific time period. Demand deposits are of two types:i. Current Account:

Meaning: A current account is usually operated by the business community as it allows them to carry out frequent transactions involving huge amount.

Operated by: It is generally operated by businessman, companies, public bodies, corporations, trusts or any other business organisation.

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S.Y.J.C Restriction on deposit/ withdrawal: In a current

account there is no restriction on number of deposits or number of withdrawals. A current account holder can deposit and withdraw money as many number of times as required.

Interest: Generally, no interest is paid on the balance in the current account.

Other services: Overdraft facilities and agency services are provided by the bank to current account holders.

ii. Savings Account Deposit: Meaning: A savings account is an account where

people deposit their personal savings. Savings accounts have encouraged the habit of saving among people in the country.

Operated by: It is generally operated by salaried people or daily wage earners or self-employed people who wish to save a portion of their income.

Restriction on deposit/ withdrawal: threre are certain restrictions on the number of times money can be withdrawn from the account.

Interest: Generally, banks pay a small rate of interest on the balance outstanding in the savings account.

Other services: Many agency and general services are provided by the ban to savings account holders.

b. Time Deposits: As the name suggests, these deposits are made b the customers in bank for a certain period of time during which the money cannot be withdrawn. Since the money is deposited for a fixed period the bank invests the money or gives it as a loan to another customer on which the banks earn interest. As a result, the bank can pay higher interest to the deposit holder on the outstanding amount. Time deposits are of 2 types:i. Fixed Deposit:

Meaning: A fixed deposit is a type of account in which money is deposited for a fixed or specified period of time (say, varying from 10 days to 10 years). It is a time bound deposit.

Interest: the rate of interest on fixed deposit is relatively higher as compared to any other deposit in the bank. The rate of interest depends on the duration for which money is deposited. Higher the duration, higher is the interest rate.

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S.Y.J.C Withdrawal: Money can be withdrawn only at the end

of the stipulated period. If the amount is withdrawn before the date of maturity of the deposit, the bank pays a lower rate of interest or it may charge penalty.

ii. Recurring Deposit: Meaning: A recurring deposit is a type of account in

which a fixed amount is deposited in the bank at regular intervals for a fixed period of time.E.g.: Mr. Aditya may deposit Rs. 5000 p.m. in recurring deposit account every month for a period of two years. At the end of two years, he will get Rs. 1,20,000 (24 ˣ 5000) plus accrued interest on this amount over the last 24 months.

Interest: The rate of interest on such deposits is higher then savings account but it is less than fixed deposit.

Withdrawal: Money can be withdrawn only at the end of the stipulated period. If the amount is withdrawn before the date of maturity of the deposit, the bank pays a lower rate of interest or it may charge a penalty.

2) Loans and Advances: The deposits collected by the banks from its customers are given as loans to customers who are in need of funds. The bank charges them a rate of interest which is, generally, higher than the rate of interest paid by the banks on deposits.The loans and advances of the banks are in the following forms: (COLD)a. Cash Credit:

Meaning: Under this facility, a separate cash credit account is opened and the customer can borrow funds from this account upto a certain limit.

Limit: The limit is decided depending on the collateral security that the customer offers to the bank for providing this facility. Collateral security is any asset that the customer mortgages with the bank.

Customer: The facility of cash credit is provided by the bank to any customer.

Interest: The bank charges interest on the amount withdrawn.

b. Overdraft:

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S.Y.J.C Meaning: Under this facility, the customer is allowed to

withdraw more than what is currently outstanding in the account (i.e. account balance) upto an agreed limit.

Limit: The limit is decided depending on the collateral security that the customer offers to the bank for providing this facility.

Customer: This facility is provided only to current account holders.

Interest: The bank charges interest on the amount overdrawn.

c. Loans: Loans are further classified as follows:i. Call Loans/ Money at call notice:

Meaning: Loans are provided by commercial banks for period of upto 7 to 15 days are known as call loans. The bank has the right to call back the loan at any time from the borrower.

Interest: The rate of interest charged is the lowest. Taken by: Generally, stock brokers and traders may

opt for this type of loan. ii. Short Term Loan:

Meaning: When the loan provided by the bank is for a period not exceeding 2 years, it is called as short term loan.

Interest: the rate of interest charged is more than call loan but less than medium and long term loans.

Taken by: Such type of loan is generally taken by business community for working capital requirement.

iii. Medium Term Loan: Meaning: When the loan provided by the bank is for a

period of 2 years to 5 years, it is called as a Medium Term Loan.

Interest: The rate of interest charged is higher than short term loan but lower than long term loan.

Taken by: It is generally taken by manufacturers for purchase of equipment or for making charges in production method or for small machinery, etc.

iv. Long Term Loan: Meaning: When the loan provided by the bank is for a

period exceeding 5 years, it is called as a Long Term Loan.

Interest: The rate of interest charged is the highest on this type of loan.

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S.Y.J.C Taken by: These loans are generally taken by big

companies/ corporations for major technology upgradation or for purchase of land or big machinery.

d. Discounting of Bills: Banks grant loan by discounting bill of exchange or other approved financial instrument. For providing this service, it charges nominal fees in the form of discounting charges or commission. At the time of maturity, the ban collects the amount from the bank of debtor who had originally accepted the bill.

5. Explain the development and non-development expenditures of government.Explain the development and non-development expenditure of governmentA. Development Expenditure: All expenditures that promote

economic growth and social development are termed as development expenditure. Expenditure on development of infrastructure, agriculture, rural areas, education, health, scientific research, etc. increase productive capacity in the economy and hence can be termed as development expenditure.

B. Non-Development Expenditure: Expenditures in the nature of consumption and which are incurred on essential services such as defence, interest payments, expenditure on law and order, public administration are called as non-development expenditure.

This expenditure does not create any productive asset which can bring income or returns to the government.

6. Explain the backward sloping of labour supply curve.A labourer maybe willing to work overtime if he is earning higher amount of wages per hour.A wage rate keeps increasing, the number of hours of work of the labourers also increase (higher the price, higher the supply).Thus, the supply curve of labour slopes upwards.However, as the wage rate further rises, the supply of labour will decrease because the labourer would prefer leisure to work.He will still be earning the same amount even by putting in lesser number of hours.Thus, hereafter, the supply curve of labour slopes backward.It can be explained with the help of the backward bending labour supply curve:

20


S.Y.J.C

In the above diagram, the X-axis represents the supply of labour and the Y-axis represents the wage rate. The curve SS1 is the backward bending labour supply. When the wage rate increases from O to P and from P to P1

the supply of labour increases from L to L1 and L1 to L2 respectively. Therefore, the supply curve slopes upward from S to A. Now, when the wage rate further increases from P1 to P2 , the supply of labour decreases from L2to L1. Therefore, the supply curve slopes backwards from A to S

Q.5 Explain with reasons whether you ‘Agree’ or ‘Disagree’ with the following statements: (Any three) [12]1. Law of Diminishing Marginal Utility is more important in practice.

Yes, I agree to the above statement.i. Law of DMU is not applicable to indivisible goods: Marginal

Utility can be calculated only when two or more units of a commodity are consumed successively at a time. Generally, a consumer will buy only one laptop or TV or house or mobile at a time. There will not be recurring purchase of such items and therefore it will not be possible to calculate the marginal utility on such goods.

ii. Impractical or unrealistic assumption: The law of DMU is based on various assumptions like homogeneity, rationality, constancy, successive consumption, etc. These assumptions are impractical and unrealistic.

iii. Measurement of utility is not possible cardinally: Utility is psychological concept and hence it cannot be measured cardinally. However, the law assumes that utility can be measured cardinally i.e. in numeric terms. This assumption of the law is not practically possible. Utility can only be measured in relative terms.

iv. Its assumption of ‘Single want’ not practical: The law assumes that one commodity is used to satisfy only a single want. However, in reality, a person may use one commodity to satisfy many wants at a time.E.g.: Water may be used for cooking, cleaning, bathing, drinking, etc.

21


S.Y.J.Cv. The marginal utility of money does not remain constant: The

law assumes that the marginal utility of each unit of money remains constant. However, the MU of money changes.a) From one person to another.b) For the same person from time to time.E.g.: The MU of money for a beggar will be more as compared to a wealthy person.

2. There are no exceptions to the Law of Demand.No, I do not agree with the above statement.i. Giffen goods: Giffen goods are inferior goods like jowar, vanaspati

ghee (Dalda), low quality rice, etc.In case of such goods, when the price falls, less quantity is demanded than before. This happens because every person wants to constantly increase his standard of living.

ii. Habitual goods: If a person is habituated or addicted to certain goods, his demand for the goods may not change with a change in price.E.g.: People who are addicted to social media websites like facebook and twitter will not reduce their usage even if the rates of internet usage are increased.

iii. Ignorance: Sometimes, people may not be aware of the change in price of goods in the market. If the price of a product falls and the consumers are not aware (ignorant) about the same, then their demand for the product will not increase.

iv. Demonstration Effect: People tend to copy other people who they look up to or who they are jealous of. In their quest to copy them, the demand for certain products will increase even if the price of such product increases.The tendency of the low income group to imitate the consumption pattern of high income groups is known as demonstration effect. E.g.: The T-shirts of “Being Human” worn by Salman Khan have a very high demand even though the prices of those T-shirts are very high.

v. Demand for prestige goods: The prestige goods are regarded as a status symbol in the society. They have a “snob appeal.” Rich people may have demand more of these goods when their prices rise so that they show-off.E.g.: Diamonds, luxury sports car, high end watches, limited edition dress, etc.

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S.Y.J.Cvi. Expectation regarding future prices: If people expect the price

of a commodity to increase in the future, they will demand more now (i.e. at present) even if the price is high.E.g.: Many hotel owners purchased more onions in huge quantities at high prices since they expected the prices to further increase in the future.

vii. Necessities: The demand for certain necessities like basic foodstuffs (wheat, salt, dal, etc.) are basic clothing (one pair of clothes) will not change due to a change in price.

viii. Price illusions or consumer’s psychological bias: Consumers may believe that high price goods are of a better quality and therefore, demand for such goods tends to increase with increase in their price.E.g.: Students and parents believe that a coaching institute charging high fees provides good quality education. In such case, even if the fees are increased the demand will not fall.

ix. Fashion: A product which is out of fashion (for e.g.Nokia 3310) will have a less demand even if the price falls. A product which is in fashion (for e.g.: Android smart phones) will have high demand even if the price rises. Thus, it is an exception to law.

2. Barter system did not have any difficulties.No, I do not agree with the above statement.i. Lack of double co-incidence of wants: Double co-incidence of

wants refers to need of each other’s goods and the willingness to accept it. The double co-incidence of wants is a pre-requisite or basic requirement in a barter system.E.g.: Mr. Ali has earthen pots and wants a can of oil in exchange. Now, there has to be somebody who has a can of oil and wants earthen pots in exchange. This double co-incidence of wants was not always possible and was one of the major difficulties in the barter system.

ii. Lack of Common measure of value: In the barter system, there was no measure of value or unit of account. Therefore, it was difficult to calculate the value of goods and services.E.g.: it was very difficult to find the value of 5 kgs of garlic or one litre of milk. Therefore, whether 5 kgs of garlic was equal to one litre of milk or two litres could not be determined. This was a hindrance in barter system.

iii. Difficulty in storage of goods: In the barter system, goods were exchanged for goods. These goods, therefore, had to be stored so that they could be used at a later date or be exchanged for some

23


S.Y.J.Cother goods. Storage was a problem for bulky goods and mainly for perishable goods like meat, vegetables, milk, bread, etc.

iv. Problem of indivisibility: The barter system posed a problem when bulky or indivisible goods were to be exchanged. E.g.: Suppose a person wanted 20 bags of rice for his buffalo. In this case, he could not give half a buffalo to one person for 10 bags and half a buffalo to another to another 10 bags.

v. Problem of making deferred payments: Under the barter system, there was problem in making deferred payments i.e. making payment at a later date.E.g.: Suppose Mr. A wants to exchange his goat for 5 steel vessels, he has to exchange it when he receives the 5 steel vessels. He cannot postpone the exchange because the physical condition of the goat will change as time passes. Similarly, lending and borrowing was difficult in barter system.

3. Commercial banks can create credit on basis of primary deposits.Yes, I agree with the above statement.1. In simple words, a bank is an organisation where people deposit

their idle savings, and borrow funds when required.2. The Banking Companies Act, 1949, defined banking as “ accepting

for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdrawable by cheque, draft or otherwise.

3. Credit creation is one of the most important functions of a commercial bank.

4. Banks create credit as the perform their basic function of accepting deposits and lending money.

5. The banking system as a whole can create credit which is several times more than the original deposits of a bank.

6. This is called as Multiple Credit Creation of Bank.7. The process of Credit creation is explained as follows :-

a. The process of credit creation starts when the customers deposit their cash in the bank. Such deposits are called as Primary Deposits or Cash Deposits.

b. The banks lend money(i.e. provide loans) out of the deposits received by them.

c. The customers can withdraw these deposits at any point of time.

d. Therefore the banks have to keep a part of the deposits received to meet the demand for cash by the depositor. This is

24


S.Y.J.Ccalled as Minimum Cash Reserve. Further the banks also have to maintain a cash reserve as per RBI guidelines.

e. The balance amount left after keeping aside the minimum cash reserves is used for providing loans and it is known as Derivative Deposits or Secondary Deposits.

f. When the bank provides a loans to the customer, the bank opens a deposit account in the name of the borrower. The loan amount is deposit is credited to this deposit account.

g. The borrower may withdraw amount from this account by means of a cheque and thereby make payments to his creditors.

h. The person (the creditor of the borrower) who receives the amount deposits it with his bank. This deposit becomes a primary deposit for the bank.

i. This bank also sets aside a portion for reserves and balance amount is used to provide loan to another customer ie, derivative deposit.

j. Therefore every loan given by a bank creates a deposit and every deposit creates a loan.

k. This process goes on till a stage where the subsequent banks receive too small an amount as deposit to advance any loan from it.

Eg., As per the guidelines every bank has to maintain 20% as cash reserve ratio. Mr. A deposits Rs. 1,00,000 in HDFC BANK. HDFC BANK keeps 20 % as a reserves and lends Rs.80,000 to Mr.B. Mr B. repays 80,000 to his creditor Mr. C who deposits in his account in ICICI Bank. ICICI maintains 20 % as reserve and loans 64000 to MR. D who repays his loan to Mr. E. Mr. E will deposit this amount in his account in Axis bank which will use it to create further loans. This process will continue till the amount to be given as loan turns near 0 or small enough to be given as further loan.The above example can be tabulated as follows

BANK Primary Deposit Reserves Secondary Deposit LoansHDFC Bank 1,00,000 20,000 80,000 80,00

0ICICI Bank 80,000 16,000 64,000 64,00

0Axis Bank 64,000 12,800 51,200 51,20

0Other Bank 51,200 10,240 40,960 40,96

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S.Y.J.C0

4. There is no difference between stock and supply.No. I do not agree with the above statement.Stock and Supply are different.The reason for this is as follows :- 1. Stock is total quantity of goods that are available for sale at a

particular period of time. It is the outcome of production.2. Stock includes the current output and also the balance of the

previous output (ie unsold goods)3. Supply refers to the quantity of goods that a person is willing and

able to offer for sale at a particular price during a certain period of time.

4. Supply is derived out of stock. An ability of a seller to supply depends on the availability of stock

Thus, supply and stock are different.5. When MU is zero, TU is maximum.

Yes, I agree with the above statement.i. Total Utility is the sum total of utilities derived by a consumer by

consuming or acquiring all possible units of a commodity at a point of time. In simple words, it is the sum of marginal utilities derived from successive consumption of units.

ii. Marginal utility is the additional utility derived by the consumer on consumption of an additional unit of the commodity. In short, it is additional utility derived from the last unit consumed.

iii. The relationship between total utility and marginal utility can be explained with the help of schedule.Schedule:

No. of chocolates TU MU1st

2nd

3rd

4th

5th

6th

101822242422

108 (18-10)4 (22-18)2 (24-22)0 (24-24)-2 (22-24)

iv. From the above schedule, it can be observed that:a. As the consumer consumes more chocolates, the TU goes on

increasing while the MU goes on decreasing. TU increases at a diminishing rate.

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S.Y.J.Cb. After consumption of the 5th chocolate, the consumer does not

derive any marginal utility and the total utility is also the same as the previous unit. This is the point of maximum satisfaction or the point of satiety.

c. At this point, MU is zero and TU is maximum.Q.6 Write explanatory answers: (Any two) [16]

1. Explain the law of demand and its assumptions. The law of Demand explains the consumer behaviour with reference to change in price. It explains the inverse relationship between price and demand. It was propounded by Dr. Alfred Marshall in his book, "Principles of Economics". The law of demand is also known as "First Law of Purchase"Statement of the law - Dr. Alfred Marshall has explained the law of demand as follows, "Other things being constant, higher the price of the commodity, smaller is the quantity demanded and lower the price of the commodity, larger is the quantity demanded"

PRICE DEMAND↑ ↓↓ ↑

The law of demand explains change in the behaviour of the consumer's demand due to various changes in price. It describes the functional relation between demand and price.

The relation between demand and price can be expressed as D = f(p) i.e. demand is a function of price

There is an inverse relationship between demand and price because Higher the price, lower the demand and lower the price, Higher the demand.

DEMAND SCHEDULE: The law of demand can be explained with the help of the following schedule:

PRICE OF MANGOES (Rs per dozen)

DEMAND PER WEEK (Quantity in dozen)

350 1300 2250 3200 4150 5

From the above schedule, it can be observed that when the price of mangoes is Rs 350 per dozen, the demand is 1 dozen

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S.Y.J.C When the price falls to 300 per dozen, the demand rises to 2 dozens.

Similarly, when price falls to Rs 250 per dozen, the demand further rises to 3 dozens and so on.

As the price of mangoes falls to Rs 250 per dozen, the demand further rises to 3 dozens and so on.

As the price of mangoes falls, the demand rised. On the other hand, as the price of mangoes rises, the demand falls.

This shows that there is an inverse relation between price and demand.DEMAND CURVE - The law can be further explained with the help of the following diagram:In the above diagram, downward sloping curve DD is the demand curve. The Y-axis represents price and the x-axis represents corresponding quantity demanded (market demand). The demand curve DD is downward sloping from left to right which represents inverse relation between price and demand.ASSUMPTIONSMarshall begins the law of demand with the words 'other things being equal'. These 'other things' refer to the various factors other than price which affect demand. The law of demand only establishes the relationship between price and demand. If there is a change in other factors, the demand will change even without a change in price. In such cases, the law of demand will not hold good. Hence, Marshall assumes that other factors are equal or they do not change.The following are the assumptions on which the law of demand is based:(SMART CODE: No change in "PRICE FACTOR DIE)(1) NO CHANGE IN PRICE OF RELATED GOODS - The law of demand

assumes that there is no change in price of related goods like complementary goods and substitute goods.If the price of a substitute increases, the demand for the substitute will fall and the demand for the said commodity will rise without a change in price of that commosdity.Eg: If price of "Mazaa" (substitute of slice) increases, the demand for "Mazaa" will fall but the demand for "Slice" will rise. Similarly, in case of complementary goods, of the price of one of the two commodities increases, the demand for the other commodity will fall even when price of such commodity has not increased.Eg. The demand for cars will fall if the price of petrol increases.

(2) NO CHANGE IN FASHION, TASTES AND HABITS - The law of demand assumes that fashion in the market and tastes and habits of consumers will not change. Any change in fashion, tastes and habits can cause a change in demand without any change in price.

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S.Y.J.C(3) NO CHANGE IN AGE STRUCTURE AND SEX RATIO - The age

structure and sex ratio in a country determines the kind of goods that are demanded in the country. Any change in the age structure or sex ratio can lead to a change in demand for the goods without a change in price. Thus, the law assumes that age structure and sex ratio remains constant.

(4) NO CHANGE IN CLIMATE - If there is a change in climate, then goods specific to that climate will be demanded more even when there is no fall in price of such goods. Thus, the law of demand assumes that the climate and whether conditions remains the same.

(5) NO CHANGE IN TAXATION POLICY - It is assumed that the taxation policy of government remains constant. If the government levies Higher tax, then the disposable income available with the consumer will fall. As a result, his demand will also fall even though there is no increase in the price of the commodity.

(6) NO CHANGE IN OVERALL POPULATION SIZE -An increase or decrease in size of population will lead to an increase or decrease in demand respectively. Hence, it is assumed that there is no change in population size.

(7) NO CHANGE IN REGULAR ADVERTISEMENTS - An aggressive promotion campaign for a certain product may lead to a surge (increase) in its demand irrespective of the change in price. Similarly, of the advertisements are reduced, the demand for that product may fall to a certain extent. As a result, the law of demand assumes that there is no change in regular advertisements.

(8) NO CHANGE IN DISTRIBUTION OF INCOME - Any change in distribution of income in the economy can lead to a change in general demand in the economy. Thus, the law assumes that there is no change in the distribution of income.

(9) NO CHANGE IN INCOME - When the income of a person rises or falls, his demand for goods a d services rises or falls respectively without a change in price for such goods and services. Therefore, the law of demand assumes that there is no change in income of the consumer.

(10) NO CHANGE IN EXPECTATION REGARDING FUTURE PRICES - If people expect that prices in future will fall, they will demand less at present and demand more in the future. In short, the present demand, will fall even when prices have not increased at present. Thus, it is assumed that there is no change in expectation regarding future prices.

CONCLUSION: The law of demand establishes that demand and price have an inverse relation. However, it neglects, other things or it assumes that other things remains constant which is not practical.

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S.Y.J.C2. Explain the theoretical difficulties in measurement of national

income.THEORETICAL DIFFICULTIES - The following are the theoretical difficulties associated with measurement of national income:(1) FOREIGN INCOME - The income of foreign companies is to be

included in the country's national income only if it has undertaken any kind of production work in the country. However, the profit of the company is to be included in the national income of the country to which it belongs.FINAL TREATMENT - Income of foreign company is included.

(2) INCOME FROM ILLEGAL ACTIVITIES - Illegal income like income from kidnapping, murder, gambling, smuggling, etc is difficult to determine. However, it does fit into the term "monetary value of goals and services produced" in the country.FINAL TREATMENT: Due to it's difficulty in determination, it is not included in national income.

(3) GOVERNMENT SERVICES: The market value of various public services provided by the government like public administration, defence, law and order, etc is difficult to measure since the real value of such services is not known.FINAL TREATMENT: Such services are treated as final consumption and hence it is included in national income.

(4) UNPAID SERVICES : National income is the 'monetary' value of goods and services produced in a country during the year. However, there are various goods and services produced in the economy whose monetary value is difficult to determine.Eg.Service of a housewife or househusband, a person teaching his friend, temporary help of a son in his father's business, etc.FINAL TREATMENT: The services which are provided out of love, affection, mercy sympathy and charity are not paid for (i.e they involve no monetary transaction). Further, they are difficult to estimate. Therefore, it is not included.

(5) REQUIRED TO ADJUST CHANGE IN PRICE LEVEL: The change in price level has an impact on the national income estimates of a country. If the price level in the country rises (inflation), the national income also increases even though the total production of goods and services has fallen. Similarly, if the price level in the country falls (deflation), the national income also decrease even though the total production of goods and services has increased.Eg. If the price of certain goods is Rs 10 in year1 and due to inflation it increases to Rs. 15 in year 2. In this case, even if the production of

30


S.Y.J.Csuch goods falls, the national income will increase in year 2 as compared to year 1. It is difficult to factor the change in price level while measuring national income.TREATMENT: The effect of change in price level has to be considered in the national income. In short, inflation or deflation has to be adjusted.

(6) ESTIMATION OF PRODUCTION FOR SELF-CONSUMPTION : The goods and services produced or retained for self-consumption are different to determine. However, if they were made available in the market, the producer would have earned the market value of such goods and services.FINAL TREATMENT: The production retained for self-consumption is estimated and included in the national income at their market place.

(7) TRANSFER PAYMENTS - Transfer payments refer to gifts, unemployment allowance, pension, charity, etc. Transfer payments are income for one person and expense for another. Whether to include transfer payments in the calculation of national income is a problemFINAL TREATMENT: Transfer Payments do not represent production of goods and services or any factor income and hence they are not included in national income.

3. Explain the functions of Central Bank.(1) The central bank is the bank of the government. It performs the

following functions for the government:(a) MAINTAINS CASH BALANCE - The government is the custodian

of all government funds it maintains the cash balance of the government however it does not pay any interest on such funds

(b) MAKES PAYMENTS - It makes all payments on behalf of the government towards salaries to the government staff interest on public debt, pension to the retired government staff, etc

(c) ALSO MANAGES FOREIGN EXCHANGE - It provides foreign exchange to government debt of foreign country has to be repaid in foreign currency and also for spending in foreign country.

(d) RAISING FUNDS - Central Bank also helps the government in raising long-term funds either directly contributing the funds or by acting as underwriters.

(e) ADVISORY SERVICE - The Central Bank has complete knowledge about the functioning of the economy and can therefore advise the government on various economic and

31


S.Y.J.Cmonetary matters it advises the government on various financial matters such as : - preparing of budget - contributing inflation - foreign exchange policy - monetary policy - commercial policy - managing fiscal deficit - devaluation of currency, etc.

(f) SHORT TERM LOANS - It provides short term loans and advances to the government when required by the government. It is known as 'ways and means payment' this is usually done by discounting government treasury bills.

(g) TRANSFER OF FUNDS - It transfers funds of government from one part of the country to another and from one account to another account. For this purpose, the RBI has 5 zonal offices and 19 regional offices. Where there is no RBI office, the SBI acts as an agent of RBI.

(h) ACTS AS AGENT - The Central Bank also acts as an agent of the government. it manages the public debt of the government i.e. raising the loan, payment of interest and repayment of loan on maturity.

It acts as a representative of the government and manages the country's relation with international Financial institutions like International Monetary Fundund IMF and World Bank.

(2) BANKER'S BANK: The central bank is a leader of all commercial banks in the country. It's supervisors and regulations the activities of the commercial banks. it perform the following functions with respect to commercial banks:(a) CUSTODIAN OF CASH RESERVES: Every commercial bank has

to set aside a certain percentage of its cash balance (time deposits + demand deposits) and compulsory deposit the same with the central bank. This percentage to be set aside is decided by the central bank and is known as cash reserve ratio (CRR). The central bank controls the credit creation by commercial bank and the flow of money in the country through the mechanism.

(b) CLEARING HOUSE FOR THE BANKS - In every country, there are several commercial banks operating in a banking system. it is not possible for them to meet personally and to debit and credit their accounts. Since all the commercial banks keep an

32


S.Y.J.Caccount with the central bank, this difficulty is solved by the central bank which acts a clearing house. The adjustment of all the dues between commercial banks is done by the central bank itself by passing necessary entries in the accounts of the banks.Example: Mr.A is having an account with HDFC Bank makes payment via cheque to Mr. B of rupees 30 lacs. Mr. B deposit the check with ICICI Bank. (HDFC > ICICI - 30 lacs).Mr. B makes payment via cheque to Mr. C of Rs. 15 lacs (ICICI > HDFC - Rs. 15 lacs). Mr. C deposits the cheque in his account at HDFC Bank.Now, the net effect of this transaction is that HDFC bank has to make a payment of 15 lacs to ICICI Bank. Since both these banks have an account with the central bank (RBI), HDFC bank's A/c is credited (increased) by rupees 15 lacs. Thus, the interbank settlement is done without the use of cash.

(c) LENDER OF LAST RESORT: A major portion of money received by commercial banks as deposits is given as loan or invested in securities. Therefore, banks do not have very high liquidity. If many account holders demand cash from the bank at a point of time, the Bank might face difficulty as the bank might not have enough cash reserves. Also, there will be panic among account Holders. At such times, the commercial banks can go to the central banks for financial assistance. The central bank is the ultimate source of financial assistance to commercial banks. Thus, the central bank is also called as ''lender of last resort''.

(d) ADVISOR TO THE BANK - The central Bank advices commercial banks, inspect their books of accounts, and advices them regarding the practices and policies to be followed by them.

(3) CONTROLLER OF CREDIT: The central bank is responsible for safeguarding the financial stability of the economy. The central bank controls the volume and direction of credit in the economy in order to achieve the objective of growth with stability. The central bank uses various quantitative and qualitative measures for this purpose. When there is inflation in the economy, the central bank has to restrict the supply of credit so that there is less borrowing and correspondingly less spending thus controlling inflation. When there is deflation in the economy, the central bank has to expand the supply of credit so that more money flows within the economy, there is more spending and the general demand increases thus reducing deflation.

(4) CUSTODIAN OF FOREIGN EXCHANGE RESERVES AND MAINTENANCE OF EXCHANGE RATE STABILITY: There is huge

33


S.Y.J.Cinflow of foreign currency in the country when the government borrows the foreign exchange loan and even when payment is received for export to foreign countries. The central bank is the custodian of the foreign currency received. The central bank exchanges or converts the foreign currency in domestic currency at a fixed rate and maintains stability in the rate of exchange. Moreover, the central bank also has to maintain liquidity of foreign of foreign currency. It requires foreign currency for repayment of debts of the foreign countries and making interest payment. The central bank also makes foreign currency available to traders and business man who have to make payment for imports and also to students who have to travel abroad for education. In India, RBI has the responsibility of maintaining exchange value of the rupee.

(5) ISSUE OF CURRENCY NOTES: The central bank of a country has the monopoly of issuing notes or paper currency to the public. The advantages of granting monopoly right to central bank for issue of notes are as follows: It brings uniformity in the currency. The notes acquire more prestige when issued by a single apex

bank. The issue of currency can be controlled and over-issue can be

avoided. It instills confidence among the citizens of the country. The circulation of currency notes can be monitored and regulated

by Central Bank.In India, RBI has the power to issue currency notes except for Re.1 notes. The Re.1 note and coins are issued by the ministry of finance but their distribution is undertaken by RBI.Certain principle have to be followed by central banks while issuing currency. Many central banks including RBI follow a minimum Reserve System. According to this system, a minimum reserve has to be maintained, then there is no limit on issuing currency notes. In India, the RBI maintains reserves of Rs. 200 crores> Rs. 115 crores in Gold balance Rs. 85 crores in Government securities.

(6) DATA COLLECTION AND PUBLICATION: the central bank conducts research and surveys on various aspects of the economy and publishes information relating to the primary, secondary and tertiary sectors of the economy, foreign trade, banking, trends in capital and money market, etc. The government uses this information to formulate and implement various economic policies. In India, RBI also publishes various reports and bulletins on a weekly basis, monthly, quarterly, half yearly and annual basis. The main publications of RBI include:

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S.Y.J.C Report on currency and finance. RBI journals RBI bulletin Various research reports

(7) PROMOTIONAL OF COMMERCIAL BANKING: The central bank performs the following promotional or development functions: (a) PROMOTION OF COMMERCIAL BANKING : The RBI has

helped in developing the commercial banking system in the country. It has promoted banking habits among people and increased their confidence in the banking system among the public through its various programs and advertisements.

(b) ESTABLISHMENT OF SPECIALIZED FINANCIAL INSTITUTIONS: The central bank establishes various financial institutions for specific purposes. In India, the RBI has established various financial institutions like: National bank for agricultural and Rural development

(NABARD). Industrial Development Bank of India (IDBI) Export Import Bank of India (EXIM) Small Industrial Development Bank of India (SIDBI) Industrial Finance Corporation of India (IFCI) National Housing Bank (NHB)Thus, the central bank has indirectly helped in development of agriculture, industries, foreign trade, etc.

(c) PROMOTION TO RURAL BANKING: The central bank promotes commercial banks to set up branches in rural areas. It has promoted rural banking and cultivated a habit of saving among people in rural areas. Thus, it promotes rural development. In India, RBI organised the Regional Rural Bank in 1975 to promote rural banking.

(d) CREDIT FACILITIES FOR PRIORITY SECTORS: The central bank provides credit facilities to agriculture, education, industry and other priority sector through commercial banks and co-operative banks. Thus, it provides a boost to the sectors that are critical for the economy.

(e) ESTABLISHING TRAINING INSTITUTIONS: The central bank established various training institutes in order to train personnel in banking and related activities. In India, RBI has five training establishments.

(f) CLEARANCE TO PROJECTS: The central bank gives clearance to various projects involving financial matters. It

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S.Y.J.Cincludes clearing joint ventures abroad and investment proposals in foreign countries. Therefore, The central bank performs various functions in an economy. We may not be dealing with the central bank directly but it touches our lives in many ways everyday.

4. Explain price elasticity of demand, its types with diagram.According to Prof. Marshall, “Price elasticity of demand is the ratio of proportionate changes in quantity demanded of a commodity to a given proportionate change in its price In simple words, price elasticity is responsiveness of demand due to change in price only.

TYPES OF PRICE ELASTICITY OF DEMAND

Unitary Relatively Relatively Perfectly PerfectlyElastic Elastic Inelastic Elastic InelasticDemand Demand Demand Demand Demand(Ed = 1) (Ed > 1) (Ed < 1) (Ed = ) (Ed = 0)(1) Unitary Elastic Demand

(a) Meaning : When the proportionate or percentage change in demand is exactly equal to the proportionate or percentage change in price, it is called as unitary elastic demand. It is rare for a commodity to have a unitary elastic demand.

(b) Value of Ed : In this Case, Ed = 1(c) Symbolic Representation

Ed = %ΔQ%ΔP =

For the Ed to be equal to 1, the numerator and denominator need to be the same.

(d) Diagrammatic Representation

PRICE

QUANTITY DEMANDEDIn the above diagram, x-axis represents quantity demanded and Y-axis represents price. DD is the demand curve. At Price P1, the quantity demanded is Q1. When the price reduces to P2, the quantity demanded increases to Q2. The proportionate

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S.Y.J.Cchange in supply is equal to the proportionate change in price. The demand curve DD represents unitary elastic demand.

(e) Demand curve : The demand curve slopes downward steadily. It is a rectangular hyperbola.Example :At Rs.400, the demand for a pen drive is 4000 pieces. If the price reduces to Rs.200, the demand increases to 6000 pieces.

Ed = %ΔQ%ΔP

= 50%50% = 1

In the above example, when the price of pen drive fell by 50%, its demand rose by 50%. In this case, Ed = 1. Thus, we can say that pen drive has unitary elastic demand.

(2) Relatively Elastic Demand(a) Meaning : When the proportionate or percentage change in

demand for a commodity is greater than a proportionate or percentage change in its price, it is called as a relatively elastic demand. In short, when a change in price has a greater effect on the quantity demanded, then the demand for the product is relatively elastic Generally, luxury goods like TV, washing machine, Fridge, high=end watches, etc are said to have relatively elastic demand.

(b) Value of EdIn this case, Ed > 1

(c) Symbolic Representation

Ed = %ΔQ%ΔP > 1

For the Ed to be greater than 1, the numerator will have to be higher than the denominator.


PRICE

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S.Y.J.CQUANTITY DEMANDEDIn the above diagram, x-axis represents quantity demanded and Y-axis represents price. DD is the demand curve. When the price increases from P1 to P2, the demand falls from Q1 to Q2. It can be observed that the proportionate fall in quantity demanded is more than the proportionate increase in price. The demand curve DD represents relatively elastic demand.

(e) Demand Curve : The demand curve is downward sloping from left to right. The slope of demand curve is flatter.Example :On a normal day at a ticket price of Rs.70, there are 50 people in the morning show at PVR. On Wednesday, when the price of the ticket is Rs.35 there are 90 people

Ed = %ΔQ%ΔP

= 80%50% = 1.60 (i.e. > 1)

In the above example, when the price of ticket reduced by 50%, the demand rose by 80% Ed = 1.60 (i.e. Ed > 1). Thus, we can say that the demand for movie tickets (luxury goods) is relatively elastic

(3) Relatively Inelastic Demand(a) Meaning : When the percentage change in demand is less than the

percentage change in price, it is called as relatively inelastic demand. In short, when a change in price has less effect on the quantity demanded, then the demand for the product is relatively inelastic.Generally, demand for necessary goods like rice, wheat, kerosene, oil, sugar, milk, etc. is relatively inelastic.

(b) Value of EdIn this case, Ed < 1


Ed = %ΔQ%ΔP < 1

For the Ed to be less than 1, the numerator has to be smaller than the denominator i.e. the percentage change in quantity demanded has to be less than the percentage change in price.

(d) Diagrammatic Representation38


S.Y.J.CPRICE

QUANTITY DEMANDEDIn the above diagram, x-axis represents quantity demanded and y-axis represents price DD is the demand curve. When the price increases from P1 to P2, the demand falls from Q1 to Q2. It can be observed that the proportionate fall in quantity demanded is less than the proportionate increase in price. The demand curve DD represents relatively inelastic demand.

(e) Demand Curve : The demand curve is downward sloping from left to right. The slope of the demand curve is steeper.Example :The demand for sugar is 2000 kgs at a price of Rs.36 per kg. when the price reduced to Rs.28, the demand rises to 2000 kgs.

Ed = %ΔQ%ΔP

= 10%22%

= 0.45In the above example, when the price of sugar fell by 22%, its demand rose by only 10% Ed = 0.49 (i.e. Ed < 1). Thus, we can say that sugar has relatively inelastic demand.NOTE : Generally, demand for complementary goods is also relatively inelastic. A person owning a car will have relatively inelastic demand for petrol. It the price of petrol increases, his demand for petrol will not fall only marginally.

(4) Perfectly Elastic Demand(a) Meaning : When there is an infinite change in demand due to a

small change in price, it is called as perfectly elastic demand. Perfectly elastic demand is only a theoretical possibility.

(b) Value of EdIn this case, Ed =


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S.Y.J.C

Ed = %ΔQ%ΔP =


PRICE

QUANTITY DEMANDEDIn the above diagram, x-axis represents quantity demanded and y-axis represents price. DD is the demand curve. The change in price is negligible but the demand changes infinitely. The demand curve DD represents perfectly elastic demand.

(e) Demand Curve : The demand curve is a horizontal line parallel to x-axis.

(5) Perfectly Inelastic Demand(a) Meaning : When there is no change in demand inspire of a change in

price. It is called as perfectly inelastic demand. Salt, water and life saving medicines are some examples of commodities having a perfectly inelastic demand. A change in their prices will have no or negligible effect on their quantity demanded.

(b) Value of EdIn this case, Ed = 0


Ed = %ΔQ%ΔP = 0

For the Ed to be equal to 0, the numerator has to be zero ie. no change in demand.


PRICE

QUANTITY DEMANDEDIn the above diagram, x-axis represents quantity demanded and y-axis represents price. DD is the demand curve. When the price

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S.Y.J.Cincreases from P1 to P2, the quantity demanded does not change. It remains constant at Q1. The demand curve DD represents perfectly inelastic demand.

(e) Demand Curve : The demand curve DD is a vertical line parallel to the Y-axisExample : At Rs.2 per litre, the demand for water is 20,000 litres. When the price increases to Rs.3 per litre, there is no change in demand.In the above example, when the price of water increased by 50%.

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