Q1)Macro economic - Meaning :

It is that part of economic theory which studies the economy in its totality or as a whole.

It studies not individual economic units like a household, a firm or an industry but the whole
economic system. Macroeconomics is the study of aggregates and averages of the entire economy.
Such aggregates are national income, total employment, aggregate savings and investment,
aggregate demand, aggregate supply general price level, etc.

Here, we study how these aggregates and averages of the economy as a whole are determined
and what causes fluctuations in them. Having understood the determinants, the aim is how to
ensure the maximum level of income and employment in a country.

In short, macroeconomics is the study of national aggregates or economy-wide aggregates. In a

way it is like study of economic forest as distinguished from trees that comprise the forest. Main
tools of its analysis are aggregate demand and aggregate supply.

Since the subject matter of macroeconomics revolves around determination of the level of income
and employment, therefore, it is also known as ‘Theory of Income and

Q2) Importance of Macroeconomics:

1. It helps to understand the functioning of a complicated modern economic system. It describes

how the economy as a whole functions and how the level of national income and employment is
determined on the basis of aggregate demand and aggregate supply.

2. It helps to achieve the goal of economic growth, higher level of GDP and higher level of
employment. It analyses the forces which determine economic growth of a country and explains
how to reach the highest state of economic growth and sustain it.

3. It helps to bring stability in price level and analyses fluctuations in business activities. It suggests
policy measures to control Inflation and deflation.

4. It explains factors which determine balance of payment. At the same time, it identifies causes of
deficit in balance of payment and suggests remedial measures.

5. It helps to solve economic problems like poverty, unemployment, business cycles, etc., whose
solution is possible at macro level only, i.e., at the level of whole economy.

6. With detailed knowledge of functioning of an economy at macro level, it has been possible to
formulate correct economic policies and also coordinate international economic policies.

7. Last but not the least, is that macroeconomic theory has saved us from the dangers of application
of microeconomic theory to the problems of the economy as a whole.

Q3) The Circular Flow of Income and Expenditure:

Circular flow refers to a simple economic model which describes the reciprocal circulation of income
between producers and consumers. In the circular flow model, the inter-dependent entities of
producer and consumer are referred to as "firms" and "households" respectively and provide each
other with factors in order to facilitate the flow of income. Firms provide consumers with goods and
services in exchange for consumer expenditure and "factors of production" from households.
In macroeconomics, we have the economy 2 sectors, 3 sectors and 4 sectors.

1. Economy 2 sectors: Household and Firm

2. Economy 3 sectors: Household, Firm and Government

3. Economy 4 sectors: Household, Firm, Government and International Trade.

Terms in circular flow

• Household Sector

This includes everyone, all people, seeking to satisfy unlimited wants and needs. This sector is
responsible for consumption expenditures. It also owns all productive resources.

• Business Sector (Firm)

This includes the institutions (especially proprietorships, partnerships, and corporations) that
undertake the task of combining resources to produce goods and services. This sector does the
production. It also buys capital goods with investment expenditures.

• Government Sector

This includes the ruling bodies of the federal, state, and local governments. Regulation is the prime
function of the government sector, especially passing laws, collecting taxes, and forcing the other
sectors to do what they would not do voluntary. It buys a portion of gross domestic product as
government purchases.

Product Markets

This is the combination of all markets in the economy that exchange final goods and services. It is
the mechanism that exchanges gross domestic product. The full name is aggregate product markets,
which is also shortened to the aggregate market.

• Resource Markets

This is the combination of all markets that exchange the services of the economy's resources, or
factors of production--including, labor, capital, land, and entrepreneurship. Another name for this is
factor markets.

• Financial Markets

The commodity exchanged through financial markets is legal claims. Legal claims represent
ownership of physical assets (capital and other goods). Because the exchange of legal claims involves
the counter flow of income, those seeking to save income buy legal claims and those wanting to
borrow income sell legal claims.

Importance:- Circular Flow in 2 Sectors Economy

Two sectors economics consist of household and firm sectors. Foreign country and government
sector does not exist. As such, in economic two sectors, circular flow is reflections on physical flow
and cash flow between firm sectors and household sector. When household sector sell factors of
production (labor, land, capital, and entrepreneur) to firm sector (Factor Flow), household sector
received income in form of wage and salary, rent, interest, and profit (Income flow).
Most of the income will be spent (consumer) on goods and services provided by firm sector (market
sector), and the rest will be deposited as fund at financial institutions (Fund Flow) as saving.

The fund available in financial institution will enable the investor to invest in product market.

Circular Flow in 3 Sectors Economy

Circular flow in 3 sectors economy refers to income flow and expenditure which occurred between
economic sectors like household (C), firm (I) and government sector (G). Household will receive
income from the firm, namely salary and wage, rent, dividend and profit because household has
offered factors of production to firm to generate goods and services.

Household would use that income to buy goods and services provided by the firm and this is called
consumption spending. However, there’s small portion of the income will be deposited in financial
institution and it is termed as leakages in income flow.

Financial institution will lend household savings to investors to invest in firm. Investment is injection
in income flow.

Government will levy on household and firm. Households imposed personal income tax, while firm
imposed corporate profitability tax. Tax is leakages in income flow and it acts as a source of
government revenue. Government then uses its tax revenue through government expenditure
which it’s distributed to household and firm. For example, government will pay wages to household
that work as government employees.

Government on the other hand will build road, bridge, government school and hospital through
investments which is done by firm. Government expenditure on firm and household is injection in
income flow.

As such, in economic three sectors, according to aggregate supply equal aggregate expenditure,
equilibrium of national income achieved when Y = C I G, while according to approach leakages equal
injection, country's income balance achieved when S T = I G.

Circular Flow in 4 Sectors Economy

Circular flow in four sectors economy is similar to 3 sectors. In 4 sectors, we have international trade
as additional. Four sectors economy also called as open economy. It includes the term of trade like
export and import. Open economy refers to the existence of international trade in economy. It
consists of four sectors; household sector, firm sector, government sector, and foreign sector.

Injection in economy four sectors has the household (C), government expenditure (G), investment (I)
and international trade (X-).

Q4) The four important features of Trade Cycle are (i) Recovery, (ii) Boom, (iii) Recession, and (iv)
Depression!:- (1) Recovery:

In the early period of recovery, entrepreneurs increase the level of investment which in turn
increases employment and income. Employment increases purchasing power and this leads to an
increase in demand for consumer goods.

As a result, demand for goods will press upon their supply and it shall, thereby, lead to a rise in
prices. The demand for consumer’s goods shall encourage the demand for producer’s goods.The
rise in prices shall depend upon the gestation period of investment. The longer the period of
investment, the higher shall be the price rise. The rise of prices shall bring about a change in the
distribution of income. Rent, wages, interest do not rise in the same proportion as prices.
Consequently, the margin of profit improves. The wholesale prices rise more than retail prices. The
prices of raw materials rise more than the prices of semi-finished goods and the prices of semi-
finished goods use more than the prices of finished goods.

(2) Boom:

The rate of investment increases still further. Owing to the spread of a wave of optimism in
business, the level of production increases and the boom gathers momentum. More investment is
possible only through credit creation. During a period of boom, the economy surpasses the level of
full employment and enters a stage of over full employment.

(3) Recession:

The orders for raw materials are reduced on the onset of a recession. The rate of investment in
producers’ goods industries and housing construction declines. Liquidity preference rises in society
and owing to a contraction of money supply, the prices falls. A wave of pessimism spreads in
business and those markets which were sometime before sellers markets become buyer’s markets
now.

(4) Depression:

The main feature of a depression is a general fall in economic activity. Production, employment
and income decline. The prices fall and the main factor responsible for it is, a fall in the purchasing
power.

Q5) Main determinants of the supply of money are (a) monetary base and (b) the money
multiplier

1. Monetary Base:

Magnitude of the monetary base (B) is the significant determinant of the size of money supply.
Money supply varies directly in relation to the changes in the monetary base.

Monetary base refers to the supply of funds available for use either as cash or reserves of the
central bank. Monetary base changes due to the policy of the government and is also influenced
by the value of money.

2. Money Multiplier:

Money multiplier (m) has positive influence upon the money supply. An increase in the size of m
will increase the money supply and vice versa.

3. Reserve Ratio:

Reserve ratio (r) is also an important determinant of money supply. The smaller cash-reserve ratio
enables greater expansion in the credit by the banks and thus increases the money supply and vice
versa.

Reserve ratio is often broken down into its two component parts; (a) excess reserve ratio which is
the ratio of excess reserves to the total deposits of the bank (re = ER/D); (b) required reserve ratio
which is the ratio of required reserves to the total deposits of the bank (rr = RR/D). Thus r = re + rr.
4. Currency Ratio: Currency ratio (c) is a behavioural ratio representing the ratio of currency
demand to the demand deposits.The effect of the currency ratio on the money multiplier (m)
cannot be clearly recognised because enters both as a numerator and a denominator in the money
multiplier expression (1 + c/r(1 +t) + c). But, as long as the r ratio is less than unity, a rise in the c
ratio must reduce the multiplier.

5. Confidence in Bank Money:

General economic conditions affect the confidence of the public in bank money and, thereby,
influence the currency ratio (c) and the reserve ratio (r). During recession, confidence in bank
money is low and, as a result, c and r ratios rise. Conversely, during prosperity, c and r ratios tend
to be low when confidence in banks is high.

6. Time-Deposit Ratio:

Time-deposit ratio (t), which represents the ratio of time deposits to the demand deposits is a
behavioural parameter having negative effect on the money multiplier (m) and thus on the money
supply. A rise in t reduces m and thereby the supply of money decreases.

7. Value of Money:

The value of money (1/P) in terms of other goods and services has positive influence on the
monetary base (B) and hence on the money stock.

8. Real Income:

Real income (Y) has a positive influence on the money multiplier and hence on the money supply.
A r se in real income will tend to increase the money multiplier and thus the money supply and
vice versa.

9. Interest Rate:

Interest rate has a positive effect on the money multiplier and hence on the money supply. A rise
in the interest rate will reduce the reserve ratio (r), which raises the money multiplier (m) and
hence increases the money supply and vice versa.

10. Monetary Policy:

Monetary policy has positive or negative influence on the money multiplier and hence on the
money supply, depending upon whether reserve requirements are lowered or raised. If reserve
requirements are raised, the value of reserve ratio (r) will rise reducing the money multiplier and
thus the money supply and vice versa.

11. Seasonal Factors:

Seasonal factors have negative effect on the money multiplier, and hence on the money stock.
During holiday periods, the currency ratio (c) will tend to rise, thus, reducing the money multiplier
and, thereby, the money supply.

Q6) What are the factors influencing velocity of money?

1. Money Supply:Velocity of money depends upon the supply of money in the economy. If the
supply of money in the economy is less than its requirements, then the velocity of money will
increase and if the money [supply is less than its requirement, the velocity of money will fall.
2. Value of Money:

The velocity of money is high during inflation when value of money decreases because people will
like to part with money as soon as possible. Similarly, during deflation, when the value of money
rises, the velocity of money is low because people like to keep money with them.

3. Credit Facilities:

The velocity of money increases with the expansion of lending and borrowing facilities in the
country. Therefore the growth of credit institutions has a favorable effect on the velocity of
money.

4. Volume of Trade:

As the volume of trade increases the number of transactions and the velocity of money increases
and as the volume of trade decreases, the velocity of money decreases.

5. Frequency of Transactions:

With the increase in the frequency of transactions, the number of payments and receipts increases
and, as a result, velocity of money increases. Similarly, with the decrease in the frequency of
transactions, the velocity of money decreases.

6. Business Conditions:

The velocity of money increases during the period of hectic business conditions and decreases
during slump conditions.

7. Business Integration:

If business is vertically integrated, the velocity of money will be less and if business is vertically
disintegrated, the velocity of money will increase.

8. Payment System:

The velocity of money is also determined by the frequency with which the labour force is paid (i.e.,
weekly or monthly) and the speed with which the bills for goods are settled.

9. Regularity of Income:

If people receive income at regular intervals, they will spend their income more freely and the
velocity of money will increase. But, if people receive their income at irregular intervals, they will
prefer to hold more cash balances to meet the uncertain conditions in future and the velocity of
money will fall.

10. Propensity to Consume:

Greater the tendency of the people to consume, other things remaining the same, higher will be
the velocity of money. On the contrary, lower the propensity to consume, lesser will t3 the
velocity of money. Saving, or not consuming, has an adverse effect on the velocity of money.

Q7)Classical and Keynesian approaches and Keynes’ liquidity preference theory of interest :-
The Liquidity Preference Theory says that the demand for money is not to borrow money but the
desire to remain liquid. In other words, the interest rate is the ‘price’ for money.John Maynard
Keynes created the Liquidity Preference Theory in to explain the role of the interest rate by the
supply and demand for money. According to Keynes, the demand for money is split up into three
types – Transactionary, Precautionary and Speculative.He also said that money is the most liquid
asset and the more quickly an asset can be converted into cash, the more liquid it is. 1.
Transactionary Demand

People prefer to be liquid for day-to-day expenses. The amount of liquidity desired depends on
the level of income, the higher the income, the more money is required for increased spending.
This is called transactionary demand.

2. Precautionary demand

Precautionary demand is the demand for liquidity to cover unforeseen expenditure such as an
accident or health emergency. The demand for this type of money increases as the income level
increases.

3. Speculative demand

Speculative demand is the demand to take advantage of future changes in the interest rate or
bond prices. According to Keynes, the higher the rate of interest, the lower the speculative
demand for money. And lower the rate of interest, the higher the speculative demand for money

Q8)Money and price?

Ans: In its modern form, the quantity theory builds upon the following definitional relationship.

Where: M=is the total amount of money in circulation on average in an economy during the
period, say a year.

Vt=is the transactions velocity of money, that is the average frequency across all transactions
with which a unit of money is spent. This reflects availability of financial institutions, economic
variables, and choices made as to how fast people turn over their money.

Pi&qi= are the price and quantity of the i-th transaction

P= is a column vector of the pi, and the superscript T is the transpose operator.

Q= is a column vector of the qi

Mainstream economics accepts a simplification, the equation of exchange:M.Vt=Pt.T
Where:- Pt = is the price level associated with transactions for the economy during the period
T=is an index of the real value of aggregate transactions.
The previous equation presents the difficulty that the associated data are not available for all
transactions. With the development of national income and product accounts, emphasis shifted
to national-income or final-product transactions, rather than gross transactions. Economists may
therefore work where
V is the velocity of money in final expenditures.
Q is an index of the real value of final expenditures.
Q8)Cambridge equation?

The Cambridge equation formally represents the Cambridge cash-balance theory, an

alternative approach to the classical quantity theory of money. Both quantity theories, Cambridge
and classical, attempt to express a relationship among the amount of goods produced, the price
level, amounts of money, and how money moves. The Cambridge equation focuses on money
demand instead of money supply. The theories also differ in explaining the movement of money:
In the classical version, associated with Irving Fisher, money moves at a fixed rate and serves
only as a medium of exchange while in the Cambridge approach money acts as a store of
valueand its movement depends on the desirability of holding cash.

Md=k.P.Y
Q8)Inflation:- i)Demand pull inflation; is caused by increases in aggregate demand due to
increased private and government spending, etc. Demand inflation encourages economic growth
since the excess demand and favourable market conditions will stimulate investment and
expansion.
ii) Cost pull inflation: also called "supply shock inflation," is caused by a drop in aggregate supply
(potential output). This may be due to natural disasters, or increased prices of inputs

Causes:- Demand pull inflation:-

1. A depreciation of the exchange rate increases the price of imports and reduces
the foreign price of a country's exports. If consumers buy fewer imports, while
exports grow, AD in will rise – and there may be a multiplier effect on the level
of demand and output
2. Higher demand from a fiscal stimulus e.g. lower direct or indirect taxes or
higher government spending. If direct taxes are reduced, consumers have
more disposable income causing demand to rise. Higher government
spending and increased borrowing creates extra demand in the circular flow
3. Monetary stimulus to the economy: A fall in interest rates may stimulate too
much demand – for example in raising demand for loans or in leading to
house price inflation. Monetarist economists believe that inflation is caused by
“too much money chasing too few goods" and that governments can lose
control of inflation if they allow the financial system to expand the money
supply too quickly.
4. Fast growth in other countries – providing a boost to UK exports overseas.
Export sales provide an extra flow of income and spending into the UK
circular flow – so what is happening to the economic cycles of other countries
definitely affects the UK

1. Cost pull inflation:- Component costs: e.g. an increase in the prices of raw
materials and other components. This might be because of a rise in
commodity prices such as oil, copper and agricultural products used in food
processing. A recent example has been a surge in the world price of wheat.
2. Rising labour costs - caused by wage increases, which are greater than
improvements in productivity. Wage costs often rise when unemployment is
low because skilled workers become scarce and this can drive pay levels
higher. Wages might increase when people expect higher inflation so they ask
for more pay in order to protect their real incomes. Trade unions may use their
bargaining power to bid for and achieve increasing wages, this could be a
cause of cost-push inflation
3. Expectations of inflation are important in shaping what actually happens to
inflation. When people see prices are rising for everyday items they get
concerned about the effects of inflation on their real standard of living. One of
 the dangers of a pick-up in inflation is what the Bank of England calls “second-
round effects" i.e. an initial rise in prices triggers a burst of higher pay claims
as workers look to protect their way of life. This is also known as a “wage-
price effect"
4. Higher indirect taxes – for example a rise in the duty on alcohol, fuels and
cigarettes, or a rise in Value Added Tax. Depending on the price elasticity of
demand and supply for their products, suppliers may choose to pass on the
burden of the tax onto consumers.
5. A fall in the exchange rate – this can cause cost push inflation because it leads
to an increase in the prices of imported products such as essential raw
materials, components and finished products
6. Monopoly employers/profit-push inflation – where dominants firms in a market
use their market power (at whatever level of demand) to increase prices well
above costs

Nature of inflation in developing country:- Developing countries in their bid to raise the
standards of living of their people through development plans have often found themselves in the
grip of inflation.
But the nature of inflation in under-developed but developing economies is quite different from
that found in advanced or developed countries. As discussed above, in advanced countries true
inflation starts after the level of full-employment is attained. But in under- developed countries
like India huge unemployment and inflation exist side by side
Q9)Meaning and scope of public finance:- According to Adam Smith “public finance is an
investigation into the nature and principles of the state revenue and expenditure”
1. Public Revenue: Public revenue concentrates on the methods of raising public revenue, the
principles of taxation and its problems. In other words, all kinds of income from taxes and
receipts from public deposit are included in public revenue. It also includes the methods of
raising funds. It further studies the classification of various resources of public revenue into
taxes, fees and assessment etc.

2. Public Expenditure: In this part of public finance we study the principles and problems relating
to the expenditure of public funds. This part studies the fundamental principles that govern the
flow of Government funds into various streams.

3. Public Debt: In this section of public finance, we study the problem of raising loans. Public
authority or any Government can raise income through loans to meet the short-fall in its
traditional income. The loan raised by the government in a particular year is the part of receipts
of the public authority.

5. Financial Administration: Now comes the problem of organisation and administration of

the financial mechanism of the Government.

Q10)Major of fiscal function:- Allocation: The provision for social goods, or the process by which
total resource use is divided between private and social goods and by which the mix of social goods
is chosen. This provision may be termed as the allocation function of budget policy. Social goods, as
distinct from private goods, cannot be provided for through the market system. The basic reasons
for the market failure in the provision of social goods are: firstly, because consumption of such
products by individuals is non rival, in the sense that one person’s partaking of benefits does not
reduce the benefits available to others. The benefits of social goods are externalized. Secondly, the
exclusion principle is not feasible in the case of social goods. The application of exclusion is
frequently impossible or prohibitively expensive. So, the social goods are to be provided by the
government. 2)Distribution: Adjustment of the distribution of income and wealth to assure
conformance with what society considers a ‘fair’ or ‘just’ state of distribution. The distribution of
income and wealth determined by the market forces and laws of inheritance involve a substantial
degree of inequality. Tax transfer policies of the government play an important role in reducing the
inequalities in income and wealth in the economy. 3)Stabilization: Fiscal policy is needed for
stabilization, since full employment and price level stability do not come about automatically in a
market economy. Without it the economy tends to be subject to substantial fluctuations, and it may
suffer from sustained periods of unemployment or inflation. Unemployment and inflation may exist
at the same time. Such a situation is known as stagflation. The overall level of employment and
prices in the economy depends upon the level of aggregate demand, relative to the potential or
capacity output valued at prevailing prices. Government expenditures add to total demand, while
taxes reduce it. This Fiscal Functions of Government Edited by Karan Gandhi suggests that budgetary
effects on demand increase as the level of expenditure increases and as the level of tax revenue
decreases.
Q11)Principle of maximum of social advantage:-a) Marginal Social Sacrifice (MSS) refers to that
amount of social sacrifice undergone by public due to the imposition of an additional unit of
tax.Every unit of tax imposed by the government taxes result in loss of utility. Dalton says that the
additional burden (marginal sacrifice) resulting from additional units of taxation goes on increasing
i.e. the total social sacrifice increases at an increasing rate. This is because, when taxes are imposed,
the stock of money with the community diminishes. As a result of diminishing stock of money, the
marginal utility of money goes on increasing. Eventually every additional unit of taxation creates
greater amount of impact and greater amount of sacrifice on the society. That is why the marginal
social sacrifice goes on increasing.
b) Marginal Social Benefit (MSB) ↓While imposition of tax puts burden on the people, public
expenditure confers benefits. The benefit conferred on the society, by an additional unit of public
expenditure is known as Marginal Social Benefit (MSB).
Just as the marginal utility from a commodity to a consumer declines as more and more units of the
commodity are made available to him, the social benefit from each additional unit of public
expenditure declines as more and more units of public expenditure are spent. In the beginning, the
units of public expenditure are spent on the most essential social activities. Subsequent doses of
public expenditure are spent on less and less important social activities. As a result, the curve of
marginal social benefits slopes downward from left to right as shown in figure below.
Q12) Relation between efficiency market and government?
Efficient economic system:-
1. Allocates resources so as to set MSB of each good or service = MSC
2. Markets are organized for the purpose of allowing mutually gainful trades between
buyers and sellers.

A PERFECTLY COMPETITIVE MARKET SYSTEM

- Can result in efficient resource use in an economy. It exists when:

1. All productive resources are privately owned

2. All transactions take place in markets, and in each separate market many competing sellers
offer a standardized product to many competing buyers.

3. Economic power is dispersed in the sense that no buyers or sellers alone can influence the
prices.

4. All relevant information is freely available to buyers and sellers.

5. Resources are mobile and may be freely employed in any enterprise.

2. Prices do not always fully reflect the marginal social costs of output. This occurs
because of the nature of certain goods, which makes them difficult to package and trade
easily in markets.

2. For services with collective or shared benefits, it might be difficult to package the
benefits flowing from outputs into units that can be sold to individuals. When packaging
into salable units is difficult so is pricing.

- The failure of markets to price and make available certain goods, such national defense
and environmental protection, gives rise to demands for governmental protection and
regulation.

- 3. When Monopolistic Power is exercised. (Figure 2.2)

- - A firm exercises monopolistic power when it influences

- the price of the product it sells by reducing output

- to a level at which the price it sets exceeds marginal

- cost of production.

- 4. Taxes – It distorts the decisions of market participants. For example, taxes influence
your decision to work by reducing the net gain from working. (Figure 2.3)

5.Government subsidies:- MARKET FAILURE: A PREVIEW OF THE BASIS FOR GOV’T

ACTIVITY

1. Exercise of monopoly power in markets

2. Damaging effect of the market (exhaust fumes from cars, trucks, factories and power
plants)

3. Public goods (national defense)

4. Incomplete information (e.g. drugs and hazardous products)

5. Economic stabilization (unemployment)

Vi)Equity vs efficiency :- EQUITY - Perceived fairness in the resource allocation

Q13)Concept of public goods and the role government?

Ans: A public good is a product that one individual can consume without reducing its
availability to others and from which no one is deprived. Examples of public goods include law
enforcement, national defense, sewer systems, and public parks. As those examples reveal,
public goods are almost always publicly financed.

1. Role: Non Excludability: This means that you cannot stop anyone from accessing a public
good through any mechanism. Now a common restricted definition of excludability that is
often found is, “you get it only if you pay for it”. But the important thing to note here is,
that the price (payment) mechanism is only one way in which you can exclude people
access to a good. Another example of such a mechanism is perhaps you have your own
goons who beat up anyone who tries to access a good (say a piece of land). But access to
 public goods due to their very nature, cannot be denied to anyone. A good example of non
excludable good, is the atmosphere. You cannot exclude anyone from breathing right?

2. Non-rivalry: This means that your consumption of the good, which is public, won't in any
way affect the consumption of someone else. For example, the sun. If you are getting
vitamin Deficiency from sunlight, that doesn't mean that anyone else will get less vitamin
D when exposed to sunlight.

Hence, any good with these two properties can be classified as a public good. But in reality

Q14) Sources of public revenue: A) Tax Revenue:

The chief source of public revenue is Tax. To define tax, it is said that tax is a mandatory
imposition of duty on public authority by government organizations to meet requirements of
general public as a whole.
Therefore, with the above defined term, some points are highlighted as below:

i) A Tax is a compulsory duty levied by the government. If any individual refuses to comply
with tax payments, he can be punished or penalized
ii) Tax basically involves some understanding and sacrifice on the basis of a tax payer
iii) Tax is a duty and not a penalty
(iv) Most part of revenue income is generated from tax by the central government.

Important sources of Non tax revenues include

a) Special Assessment:

This can be called as betterment charge

This tax is imposed to a certain category of members of a community who are generally
benefited from governmental activities or public functions like constructions of road, railways,
parks, etc
Therefore, government imposes special charges on such properties

b) Surplus of Public Enterprises

The government has arranged public sector enterprises that are concerned in commercial
activities.
The surpluses generated of these enterprises are a significant source of non-tax revenue.
These incomes are in the form of profits that are known as commercial revenues.

c) Fees:

A fee is a significant source of managerial non-tax revenue charged by Government authorities

for depiction services to the members of the public.
There is no compulsion to pay fees. All those utilize services may pay fees.
Fees may be charged for getting licenses, passports or registrations, filing of court cases, etc.

d) Fine and Penalties

These are general sources of administrative non tax revenues

These may be applied on public for non compliance with certain rules and regulations.
These are not considered as the major source of revenue for the government

e) Grants and Gifts

 Grants are financial support
These are provided to public authority to perform certain social activities
These are generated by higher public authority to lower ones

Q15) Objectives of taxation:- 1. Full Employment:

Second objective is the full employment. Since the level of employment depends on effective
demand, a country desirous of achieving the goal of full employment must cut down the rate
of taxes. Consequently, disposable income will rise and, hence, demand for goods and services
will rise. Increased demand will stimulate investment leading to a rise in income and
employment through the multiplier mechanism.

2. Thirdly, taxation can be used to ensure price stability—a short run objective of taxation.
Taxes are regarded as an effective means of controlling inflation. By raising the rate of direct
taxes, private spending can be controlled. Naturally, the pressure on the commodity market is
reduced.

But indirect taxes imposed on commodities fuel inflationary tendencies. High commodity
prices, on the one hand, discourage consumption and, on the other hand, encourage saving.
Opposite effect will occur when taxes are lowered down during deflation.

3. Fourthly, control of cyclical fluctuations—periods of boom and depression—is considered

to be another objective of taxation. During depression, taxes are lowered down while
during boom taxes are increased so that cyclical fluctuations are tamed.
4. Taxes like custom duties are also used to control imports of certain goods with the
objective of reducing the intensity of balance of payments difficulties and encouraging
domestic production of import substitutes.

Q16)Types of taxes:- Direct taxes:

Direct taxes are levied on wealth and income of individuals or organizations. These taxes are
personal income tax, corporate tax, and gift or wealth tax. The impact of direct taxes is on the
same person.
Direct taxes are developing in nature and the tax rate increases along with the tax base.
Progressive direct taxes are involved in falling income discrimination especially in rising countries.

Indirect tax: An indirect tax is collected by one entity in the supply chain (usually a producer or
retailer) and paid to the government, but it is passed on to the consumer as part of the purchase
price of a good or service. The consumer is ultimately paying the tax by paying more for the
product.

Q17)Progressive tax:- A progressive tax is a tax in which the average tax rate (taxes paid ÷ personal
income) increases as the taxable amount increases.[1][2][3][4][5] The term "progressive" refers to the
way the tax rate progresses from low to high, with the result that a taxpayer's average tax rate is
less than the person's marginal tax rate.[6][7] The term can be applied to individual taxes or to a tax
system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an attempt to
reduce the tax incidence of people with a lower ability to pay, as such taxes shift the incidence
increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive
tax, where the average tax rate or burden decreases as an individual's ability to pay increases. [5]
Q18)Regressive tax:- A regressive tax is a tax imposed in such a manner that the average tax
rate (tax paid ÷ personal income) decreases as the amount subject to taxation
increases.[1][2][3][4][5] "Regressive" describes a distribution effect on income or expenditure, referring
to the way the rate progresses from high to low, so that the average tax rate exceeds the marginal
tax rate.[6][7]In terms of individual income and wealth, a regressive tax imposes a greater burden
(relative to resources) on the poorthan on the rich: there is an inverse relationship between the
tax rate and the taxpayer's ability to pay, as measured by assets, consumption, or income. These
taxes tend to reduce the tax burden of the people with a higher ability to pay, as they shift the
relative burden increasingly to those with a lower ability to pay.

Q19)Shifting tax burden:- 1) Impact and incidence of taxation:- Raise revenue for the government.
The main purpose of tax is to raise income for the government which can lead to higher spending
on health care and education. The impact depends on what government spend the money on. For
example, it may be necessary public sector investment (repairing roads) or it could be to fund
shortages in pension funds)

 Less discretionary income. Those paying income tax will be left with less discretionary
income to spend after income tax has been deducted. This is likely to lead to lower levels
of household spending and lower levels of household saving. However, if the government
spend the tax revenue – overall aggregate demand (AD) will not be affected.

 Incentive effect. Higher income tax reduces the take-home pay and can reduce the
incentive to work. Either workers chose not to do overtime or even leave the labour
market altogether. However, there are two conflicting effects of higher tax

 Substitution effect. Higher tax leads to lower wages – and work becomes relatively
less attractive than leisure. The substitution effect of higher tax is that workers will
want to work less.

 Income effect. However, if higher tax leads to lower wages, then a worker may feel
the need to work longer hours to maintain his target level of income. Therefore,
the income effect means that higher tax may mean some workers feel the need to
work longer.

 This means there is no guarantee of the impact of higher tax – it depends whether
substitution effect is greater than income effect.

B)Incidence:- When a tax is imposed on some person, it is quite possible that it

may be transferred by him to a second person, and this tax may be ultimately
borne by this second person or transferred to others by whom it is finally borne.
Thus, the person who originally pays the tax may not be actually bearing its money
burden as such. This problem is, therefore, to determine who bears the tax,
ultimately. This is known as incidence of taxation.

The concept of “incidence” of taxation has been variously described by different

economists. Dalton, for instance, considers incidence as the direct money burden
of tax on the person who ultimately pays it. Incidence, thus, rests on the person
who cannot shift the money burden of the tax to any other person.

Q20)Factor influencing the taxation:- (a) Elasticity: While considering incidence we consider both
elasticity of demand and elasticity of supply. If the demand for the commodity taxed is elastic, the
tax will tend to be shifted to the producer but in case of inelastic demand, it will be largely borne
by the consumer. In case of elastic supply, the burden will tend to be on the purchaser and in the
case of inelastic supply on the producer.

(b) Price: Since shifting of the tax burden can only take place through a change in price, price is a
very important factor. If the tax leaves the price unchanged, the tax does not shift.

(c) Time: In short run, the producer cannot make any adjustment in plant and equipment. If,
therefore, demand falls on account of price rise resulting from the tax, he may not be able to
reduce supply and may have to bear the tax to some extent. In the long run, however, full
adjustment can be made and tax shifted to the consumer.

(d) Cost: Tax raises the price; rise in price reduces demand and reduced demand results in the
reduction of output. A change in the scale of production affects cost and the effect will vary
according as the industry is decreasing, increasing or constant costs industry. For instance, if the
industry is subject to decreasing cost, a reduction in the scale of production will raise the cost and
hence price, shifting the burden of the tax to the consumer.

(e) Nature of tax: The incidence of taxation will definitely depend on the nature of tax. For
example, an indirect tax’s burden is fall on the consumer.

(f) Market form: Another factor determining the incidence of taxation is the market
form. Under perfect competition, no single producer or single purchaser can affect the price;
hence shifting of tax in either direction is out of the question. But under monopoly, a producer is
in a position to influence price and hence shift the tax.

Q21)Economic effect of taxation:- 1. Effects of Taxation on Production:Taxation can influence

production and growth. Such effects on production are analysed under three heads:

(i) effects on the ability to work, save and invest

(ii) effects on the will to work, save and invest

(iii) effects on the allocation of resources.

2. Effects on the Ability to Work Save:Imposition of taxes results in the reduction of disposable
income of the taxpayers. This will reduce their expenditure on necessaries which are required to
be consumed for the sake of improving efficiency. As efficiency suffers ability to work declines.
This ultimately adversely affects savings and investment. However, this happens in the case of
poor persons. Taxation on rich persons has the least effect on the efficiency and ability to work.
Not all taxes, however, have adverse effects on the ability to work. There are some harmful goods,
such as cigarettes, whose consumption has to be reduced to increase ability to work. That is why
high rate of taxes are often imposed on such harmful goods to curb their consumption.

But all taxes adversely affect ability to save. Since rich people save more than the poor,
progressive rate of taxation reduces savings potentiality. This means low level of investment.
Lower rate of investment has a dampening effect on economic growth of a country.Thus, on the
whole, taxes have the disincentive effect on the ability to work, save and invest.

3. Effects on the will to Work, Save and Invest: The effects of taxation on the willingness to work,
save and invest are partly the result of money burden of tax and partly the result of psychological
burden of tax. Taxes which are temporarily imposed to meet any emergency (e.g., Kargil Tax
imposed for a year or so) or taxes imposed on windfall gain (e.g., lottery income) do not produce
adverse effects on the desire to work, save and invest. But if taxes are expected to continue in
future, it will reduce the willingness to work and save of the taxpayers.Taxpayers have a feeling
that every tax is a burden. This psychological state of mind of the taxpayers has a disincentive
effect on the willingness to work. They feel that it is not worth taking extra responsibility or
putting in more hours because so much of their extra income would be taken away by the
government in the form of taxes.

4. Effects on the Allocation of Resources:By diverting resources to the desired directions, taxation
can influence the volume or the size of production as well as the pattern of production in the
economy. It may, in the ultimate analysis, produce some beneficial effects on production. High
taxation on harmful drugs and commodities will reduce their consumption.

This will discourage production of these commodities and the scarce resources will now be
diverted from their production to the other products which are useful for economic growth.
Similarly, tax concessions on some products are given in a locality which is considered as
backward. Thus, taxation may promote regional balanced development by allocating resources in
the backward regions.

5.Income distribution: Taxation has both favourable and unfavourable effects on the distribution
of income and wealth. Whether taxes reduce or increase income inequality depends on the nature
of taxes. A steeply progressive taxation system tends to reduce income inequality since the
burden of such taxes falls heavily on the richer persons.But a regressive tax system increases the
inequality of income. Further, taxes imposed heavily on luxuries and nonessential goods tend to
have a favourable impact on income distribution. But taxes imposed on necessary articles may
have regressive effect on income distribution.However, we often find some conflicting role of
taxes on output and distribution. A progressive system of taxation has favourable effect on
income distribution but it has disincentive effects on output.A high dose of income tax will reduce
inequalities but such will produce some unfavourable effects on the ability to work, save,
investment and, finally, output. Both the goals—the equitable income distribution and larger
output—cannot be attained simultaneously.

Q22)Public expenditure meaning & classification?

Ans: Public expenditure refers to Government expenditure i.e. Government spending. It is

incurred by Central, State and Local governments of a country.

Public expenditure can be defined as, "The expenditure incurred by public authorities like central,
state and local governments to satisfy the collective social wants of the people is known as public
expenditure."

Classification: 1. Revenue Expenditure

Revenue expenditures of the government are those expenditures which have the following two
characteristics:

 These expenditure do no create assets for the government.For example,expenditure by

the government on old-age pensions,salaries and scholarships are to be teated as revenue
expenditure.Because these are just routine expenditures,not creating assets of any sort.

 These expenditures do not cause any reduction of liability of the government.Expenditure

on the repayment of loans,for example,causes reduction of government
liability.According,this is not to be treated as revenue expenditure.
In short,revenue expenditure refers to estimated expenditure of the govenmnet in a a fiscal year
which does not either create assets or cause a reduction in liabilities.

2. Capital Expenditure are Those expenditures of the government are capital expenditures which:

 Create assets for the government. Equity(or shares) of the domestic or multinational
corporations purchased by the government may be cited as an example.

 Cause reduction in liabilities of the government.Repayment of loans certainly reduces

liability of the government. According this is to be treated as capital expenditure.

In short, capital expenditure refers to the estimated expenditure of the government in a fiscal year
which either creates assets or causes a reduction in liabilities.

Q23)Effects of public expenditure: 1. Effects on Distribution: The primary aim of the government is
to maximise social benefit through public expenditure. The objective of maximum social welfare
can be achieved only when the inequality of income is removed or minimised. Government
expenditure is very useful to fulfill this goal. Government collects excess income of the rich
through income tax and sales tax on luxuries. The funds thus mobilised are directed towards
welfare programmes to promote the standard of poor and weaker section. Thus public
expenditure helps to achieve the objective of equal distribution of income.

Expenditure on social security & subsidies to poor are aimed at increasing their real income &
purchasing power. Public expenditure on education, communication, health has a positive impact
on productivity of the weaker section of society, thereby increasing their income earning capacity.

2. Effects on Consumption:Public expenditure enables redistribution of income in favour of

poor. It improves the capacity of the poor to consume. Thus public expenditure promotes
consumption and thereby other economic activities. The government expenditure on welfare
programmes like free education, health care and housing certainly improves the standard of the
poor people. It also promotes their capacity to consume and save.

3. Effects on Economic Stability:Economic instability takes the form of depression, recession and
inflation. Public expenditure is used as a mechanism to control instability. The modern economist
Keynes advocated public expenditure as a better device to raise effective demand & to get out of
depression. Public expenditure is also useful in controlling inflation & deflation. Expansion of
Public expenditure during deflation & reduction of public expenditure during inflation control
money supply & bring price stability.

4. Effects on Economic Growth:The goals of planning are effectively realised only through
government expenditure. The government allocates funds for the growth of various sectors like
agriculture, industry, transport, communications, education, energy, health, exports, imports, with
a view to achieve impressive growth.

Government expenditure has been very helpful in maintaining balanced economic growth.
Government takes keen interest to allocate more resources for development of backward regions.
Such efforts reduces regional inequality and promotes balanced economic growth.

Q24)Theories of public expenditure: Peacock and jack wiseman advanced the study of growth of
public expenditure through peacock wiseman hypothesis by their study of public expenditure at
great britian during the period 1890 to 1955. Peacock wiseman hypothesis focused on the pattern
of the public expenditure and stated that public expenditure does not follow a smooth or
continuous trend but the increase in public expenditure takes in steps they give three separate
concept to justify the hypothesis:

Accoding to peacock wiseman due to some social or other disturbance in an economy there is a
need for increase in expenditure as the existing public revenue cannot solve the disturbance the
fiscal activities of the government rise step by step to successive new higher level during the span
of decades to meet successive social disturbances .

1)When a social disturbance occur the government raises the taxex to increase revenue and
increase public exp to meet the social disturbance these create a displacement effect by which low
taxes and expenditure are replaced by higher tax and expenditure level However after
disturbance end the newly emerged level of tax tolerance make the people willing to support
higher level of public exp since it is capable of bearing heavier tax burden than before. As a result
the new level of public exp and public revenue stabalize but are soon destabilized by another new
disturbance which causes another displacement effect.

2)Even there is no new disturbance there is no wrong motivation return to lower level of taxation
as the increased revenue can be used to support a higher level of public expenditure.Therefore
government expands its fiscal operation partly due to disturbance and partly to expand economic
activity and take up new function that were earlier neglected these is known as inspection effect.

3)when an economy is experiencing economic growth there is a tendency pf central government

economic activities to grow at a faster rate than that of state and local government activities these
is known as concentration effect.

Q25)Causes of public expenditure growth:1) The increase in national income also resulted in
more income to the government by way of tax revenue and other income. As a result of which the
government Expenditure also increased because under the circumstances, the Government is not
only expected to expand its traditional activities but it also undertakes new activities.

2) Development Projects:The government has been undertaking various development projects

such as irrigation, iron and steel, heavy machinery, power, telecommunications, etc. The
development projects require lot of capital and revenue expenditure.

3) Setting up key and basic industries requires a huge capital and profit may arise only in the long
run. It is the government which starts such industries in a planned economy. India needs a strong
network of infrastructure including transport, communication, power, fuel, etc. The public sector
has created a strong infrastructure as a support base for our industrial sector by investing huge
capital. The government has not only improved the rail, air and sea transport but has also
expanded them manifold.

4) Education not only contributes to mental development of man but also raises productivity.
Moreover mass education is necessary condition for the success of democracy. The state has made
attempts to create various types of educational facilities. In order to meet growing demand for
skilled labours. Government has also set up specialised institutes for medical & technical
education which involves heavy expenditure.

Q26)Importance of public expenditure:1) Social security contributions are compulsory

payments paid to general government that confer entitlement to receive a (contingent) future
social benefit. They include: unemployment insurance benefits and supplements, accident,
injury and sickness benefits, old-age, disability and survivors' pensions, family allowances,
reimbursements for medical and hospital expenses or provision of hospital or medical
services. Contributions may be levied on both employees and employers. Such payments
are usually earmarked to finance social benefits and are often paid to those institutions of
general government that provide such benefits. This indicator relates to government as a
whole (all government levels) and is measured in percentage both of GDP and of total
taxation.
2) Social insurance is one of the devices to prevent an individual from falling to the depths of
poverty and misery and to help him in times of emergencies. Insurance involves the setting
aside of sums of money in order to provide compensation against loss, resulting from
particular emergencies.

The elimination of the risk of the individual is the basic idea of insurance. It is primarily the
effort of the social group, in place of the individual effort, to lessen the incidence of loss on
the individual.

We may define social insurance as “a co-operative device, which aims at granting adequate
benefits to the insured on the compulsory basis, in times of unemployment, sickness and
other emergencies, with a view to ensure a minimum standard of living, out of a fund created
out of the tripartite contributions of the workers, employers and the State, and without any
means test, and as a matter of right of the insured”.

Q27)Classification/types of public debt :1) Sums owed to the citizens and institutions are
called internal debt and sums owed to foreigners comprise the external debt. Internal debt
refers to the government loans floated in the capital markets within the country. Such debt is
subscribed by individuals and institutions of the country.On the other hand, if a public loan is
floated in the foreign capital markets, i.e., outside the country, by the government from foreign
nationals, foreign governments, international financial institutions, it is called external debt.

2) Loans are classified according to the duration of loans taken. Most government debt is held
in short term interest-bearing securities, such as Treasury Bills or Ways and Means Advances
(WMA). Maturity period of Treasury bill is usually 90 days.Government borrows money for
such period from the central bank of the country to cover temporary deficits in the budget.
Only for long term loans, government comes to the public. For development purposes, long
period loans are raised by the government usually for a period exceeding five years or more.

3) Funded debt is the loan repayable after a long period of time, usually more than a year.
Thus, funded debt is long term debt. Further, since for the repayment of such debt government
maintains a separate fund, the debt is called funded debt. Floating or unfunded loans are
those which are repayable within a short period, usually less than a year.

It is unfunded because no separate fund is maintained by the government for the debt
repayment. Since repayment of unfunded debt is made out of public revenue, it is referred to
as a floating debt. Thus, unfunded debt is a short term debt.

Q28) Burden of debt finance :1) It is said that an internal debt has no direct money burden
since the interest payment on debt and the imposition of taxation to pay interest to the lenders
is simply a transfer of purchasing power from one to another. This means that in case of
internal debt, money is borrowed from individuals and institutions within the
country.Repayment (raised from taxation) constitutes just a transfer of resources from one
group of persons to another. In other words, these are transfer payments and do not affect the
total resources of the community Truly speaking, government collects money through taxation
imposed on the richer people who are also the buyers of government bonds. That is to say,
government collects money from the left pocket and pays it back to the right pocket. Thus,
under internal debt, since all payments cancel out each other in the community as a whole,
there is no direct money burden.Above all, money collected from internal source of borrowing
is usually spent for various developmental activities. Such expenditure results in transfer of
resources in the community and, as a result, aggregate resources of the country increase.
Thus, there can be no direct money burden of internal debt.But there is no denying the fact
that internal debt involves direct real burden to the community according to the nature of the
series of transfer of incomes from taxpayers to the creditors. If we assume that the taxpayers
and bondholders are the same persons then there can be no direct real burden of debt. But we
know that the taxpayers and the bondholders belong to different income groups in the
community.Usually, the bondholders are richer people compared to the taxpayers. Certainly, it
is necessary to raise taxation to pay interest on the debt and, the greater the debt, greater the
amount of taxation required to provide the interest on it. Ordinarily, taxpayers are poor people.
When the government pays interest with principal to the bondholders, it results in the transfer
of purchasing power from the poor people to the richer people.

2) During a given period, the direct money burden of external debt is the interest payment as
well as the principal repayment (i.e., debt servicing) to external creditors. The direct real
burden of such external borrowing is measured by the sacrifice of goods and services which
these payments involve to the members of the debtor country.There is also indirect money
burden of external debt. Loan repayment by the debtor country implies more exports of goods
and services to the creditor country. Thus a debtor country experiences a fall in welfare of the
community. Indirect real burden of external borrowing is crucial. Usually, government
imposes taxes to finance external debt. But taxes have disincentive effects. It discourages
work- effort and saving. Lower the saving, lower is the capital formation. Thus, external
borrowing eats away economic growth since growth largely depends on capital formation.
This indirect real burden of external debt is quite similar to internal debt.Knowing fully well the
dangers of borrowing, governments of LDCs are compelled to public borrowing—both from
internal and external sources.

Q29)Fiscal policy meaning and objectives/importance: Fiscal policy must be designed to be

performed in two ways-by expanding investment in public and private enterprises and by
diverting resources from socially less desirable to more desirable investment channels.The
objective of fiscal policy is to maintain the condition of full employment, economic stability
and to stabilize the rate of growth.For an under-developed economy, the main purpose of
fiscal policy is to accelerate the rate of capital formation and investment.

1) The central and state governments have tried to make efficient allocation of financial
resources. These resources are allocated for Development Activities which includes
expenditure on railways, infrastructure, etc. While Non-development Activities includes
expenditure on defence, interest payments, subsidies, etc.But generally the fiscal policy
should ensure that the resources are allocated for generation of goods and services which are
socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to
encourage production of desirable goods and discourage those goods which are socially
undesirable.
2) One of the main objective of fiscal policy is to control inflation and stabilize price.
Therefore, the government always aims to control the inflation by Reducing fiscal deficits,
introducing tax savings schemes, Productive use of financial resources, etc.
3) The government is making every possible effort to increase employment in the country
through effective fiscal measure. Investment in infrastructure has resulted in direct and
indirect employment. Lower taxes and duties on small-scale industrial (SSI) units encourage
more investment and consequently generates more employment. Various rural employment
programmes have been undertaken by the Government of India to solve problems in rural
areas. Similarly, self employment scheme is taken to provide employment to technically
qualified persons in the urban areas.
4) Another main objective of the fiscal policy is to bring about a balanced regional
development. There are various incentives from the government for setting up projects in
backward areas such as Cash subsidy, Concession in taxes and duties in the form of tax
holidays, Finance at concessional interest rates, etc.
5) The objective of fiscal policy in India is also to increase the rate of capital formation so as
to accelerate the rate of economic growth. An underdeveloped country is trapped in vicious
(danger) circle of poverty mainly on account of capital deficiency. In order to increase the
rate of capital formation, the fiscal policy must be efficiently designed to encourage savings
and discourage and reduce spending.
6) Fiscal policy attempts to encourage more exports by way of Fiscal Measures like,
exemption of income tax on export earnings, exemption of sales tax and octroi, etc. Foreign
exchange provides fiscal benefits to import substitute industries. The foreign exchange
earned by way of exports and saved by way of import substitutes helps to solve balance of
payments problem.
Q30)Limitation of fiscal policy : 1) Conflict of Objectives -- When the government uses a
mix of expansionary and contractionary fiscal policy, a conflict of objectives can occur. If the
national government wants to raise more money to increase its spending and stimulate
economic growth, it can issue bonds to the public. Since government bonds offer a range of
benefits to buyers, individuals and businesses will buy them heavily. According to the
Michigan Institute of Technology, the private sector consequently will have little money left
to invest. With reduced investment activity, the economy can slow down.
Inflexibility - There are usually delays in the implementation of fiscal policy, because some
proposed measures may have to go through legislative processes. A good demonstration of
implementation delays is illustrated by the Great Recession. According to the National
Bureau of Economic Research, it began in December 2007, and the country was only able to
enact the Economic Stimulus Act in February 2008. Even when the government increases
its spending, it takes some time before the money trickles down to people's pockets.
Q31)Contracyclical fiscal policy and discretionary fiscal policy:1) Functional finance says the
fiscal balance instrument should be assigned to the full employment target and the interest
rate instrument should be assigned to the debt sustainability target. Sound finance says the
interest rate instrument should be assigned to the full employment target and and the fiscal
balance instrument should be assigned to the debt sustainability target.Functional finance
and sound finance agree that the economy should be at a point like b. If policy were executed
perfectly, the economy would always be at such a point, and there would be no way of
knowing which rule was being followed. Since both target should always be at their chosen
levels, it would make no difference — and be impossible to tell — which instrument was
assigned to which target. The difference between the positions only becomes apparent when
policy is not executed perfectly, and the economy departs from a position of full employment
with sustainable public debt.Consider a point somewhere above b, where we are have high
unemployment but the debt-GDP ratio is rising without limit. What to do? Both orthodoxy
and Lernerism want to get the economy back to a point like b, but they disagree on how.
2) In the sound-finance view, the interest rate instrument is committed to the output target.
This means we must use the fiscal balance instrument free to meet the debt sustainability
condition. This is how policy is normally discussed: An unsustainable upward trajectory in
the debt position requires the government balance to move toward surplus. In this case, that
means that the government must cut spending or raise taxes, despite the fact that demand is
already too low. Under Lernerian functional finance, on the other hand, the fiscal balance is
committed to the output target, so the rule calls for higher deficits even though the debt
position is already unsustainable. It is then the responsibility of monetary policy to adjust to
maintain debt sustainability.These alternatives are shown in Figure 4. The right-hand
trajectory from c to b is the orthodox path. The left-hand trajectory is the Lernerian path.
Implicit in the orthodox path is the idea that deficits must be brought down first, meaning a
substantial period of high unemployment and output below potential; only once debt is on a
sustainable path can interest rates be reduced to move back toward full employment. While
the Lernerian path says in effect: If government debt is rising out of control, the central bank
should intervene to force interest rates down to a level where the debt is sustainable. Then, if
the resulting liquidity raises expenditure above the full employment level, you can
subsequently raise taxes or cut transfers to bring demand back down. Orthodoxy says that
budget problems must be addressed fiscally. But this is true only on the implicit assumption
that the interest rate is not available as an instrument to target debt sustainability. Sound
finance’s policy rule is a Taylor-type rule for monetary policy, combined with a long-term
government budget position that satisfies the debt-sustainability constraint at that interest
rate. Functional finance’s policy rule: (1) fix the interest rate at a level at or below the
expected growth rate (maybe even zero); (2) adjust transfers and taxes until output is at the
full employment/stable prices level. The claim that fiscal policy must be subject to a budget
constraint, comes down to the claim that the central bank cannot or will not keep r
sufficiently low to make the full-employment fiscal position sustainable.Why is there such
disagreement about which instrument should be assigned to which target? It seems to me
that the most important argument from the sound finance side is that elected governments
cannot be trusted with the instrument of discretionary fiscal policy. They will not set taxes
and transfers to bring aggregate demand to the full employment level, but will choose a
higher, inflationary level of demand. Only independent central banks can be trusted to bring
output to its socially optimal level. In this sense, the functional finance-sound finance divide
is not a debate about economic theory, but about politics and sociology.
Q32)Budget meaning and classification?
Ans: There are tons of different kinds of budgets from short-term and long-term to
department specific. Management can make a budget for anything. The important thing to
remember is these budgets are really just the management’s future goals and plans for the
business written down in financial form.
1) Based on time
 Long-term Budget: The budget designed by the management for a long-term, i.e.
three to ten years is called as long-term budget.
 Short-term Budget: As the name suggests, the budget which is prepared for a
period ranging from 1 to 2 years, is called short-term budget.
2) Based on Capacity
 Fixed Budget: The budget created for a fixed activity level, i.e. the budget
remains constant regardless of the level of activity, is called as fixed
budget.
 Flexible Budget: The budget which changes with the change in the level of
activity is a flexible budget. It identifies the fixed cost, semi-variable cost
and variable cost, to show the expected results at different volumes.
3) Based on Receipts and Expenditure
 Capital Budget: The budget takes into account the estimated capital receipts and
expenditure of the business for a specified period.
 Revenue Budget: The budget that covers all the revenue receipts and expenses of a
particular financial year is a revenue budget.
Q33) Objectives/importance of budget:1) To provide a realistic estimate of income and
expenses for a period and of the financial position at the close of the period.

2)To provide a coordinated plan of action which is design to achieve the estimates reflected
in the budget.

3) To provide a comparison of actual results with those budgeted and an analysis and
interpretation of deviations by areas of responsibility to indicate courses of corrective actions
and to lead to improvement in future plans.

4)To provide a guide for management decisions in adjusting plans and objectives if there is
an uncontrollable change in conditions.

5)To provide a ready basis for making forecasts during the budget period to guide
management in making day to day decisions.
Q34)Structure of union budget: Union Budget keeps the account of the government's
finances for the fiscal year that runs from 1st April to 31st March. Union Budget is classified
into Revenue Budget and Capital Budget.

Revenue budget includes the government's revenue receipts and expenditure. There are two
kinds of revenue receipts - tax and non-tax revenue. Revenue expenditure is the expenditure
incurred on day to day functioning of the government and on various services offered to
citizens. If revenue expenditure exceeds revenue receipts, the government incurs a revenue
deficit.

Capital Budget includes capital receipts and payments of the government. Loans from public,
foreign governments and RBI form a major part of the government's capital receipts. Capital
expenditure is the expenditure on development of machinery, equipment, building, health
facilities, education etc. Fiscal deficit is incurred when the government's total expenditure
exceeds its total revenue.
35) Deficit concept: The Fiscal Responsibility and Budget Management Act,
2003 (FRBMA) is an Act of the Parliament of India to institutionalize financial discipline,
reduce India's fiscal deficit, improve macroeconomic management and the overall
management of the public funds by moving towards a balanced budget and strengthen
fiscal prudence. The main purpose was to eliminate revenue deficit[Note 1] of the country
(building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of
the GDP by March 2008. However, due to the 2007 international financial crisis, the
deadlines for the implementation of the targets in the act was initially postponed and
subsequently suspended in 2009. In 2011, given the process of ongoing recovery, Economic
Advisory Council publicly advised the Government of India to reconsider reinstating the
provisions of the FRBMA. N. K. Singh is currently the Chairman of the review committee for
Fiscal Responsibility and Budget Management Act, 2003, under the Ministry of Finance
(India), Government of India.
36)Intergovernmental fiscal relation : Intergovernmental fiscal relations has been an
important area of research at NIPFP. These include studies on fiscal relations, both between
the Union and State governments, and the State and the local governments. Various aspects
of fiscal federalism including expenditure assignments and fiscal instruments for revenue
generation at different levels of the government have been studied. Between the Union and
the State governments, the horizontal distribution of expenditure across States and the
extent of vertical distribution of revenue and expenditure have been researched upon. On
fiscal relations between the State and local-governments, analysis of the role and
performance of rural and urban local bodies, and the degree of devolution of funds and
functions at the local government level have been the focus of research. Decentralization in
sectors like health and education, and equalization grants for providing basic public services
across States have also been a part of the institute's research in this area.