Solutions For Unspolved MSP ISC Economics PDF

SOLUTION
MODEL SPECIMEN PAPER – 3

PART – I
Answer 1. Answer briefly each of the questions (i) to (x).
(i) Marginal utility becomes negative if the consumption of an additional unit of a commodity
causes a fall in the total utility. It refers to the loss of satisfaction due to consumption of
too much of a thing. It means that the marginal utility of that unit is negative. Negative
utility is also known as disutility.
Y
20
16
12
8
4 Zero MU
X' X
O 1 2 3 4 5 6
–4
–ve MU
–8
Y'
(ii) Implication of differentiated product in monopolistic competition is that buyers of a
product differentiate between the same products produced by different firms. Therefore,
they are also willing to pay different prices for the same product produced by different
firms. This gives some monopoly power to an individual firm to influence market price
of its product.
(iii) Accounting costs are an amount that is incurred on to purchase something like input
cost, cost of producation, rent etc. These costs are always recorded in an accounting or
book-keeping system and reported on the company's financial statements.
Opportunity cost is the cost of next best alternative foregone. This is the economic idea
that when you pursue one course of action, you lose out on another because you can't do
two things at once. These costs are theoretical in nature. Although they might be useful
for decision making, they are not physical costs, so they aren't recorded in an accounting
system.
(iv)
Extension in Supply Increase in Supply
1. Extension in Supply refers to a rise Increase in supply refers to a rise in the supply
' in the quantity supplied due to increase of a commodity caused due to any factor
in the price of the commodity, other other than the own price of the commodity.
factors remaining constant.
2. It leads to an upward movement along It leads to an rightward shift in the same
the same supply curve. supply curve.
2 | ISC Model Speciman Paper, XII
Extensis in Supply Increase in Supply
Y Y
S S S1
Price (in ` )
25 B
Price (in ` )
A
20
20
S
S S1
X X
O 100 150 O 100 150
Quantity Supplied Quantity Supplied
(in units) (in units)
(v) When there is involuntary unemployment in the economy, there is a short fall in the
aggregate demand from the level required to maintain full employment equilibrium.
This shortfall is termed as deflationary gap.
Full employment
Y equilibrium
E
Aggregate Demand
Deficient Demand
E1
45º
O X
Income/output/
Employment 
Deflationary gap = Deficient demand
= ADFE – ADIU
= EF
Where, ADFE = Aggregate demand in full employment.
ADIU = Aggregate demand in involuntary unemployment.
(vi) Budget line is a line representing all the bundles of goods whose cost is exactly equal to
the customer's income. Budget line show the maximum units of the commodity, the
consumer can purchase with his given money income and given market prices of the
goods. However, within these two limits, consumer can have any combination of x and
y. If the consumer moves from one combination to another option, he will have to give
up some units of x to gain extra unit of y. As a result, the budget line has downward
slope from left to right. The slope of budget line is – px/py.
Equation of budget line can be expressed as, p1x1 + p2x2 = M
Y
A1
A
Good y 
X
O B A1
Good x
(vii) Revenue Budget : It deals with the revenue aspect of the government budget. It explains
how revenue is generated or collected by the government and how it is allocated among
various expenditure heads. Revenue budget has two parts : (i) Revenue Receipts
(ii) Revenue Expenditures.
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Capital Budget : It deals with the capital aspect of the government budget and it consists
of : (i) Capital Receipts (ii) Capital Expenditures.
(viii) There are a number of commercial banks in a country. There should be some agency to
regulate and supervise their proper functioning. Being the apex bank, the Central Bank
(RBI) acts as the banker to other banks. In this sense, it bears the same relationship with
commercial banks as the latter maintains with the general public. As the banker to banks,
the central bank functions in three capacities :
(a) Custodian of Cash Reserves : Commercial banks are required to keep a certain
proportion of their deposits (known as Cash Reserve Ratio or CRR) with the Central
Bank. In this way, Central Bank acts as a custodian of cash reserves of commercial
banks.
(b) Lender of the Last Report : When commercial banks fail to meet their financial
requirements from other sources, they approach the Central Bank to give loans and
advances as the lender of last resort. Central Bank assists these banks through
discounting of approved securities and bills of exchange.
(c) Clearing House : As Central Banks holds the cash reserves of all the commercial
banks, it become easier and more convenient for it to act as their clearing house. All
commercial banks have their accounts with the Central Bank. Therefore, the Central
Bank can easily settle claims of various commercial banks against each other, by
making debit and credit entries in their accounts.
(ix) Involuntary unemployment refers to an unemployment in which all those people, who
are willing and able to work at the existing wage rate, do not get work. Under involuntary
unemployment, people are rendered unemployed against their wishes or under
compulsion. It must be noted that only involuntary unemployment is considered while
estimating the total unemployment in an economy.
(x) Net exports different from net factor income abroad because of two reasons :
(a) Export refers to the purchase of domestically produced goods by the rest of the
world. Goods produced within the domestic tertiary of a country are to be treated as
a part of GDP.
(b) Export receipts refer to revenue of the firms from the sale of its output. These are not
the receipts of factor income from abroad which are to be in the form of rent,
interest, profit and wages.
PART - II
Answer 2.
(a) Some noteworthy points about Price Elasticity of demand :
(i) It establishes a quantitative relationship between quantity demanded of a com-
modity and its price, while other factor remain constant.
(ii) Higher the numerical value of elasticity, larger is the effect of a price change on the
quantity demanded.
(iii) For certain goods, a change in price leads to a greater change in the demand,
whereas, in some cases, there is a lesser change in demand due to change in price.
For Example : if prices of two commodities 'x' and 'y' rise by 10% and their demands
fall by 20% and 5% respectively, then commodities 'x' is said to be more elastic as
compared to commodity 'y'.
(iv) Price is the most important determinant of demand. So, price elasticity of demand is
sometimes shortened as 'Elasticity of Demand' or 'Demand Elasticity' or simply
'Elasticity'. Unless otherwise stated, whenever these words are used, they mean ‘Price
Elasticity of Demand'.
(b) Income effect refers to effect on demand when real income of the consumer changes due to
change in price of the given commodity. When price of the given commodity falls, it
increases the purchasing power (real income) of the consumer. As a result, he can purchase
more of the given commodity with the same money income.
For Example : Suppose Isha buys 4 chocolates @ 10 each with her pocket money of
40. If price of chocolate falls to 8 each, then with the same money income, Isha can
buy 5 chocolates due to an increase in her real income.
(c) Consumer's equilibrium will be at the point where he gets maximum satisfaction with the given
money income. As such, a consumer will attempt to reach the highest indifference curve
which is under his purchasing power shown by the budget line. Hence a consumer
will be at equilibrium at the point when following two conditions are satisfied :
(i) MRS = Ratio of price : Let the two goods be X and Y. The first condition for
consumer's equilibrium is that MRS = Px/Py. Now suppose MRS is greater than
Px/Py. It means the consumer is willing to pay more for X than the price prevailing
in the market. As a result of consumer buy more for X. This leads to fall in MRS.
MRs continue to fall till it become equal to ratio of price and the equilibrium is
established.
(ii) MRS Continuously falls : Unless MRS continuously falls, the equilibrium cannot
be established.
Adjacent diagram shows the equilibrium of a consumer.
A consumer will be at equilibrium at E became he gets maximum satisfaction is form
his given money income. He will not like to shift to any point left to E because the
level of satisfaction is lower. He will like to move to right of E but his money income
is not sufficient to achieve it.
Y
Commodity y 
Y0 E
IC3
IC2
IC1
O X
X0
Commodity x
Answer 3.
(a) Income effect refers to the effect on demand when real income of the consumer changes
due to change in price of the given commodity. When price of a given commodity falls,
it increases the purchasing power (real in come) of the consumer. As a result, he can
purchase more of the given commodity with the same money income.
Normal goods refer to those goods whose demand increases with the increases in income.
Inferior goods refer to those goods whose demand decrease with an increase in income.
For e.g. Income effect for normal goods would be depicted as below.
Y
D
Y1
Income (in ` )
Y Demand of normal good

D (TV) rises from OQ to OQ1
due to increase in income from OYto OY1
Q Q1 X
O
Demand of TV
(in units)
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Inferior goods refer to those goods whose demand decreases with an increase in
income. It means that there exist an inverse relationship between income and the
demand for inferior goods. So, income effect is negative in case of inferior goods.
For Example : If the income of a consumer rises and he prefer to replace his black-and-
white (B/W) TV with the coloured one, then demand for (B/W) TV will fall. In such
case B/W TV is an inferior goods.
Y D
Demand of inferior good (Black-and-

Y1 White TV) Falls from OQ to OQ1 due to
Income (in ` )
increase in income from OYto OY1
Y
X
O Q1 Q
Demand of Black-and-white TV
(in units)
Income of the consumer is shown on the Y-axis and demand for an inferior goods
(B/W TV) is shown on the X-axis. When income rises from OY to OY1, the demand
for B/W TV falls from OQ to OQ1 as the consumer shifts to Colour TV.
(b)
Basic Contraction in Supply Decrease in Supply

1. Meaning When the quantity supplied falls due Decrease in supply refers to a fall
to a decrease in the price, keeping in the supply of commodity due
other factor constant, it is known as to the factor other than the own
contraction in supply. price of the commodity.
2. Tabular Price ( ) Supply (units) Price ( ) Supply (units)
Presentation 12 150 12 150
10 100 12 100
3. Effect on There is a downward movement There is a leftward shift in the
supply curve along the same supply curve. supply curve.
4. Reason It occurs due to decrease in price of It occurs due to other factors like
the given commodity. increase in the price of inputs,
increase in taxes, technological
degradation etc.
(c) Demand and Supply model is very easy to use, when there is a change in either demand
or supply. There are number of situation which leads to simultaneous changes in
both demand and supply. To predict whether the equilibrium price and the equilibrium
quantity rise and fall in such case, we need to know the magnitude of changes in both
demand and supply.
We can study following four cases of simultaneous shift in demand and supply curves :
(A) Both Demand and Supply decrease
When there is simultaneous decrease in demand and supply of a good, there may be
following situations :
(i) When there is a simultaneous decrease in demand and supply of a commodity, it will
result in no change in equilibrium price i.e., decrease in demand and supply both are
equal in ratio. For example, if demand decrease by 25%. Supply also decrease
by 25%.
In the diagram original demand curve is DD and original supply curve is SS. Both
intersect at A and equilibrium price is OP. When demand declines, the new
demand curve shift to D1D1. When supply decline, the new supply curve is S 1S1. As
a result, equilibrium point becomes A1, and new price remains OP, because the
changes in supply and demand are in the same ratio.
(ii) When there is a simultaneous decrease in demand and supply of commodity, it will
result in fall in equilibrium price when proportionate decrease in demand is more
than proportionate decrease in supply. For example, decrease in demand in 20%,
while decrease in supply is 10%.
In the diagram original demand curve is DD and original supply curve is SS. Both
intersect at a resulting in OP equilibrium price. Both demand and supply decrease
but the decrease in demand is more than decrease in supply. As a result, new
equilibrium price is OP1, which is lower than OP.
(iii) When there is simultaneous decrease in demand and supply of commodity, it will
result in rise in equilibrium price when proportionate decrease in demand in less
than proportionate decrease in supply. For example, decrease in demand is 20%
while decrease in supply is 40%.
In the diagram, original demand curve is DD and original supply curve is SS. Both
demand and supply decrease but the decrease in demand is less than decrease
in supply. As a result, new equilibrium price is OP1, which is higher than OP.
P S''
Y
D S1 S D
D1
D'' S
D S'' S
D''
P1 E'
P
Price 
A1 A
Price 
Price 
P E
P E
P1 E'
S''
D D
S1 S S D''
D1
S D
S'' D''
X O O Q
O Q1 Q Q1 Q Q1 Q
Quntity demanded Quntity demanded Quntity demanded
and Supplied  and Supplied  and Supplied 
(B) Both Demand and Supply increase.
When there is simultaneous increase in both demand and supply of a good, there
may be following situations :
(i) If increase in demand and supply both are equal, there will be no change in the
change in the equilibrium price but equilibrium quantity will increase.
In the diagram (a), demand and supply both increase in same proportion. As a
result, price remains same at OP but quantity increase from OQ to OQ 1.
(ii) If increase in demand is more than increase in supply, both equilibrium price
quantity will increase.
In the diagram (b), the proportionate increase in demand is more proportionate
increase in supply, As a result, price increase from OP to OP1 and quantity
increase from OQ to OQ1.
(iii) If increase in demand is less than the increase in supply, equilibrium price will
decline and equilibrium quantity will increase.
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In the diagram, the proportionate increase in demand is less than proportionate

increase in supply. As a result, price decrease from OP to OP1 but quantity
increase from OQ to OQ1 goods are used in place of one another.
Y
D1 S S1
D S S1 Y
Y D1
D
Price 
P1 E1
E1 E
E P P E
E1
Price 
P1
Price 
D1 D1
S S1 D D
S S1
X X
X Q Q1 O Q Q1
O Q1 Q
Quantity  Quantity 
Quantity 
(C) The effect of simultaneous decrease in demand and increase in supply on equilibrium
price and equilibrium quantity is analysed in the follwing points :
(i) When decrease in demand is proportionately equal to increase in supply, then leftward
shift in demand curve. The new equilibrium is determined at E 1, equilibrium quantity
remains the same at OQ, but equilibrium price falls from OP to OP 1.
(ii) When decrease in demand is proportionately more than increase in supply, then
leftward shift in demand curve. The new equilibrium is determined at E 1, equilibrium
quantity falls from OQ to OQ1 and equilibrium price falls from OP to OP1.
(iii) When decrease in demand is proportionately more than increase in supply, then
leftward shift in demand curve. The new equilibrium is determined at E 1, equilibrium
quantity rise from OQ to OQ1 whereas, equilibrium price falls from OP to OP 1.
D
Y
D S
Y S1 Y
D1 S
S1 D
D1
E E
D1 E
Price 
P
Price 
E1 P1
Price 
D E1
D E1
D
D1 D1
X S X
O Q S1 D1 O Q Q1
O X Quantity demanded
Quantity demanded
Quantity demanded and Supplied 
and supplied 
and supplied 
(D) The effect of increase in demand and decrease in supply on equilibrium price and
equilibrium quantity is discussed in the following three points :
(i) When increase in demand is proportionately equal to decrease in supply, then
rightward shift in demand curve proportionately equal to leftward shift in supply
curve. The new equilibrium is determined at E1, equilibrium quantity remains the
same from OP to OP1 and equilibrium rise from OP to OP1.
(ii) When increase in demand is proportionately equal to decrease in supply, then

curve. The new equilibrium is determined equal at E1, equilibrium quantity rise from
OQ to OQ1 and equilibrium price rise from OP to OP1.
(iii) When increase in demand is proportionately equal to decrease in supply, then
curve. The new equilibrium is determined at E1, equilibrium quantity is falls from
OQ to OQ1 whereas, equilibrium price rise from OP to OP1.
Y
S D1
Y S1
D
S
E S1 P1 E1
P
P1
Price 
Price 
P E
E1
D
D1
D1
X S1 D
O Q Q1
Quantity demanded S
X
and Supplied  O Q
Y
S1
S Y
D1 S1
E1
D
E1
P1
Price 
S
Price 
D1
E P E
S1
S D X
X O Q1 Q
O Q1 Q Quantity demanded
Quantity demanded and Supplied 
and supplied 
Answer 4.
(a) Firms can increase their volume of sales only by decreasing the price, than AR falls with
increase in sale. It means, revenue from every additional unit (i.e., MR) will be less than
AR. As a result, both AR and MR curve slope downwards from left to right. This
relationship can be better understood through the following points :
(i) At A : Both MR and AR falls with increase in output. However fall in MR is double
than the fall in AR i.e., MR falls at a rate which is twice the rate of AR.
(ii) At B : MR become zero AR falls at a slower rate or, MR curve is steeper than the AR
curve because MR is limited to one unit, where as, AR is derived by the units. It
leads to comparatively lesser fall in AR than fall in MR.
(iii) At C : A point C, the MR curve become negative however AR is neither zero nor
negative as AR is always positive. It is because the proportionate fall in demand is
less than MR or price of the commodity.
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(b) AR 7 5 4 2
Output 1 2 3 4
TR 7 10 12 8
MR 7 3 2 (–) 4
MRn = TRn – TRn–1
TR = P × Q or AR × Q or MR
AR = TR  Q
(c) When more of output can be sold only by lowering the price, then revenue from every
additional unit (i.e., MR) will fall, MR is the addition, to TR when one more unit of
output is sold. So, TR will increase when MR is positive, TR will fall when MR is negative
and TR will be maximum when MR is zero. This relationship can be better understood
with the help of following schedule diagram.
Unit Sold AR ( ` ) TR ( ` ) MR ( ` )
1 5 5 5
2 4 8 3
3 3 9 1
4 2.25 9 0
5 1 5 –4
Relationship between TR and MR

Y
A
Total Revenue (in ` )
TR
X
O Unit Sold
Y
Marginal Revenue (in ` )
B
X
O
MR
Answer 5.
(a) Oligopoly refers to a market situation in which there are a few firms selling homogeneous
or differentiated products. Under oligopoly, the exact behaviour pattern of a producer
cannot be determined with certainity. So, demand curve faced by an oligopoly is
indeterminate. As firms are inter-depend, a firm cannot ignore the reaction of the rival
firms. Any change in price by one firm may lead to change in price by the competing
firms. So demand curve keeps on shifting and it is not definite, rather it is indeterminate.
(b) (i) Im p li c a t i o n o f `P r o du c t s di ff e r e n t i a t e d ' i s t h a t b u y er s of a p r o du c t
differentiated between the same product produced by different firms. Therefore,
they are also willing to pay different prices for the same product produced by different
different firms. This gives some monopoly power to an individual firm to influence
market price of its product.
(ii) Very large number of buyers and sellers : In a perfectly competitive market, there
are very large number of buyers and sellers. Implication of very large number of
buyers and sellers is that the number of sellers is so large that the share of each seller
is insignificant in the total supply. Hence, an individual seller cannot influence the
market price.
Under such conditions, price of a commodity is determined by the market forces of
demand and supply and each buyer and seller has to accept the same price. As a
result uniform price prevail in a market.
(c) (i) If a price higher than equilibrium price prevail in the market, there will be excess
supply. It may be explained with the help of following demand and supply schedule :
Price Per unit Market Supply Market Demand Situation
( ) (Units) (Units) (Units)
60 1,000 200 Excess supply
55 800 400 Exces supply
50 600 600 Equilibrium
45 400 800 Excess demand
40 200 1,000 Excess demand
In the above schedule, the market is at equilibrium at a price of 50 where Demand
and Supply are equal (600 units). When the price of the commodity at the given price
(which is higher than equilibrium price) ensure equality of demand and supply, there
will be no change in the price of the commodity.
(ii) If a price lower than equilibrium price prevail in the market, there will be excess
demand. It may be explained with the help of following demand and supply schedule :
Price Per unit Market Supply Market Demand Situation
( ) (Units) (Units) (Units)
60 1,000 200 Excess supply
55 800 400 Excess supply
50 600 600 Equilibrium
45 400 800 Excess demand
40 200 1,000 Excess demand
In the above schedule, the market is at equilibrium at a price of 50 where Demand
and Supply are equal (600 units). When the price of the commodity comes down to
45, there is excess demand because demand increase but supply decreases.
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When there is excess demand, price of the commodity tends to increase. However, if
the supplies are prepared to increase the supply, there will be no change in the price
of the commodity.
Answer 6.
(a) Income method measures the national income from the side of the factor payments in
the form of rent, wages, interest and profit.
Following are the steps involved in the estimation of the national income by income
method :
(i) First of all producing enterprise are identified and classified.
(ii) Different factor payments by enterprise are estimated to get National Domestic Product
at factor cost. For this rent, wages, interest and profit are measured.
(iii) In National domestic product at factor cost, net factor income from abroad is added
to get national income.
Thus, National income or Net National Product at factor cost
Rent + Interest + Profit (= Operating Surplus) + Compensation of employees + mixed
income of self employed
= Net Domestic Income FC + Net Factor Income from abroad.
(b) Real Gross Domestic Product (Real GDP) may be defined as the money value of goods
and services at base year's prices produced in the accounting year within domestic territory
of the country Thus, Real Gross Domestic Product = Output × base year's prices.
Nominal Gross Domestic Product (nominal GDP) may be define as a money value of
goods and services at current year's prices produced in the accounting year within
domestic territory of a country. Thus, Nominal Gross Domistic Product = Output × current
year's prices.
For Example : Assume 2016 as the base year. Output of tea is 2,000 tones in 2016 as well
as in 2017. But, the price are 1,000 and 1,500 per tonne respectively in 2016 and
2017. Nominal GDP in 2017 will be 30,00,000 (2,000 × 1,500) while real GDP in 2017
will be 20,00,000 (2,000 × 1,000).
Real GDP is a good indicator of economic welfare because it shows real increase in the
income over a period of time. Real GDP neutralizes the effect of change in price over a
period of time. Nominal GDP becomes inflated due to inflation (increase in price) and
does not reflect the true growth of national income.
(c) GDP provide a satisfactory measure of aggregate output and services and act as an
indicator of overall economic performance of the country.
Following are some limitations of using GDP as an index of welfare.
(i) Distribution of GDP : GDP ignore distribution of income. There will be no change
in economic welfare if the distribution of GDP is not equitable. A large fraction of
the increase in income may be concentrated in a very small percentage of society.
GDP does not tell us much about the living standard of average person in a country.
(ii) Non-monetary exchanges : Many activities in an economy are not considered as part
of a economic activity. Hence, a number of transaction is not counted in the GDP of
a developing country thus there is an under estimate of GDP. Hence, GDP is not a
good indicator of economic welfare.
(iii) Externalities : Externalities refer to those benefits or harms accruing to another for
which they are not paid or penalised. Externalities may positive or negative. For
example, increase in GDP may be at the cost of considerable pains and sacrifice
in the form of environmental pollution. As a result, increase in GDP may mean less
economic welfare. If increase in GDP has been brought about by making worker
in bad working conditions increase in GDP will not raise the level of economic welfare.
(iv) Composition of GDP : The composition of GDP effects the economic welfare of
country. If the GDP of a country consists of a large quantity of investment goods
and/or raw materials, economic welfare may be very low.
(v) Rate of population growth : Economic welfare depends on the per capita
availability of goods and services. If the per capita availability of goods
services increase, economic welfare will be higher. It is possible only rate of population
growth is lower than the growth in GDP. If the rate of population growth is higher
than the rate of growth of GDP, economic welfare will be less.
(vi) Leisure : The growth in GDP should not beat the cost of leisure of the people. If the
growth in GDP is at the cost of leisure of people, economic welfare will be lower. If
increase in GDP is brought about making worker work for longer hours, then
increase in GDP will not raise the level of welfare.
Answer 7.
(a) Import of machinery shall be recorded in capital account because it increases the assets
on long term basis.
Basis Current Account Capital Account
1. Influence on Current account transactions bring Capital transaction brings about a

the economy a change in a current level of a change in a capital stock of a
country's income. country.
2. Concept It is a flow concept as it include all It is a stock concept as it includes
item all nature. all item of expressing changes in
stock.
3. Components Current account = Visible trade + Capital Account = Borrowings
invisible trade + unilateral transfer + and lendings to and from abroad
income receipt and payments. + investment to and from abroad
+ change in foreign exchange
reserves.
(b) Income (Y) ( in crores) Consumption (C) ( in crores)
0 20
50 60
110 110
170 160
230 210
290 260
350 310
The relationship between the consumption expenditure and the income is known as
consumption function.
C = F (Y)
When we write consumption function in terms of an algebraic expression, we write,
C = $ \overline{C}$ +bY
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Where, C = Consumption expenditure, $\overline{C}$ = Autonomous consumption i.e.,
consumption at zero level of income, b = Marginal Propensily to Consume, Y = Income.
Production of goods and services, leading to increase in induced investment and hence
National Income. On the other hand, savings are considered as leakages from the circular
flow of income by reducing consumption demand and hence production, investment
and National Income also fall.
(c) Components of a Budget refers to the structure of the budget. Two main components of
budget are :
(i) Revenue Budget : It deals with the revenue aspect of the government budget. It explains
how revenue is generated or collected by the government and how it is allocated
among various expenditure heads. Revenue budget has two important parts :
(1) Revenue Receipts : Revenue receipts refer to those receipts which neither create
liability nor cause any reduction in the assets of the government.
(2) Revenue Expenditure : Revenue expenditure refers to the expenditure which
neither creates any asset nor causes reduction in any liability of the government.
(ii) Capital Budget : It deals with the capital aspect of the government budget and it
consists of :
(1) Capital Receipts : Capital receipts refer to those receipts which either create a
liability or cause a reduction in the assets of the government. They are non-
recurring or non-routine in nature.
(2) Capital Expenditures : Capital expenditure refers to the expenditure which either
creates an asset or causes a reduction in the liabilities of the government. It is non-
recurring in nature and adds to capital stock of an economy.
The components of budget can also be catagorised according to the receipts and
expenditures.
(1) Budget Receipts : Budget receipts refer to the estimated money receipts of the
government from all sources during a given fiscal year. Budget receipts can be
further classified as – Revenue receipts and Capital receipts.
(2) Budget Expenditures : Budget expenditure refers to the estimated expenditure
of the government during a given fiscal year. They budget expenditure can be
broadly classified as – Revenue expenditure and Capital expenditure.
Answer 8.
(a) Excess demand may rise due to several factors. Important among them, are mention
below :
(i) Rise in the Propensity to consume : Excess demand may arise because of increase in
consumption expenditure due to rise in the propensity to consume or fall in propensity
to save.
(ii) Reduction in taxes : It may also occur due to increase in disposal income and
consumption demand because of decrease in taxes.
(b) Four measures to correct unfavourable balance of payment :
(i) Import substitution : Import substitution means promoting domestic production of
the items normally imported by the residents of domestic country.
(ii) Export promotion : Export promotion means promoting exports by granting
concession and incentives to exporters like credit and finance, packaging, quality
control, tax concessions.
(iii) Depreciation : Depreciation leads to fall in external purchasing power of home
currency. Depreciation of home currency encourages exports of the home country
by making exports cheaper and discourages imports by raising the prices of imports.
(iv)Exchange control : The government may order all exporters to surrender their
foreign exchange to Central Bank and then ration out among the importers.
(c) Govenment budget is an annual statement, showing item wise estimates of receipts and
expenditures during a fiscal year. The receipts and expenditures, shown in the budget, are :
(i) Economic growth : The budget is an avenue to ensure the country’s economic
growth. The government makes provisions to increase budgetary spending and
promote savings. It aims to accelerate the country’s economic growth. The
government calibrates its budgetary policy depending on economic conditions. For
example, if there is inflation, the government will come out with surplus policy. If
there is deflation, the government will look at ways to improve people’s spending
power. This balancing act results in economic stability.
(ii) Businesses get direction: The budget is a pointer of things to come over the next
three to five years. Companies try to get wind of which way the country is heading.
They then plan their policies accordingly. The budget tells them how much the
government will spend on various sectors. Many companies are invested in
infrastructure, roads, agriculture and the rural sector. Information about these
sectors is important for them.
(iii) Reduces disparities: The budget caters to certain government objectives. One of
the objectives is to reduce the country’s income disparity. Through the budget, the
government aims to tax the rich and carry out welfare for the poor. Changes in the
tax slabs are announced during the budget.
(iv) Taking care of PSUs: The government runs several public sector units. Many of
these units have emerged as a source of national pride. The budget decides how to
manage the PSUs better or if they need disinvestment, etc.
(v) One nation: Through the budget, the government seeks to iron out the heterogeneity
in the country’s economic progress. For example, an area A is more economically
backward than area B. The government attempts to address the problem by setting
up industries in area A. This helps locals of area gain employment and improves
the quality of their lives.
Answer 9.
(a)
Basis of Distinction Oligopoly Monopoly
(i) Number of sellers There are few sellers in the There is only one seller in the
market. market.
(ii) Nature of product Product may be homogenous Product is unique in the sense
or differentiated and has some that it has no close substitutes.
sort of substitution.
Economics | 15
(iii) Barriers to entry There are entry barriers due to There are strong barriers to
dominance of few firms or entry.
differentiation. Entry is not
impossible but difficult.
(iv) Monopoly power A firm has a cosiderable
A firm has absolute monopoly
monopoly power.
power.
(v) Price A firm has a considerable
A firm is a price maker. Prices
control over the prices which
are very high.
tend to be rigid. Prices are
high.
(vi) Elasticity of Demand Price elasticity of demand is
Price elasticity of demand is
low
very low
(b) (i) Reasons for Increasing Returns to a Factor (Phase 1

(1) Better Utilization of the Fixed Factor
(2) Increased Efficiency of Variable Factor
(3) Indivisibility of Fixed Factor
(ii) Reasons for Diminishing Returns to a Factor (Phase 2) :
(1) Optimum Combination of Factors
(2) Imperfect Substitutes
(iii) Reasons for Negative Returns to a Factor (Phase 3) :
(1) Limitation of Fixed Factor
(2) Poor Coordination between Variable and Fixed Factor
(3) Decrease in Efficiency of Variable Factor
(c) Following are the relationship between average cost and marginal cost :
(i) When the average cost falls, as a result in the increase in output, marginal cost is less
than the average cost. It means MC falls rapidly in comparison to AC.
(ii) When average cost is minimum, marginal cost is equal to the average cost. Marginal
cost curve cuts the average cost curve at its minimum point.
(iii) When average cost rises, marginal cost is more than average cost.
Y
MC
ATC
AVC
Cost 
O X
Output 
MC = Marginal cost
ATC = Average total cost
AVC = Average Variable cost.

SOLUTION

PART – I
Answer 1. Answer briefly each of the questions (i) to (x).

(i) Opportunity cost is the cost of next best alternative foregone. For example, I am working
in a bank at the salary of 40,000 per month. Further suppose, I receive two more job
offers :
To work as an executive at 30,000 per month; or
To become a journalist at 35,000 per month.
The opportunity cost of working in the bank is the cost of next best alternative foregone,
i.e., 35,000. The amount of other goods and services, that must be sacrificed to obtain
more of any one good, is called the oppostunity cost of that good.
(ii) Monopoly is an example of imperfect competition. Two features of imperfect
competition are :
(a) Single Seller : Under monopoly, there is a single seller selling the product. As a
result, the monopoly firm and industry are one and the same things and monopolist
has full control over the supply and price of the product.
(b) No close Substitutes : The product produced by a monopolist has no close
substitutes So, the monopoly firm has fear a competition from new or existing
products. For example, there is no close substitute of electricity services provided by
TPDDL in some parts of Delhi. However, the product may have distant substitutes
like inverter and generator.
(iii) Autonomous Consumption : Even when income (Y) is zero, there is some minimum
consumption, known as autonomous consumption (C) which is always positive. Au-
tonomous consumption expenditure is not influenced by income.
Autonomous Investment : Autonomous investment refers to the investment which is
not affected by changes in the level of income and is not induced solely by profit motive.
It is income inelastic, i.e., it is not influenced by change in income. Automonous Invest-
ments are generally made by Government for Infrastructural activities.
(iv) Objective of fiscal policies are :
(a) To stabilize the price level.
(b) To maintain equilibrium in balance of payment.
(v) Market equilibium refers to a situation of market in which market demand for a com-
modity is equal to its market supply. This situation is considered stable.
P = Equilibrium price
Q = Equilibrium quantity
Y
D S
P Equilibrium point
Price 
S D
O X
Quantity  Q
(vi) Output TC MC TVC TFC

0 40 – – 40
1 60 20 20 40
2 78 18 38 40
3 97 19 57 40
4 124 27 84 40
(vii) Primary deficit refers to the difference between fiscal deficit of the current year and
interest payments on the previous borrowings.
Primary Deficit = Fiscal Deficit — Interest Payments
It indicates, how much of the government borrowings are required, to meet expenses
other than the interest payments. The difference between fiscal deficit and primary defi-
cit shows the amount of interest payments on the borrowings made in past. So, a low or
zero primary deficit indicates that interest commitments (on earlier loans) have forced
the government to borrow.
(viii) Method of calculating price elasticity of Demand :
% change in demand
Price elasticity of demand = % change in price
(a) At point A : Perfectly Elastic Demand
Lower segment AE
= Upper segment = =
0
(b) At point B : Highly Elastic Demand
Lower segment BE
= Upper segment = =>1
AB
(c) At point C : Unitary Elastic Demand
Lower segment CE
= Upper segment = =1
CA
(d) At point D : Less Elastic Demand
Lower segment DE
= Upper segment = <1
DA
(e) At point E : Perfectly Inelastic Demand
Lower segment 0
= Upper segment = =0
EA
Y
A Ed = 
Ed > 1
B
Price 
Ed = 0
C
Ed < 1
D
Ed = 0
O X
E
Quantity Demanded
(in units) 
Economics | 3
(ix) Assumptions of indifference curve are :
(a) Two Commodities : It is assumed that the consumer has a fixed amount of money,
whole of which is to be spent on the two goods, given constant prices of both the
goods.
(b) Ordinal Utility : Consumer can rank his preference on the basis of the satisfaction
from each bundle of goods.
(x) Show under what circumstances :
(i) NDPmp > NNPmp. (ii) NNPmp < NNPfc.
(i) Net Dmestic Product at market price is more than Net national Product at market
price when factor income paid abroad is more than the factor income earned from
abroad.
(ii) Net National Product at factor cost exceeds Net National Product of market price
when, market value of the national product exceeds income paid to the factors of
production by the amount of indirect taxes.
PART – II
Answer 2.
(a) When price of a good falls by 10%, its quantity demanded rises from 40 units to 50 units.
Calculate price elasticity of demand by the percentage method.
% change in demand
Price elasticity of demand = % change in price
Original Demand = 40 units
New Demand = 50 units
Change in quantity = 50 – 40
= 10 units
% change in price = 10%
Q
% change in demand = × 100
Q
10
=  100
40
= 25%
25
Price elasticity of demand =
– 10
Ans. = – 2.5
(b) Cardinal Utility Vs Ordinal Utility :
(i) Under cardinal utility approach, it is assumed that utility can be measured in cardinal
terms, such as 1, 2, 3 etc. However, according to ordinal utility approach, utility is a
subjective concept, which cannot be measured and we can just rank it on the scale of
preferences.
(ii) Under cardinal approach, the term utils was developed as a unit to measure utility,
whereas, no such unit of measurement was developed under ordinal approach.
(iii) Example : Suppose a person consumes apple and banana.
 According to cardinal approach, the consumer can assign utils to both the commodities,
say 20 utils to apple and 15 utils banana. It signifies that apple offers 5 more utils than
banana.
 According to ordinal approach, the consumer cannot express the satisfication in exact
terms. It means, if the consumer likes apple more than banana, then be will give 1st rank
to apple and 2nd rank to banana.
(C)
Basis Change in Supply Change in quantity supplied
1. Meaning When the supply changes due When the quantity supplied
to change in any factor other changes due to change in
than the own price of the price, keeping other factors
commodity, it is known as constant, it is known as change
change in supply. in quantity supplied.
2. Effect on supply curve It leads to shift in the supply It leads to a movement along
curve either right word (known the same curve either upward
as Increase in supply) or (Known as Expansion in
leftward (known as decrease in supply) or downward.
supply) (known as contraction in
3. Reason It occurs due to a change in supply).
other factors like changes in the It occurs due to an increase or
price of inputs, change in taxes, decrease in the price of the
change in technology etc. given commodity.
4. Example A good period of weather may Because of festival seasons
increase the rice crop in market for rice increase which
country. This will make it increases its market price
possible for rice former to encouraging producers to
supply more. supply more rice in the market.
Answer 3.
(a) Supply function shows the functional relationship between quantity supplied for a par-
ticular commodity and the factors influencing it. It can be either with respect to one
producer (individual supply function) or to all the producers in the market (Market
supply function).
Two reasons for decrease in Supply :
(i) Increase in Price of other goods : When prices of other good rises, then production
of such other good rises, become more profitable in comparison to the given
commodity. As a result, supply falls from OQ to OQ1 at the same price OP. It leads
to a leftward shift in the supply curve from SS to S1S1.
Y
S1
S
Price (in ` ) 
S1
S
O Q1 Q X
Supply (in units) 
Economics | 5
(ii) Increase in Price of factors of Production : Rise in price of factors of production
increases the cost of production and reduces the profit margin. As a result, supply
falls from OQ to OQ1 at the same price OP. It leads to a leftward shift in the supply
curve from SS to S1S1.
Y
S1
S
Price (in ` ) 
P
S1
S
O Q1 Q X
Supply (in units) 
(b) Importance of Elasticity of Demand :

(i) International trade : In order to fix prices of the goods to be exported, it is important
to have knowledge about the elasticities of demand for such goods. A country may
fix higher prices for the products with inelastic demand. However, if demand for
such goods in the importing country is elastic, then the exporting country will have
to fix lower prices.
(ii) Decisions of Monopolist : A monopolist considers the nature of demand while
fixing price of his product. If demand for the product is elastic, then he will fix low
price. However if demand is inelastic, then he is in a position to fix a high price.
(c) Degrees of elasticity of supply of a good :
(i) Perfectly Elastic Supply : When there is an infinite supply at a particular price and
the supply becomes zero with a slight fall in price, then the supply of such a
commodity is said to be perfectly elastic.
Y
Price (in ` ) 
P SS
X
O Q1 Q Q2
Quantity supplied
(in units) 
Perfectly Elastic supply (ES = )
(ii) Perfectly Inelastic Supply : When the supply does not change with change in price,
then supply for such a commodity is said to be perfectly inelastic.
Y
SS
P1
Price (in ` ) 
P
P2
X
O Q
Quantity supplied
(in units) 
Perfectly Elastic supply (ES = 0)

(iii) Highly Elastic Supply : When percentage change in quantity supplied in more than the
percentage change in price, then supply for such a commodity is said to be highly elastic.
Y
SS
P1
Price (in ` ) 
P
O Q Q1 X
Quantity supplied
(in units) 
Perfectly Elastic supply (ES > 1)
(iv) Less Elastic Supply : When percentage change in quantity supplied is less than the
percentage change in price, then supply for such a commodity is said to be less elastic.
P
P1P2 > Q1Q2 S2 (ES < 1)
P2
P1
S2
Q
O Q1 Q2
(v) Unit Elastic Supply : When proportionate change in supply equals the proportion change
in price, the supply is said to be unit elastic.
There, ES = 1
Q P
 . =1
P Q
Q P
  100 =  100
Q P
 % change in quantity supplied = % change in own price.
P
P1P2 > Q1Q2 S2 (ES < 1)
P2
B
P1
A
S2
Q
O Q1 Q2
Answer 4.
(a) Producer's equilibrium is the position where a producer earns maximum profit and as a
result, there is no tendency to change.
Economics | 7
According to marginal cost and marginal revenue approach, there are two conditions of
producer's equilibrium :
(i) Marginal Revenue (MR) = Marginal cost (MC)
(ii) Marginal cost must be rising i.e., MC curve must cut MR curve from below
following are two cases :
(i) Producer selling any quantity at prevailing Market price : Producer's equilibrium may
be shown as :
In the diagram, marginal revenue and marginal cost are equal to each other at two
points A and E. But, the producer will be at equilibrium at E because at this level rising
marginal cost is equal to marginal revenue. Producer will earn more profit at E than at A
because number of units produced are maximum.
Y
MC = MR MC
A
P = AR = MR
Price/Cost 
O Q Q1 X
Output Units 
(ii) Producer selling more of quantity only by lowering the price : Producer's equilibrium
may be shown as :
In the diagram, MC = MR condition is satisfied at both A and B. But the second condi-
tion – MC is greater than MR or MC curve cuts MR from below — is satisfied only at B.
So, the equilibrium level of output is OQ2.
Y
MC
A
Price 
MR
O X
Q1 Q2
Output 
(b) Demand Curve under Perfect Competition : In case of Perfect Competition, there are
very large number of buyers and sellers selling a homogeneous product, at a price fixed
by the market.
Each firm is a price-taker and faces a perfectly elastic demand curve.
Y
Ed = 
Price 
Demand Curve
(AR curve)
O X
Q1 Q2
Quantity 
Firms demand curve is indicated by the horizontal straight line parallel to the x-axis.
(b) Demand Curve under Monopolistic Competition : Under monopolistic competition

large number of selles sells closely related but differentiated products, making the de-
mand curve downward sloping.
It implies that firm can sell more output only by reducing the price of its product.
Y
Price 
P
P1
X
O Q Q1
Quantity 
Firms under monopolistic competition faces a downward sloping demand curve.

Demand curve under monopolistic competition is negatively sloped as more quantity
can be sold only at a lower price.
(b) Demand Curve under Monopoly market structure : A monopoly firm is like an indus-
try as the single seller constitute the entire market for the product, which has no close
substitues. So a monopolist has full freedom and power to fix price for two product.
Demand of the product is not under direct control of the monopoly firm. In order to
increase the output to be sold, monopolist will have to reduce the price. Therefore,
monopoly firm faces a downward sloping demand curve.
Y
P
Price 
Demand Curve
P1
O Q Q1 X
Quantity 
Demand curve under monopoly is negatively sloped, as more and more quantity can be
sold at a lower price.
(c) (i) Perfect competition is used in a wider sense as compared to pure competition.
(ii) The competition is said to be as pure competition, when following fundamental
criterion are met :
(1) Very large nuber of buyers and sellers,
(2) Homogeneous product,
(3) Freedom of entry and exit.
Economics | 9
(iii) For a market to be perfectly competitive, in addition to three fundamental

conditions following four additional conditions must be saftisfied :
(1) Perfect knowledge among buyers and sellers,
(2) Perfect mobility of factors of production,
(3) Absence of transportation costs,
(4) Absence of selling costs.
Answer 5.
(a) There is a closer relationship between Average Cost (AC) Average Variable Cost (AVC)
and Marginal Cost (MC).
(i) All the three AC, AVC and MC are derived from Total cost (TC).
(ii) All the three AC, AVC and MC Curves are U-shaped.
The relationship can be further explained with the help of following table and diagram.
Output Total Cost Total Fixed Total Variable Average Average Variable Marginal
Qty. TC Cost (TFC) Cost (TVC) Cost (AC) Cost (AVC) Cost (MC)
( ) ( ) ( ) ( ) ( )
0 12 12 0 – – –
1 18 12 6 18 6 6
2 22 12 10 11 5 4
3 27 12 15 9 5 5
4 36 12 24 9 6 9
5 47 12 35 9.40 7 11
Y
MC AC
18
16
Price (in ` ) 
14
12
A
10
8 C AVC
6
4 B
2
O X
1 2 3 4 5
Output (in Units) 
From the above table and diagram we can conclude that;

(i) When MC is less than AC and AVC, both of them fall with increase in the output.
(ii) When MC become equal to AC and AVC, they become constant. MC curve cuts AC
and AVC curve at their minimum point.
(iii) When MC is more than AC and AVC, both rise with increase in output.
(b)
Basis Short–run Long-run
1. Meaning Short-run refer to a period in Long-run refers to a period in

which output can be changed which, output can be changed
by changing only only variable by changing all factors of pro-
factors. duction.
2. Classification Factors are classified as fixed All factors are variable in long-
factors and variable factors in run.
the short-run.
3. Price In short-run demand is more In long-run, both demand and
Determination active in price determination as supply play equal role in price
supply cannot be increased im- determination as both can be
mediately with increase in de- increased.
mand.
(c) When there is simultaneous decrease in both demand and supply of a commodity.
(i) No change in Equilibrium Price : When there is simultaneous decrease in demand and
supply of a commodity, it will result in no change in equibrium price, if decrease in
demand and supply are equal in ratio.
For e.g. if demand is decreased by 25% and supply also decreases by 25%.
this can be further explained by following diagram.
Y
D1 S1 S
D
A1
P A
Price 
D
S1 S D1
X
O Q1 Q
Quantity 
In the above diagram, original demand curve is DD and original supply curve is SS. Both
intersect at A and equilibrium price is OP. When demand dclines, the new demand
curve shifts to D1D1 and when the supply declines the supply curve shifts to S1S1.
As a result the new equilibrium point becomes A1 and the new price becomes OP. So
there is no change in the price, when the changes in demand and supply are in the same
ratio.
(ii) A fall in equilibrium Price : When there is simultaneous decrease in demand and sup-
ply of a comodity, it will result in fall in equilibrium price when propertionate decreases
in demand is more than the proportionate decrease in supply.
For eg. decrease in demand is 20% and decrease in supply is 10%.
Economics | 11
This can be explained by the following diagram.
D S1 S
Y
D1
P A
A1
P1
Price 
D
S1 S D1
X
Q1 Q
Quantity 
In the above diagram, original demand curve is DD and original supply curve is SS. Both
interect at A, resulting in OP equilibrium price. Both demand and supply decrease but
the decrease in demand is more than decrease in supply. As a result, new equilibrium
price is OP1, which is lower than OP.
Answer 6.
(a) Private Income : Private income refers to the income which accroes to private sector
from all the sources within and outside the country.
(i) It includes both earned income and unearned income received by private sector.
(ii) It consists of two types of income :
(a) Factor income (b) Transfer income
(iii) Private income = Personal Income + Corporate tax + Retained earnings.
(iv) Private income includes personal income.
Personal Income : Personal Income is the sum total of all the income that are actually
received by households from all the sources.
(b) Following are the steps involved in estimating national income by value added method.
(i) Identification of producing enterprises and their classification : In the first step,
the productive enterprise are identified and classified to primary, secondary and
tertiary sectors.
Primary sector includes agriculture and allied activities etc, second sector incdudes
manufacturing activities, and tertiary sector includes the service sector like banking,
insurance etc.
(ii) Estimation of net value added : The second step is the estimation of net value added.
This requires the information of value of output. We have to deduct the following
from the value of output :
Value of intermediate consumption, consumption of fixed capital and net indirect
taxes.
(iii) Estimation of net factor income from abroad : The final step is to estimate the net
factor income earned from abroad and add it to the net domestic product. Thus,
National Income or Net National Product at Factor Cost.
= Gross Value Added in the primary sector at market prices
+ Gross Value Added in the secondary sector at market prices
+ Gross Value Added in the tertiary sector at market prices
(= Gross domestic product at market prices)
+ Consumption of fixed capital

(= Net domestic product at market prices)
+ Net Indirect Taxes (Indirect Tax – Subsidies)
(= Net Domestic product at factor cost)
+ Net factor Income from abroad.
(c) (i) National Income by Income Method :
National Income = NDPFC + Net factor income from abroad
NDPFC = Compensation of employees + rent and
royalty interest + profit + mixed income
= 1000 + 250 + 150 + 640
= 2040
NNPFC = 2040 – 30 = 2010.
(ii) Expenditure Method :
National Income = – GDPMP – Depreciation + NF/A
GDPMP = Private final consumption + Govt. final
Consumption + gross domestic capital
formation + Net Exports.
Gross Domestic Capital formation = Net Domestic Capital formation + Depreciation
= 340 + 50
= 390
GDPMP = 1200 + 600 + 390 – 40
= 2150
NNPFC = 2150 – 50 – 60 – 30
= 2010.
Answer 7.
(a)
Average Propensity to Save (APS) Marginal Propensity to Save (MPS)
(1) It refers to the ratio of saving to the It refers to the ratio of change in saving to
corresponding level of income at a change in total income over a period of time.
point of time.
(2) APS can be less than zero when MPS can never be less than zero as change in
there are dissavings, till consump- saving can never be negative i.e., change in
tion is more than national incomes. consumption can never be more than change
in income.
(3) APS = S/Y MPS = S/Y
(i) APS can be negative or less than 1 : At income levels which are lower than the break -
even point, APS can be negative as there will be dissavings in the economy.
(ii) MPS can never be less than zero as change in saving can never be negative i.e., change in
consumption can never be more than change in income.
Economics | 13
(b) Deficit demand refers to the situation when aggregate demand is less than the aggregate
supply corresponding to the full employment level of output in economy.
Full employment
Y equilibrium
E
Aggregate Demand
Deficient Demand
E1
45º
O X
Income/output/
Employment 
Open market operations refer to sale and purchase of securities in the open market by
the Central Bank. It directly influences the level of money supply in the economy.
During excess demand, Central Bank offers securities for sale that reduces the reserves
of commercial banks, decreasing the level of aggregate demand in the economy.
(c) An indifference curve is a curve which depicts the various alternative combinations of
the goods which provide same level of satisfaction to the consumer. It is a graphical
representation of indifference schedule which lists such combination of the goods giving
same total satisfaction to the consumer.
Y
Good Y
IC4
IC3
IC2
IC1
O X
Good X
IC1 represents the lowest satisfaction, IC2 show's satisfaction more than that of IC1 and
highest level of satisfaction is depicted by Indifference IC4. However, each indifference
curve shows the same level of satisfaction individually.
Answer 8.
(a) (i) The basis of classification of Budget into Revenue expenditure and capital
expenditure is whether;
(1) The expenditure creates an Asset or not.
(2) The expenditure reduces a liability or not.
Revenue Expenditure neither creates any assest nor reduces any liability of the govern-
ment. They are recurring in nature.
Capital Expenditure either creates an asset or reduces a liability of the govt. It is non-
recurring in nature.
(ii) The basis of classification of Budget into plan budget and performance budget is :
(1) How the funds spent are expected to give outputs and ultimately the outcomes.
(2) Whether the expenditure of government is to fulfill its planned development
programmes or beyond the scope of the planned expenditure.
(3) Expenditure is related to the current five year plan or otherwise.
(b) Marginal rate of substitution refers to the rate at which the commodities can be substi-
tuted with each other, so that total satisfaction of the consumer remains the same.
Quantity of good sacrificed
MRSxy = Quantity of good obtained
y
MRSxy =
x
For e.g. In the case of oranges (A) and Guavas (B), MRS of A for B will be number of unit
of B that the consumer is willing to sacrifice for an additional unit of A.
B
MRSAB =
A
(c) different measures to check inflation are as follows :
(i) Legal Reserves : Legal or Statutory reserve is the fraction of total demand deposites
which the commercial banks are required to keep with central bank. Inflationary
gap or excess demand is a situation in which aggregate demand exceeds aggregate
supply at full time employment.
To reduce the inflationary gap following components of legal reserves can be used :
(1) Cash Reserve Ratio (CRR) : CRR is the ratio between cash reserves of the
commercial banks with Central Banks and its total deposits Central bank raises CRR
to reduce capacity of commercial banks to create credit. Reduction in the credit
leads to reduction in aggregate demand.
(2) Statutory Reserve Ratio (SLR) : SLR is the ratio between the liquid assets and total
assets of the commercial banks. Central bank raises statutory reserve ratio to
reduce the capacity of commercial banks to create credit.
(3) Open Market Operations : Open market operations means policy of Central Bank to
sell and buy government securities in the market. Open market operations affect the
volume of cash reserves with the commercial banks and thus the overall
availability of credit. Sale of government securities, by Central Banks results in
decline of credit. Purchase of securities by the Central Bank increases the cash
researves with the commercial banks and thus credit. During excess demand
Central Bank sells government securities to commercial banks which motivates the
commercial banks to create less credit.
Answer 9.
(a) Law of Diminishing Marginal Utility : Law of Diminishing Marginal Utility states that
as we consume more and more units of a commodity, the utility derived from each
successive unit goes on decreasing.
The law of Diminishing Marginal Utility can be explained by the following table and
diagram :
Units of ice-cream Total Utility (in Uts) Marginal Utility

1 20 20
2 36 16
3 46 10
4 50 4
5 50 0
6 44 –6
Economics | 15
Y
20 A
16 B
12
C
8
D
4
E
X
O 1 2 3 4 5 6
–4 Units of Ice-cream Negative MU
F
–8 MU
–Y
from the given schedule and diagram it can be calculated that, with the increase in the
consumption of ice-cream the marginal utility decreases and finally after the saturation
point or optimum level it becomes negative.
MU curve slopes downwards showing successive decrease in the utility.
Starting from point A in the above diagram the MU keeps on falling as seen on point B,
C, D and finally at point E (i.e., point of optimum satisfaction, (MU = 0).
Beyond E, MU becomes negative as seen on point F.
(b) Due to inverse relationship between price and demand, demand curve slopes down-
ward. Following three factors causes on increase in demand of commodity or rightward
shift of the demand curve :
(i) Rise in income of the consumer : A rise in the income of the consumer increases the
capacity of the consumer to purchase more quantity of the commodity. As a result,
there will be increase in demand of a commodity.
(ii) Fall in the price of complementary good : A fall in the price of a complementary
good results in the increase in demand of complementary good as well as of good in
question because complementary goods are used together.
(iii) Rise in the price of substitute : A rise in the price of substitute good makes the
commodity in question relatively cheaper. Hence, demand of the commodity
increases because substitute goods can be used in place of another.
(c) Substitute and complementary goods :
(i) Substitutute Goods Complementary Goods
1. Substitute goods refer to those 1. Complementary goods refer to those goods

goods which can be used in place which are used together to satisfy a
of one another to satisfy a particular want.
particular want.
2. Substitute goods have competitive 2. Complementary goods have joint demand.
demand.
3. Price of one substitute good has 3. Price of complementary good has negative
positive relationship with quantity relationship with quantity demanded of
demanded of substitute good. another complementary good.
Eg., Tea and Coffee. Eg., Tea and Sugar.
(ii) Marginal Utility Total Utility

1. Marginal Utility is the additional 1. Total Utility refers to the total satisfaction
utility derived from the obtained from the consumption of are
consumption of one more unit of the possible units of a commodity.
given comodity.
2. MU = TUn – TUn – 1 2. TU = U1 + U2 + U3 .......... + Un
3. It measures satisfaction obtained 3. It measures total satisfaction obtained from
from the consumption of one more the consumption of all possible units.
unit of commodity made to the total
utility.

SOLUTION

PART – I
Answer 1.
(i) Supply refers to quantity of a commodity that a firm is willing to produce and offer for
sale at a given price during a given period of time.
Supply consists of four essential elements :
(a) Quantity of a commodity
(b) Willingness to sell
(c) Price of the commodity
(d) Period of time.
(ii) (a) Competitive Demand : When two goods are close substitutes of each other and
increase in demand for one of them will decrease the demand for the other, then the
demand for any one of them is known as competitive demand.
(b) Joint Demand : When two or more goods are demanded simultaneously to satisfy a
particular want, then such a demand is called joint demand.
(iii) Total product refers to total quantity of goods produced by a firm during a given period
of time with given number of inputs.
Marginal product refers to addition to total product, when one more unit of variable
factor is employed.
MPn = TPn – TPn–1
MPn = Marginal product of n unit of variable factor;
th
TPn = Total product of n units of variable factor;

TP n–1 = Total product of (n – 1) units of variable factor;
n = Number of units of variable factor.
(iv) Total Average cost refers to the per unit total cost of production. It is calculated by
divding TC by total output.
TAC = TC  Q
Y
Total Average cost (in ` )
18 TAC
15
A
12
9 B
6
3
O X
1 2 3 4 5
Output (in unit)
(v) Difference between Personal Income and Per Capita Income
Personal Income Per Capita Income

1. It refers to income actually received by It refers to income per person or average
households from all sources. income of the population of a nation.
2. It is a narrower concept as it is a part of It is a broader concept as it is the measurement
private income. of growth of a country.
3. Personal Income = Private Income- Per capita Income = GDP + Income earned by
Corporate tax–Retained earnings foreign investment  population
(vi) These are special kind of inferior goods on which the consumer spends a large part of his
income and their demand rises with an increase in price and demand falls with decrease
in price.
(vii) Indifference Map refers to the family of indifference curves that represent consumer
preferences over all the bundles of the two goods.
Y
Commodity Y
I3
A B I2
I1
O R S X
Commodity X
(viii) Concept of Money supply
M1  It is the first and basic measure of money supply. It is also knowns as `transaction
money' as it can be directly used for making transactions.
M2  It is a broader concept of money supply as compared to M1. In addition to M1, it
also includes savings deposits with Post Office saving banks.
M3  This concept is broader as compared to M1. In addition to M1, it also includes Net
Time Deposits.
M4  This measure includes total deposits with Post Office saving banks in addition to
M3.
(ix) Difference between Fixed and Fluctuating exchange rates.
Fixed Exchange Rate Fluctuating Exchange Rate

1. It is officially fixed in terms of gold It is determined by forces of demand and
or any other currency by supply of foreign exchange.
government.
2. The exchange rate generally The exchange rate keeps on changing.
remains stable and only a small
variation is possible.
(x) Full employment is a situation in which all resources are fully employed and economy
produces the largest output that the economy is capable of producing.
PART – II
Answer 2.
(a) Budget line is a graphical representation of all possible combinations of two goods which
can be purchased given current prices wihin his or her given income such that the cost
of each of these combinations is equal to the money income of the consumer.
Combination of Oranges Oranges (A) Mangoes (B) Money spent
and Mangoes ( 4 each) ( 2 each) Income
E 5 0 (5 × 4) +(0 × 2) = 20
F 4 2 (4 × 4) +(2 × 2) = 20
G 3 4 (3 × 4) +(4 × 2) = 20
H 2 6 (2 × 4) +(6 × 2) = 20
I 1 8 (1 × 4) +(8 × 2) = 20
J 0 10 (0 × 4) +(10 × 2) = 20
Economics | 3
Y C
Budget line
Unattainable
10 J Combination
Mangoes (B) 
8 I
6 H
4
D
2 E
E
X
O 1 2 3 4 5 A
Oranges (A) 
Point ‘D’ indicates that income is underspent.
(b) An indifference curve is convex to the origin due to diminishing marginal rate of
substitution (MRS). Diminishing MRS means that the number of units of `Good Y' for
which consumer wants to substitute for one extra unit of `Good X' goes on decreasing as
the consumption of Good X increases. As consumption of Good X increases, the willingness
to pay for it diminishes (due to the law of diminishing marginal utility). This payment is
in terms of the units of good Y sacrificed. Thus, MRS diminishes along an the indifference
curve, which makes it convex to the origin.
Y
65
60
55
50
GoodY
45
40
35
30
25
20
15
10
5
O X
1 2 3 4 5 6 7 8
Good X
(c) Three determinant of demand for a commodity are as follows :
(i) Price of the given commodity : It is the most important factor affecting demand for
the given commodity. Generally, there exists an inverse relationship between price
and quantity demanded. It means, as price increases, quantity demanded falls due
to decrease in the satisfaction level of consumers.
(ii) Income of the Consumer : Demand for a commodity is also affected by income of
the consmer. However, the effect of change in income on demand depends on the
nature of the commodity under consideration.
• If the given commodity is a normal good, then an increase in income leads
to rise in its demand, while a decrease in income leads to fall in its demand.
• If the given commodity is an inferior good, then an increase in income leads
to fall in its demand, while a decrease in income leads to rise in its demand.
(iii) Tastes and Preferences : Tastes and preferences of the consumer directly influence
the demand for a commodity. They include changes in fashion, customs, habits,
etc. If a commodity is in fashion or is preferred by the consumers, then demand
for such a commodity rises. On the other hand, demand for a commodity falls,
if the consumers have no taste for that commodity.
Answer 3.
(a) When proportionate increase in total output is less than proportionate increase in inputs,
it is Diminishing Returns to Scale. It means, if all the inputs are increased by 100%, then
the output increase by less than 100%. Decreasing Returns to scale occurs mainly due to
diseconomies of large scale. Diseconomies of scale mean that a firm has grown so large
that it becomes very difficult to manage it.
Y
R
P1
Returns 
O X
Q Q1
Units of labour Capital 
When factors of production increases from Q to Q1, price increase from P to P1. Increase
in factors of production is more and increase in production is comparatively less. Output
changes due to change in efficiency of all factors.
(b) Difference between Increase and Extension in Demand
Increase in Demand Extension in Demand

1. Increase in demand refers to a rise in When the quantity demanded rises due to a
the demand of a commodity caused due decrease in the price, keeping other factors
to change in factors other than the price constant, it is known as expansion in
of the commodity. demand.
2. There is a rightward shift in demand There is a downward movement along the
curve. same demand curve.
3. Price ( ) Demand units Price ( ) Demand (units)
12 100 12 100
12 150 10 150
4. It occurs due to favourable change in It occus due to a decrease in the price of the
the other factors like increase in the given commodity.
prices of substitutes, decrease in the
prices of complementary goods, increase
in income in case of normal goods, etc.
(c) Marginal cost refers to addition to total cost when one more unit of output is produced.
MC can be calculated from both TC and TVC. MC curve is obtained by plotting the
points. MC is a U-shaped curve, i.e., MC initially falls till it reaches its minimum point
and, thereafter, it starts rising. The reason behind its U-shaped is the law of variable
proportions.
Y
18 Marginal Cost Curve

Marginal Cost (in ` ) 
15 MC
12
O X
1 2 3 4 5
Output (in units) 
Answer 4.
(a) Producer's Equilibrium refers to that price and output combination which brings
maximum profit to the producer and profit declines as more is produced. Producer's
Economics | 5
Equilibrium can be well understood with the diagram of MC (Marginal Cost) and Price
line given below.
Y
MC
Revenue andCost (in ` ) 

R K
P AR = MR
O Q1 Q X
When price remains constant, firms can sell any number of quantity of output at the
fixed price.
In this situation, the average revenue curve (AR) or price line remains the same at all
levels of output.
Also MR = AR or MR curve coincides with the AR curve which is a straight line.
Producer's Equilibrium will be determined at a level where MC = MR output level.
As long as MC is less than MR, it is profitable for the producer's to produce as many
quantity as he can because this situation adds to producer's profit.
When MC = MR is satisfied the producer will be at equilibrium.
When MC is greater than MR, producing more units of output will lead to the decline in
profit.
(b) Equilibrium is at MR = MC i.e., at output level 5.
Output Price in TR TC MR MC Profit = TR – TC
(Units) ( ) ( ) ( ) ( ) ( ) ( )
1 5 5 7 5 7 –2
2 5 10 12 5 5 –2
3 5 15 15 5 3 0
4 5 20 18 5 3 2
5 5 25 23 5 5 2
6 5 30 32 5 9 –2
7 5 35 44 5 12 –9
(c) In case of perfect competition, There are very large number of buyers and sellers selling
a homogeneous product at a fixed price by the market. Therefore, each firm is a price-
taker and faces a perfectly elastic demand curve.
Y
Price/Revenue (in ` ) 
Ed = 
P Demand Curve
(AR Curve)
O Q1 Q2 X
Outputs (in units) 
Under monopolistic competition, large number of firms selling closely related but
differentiated products makes the demand curve downward sloping. It implies that a
firm can sell more output only be reducing the price of its product.
Demand curve under monopolistic competition is negatively sloped as more quantity
can be sold at a lower price.
Y
P
Demand Curve
P1 (AR curve)
O X
Q Q1
Answer 5.
(a) Perfect competition is used in wider sense as compared to pure competition. The
competition is said to be `Pure competition'. When the following three fundamental
conditions exist :
(i) Very large number of buyers and sellers;
(ii) Homogeneous product;
(iii) Freedom of entry and exit.
Perfect competition is a wider concept for the market to be perfectly competitive, in
addition to three fundamental conditions, four additional conditions must be satisfied :
(i) Perfect knowledge among buyers and sellers;
(ii) Perfect mobility of factors of production;
(iii) Absence of transportation costs;
(iv) Absence of selling costs.
(b) Price Discrimination refers to the practice of charging different prices from different
buyers at the same time for the same product. In other words price discrimination can be
defined as the practice of selling same product at different prices to different kinds of
buyers or at different places or on the basis of different uses.
A monopolist may charge different prices of his product from different set of consumers
at the same time.
Under monopoly a single seller selling the product has numerous advantages.
(i) As monopolist has full control over the supply and price of the product, for example
Railway ticket is cheaper for senior citizens as compared to young citizens.
(ii) As monopolist is a price-maker and fixes its own price so that it can charge different
prices on the basis of different uses, For example—Electricity charges are lower for
residential use as compared to commercial use.
(c) When decrease in demand is equal to increase in supply that is the leftward shift in
demand curve from DD to D1D1 is equal to the rightward shift in supply curve from SS
to S1S1. The new equilibrium is determined at E1 equilibrium quantity remains the same
at OQ, but equilibium price falls from OP to OP 1.
Economics | 7
Y
D S
D1
S1
P
Price (in ` ) 
E
P1 E1
S D
S1 D1
X
O Q
Quantity demanded and
supplied (in units) 
When Decrease in demand more than increase in supply that is the leftward shift in
demand curve from DD to D1D1 is more than the rightward shift in supply curve from
SS to S1S1. The new equilibrium is determined at E1, equilibrium quantity falls from OQ
to OQ1 and equilibrium price fall from OP to OP1.
Y
D S
S1
P E
Price (in ` ) 
D1
D
E1
S D1
S1
O X
Q1 Q
supplied (in units) 
When decrease in demand is less than increase in supply then leftward shift in demand
curve from DD to D1D1 is less than the rightward shift in supply curve from SS to S1S1.
The new equilibrium is determined at E1, equilibrium quantity rises from OQ to OQ1
whereas, equilibrium price falls from OP to OP 1.
Y
D S
D1
Price (in ` ) 
E S1
P
P1 E1
D
S
S1 D1
X
O Q Q1
Supplied (in units) 
Answer 6.
(a) Real Flow Factors Services
(Land, Labour, Capital and Enterprise)
Households Firms
Goods and Services
(i) It is the flow of goods and services between firms and households.
(ii) There may be difficulties of barter system in exchange of goods and factor services.
(iii) It is also known as physical flow.

(iv) It involves exchange of goods and services.
Money flow
Consumption
Expenditure
(on goods and services)
Households Firms
Factor Payments
(Rent, Wages, Interest and Profit)
(i) It is the flow of money between firms and households.
(ii) There is no such difficulty in case of money flow.
(iii) It is also known as Nominal flow.
(iv) It involves exchange of money.
(b) Following are the components of domestic factor income :
(i) Compensation of employees (traditionally called wages)
(ii) Rent
(iii) Interest
(iv) Profits (= Dividend + profit tax + Undistributed profit)
(v) Mixed income.
Sum of these components received within the domestic territory of a country in a
year is called Domestic Income or NDPFC.
(c) Value of output = Sales + Change in stock
= 600 + (40 – 10)
= 600 + 30
= 630
Value added = Value of output – Intermediate Consumption
= 630 – 200
= 430
Intermediate consumption = Purchase of raw material
Imports in this case won't be added.
Answer 7.
(a) Difference between Marginal Propensity to save and Marginal Propensity to consume.
Marginal Propensity to Save (MPS) Marginal Propensity to Consume (MPC)
1. It refers to the ratio of change in saving It is the ratio of change in consumption

(S) to change in total income (Y) over expenditure (C) to change in income (Y)
a period of time. over a period of time.
2. MPS can never be less than zero as MPC cannot be more than one as change in
change in saving can never be negative, consumption cannot be more than change
i.e., change in consumption can never in income.
be more than change in income.
S C
3. MPS = MPC =
Y Y
Economics | 9
The sum of MPC and MPS is equal to one.
MPC + MPS = 1
This is because total increment in income is either used for consumption or for saving.
(b) Multiplier expresses the relationship between an initial increment in investment and the
resulting increase in aggregate income when investment is increasd by a certain amount,
then the change in income is not restricted to the extent of the initial investment, but it
changes several times to the change in investment. In other words, change in income is
a multiple of the change in investment.
Y
K=
I
The minimum value of multiplier is one when the value of MPC is zero. MPC = O indicates
that the economy decides to save the whole of its additional income and nothing is spent
as consumption expenditure.
(c) Deficient demand refers to the situation when aggregate demand (AD) is less than the
aggregate supply (AS) corresponding to full employment level of output in the economy.
Full employment
Y equilibrium
E
Aggregate Demand
Deficient Demand
E1
45º
O X
Income/output/
Employment 
Deficient demand adversely affects the level of output, employment and price level in
the economy.
(i) Effect on output : Due to lack of sufficient aggregate demand, there will be an increase
in the inventory stock. It will force the firms to plan for lesser production for the
subsequent period. As a result, planned output will fall.
(ii) Effect on Employment : Deficient demand causes involuntary unemployment in
the economy due to fall in the planned output.
(iii) Effect on General Price level : Deficient demand causes the general prices to fall
due to lack of demand for goods and services in the economy.
Answer 8.
(a) Balance of Payment is an accounting statement that provides a systematic record of all
the economic transactions, between residents of a country and the rest of the world, in a
given period of time.
Disequilabrium in BOP of a country may arise if their is surplus or deficit in BOP. Deficit
in BOP account arises because of the following reasons.
(i) When total inflow on account are less than that of outflow of foreign exchange.
(ii) When there is large imports due to heavy scale development expenditure and less
exports.
(iii) Instability in the political environment of the country leading to frequent change of
the government or lack of adequates support to the government.
(b) Fiscal deficit refers to the excess of total expenditure over total receipts (excluding
borrowings during the given biscal year.
Fiscal deficit indicates the total borrowings requirements of the government. Borrowings
not only involve repayment of principal amount, but also require payment of interest.
Interest payment increase the revenue expenditure, which leads to revenue deficit. It
creates a vicious circle of fiscal deficit and revenue deficit, wherein government takes
more loans to repay the earlier loans. As a result, country is caught in a debt trap.
Government mainly borrows from Reserve Bank of India (RBI) to meet its fiscal deficit
RBI prints new currency to meet the deficit requirements. It increases the money supply
in the economy and creates inflationary pressure.
Government also borrows from rest of the world, which raises its dependence on other countries.
Borrowings increase the financial burden for future generations. It adversely affects the
future growth and development prospects of the country.
(c) Three monetary measures to control excess demand in the economy are.
(i) Cash Reserve Ratio : Cash reserve ratio is the ratio between cash reserves of the
commercial banks with central bank and its total deposits when Central Bank
raises cash reserve ratio it reduces the capacity of commercial banks to create
credit. Reduction in the credit leads to reduction in aggregate demand.
(ii) Bank Rate : Bank rate means the rate of interest at which Central Bank lends to
commercial banks. Any change in bank rate affects credit creation by commercial
banks. An increase in bank rate leads to an increase in commercial banks leading
rate of interest. As a result, credit becomes costly because rate of interest is cost of
credit. An increase in bank rate discourages commercial banks in borrowing from
Central Bank. Thus, increase in bank rate reduces the quantum of credit with the
commercial banks that can be advanced to public as loans.
(iii) Open Market Operations : Open market operation means policy of Central Bank to
sell and buy government securities in the market. Open market operations affect
the volume of cash reserves with the commercial banks and, thus the overall
availability of credit. Sale of government securities by Central Bank to commercial
banks reduces the cash reserves with the banks resulting in decline of credit. Purchase
of securities by the Central Bank increases the cash reserves with the commercial
banks and thus credit. During the phase of excess demand, Central Bank sells
government securities to commercial banks which motivates the commercial bank
to create less credit.
Answer 9.
(a) Difference between Market Price and Normal Price
Market Price Normal Price

1. Market price is the price which Normal price is that price which is the
prevails in the market on a single outcome of permanent forces which bring
day. about changes in demand and supply.
2. Market price is very short period Normal price is that price which tends to
price which prevails at a particular prevail in the long run.
time.
3. Market price has temporary Normal price is stable and thus, has a
equilibrium. permanent equilibrium.
4. Market price can be above or below Normal price is always equal to the long-
the average cost of production. run average cost at its minimum point.
Economics | 11
(b) The relationship between an increase in the price of an input and the supply curve of a
firm can be well understood by the following schedule and diagram.
Y
S2 SS
decrease in supply S1
Price (in) ` Quantity (in units) 5 increase in supply

B A C
10 10
Price (in ` ) 
4
10 20 3
10 30 2
S2 S1
10 40 1
10 50 X
O 10 20 30 40 50
Quantity supplied (in units)
Price remains constant.
Supply of a good is also affected by other factors of production keeping price of the
goods as constant.
There is inverse relationship between supply and cost of production of a commodity. As
there will be rise in the input prices, the marginal cost of production increases and
production of that good or commodity becomes less profitable. As a result there will be
decrease in supply of the commodity.
On the other hand, when there is fall in the price of the inputs, cost of production decreases
and its will be more profitable to supply those commodity. Thus increase in supply.
(c) Following are the three reasons for rightward shift of demand curve for a commodity.
(i) Rise in income of the consumer : A rise in the income of the consumer increases
the capacity of the consumer to purchase more quantity of the commodity. As a
result, there will be increase in demand of a commodity.
(ii) Fall in the price of complementary good : A fall in the price of a complementary
good results in the increase in demand of complementary good as well as of good
in question because complementary goods are used together.
(iii) Rise in the price of substitute good : A rise in the price of substitute good
makes the commodity in question relatively cheaper. Hence, demand of the
commodity increases because substitute goods are used in place of one another.

SOLUTION

PART – I
Question 1.
(i) Variable costs refer to those costs which vary directly with level of output. For example,
payment for raw material, power fuel, wages of casual labour etc. Variable costs are
incurred on variable factors like raw material, direct labour, power, etc., which changes
with change in level of output. It means, variable costs rise with increase in the output
and fall with decrease in the output.
(ii) Demand deposits refer to those deposits which are repayable by the banks on demand.
Such deposits are generally maintained by businessmen with the intention of making
transactions with such deposits. They can be drawn upon by a cheque without any
restriction. Banks do not pay any interest on these accounts. Rather, banks impose service
charges for running these accounts.
(iii) Supply refers to the quantity, which a producer is willing to offer for sale, which changes
with change in price, whereas, stock indicates a fixed quantity.
Supply relates to a period of time, whereas, stock relates to a particular point of time.
(iv) Implication of large number of buyers and sellers is that the number of sellers is so large
that the share of each seller is insignificant in the total supply. Hence, an individual
seller cannot influence the market price. Similarly, a single buyer's share in total purchase
is so insignificant because of their large numbers. Therefore individual buyer can not
influence the market price.
Under such conditions, price of a commodity is determined by the market forces of
demand and supply and each buyer and seller has to accept the same price.
(v) The various contingent functions of money are :
(a) Basis of credit creation : Credit creation by commercial banks was not possible
until money was introduced. Money as a store of value has encouraged savings by
people in the form of demand deposits in banks. Such demand deposits are used by
the commercial banks to create credit.
(b) Productivity of capital : Money increases the productivity of capital as it is the most
liquid asset and can be put to use. Due to liquidity of money, capital can be
easily transferred from less productive uses to more productive uses.
(vi) Features of Monopoly :
(a) Single Seller : Under monopoly, there is a single seller selling the product. As a result,
the monopoly firm and industry are one and the same thing and monopolist has full
control over the supply and price of the product. However, there are large number
of buyers of monopoly product and no single buyer can influence the market price.
(b) No close Substitutes : The product produced by a monopolist has no close substitutes.
So, the monopoly firm has no fear of competition from new or existing products. For
example, there is no close substitute of electricity services provided by TPDDL in
some parts of Delhi. However, the product may have distant substitutes like inverter
and generator.
(vii) Two assumptions behind ordinal approach of determining consumer equilibrium are :
(a) Utility is a psychological phenomenon and it is impossible to measure the utility in
absolute terms.
(b) Consumer can rank various combinationgs of goods and services according to
his preferences.
(viii) The corporation tax is the tax on the income (profits) of the companies, both domestic
and foreign companies, operating in India. Corporation tax is a type of direct tax as its
liability to pay the tax and actual burden of the tax lie on the same person. These taxes
are generally progressive in nature and have limited reach as they do not reach all the
sections of the economy.
Households do not spend there entire income on consumption rather part of the payment
is saved. Part of this payment is also spent on paying various taxes levied by the
government. These taxes are used by the government to regulate money flow in the
Fconomy.
nts Government
yme ts
a en
r P ym ts
to
Borrowings
en
pa
c
Fa
ym
Savings
er
nsf
pa
Tra
Tax
Savings Savings
Households Financial Firms
Market
Borrowings Borrowings
Con
sump
tion Expenditure
Factor Payments
(ix) Private Income = Income from Domestic Product Accruing to Private sector + Net Factor
Income from Abroad + National Debt Interest + Current Transfers from Govenment + Net
Current Transfers from rest of the world
(x) The situation when equilibrium price doesn't change despite the change in the demand
are as follows :
(a) Increase in demand = Increase in supply
(b) Decrease in demand = Decrease in supply
(c) Increase in demand when the supply is perfectly elastic.
(d) Decrease in demand when the supply is perfectly elastic.
PART – I
Answer 2.
(a) Assumptions of Law of Supply.
(i) Price of other goods is constant;
(ii) There is no change in the state of technology;
(iii) Price of factors of production remain the same;
(iv) There is no change in the taxation policy.
(b) Budget line is a line representing all the bundles of goods which cost exactly equal to
the consumer's income. Budget line shows the maximum units of the commodity,
the consumer can purchase with his given money income and given market prices of
the goods (x and y). However, within these two limits, the consumer can have any
Economics | 3
combination of x and y. If the consumer moves from one combination to another option,
he will have to give up some units of x to gain extra unit of y. As a result, budget line has
a downward slope i.e., it slopes downward from left to right. The slope of budget line
Px
is P . Here, Px is the price of commodity shown on horizontal axis and Py is the price of
y
commodity shown on vertical axis.
Y
Good Y
B
X
O Good X
(c) The Giffen's Paradox states, Giffen goods have an indirect relationship with price and
demand as well as a direct relationship with income and demand. It is an exception to
the law of demand. Giffen goods are inferior goods. The demand curve for the Giffen
goods can be shown in the following diagram.
Y
D1 D
Price (in ` ) 
D
D1
O Q1 Q X
Demand of X(inferior) 
Giffen Goods Inferior Goods
1. Giffen goods are special kind of Inferior goods are those goods in which
inferior goods is which negative substitution effect is postive but income effect
income effect is stronger than is negative.
positive substitution effect.
2. It has negative price effect or its It has positive price effect as its demand rises
demand falls with fall in its price with fall in its price.
3. Law of demand does not apply for Law of demand applies for these goods.
Giffen goods.
4. Demand curve slope upwards. Demand curve slope downwards.
5. Eg. Jowar E.g. Amul Toned Milk
Answer 3.
(a) Price Elasticity of demand can also be calculated by total expenditure method. This method
was suggested by Prof. Marshall. This method is also known as Total Outlay or Total
revenue method. Under this method, price elasticity is measured by comparing.Total
Expenditure (TE) on the commodity before and after the change in price. It has three
possibilities :
 Ed > 1, if TE is inversely related to the price.

 Ed < 1, if TE is directly related to the price.
 Ed = 1, if TE does not change with change in price.
(b) When supply of a commodity change due to change in any factor other than the own
price of the commodity, it is known as `change in supply'. It is graphically expressed as
a shift in the supply curve.
Y
S2 S
S1
Price (in ` ) 
S2
S
S1
O Q2 Q Q1 X
Quantity supplied (in units)
Increase in supply is shown by rightward shift in supply curve from SS to S 1S1. Supply
rises from OQ to OQ1 due to favourable change in other factors at the same price OP.
Decrease in supply is shown by leftward shift in supply curve from SS to S2S2. Supply
falls from OQ to OQ2 due to unfavourable change in other factors at the same price OP.
(c) Various factors which affect the elasticity of demand of a commodity are :
(i) Availability of Substitutes : Demand for a commodity with large number of
substitutes will be more elastic. The reason is that even a slight rise in its
prices will induce the buyers to go for its substitutes. For example a rise in the
price of Pepsi would encourage buyers to buy Coke and vice-versa. Thus,
availability of close substitutes makes the demand sensitive to change in the prices.
On the other hand, commodities with few or no substitutes like wheat and salt
have less price elasticity of demand.
(ii) Income level : Elasticity of demand for any commodity is generally less for higer
income level groups in comparison to people with low incomes. It happens
because rich people are not influenced much by changes in the price of goods.
But, poor people are highly affected by increase ordecrease in the price of goods. As
a result, demand for lower income group is highly elastic.
(iii) Level of Price : Level of price also affects the price elasticity of demand. Costly
goods like laptop, AC, etc. have highly elastic demand as their demand is very
sensitive to change in the prices.
However, demand for inexpensive goods like needle, match box, etc is inelastic as
change in prices of such goods do not change their demand by a considerable amount.
Answer 4.
(a) The relationship between AVC and MC curves can be explained as follows :
Both AVC and MC are derived from total variable cost (TVC). AVC refers to TVC per
unit of output and MC is the addition to TVC, when one more unit of output is produced.
Both AVC and MC curves are U-Shaped due to the law of variable proportions.
Economics | 5
The relationship between AVC and MC can be well understood by the following schedule
and diagram.
Output TVC AVC MC
0 0 – –
1 6 6 6
2 10 5 4
3 15 5 5
4 24 6 9
5 35 7 11
MC
Y
12 AVC
10
Cost (in ` ) 
8
6
4 B
2
X
O 1 2 3 4 5
(i) When MC is less than AVC, AVC falls with increase in the output, i.e. till 2 units of
output.
(ii) When MC is equal to AVC, i.e. when MC and AVC curves intersect each other at
point B, AVC is constant at its minimum point (at 3rd unit of output).
(iii) When MC is more than AVC, AVC rises with increase in output, i.e. from 4 units of
output.
(iv) Thereafter, both AVC and MC rise, but MC increases at a faster rate as compared to
AVC. As a result, MC curve is steeper as compared to AVC curve.
(b) Difference between Fixed and Variable costs.
Fixed Costs Variable costs
1. Fixed costs refer to those costs which do Variable costs refer to those costs which vary
not vary directly with the level of out directly with the level of output.
put.
2. It cannot be changed in the short run. It can be changed in the short run
3. It can never be zero even if there is no It can be zero when there is no production.
production.
4. It is incurred on fixed factors like land, It can be incurred on variable factors like
building etc. labour, raw material etc.
5. FC is a horizontal straight line parallel VC is inversely S-shaped as variable cost
to the X-axis as fixed cost remains the increases initially at a decreasing rate, then at
same at all levels of output. constant rate and finally at an increasing rate.
6. Salary of permanent staff, insurance Wages of casual labour, payment of raw
premium, building rent, etc. material etc.
(c) Law of Variable Proportion explains the production function in the short run when all
the factors of production are not variable. In other words, it explains the relationship
between physical inputs and physical outputs when one or more factors is kept constant
and other factors are varied. When the application of one factor is varied while keeping
the other factors constant, the proportions in which the various factors are combined,
change. According to Law of Variable Proportions, given an increase in one factor of
production, other factors remaining unchanged, total production increases initially at an
increasing rate, and finally at a diminishing rate.
There are three stages of the law :
(i) Total product increases at increasing rate i.e., marginal product increases.
(ii) Total product increases at diminishing rate i.e., marginal product decreases.
(iii) Total product starts falling i.e., marginal product decreases and becomes negative.
Three stages of Law of Variable Proportions may be shown in the diagram below.
In the diagram, phase I remains upto A on TP curve and upto K on MP curve, Phase
II remains from A to B on TP curve and K to L on MP curve and Phase III starts from
B on TP curve and L on MP curve.
Y
TP
A TP
Output
Phase I Phase II Phase III

O X
Variable Input
MP
Phase I Phase II L Phase III

X
O Variable Input
Unit of Variable factor
MP
Answer 5.
(a) Difference between Average Revenue and Marginal Revenue :
Average Revenue Marginal Revenue

1. Average revenue refers to revenue per Marginal revenue is the additional revenue
unit of output sold. generated from the scale of an additional unit
of output.
2. It is obtained by dividing the total It is the change in TR from scale of one more
revenue by the number of units sold. unit of commodity.
Total Revenue MRn = TRn – TRn–1
Average Revenue = Quantity
(b) Elasticity of supply depends upon a number of factors.

(i) Nature of commodity : On the basis of nature, commodities may be classified as
perishable goods and durable goods.
Durable goods like furniture, TV etc. have elastic supply, as they can be stored and
their supply can be changed according to changes in their prices.
Economics | 7
On the other hand, perishable commodities like vegetables, fruits etc. have
inelastic supply, because they cannot be stored and have to be disposed off
within a very short period, irrespective of their prices.
(ii) Time element : In the market period, supply of a commodity is perfectly inelastic as
supply cannot be changed immediately with change in price. In the short period,
supply is relatively less elastic as firm can change the supply by changing the variable
factors.
In the long period, supply is more elastic as all the factors can be changed and
supply can be easily adjusted as per changes in price.
(c) According to TR and TC approach, producer's equilibrium refers to stage of that output
level at which the difference between TR and TC is positively maximized and total profits
fall as more units of output are produced. Two essential conditions for producer's
equilibrium are :
 The difference between TR and TC is positively maximized;
 Total profits fall after that level of output.
Producers equilibrium in case of perfect competition can be well understood with the
help of the following schedule and diagram.
Output Price TR TC Profit = TR – TC
0 10 0 5 –5
1 10 10 8 2
2 10 20 15 5
3 10 30 21 9
4 10 40 31 9
5 10 50 42 8
6 10 60 54 6
Producers equilibrium will be at four units of output because difference between TR and
TC is maximum here and after this level their is a fall in the total profit.
Y When price TC
remains constant TR
TRand TC
Maximum H
profit
A
G
Q1 Q Q2 X
O
Output 
In the above diagram, Producer's equilibrium will be determined at OQ level of output at
which the vertical distance between TR and TC curves is the maximum. The difference
between TR and TC curve (represented by GH level) is maximum.
Answer 6.
(a) Four objectives of fiscal policy in an economy are as follows :
(i) Effectively mobilize resources for development programmes : One of the most
important objective of fiscal policy is to effectively mobilize all available resources
towards the execution of development programmes. Taxation can be one of the
most effective tool in total saving and investment in an economy.
(ii) To promote development in the private sector : Public spending is no doubt and
important constituent of an economy but the objective of fiscal policy is also to
promote development in the private sector by reliefs, rebates, depreciation
allowances etc.
(iii) For dealing with inflationary or deflationary situation to ensure economic
stability : Fiscal policy may be used as an instrument to ensure economic stability in
the country by dealing with inflationary and deflationary situations.
(iv) To improve distribution of income and wealth in the country : Fiscal policy can
directly change the total spending of government by increasing or decreasing the
expenditure. Through taxation and increase in public expenditure the national
income can be properly distributed among all sections of society.
(b) Difference between Revenue Receipts and Capital Receipts
Revenue Receipts Capital Receipts

1. They neither create any liability nor They either create any liability or reduce any
reducce any asset of the government. asset of the government.
2. They are regular and recurring in They are irregular and non-recurring in
nature. nature.
3. There is no future obligation to return In case of certain capital receipts (like
the amount. borrowings), there is future obligation to
return the amount along with interest.
4. Tax revenue (like Income tax, sales tax, Borrowings, Disinvestment, etc.
etc.) and Non-tax revenue (like interest
fees, etc.)
(c) Primary deficit refers to difference between fiscal deficit of the current year and interest
payments on the previous borrowings.
Primary Deficit = Fiscal Deficit – Interest Payments
Implications of Primary Deficit : It indicates, how much of the government borrowings
are going to meet the expenses other than the interest payments. The difference between
fiscal deficit and primary deficit shows the amount of interest payments on the borrowings.
So, a low or zero primary deficit indicates that interest commitments (on earlier loans)
have forced the government to borrow.
Answer 7.
(a) Real Gross Domestic Product may be defined as the money value of goods and services at
at base year's prices produced in the accounting year within the domestic territory of a
country.
Thus, Real Gross Domestic Product Output × Base year's prices.
Nominal Gross Domestic Product may be defined as the money value of goods and
services at current year's prices produced in the accounting year within the domestic
territory of a country.
Thus, Nominal Gross Domestic Product = Output × current year's prices.
For example, 2016 as the base year. Output of tea is 2,000 tones in 2016 as well as
2017. But the prices are ` 1,000 and ` 1,500 per ton respectively in 2016 and 2017.
Nominal GDP in 2017 will be ` 30,00,000 (2,000 × 1,500) while real GDP in 2017 will
be ` 20,00,000 (2,000 × 1,000)
Economics | 9
Real GDP is a good indicator of economic welfare because it shows real increase in the
income over a period of time. Real GDP neutralises the effect of change in prices over a
period of time. Nominal GDP becomes inflated due to inflation (increase in prices) and
does not reflect the true growth of national income.
(b) Circular Flow of income in a four-sector economy consists of households, firms, government
and foreign sector. The various money flows in each sector are :
(i) Household Sector : Households provide factor services to firms, government and
foreign sector. In return, it receives factor payments. Households also receive transfer
payment from the government and the foreign sector. Households spend their income
on : (a) Payment for goods and services purchased from firms; (b) Tax payments to
government; (c) Payments for imports.
(ii) Firms : Firms receive revenue from households, government and the foreign sector
for sale of their goods and services. Firms also receive subsidies from the government.
Firm makes payments for : (a) Factor services to households; (b) Taxes to the government;
(c) Imports to the foreign sector.
(iii) Government : Government receives revenue from firms, households and the foreign
sector for sale of goods and services, taxes, fees etc. Government makes factor
payments to households and also spends money on transfer payments and subsidies.
(iv) Foreign Sector : Foreign sector receives revenue from firms, households and
government for export of goods and services. It makes payments for import of goods
and services from firms and the government. It also makes payment for the factor
services to the households.
Foreign
Sector
Pa
y
Re
m
s
en
rt ce
ts
po
ip
for
Im
ts
Im
fro
or
tf
por
en
n ts
Exp
Government ts
ym
y me t s
en
orts
a
Pa
r P ym ts
to
Borrow ings
en
pa
c
Fa
ym
Savings
er
pa
nsf
Tr a
Tax
Savings Savings
Households Financial Firms
Borrowings Market Borrowings
Cos
um p t ion Ex p en dit u re
Fact or Pay ments
(c) Calculation of national income by value added method

National income = GVAMP – Depreciation – NIT + NFIA
Value of Output = Sales + Changes in Stock
Value Added (GVAMP) = Value of Output – Intermediate Consumption
Value of output = 350 + (20 – 30)
= 340
Value added = 340 — (150 + 170)
= 340 – 320
= 20
NNPFC = 20 – 35 + 20 – (60 – 40)

= 40 – 35 – 20
= 40 – 55
Ans. = – 15
Answer 8.
(a) Qualitative methods of credit control include.
(i) Margin requirements
(ii) Moral Suasion
(iii) Selective credit controls
(i) Margin requirements : Margin is the difference between the amount of loan and
market value of the security offered by the borrower against the loan. If the margin
fixed by the Central Bank is 40%, then commercial banks are allowed to give a loan
only upto 60% of the value of security. By changing the margin requirements, the
Reserve Bank can alter the amount of loans made against securities by the banks.
(ii) Moral Suasion : This is a combination of persuasion and pressure that Central
Bank applies on other banks in order to get them act in a manner in line with its
policy. Moral suasion is exercised through discussions, letters, speeches and hints to
banks. The Reserve Bank frequently announces its policy position and urges the
banks to cooperate in implementing its credit policies.
(iii) Selective credit controls : Under selective credit controls, the RBI gives directions to
other banks to give or not to give credit for certain purposes to particular sectors.
This method can be applied in both positive and negative manner. In positive manner,
it means using measures to channelise credit to priority sectors. The priority sector
includes small-scale industry, agriculture, exports, etc. In negative manner, it means
using measures to restrict flow of credit to particular sectors.
(b) Multiplier (K) refers to the ratio of change in income (Y), to a change in investment (I).
Y
K =
I
The minimum value of multiplier can be one and the maximum value can be infinity.
Multiplier is inversely related with the MPS, i.e.,
1
K =
MPS
It means the value of multiplier can be known if the MPS is known.
(c) There are number of measures to control excess and deficient demand.
(i) Change in Government Spending : Government spending is an important
component of aggregate demand. This measure is a part of fiscal policy and is termed
as Èxpenditure Policy' of the Government. Government spends huge amount on
public works like construction of roads, flyovers, buildings, railway lines, etc.
Changes in such expenditure directly affect the level of AD in the economy and
helps to control the situations of excess and deficient demand.
(ii) Change in Taxes : `Taxes' is the main source of revenue for the government. This
measure is a part of Fiscal Policy and is termed as `Revenue Policy' of the Government.
Economics | 11
Government imposes different kinds of direct and indirect taxes on the public.
C h a n g e s
in taxes by the government directly influence the level of aggregate demand and
helps to control excess and deficient demand in the economy.
(iii) Change in Money Supply or Availability of Credit : The Reserve Bank of India
(RBI) is empowered to regulate the money supply in the economy through its
`Monetary Policy'. It is policy of Central Bank to control money supply and credit
creation in the economy. Monetary policy helps to control the situations of excess
and deficient demand through its the following instruments.
(i) Quantitative Instruments : These instruments aim to influence the total volume
of credit in circulation. Major instruments or measures are : (i) Bank Rate and
Repo Rate, (ii) Open Market Operation, and (iii) Legal Reserve Requirements.
(ii) Qualtitative Instruments : These instruments aim to regulate the direction of
credit. Major qualitative instruments or measures are : (i) Margin
Requirement, (ii) Moral suasion, and (iii) Selective Credit controls.
Answer 9.
(a) Money Supply refers to total volume of money held by public at a particular point of
time in an economy.
According to Milton Friedman, “The money supply at any time refers to literally the
number of dollars (currency units) people are carrying around in their credit at banks in
the form of demand deposits and also commercial bank time deposits.”
It is a `Stock Concept', i.e., it is concerned with a particular point of time.
(b) Secondary functions refer to those functions of money which are supplementary to the
primary functions. These functions are derived from primary functions and, therefore,
they are also known as `Derivative Functions'.
The major secondary functions are :
(i) Standard of Deferred Payments : Money as a standard of deferred payments means
that money acts as a `Standard' for payments, which are to be made in future. This
function of money is significant because money as a standard of deferred payments
has simplified the borrowing and lending operations. It has lead to the creation of
financial institutions
(ii) Store of Value : Money has a store of value which means that money can be used
to transfer purchasing power from present to future. Money is a way to store
wealth.Although wealth can be stored in other forms also, but money is the most
economical and convenient way.
(c) Different general utility functions rendered by Commercial Banks are as follows.
(i) Locker facility : Commercial banks provide facility of safety vaults or lockers to
keep valuable articles of customers in safe custody.
(ii) Traveller's Cheques : Commercial banks issue traveller's cheques to their customers
to avoid risk of taking cash during their journey.
(iii) Letter of Credit : They also issue letters of credit to their customers to certify their
creditworthiness.
(iv) Underwriting Securities : Commercial banks also undertake the task of
underwriting securities. As public has full faith in the creditworthiness of banks,
public do not hesitate in buying the securities underwritten by banks.
(v) Collection of Statistics : Banks collect and publish statistics relating to trade,
commerce and industry. Hence, they advice customers on financial matters.

SOLUTION

PART – I
Answer 1.
(i) Monetary Policy : Monetary policy is the policy taken by Central Bank of the country
which relates to the regulation of supply of money, rate of interest and availablity of
money. It regulates the inflationary or deflationary gap in the economy.
(ii) Marginal Physical Product : Marginal Physical Product refer to addition to total product,
when one more unit of variable factor is employed.
MPPn = TPn – TPn–1
MPPn = Marginal physical product of nth unit of variable factor.
TPn = Total product of n units of variable factors.
TPn–1 = Total product of (n – 1) unit of variable factors.
n = Number of units of variable factors.
(iii) As the output increases, the gap between AC and AVC curves decreases but they never
intersect each other. This is because,
(a) AC at all levels of output includes both AVC and AFC
(b) Vertical distance between AC and AVC curves is AFC, which can never be zero.
(iv) (a) The shape of Average Revenue curve (and MR curve) is a horizontal straight line
parallel to the X-axis and total revenue curve is positively sloped straight line passing
through the origin.
Y
35 TR
30
TRandMR
25
20
15
10
Price = AR = MR
5
O X
Units sold 
(b) When TR curve is a straight horizontal line the AR curve will concide with that of
AR = MR = Price or = TR
Y
TR, ARand MR
Price line R Price = AR = MR

P
O X
Q
Units sold 
(v) In the given case, due to improvement in technology the marginal cost of production of
`x' commodity has gone down. Technology change influences the supply of a commodity.
Advanced technology reduces the cost of production, which in turn to raises the profit
margin. It induces the seller to increase the supply.
The improvement in the technology will lead to increase in supply of a commodity
(vi) Monopoly Monopsony

1. There is a single seller but large There is a single buyer but large number
number of buyers of seller.
2. Monopoly is price setter in its Monopsony is price setter in factor market.
Product Market.
(vii) Accounting costs are an amount that are incurred on input costs, cost of production etc.
These costs are always recorded in an accounting or book keeping system and reported
on the company's financial statements.
Opportunity cost is the cost of next best alternative foregone. This is an economic idea
that when you pursue one course of action, you loose out on another because you can't
do two things at the same time. These costs are theoretical in nature. Although they
might be useful in decision making, they are not physical costs, so they are not recorded
in the accounting system.
(viii) Factor payments are the payments made to a factor of production in return for rendering
productive services. Eg. rent, wages, interest, profit. All factor payments are included in
the National Income.
Transfer payments are the payments received without any good or service provided in
return. Eg. Old age pension, scholarships to students, unemployment allowance etc.
Transfer payment are not included in the National income of a country.
(ix) Autonomous Investment Induced Investment
1. Autonomous investment is done for Induced investment is driven by profit

social welfare and not for profit. motive i.e. it depends on profit expectations.
2. It is unaffected by changes in income It is income elastic as increase in income
level i.e. income inelastic. level raises its level.
3. Its curve is parallel to X-axis as it is Its curve slopes upwards as it is income
income inelastic elastic.
(x) Broad Definition of Money : Broad definition of money not only includes currency
notes, coins and demand deposits of banks (narrow concept of money), but it generally
includes time deposits in banks and post offices. Time deposits are included as they have
high degree of moneyness and can be converted into chequeable deposits within a short
span of time.
Broad definition of money = Money Assets + Near Money
PART – II
Question 2.
(a) (i) An unfavourable change in taste of the buyer for the commodity.
(1) Sometimes there is a unfavourable change in the fashion or tastes of the consumers
to the commodity. As a result the consumers will demand less of that commodity. In
Economics | 3
other words the demand of that commodity will fall and as a result of it the demand
curve of the commodity will shift to the left.
Y
D1 D
Price (in ` ) 
B A
P
D
D1
O Q1 Q X
Quantity demanded 
At the same price level P, demand for the commodity will decrease and shift towards
left from Q to Q1.
DD original demand curve
D1D1 New Demand curve
(ii) A fall in the income of its buyer if the commodity is inferior.
(1) Inferior goods are the goods which are rated very low in the consumer's estimation.
A consumer uses inferior good because he is not in a position to use superior or
normal goods due to low income. As the income of the consumer falls, the consumer
is not in the position to buy superior goods. As a result the demand for inferior
goods increases resulting in a rightward shift of the demand curve.
Y
D1
D
Price (in ` ) 
A A'
P
D1
D
O Q1 Q X
Quantity demanded 
DD  original demand curve

D1D1  New demand curve
(2) At the same price level P, the demand for inferior goods will increase as the income
level decreases, So the new quantity demanded will be Q 1.
(b) Individual demand schedule refers to a tabular statement showing various quantity
of a commodity that a consumer is willing to buy at various levels of price, during a
given period of time. Individual demand schedule states the relationship between
price and quantity. Eg :
Price Quantity Demand
0 1
1 2
2 3
3 4
4 5
Market demand schedule refers to a tabular statement showing various quantities of a
commodity that all the consumers in th market are willing to buy at various levels of
price during a given period of time. It is the sum of individual demand schedules at each
and every point.
Price Household A Household B Market Demand
5 1 2 1 2  3
4 2 3 235
3 3 4 347
2 4 5 459
1 5 6 5  6  11
Market demand curve refers to a graphical representation of market demand schedule.
It is obtained by horizontal summation of individual demand curves.
The points shown in figure DA and DB are the individual demand curves. Market demand
curve (DM) is obtained by horizontal summation of the individual demand curves (DA
and DB).
Y
DA DB DM
5
Price (in ` ) 
4
3
2
1
DA DB DM
O X
2 4 6 8 10 12
Quantity demanded (in units) 
(c) According to the law of Equi-marginal utility, a consumer gets maximum satisfaction,
when ratios of MU of two commodities and their respective prices are equal and Mu
falls as consumption increases.
It means, there are two necessary condition to attain Consumer's Equilibrim in case of
two commodities.
(i) The ratio of Marginal Utility to price is same in case of both the goods.
MU x MU y
= = MUM
Px Py
(ii) MU falls as consumption increases : The second need to attain consumer's
equilibrium is that MU of a commodity must fall as more of it is consumed. If MU
does not fall as consumption increases, the consumer will end up buying only one
good which is unrealistic and consumer will never reach the equilibrium position.
Finally, it can be concluded that a consumer in consumption of two commodities
will be at equilibrium when he spends his limited income in such a way that the
ratios of marginal utilities of two commodities and their respective prices are equal
and MU falls as consumption increases.
To reach the equilibrium, consumer should purchase that combination of both the
goods, when :
(1) MU of last rupes spene on each commodity is same; and
(2) MU falls as consumption increases.
Economics | 5
Answer 3.
(a) The conupt of TU and MU can be better understood from the following schedule :
Icecream Marginal Utility Total Utility
Consumed (MU) (TU)
1 20 20
2 16 36
3 10 46
4 4 50
5 0 50
6 –6 44
TU increases with an increase in consumption of a commodity as long as MU is positive,

i.e., till the 4th ice-cream. In this phase, TU increases, but a diminishing rate as MU from
each successive unit tends to diminish.
W hen TU reaches i ts m axi mum , M U becom es to zer o, i.e., when 5th ice-cream is
consumed. This is known as point of satiety. TU curve stops rising at this stage.
When consumption is increased beyond the point of satiety, TU starts falling as MU
becomes negative.
Y
50
Maximum TU
TUof Ice-cream
40
30
TU
20
10
O X
1 2 3 4 5 6
Y
Units of Ice-cream
20
MUof Ice-cream
16
12
X
O 1 2 3 4 5 6
4 Units of Ice-cream
MU curve
8
(b) In order to measure Ed at any particular point, lower portion of the curve from that point
is divided by the upper portion of the curve from the same point.
Lower segment of demand curve (LS)
Elasticity of Demand (Ed) =
Upper segment of demand curve (US)
NQ
Elasticity at a particular point `N' is calculated as
NP
Y
U
pp
er
se
Price (in ` )
gm
en
t
Lo me
se
N
w nt
g
er
O X
Q
Quantity demanded (in units)
(c) Properties of Indifference curve are as follows :
(i) Indifference curves are always convex to the origin : An indifference curve is
convex to the origin because of diminishing MRS.MRS declines continuously
because of the law of diminishing marginal utility.
(ii) Indifference curve slope downwards : It implies that as a consumer consumes
more of one good, than he must consume less of the other good. It happens because if
the consumer decides to have more units of one good (say ice-creams), he will have
to reduce the number of units of another good (say chocolales), So that total utility
remains the same.
(iii) Higher indifference curves represent higher levels of satisfaction : Higher
indifference curve represents large bundle of goods, which means more utility
because of monotonic preference.
(iv) Indifference curves can never intersect each other : As two indifference curves
can not represent the same level of satisfaction, they cannot intersect each other. It
means, only one indifference curve will pass through a given point on an
indifference map.
Y
IC2
IC1
O X
Answer 4.
(a) Under Monopoly competition the AR and MR curves are elastic. It happens because of
the absence of close substitutes under monopoly. So when price of a commodity is
increased, then proportionate fall in demand under monopoly is less. AR and MR curves
slopes downward for a monopoly firm because more unints can be sold only by reducing
the price.
Y
ARand MR(in ` )
AR
MR
X
O Units sold
Economics | 7
(b) Difference between rise in quantity supplied and Increase in supply.
Increase in Quantity Supplied Increase in Supply
1. When the quantity supplied rises due Increase in supply refers to a rise in the supply
to an increase in the price, keeping of a commodity caused due to change in
other factors constant, it is known factor other than the own price of the
as increased in quantity supplied. commodity.
2. Price Supply Price Supply
10 100 10 100
12 150 10 150
3. There is an upward movement There is a rightward shift in the supply curve.
along the same supply curve. It occurs due to other factors like decrease in
4. It occurs due to increase in price of the price of inputs, decrease in taxes
the given commodity technological upgradation etc.
Y Y
S S S1
Price (in ` )
12 B
Price (in ` )
A
10
10
S
S S1
X X
O 100 150 O 100 150
Quantity Supplied Quantity Supplied
(in units) (in units)
(c) Three determinants of Elasticity of supply are as follows :

(i) Cost of Production : If cost of production rises rapidly with increase in output, then
there is less incentive to raise the supply with increase in price. In such cases,
supply will be inelastic. However, if cost of production increases slowly with rise
in output, then supply will increase with rise in prices. In this case, supply will be
more elastic.
(ii) Time period : In the market period, supply of a commodity is perfectly inelastic as
supply cannot be changed immediately with change in price. In the short period,
supply is relatively less elastic as firm can change the supply by changing the variable
factors. In the long period, supply is more elastic as all the factors can be changed
and supply can be easily adjusted as per changes in price.
(iii) Technique of Production : Supply is generally elastic for commodities, which
involve simple techniques of production. However, supply is inelastic for commodities
which involve complex techniques of production. Output of such goods cannot be
easily increased with increase in their prices.
Answer 5.
(a) Under perfect competition, there are large numbers of buyers and sellers in the market.
Each seller sells so little and each buyers buys so little that none of them is able to influence
the price in the market. The seller's course of action is dictated by forces outside its
control i.e., by the industry. In the industry, the price is determined by the relative force
of market demand and market supply. Each firm has to accept the market price as
something given and unchangeable by an individual action so the industry is the price-
maker and each seller is the price-taker.
Y Industry Y
Seller
D S
Price
P = AR = MR
P
Price
S D
O X O X
Quantity Quantity
Price is determined at the point where market demand curve intersects market supply
curve. The market demand curve DD and market supply curve SS intersects at point E
at this point OP price is determined. This makes the AR curve perfectly elastic and parallel
to the x-axis. MR = AR, AR curve is also the MR curve of the firm under perfect
competition.
(b) Under perfect competition MR = AR the reason for this is the perfectly competitive market,
each firm is a price taker. All the firms have to accept the same price as determined by market
forces of demand and supply. As a result, uniform price prevails in the market. It means,
revenue from every additional unit (Known as MR) is equal to price (AR) of the product.
So, MR = AR.
Y
Ed = 
P Demand Curve
(AR curve)
O X
Q1 Q2
Under monopoly, a monopoly firm faces a downward sloping demand curve as more
output can be sold only by reducing the price. As a result, revenue generated from every
additional unit (Known as MR) is less than price (AR) of the product. Due to this reason,
MR is less than AR
Y
ARand MR(in ` )
AR
MR
X
O Units sold
Economics | 9
(c) Difference between Break-even point and Shutdown point.
Break-even point Shut down Point
(1) Break-even point refers to the point Shut-down point refers to a situation when
where the total revenue is equal to a firm is able to cover its variable costs only.
the the total cost.
(2) At break-even point TR = TC In this situation TR = TVC.
(3) At break-even point there is a At shut-down point, firm incurs loss of fixed
situation of no profit no loss or cost.
situation of normal profit. Y AC
AVC
Cost and Revenue (in ` )

Y TR
Cost and Revenue (in ` )
Abnormal profits TC
Abnormal AR (or MR)

P
losses EBEP
Shut down
point
X
O Q
X Output (in units)
O Q
Output (in units)
Answer 6.
(a) Leakages : Leakages refers to withdrawl of money from the circular flow. When
households and firms save a part of their income, it leads to a leakage from the circular
flow of income. Leakage or withdrawl refers to that part of income, which does not
pass through the circular flow of income. As a result, it is not available for spending on
currently produced goods and services. It means leakages reduce the flow of income.
Injections : Injections refers to the introduction of income into the circular flow when
households and firms borrow money from external sources like financial institiutions, it
adds to their income. Such additional income does not result in immediate expenditure.
So injections increase the flow of income.
(b) Sum of value added refers to the value of final goods and services produced in an economy
during a financial year. Net value added at factor cost implies cost of the factors for
production in terms of rent, interest, profit and wages. This is equal to income generated.
Thus, the sum of value added is equal to the sum of factor income.
Since value added equals factor income for each firm, the sum of value added must be
equal to the sum of factor income.
(c) The following points highlight the measure problems in calculating the National Income.
(i) Non-monetary transactions : One of the major problem in the calculation of
national income is related to the non-monetary transactions such as service of
housewifes to the member of the families.
(ii) Problem of double counting : Since it is difficult to distinguish between final
goods, intermediate goods and services it is often seen that problem of double
counting arises while calculating national income.
(iii) Transfer Payments : Individual gets pension, unemployment allowance and
interest on public loans, but these payments create difficulty in measurement of
national income as these earnings are part of individual income and are also part
of government expenditure.
(iv) Problem of Underground economy : The underground economy consist of illegal
and unclear transactions where the goods and services are illegal such as drugs,
gambling, smuggling and prostitution. Since these incomes are not included in the
national income, this is considered as a problem in accounting of national income.
Answer 7.
(a) If in an economy intended investment is greater than intended savings this would lead
to the situation of excess demand in an economy. Excess demand gives rise to an
inflationary gap.
Inflationary gap refers to the gap by which actual aggregate demand exceeds the
aggregate demand required to establish full employment equilibrium.
The concepts of excess demand and inflationary gap can be depicted as below.
Y inflationary
gap
AD1
Aggregate Demand 
F
AD
E
E = Full employment
equilibrium
O X
Income/output/
Employment 
The effect of excess demand on national economy are listed as follows :

(i) Excess demand leads to rise in general price level also known as `Ìnflation''.
(ii) It does not lead to any increase in level of aggregate supply in an economy.
(iii) Level of employment will not increase as there is no involuntary unemployment.
(iv) There is no change or no effect of excess demand on the level of output in an economy,
because economy is already operating at full employment equilibrium and there is
no involuntary unemployment.
(b) The working of multiplier is based on the fact that Òne persons's expenditure is another
person's income when an additional investment is made, then income increases many
times more than the increases in investment.
Investment multiplier may be defined as the rate of change in national income due to
change in investment. Thus,
Change in National Income

Multiplier =
Change in Investment
Multiplier is related to marginal propensity to consume (MPC). Higher the MPC, higher
will be multiplier. Higher MPC means higher consumption which induces producers to
produce more resulting in increase in income. Multiplier coefficient is obtained by the
following formula :
1 1
= K =
1  MPC MPS
(c) (i) Aggregate Demand : Aggregate demand refers to the amount of money which all
the households, firms and government are willing to spend on final goods and services
produced in an economy.
Thus, Aggregate Demand = Consumption (C) + Investment (I)
Economics | 11
(ii) Aggregate Supply : Aggregate supply (AS) refers to money value of final goods and
services that all the producers are willing to supply in an economy in a given time
period.
Thus, Aggregate Supply = Consumption (C) + Savings (S)
(iii) Excess Demand : Excess demand is an excess of anticipated expenditure over available
output at constant prices. In other words, when aggregate demand exceeds
aggregate supply at full employment the demand is said to be an excess demand.
Thus,
Excess Demand = Aggregate Demand – Aggregate Supply
Answer 8.
(a) Agency functions performed by commercial banks are as follows :
(i) Transfer of funds : Bank provide the facility of economical and easy remittance of
funds from place-to-place with the help of instruments like demand drafts, mail
transfers, etc.
(ii) Collection and Payment of various items : Commercial banks collect cheques, bills,
interest, dividends, subscriptions, rents and other periodical receipts on behalf of
their customers and also make payments of taxes, insurance premium, etc. on standing
instructions of their clients.
(iii) Purchase and sale of foreign Exchange : Some commercial banks are authorised by
the central bank to deal in foreign exchange. They buy and sell foreign exchange
on behalf of their customers and help in promoting international trade.
(iv) Purchase and sale of securities : Commercial banks buy and sell stocks and shares
of private companies as well as government securities on behalf of their customers.
(b) Four measures to correct disequilibrium in Balance of Payment are as follows :
(i) Import Substitution : Import substitution means promoting domestic production of
the items normally imported by the residents of domestic country.
(ii) Export Promotion : Export promotion means promoting exports by granting
concession and incentives to exporters like credit and finance, packaging, quality
control, tax concessions.
(iii) Depreciation : Depreciation leads to fall in external purchasing power of home
currency. Depreciation of home currency encourages exports of the home country
by making exports cheaper and discourages imports by raising the prices of
imports.
(iv) Exchange control : The government may order all exporters to surrender their foreign
exchange to Central bank and then ration out among the importers.
(c) Fiscal policy refers to the government's use of revenue generation and spending strategies
to control public revenue and expenditure. Fiscal policy can influence the National
Income and can bring equity and stability in the economy.
Below are the listed advantages of fiscal policy for the economy :
(i) Unemployment Reduction : By employing the expansionary fiscal policy,
government can reduce the unemployment level in an economy. This involves
increasing spending purchases or lowering taxes.
(ii) Budget Deficit Reduction : Budget deficit arises when a country's expenditure
exceeds its revenue. Since, the economic effect of this defict include increased public
debt, the country can pursue a contraction in fiscal policy. It will therefore reduce
public spending and increase tax rates to raise more revenue and ultimately
lower the budget deficit.
(iii) Economic growth increase : The various fiscal policy measures facilitate
expansion in the national economy. When the government reduces tax rates,
business and individual will have a greater incentives to invest and steer the
economy further.
Answer 9.
(a) When proportionate increase in total output is more than proportionate increase in inputs,
it is Increasing Returns to Scale. It means, if all the inputs are increased by 100%, then
the output increases by more than 100%.
Increasing Returns to Scale occurs mainly due to Èconomies' of large scale. Economics refer
to benefits due to large scale of production.
Economies of scale can be classified into two categories :
(i) Internal Economies : It refer to benefits of large scale production which are
available to a firm within its own operation. Technical Economies is the form of use
of bigger and better machinery and managerial economies through division of labour
and specialisation.
(ii) External Economies : It refers to benefits of large scale production which are sharel
by all the firms in an industry, when industry as a whole expands. For example,
better infrastructural facilities.
(b) The various points of relationship between TFC, TVC and TC are as follows :
(i) TFC curve is a horizontal straight line parallel to X-axis as it remains constant at all
levels of output.
(ii) TC and TVC curves are inversely S-shaped because they rise initially at a decreasing
rate, then at a constant rate and finally, at an increasing rate. The reason behind
their shape is the Law of Variable Proportions.
(iii) At zero output, TC is equal to TFC because there is no variable cost at zero level of
output. So TC and TFC curves start from the same point, which is above the origin.
(iv) The vertical distance between TFC curve and TC curve is equal to TVC. As TVC
rises with increase in the output. The distance between TFC and TC curves also goes
on increasing.
(v) TC and TVC curves are parallel to each other and the vertical distance between them
remains the same at all level, of output because the gap between them represents
TFC, which remains constant at all levels of output.
Y
TC
FC, TVCand TFC(in ` )
48
42 TVC
36
30
24
18
12 TFC
6
X
O 1 2 3 4 5
Output (in units)
Economics | 13
(c) In this Question Average Fixed cost is not given so MC can not be calculated :
Output (Units) AVC (` ) TVC (AVC × Q) MC
1 60 60 –
2 40 80 (80 – 60)  20
3 30 90 (90 – 80)  10
4 26.25 105 (105 – 90)  15
5 28 140 (140 – 105)  35
6 35 210 (210 – 140)  70


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SOLUTION

MODEL SPECIMEN PAPER – 3

Extension in Supply Increase in Supply

Y Demand of normal good

Demand of inferior good (Black-and-

Basic Contraction in Supply Decrease in Supply

In the diagram, the proportionate increase in demand is less than proportionate

(ii) When increase in demand is proportionately equal to decrease in supply, then

MRn = TRn – TRn–1

Relationship between TR and MR

Basis Current Account Capital Account

1. Influence on Current account transactions bring Capital transaction brings about a

Basis of Distinction Oligopoly Monopoly

(b) (i) Reasons for Increasing Returns to a Factor (Phase 1

MODEL SPECIMEN PAPER – 6

Answer 1. Answer briefly each of the questions (i) to (x).

(vi) Output TC MC TVC TFC

Basis Change in Supply Change in quantity supplied

(b) Importance of Elasticity of Demand :

Perfectly Elastic supply (ES = 0)

(b) Demand Curve under Monopolistic Competition : Under monopolistic competition

Firms under monopolistic competition faces a downward sloping demand curve.

(iii) For a market to be perfectly competitive, in addition to three fundamental

From the above table and diagram we can conclude that;

Basis Short–run Long-run

1. Meaning Short-run refer to a period in Long-run refers to a period in

+ Consumption of fixed capital

Average Propensity to Save (APS) Marginal Propensity to Save (MPS)

Units of ice-cream Total Utility (in Uts) Marginal Utility

(i) Substitutute Goods Complementary Goods

1. Substitute goods refer to those 1. Complementary goods refer to those goods

(ii) Marginal Utility Total Utility

MODEL SPECIMEN PAPER – 9

TPn = Total product of n units of variable factor;

Personal Income Per Capita Income

Fixed Exchange Rate Fluctuating Exchange Rate

Increase in Demand Extension in Demand

18 Marginal Cost Curve

Revenue andCost (in ` ) 

Goods and Services

(iii) It is also known as physical flow.

Marginal Propensity to Save (MPS) Marginal Propensity to Consume (MPC)

1. It refers to the ratio of change in saving It is the ratio of change in consumption

Market Price Normal Price

Price (in) ` Quantity (in units) 5 increase in supply

MODEL SPECIMEN PAPER – 12

Giffen Goods Inferior Goods

 Ed > 1, if TE is inversely related to the price.

Fixed Costs Variable costs

Phase I Phase II Phase III

Phase I Phase II L Phase III

Average Revenue Marginal Revenue

(b) Elasticity of supply depends upon a number of factors.

Revenue Receipts Capital Receipts

Fact or Pay ments

(c) Calculation of national income by value added method

NNPFC = 20 – 35 + 20 – (60 – 40)

MODEL SPECIMEN PAPER – 15

Price line R Price = AR = MR

(vi) Monopoly Monopsony

(ix) Autonomous Investment Induced Investment

1. Autonomous investment is done for Induced investment is driven by profit

DD  original demand curve