Category: Important Questions

We have given these Economics Class 12 Important Questions Macroeconomics Chapter 5 Government Budget and the Economy to solve different types of questions in the exam. Go through these Government Budget and the Economy Class 12 Important Questions and Answers Solutions & Previous Year Questions to score good marks in the board examination.

Important Questions of Government Budget and the Economy Class 12 Macroeconomics Chapter 5

Question 1.
What do you mean by direct tax? (All India 2019)
Or
What is a direct tax? (Delhi (C) 2014)
Or
Define a direct tax. (All India 2012)
Answer:
Direct taxes are those taxes for which the incidence and impact of tax falls on the same person, i.e. actual burden of these taxes cannot be shifted, e.g. income tax, corporation tax etc.

Question 2.
State any two examples of non-tax revenue receipts of the government. (All India 2019)
Or
Give two examples of non-tax revenue receipts. (All India (C) 2014)
Or
State any two sources of non-tax revenue receipts. (Delhi (C) 2011)
Answer:
Two sources of non-tax revenue receipts are

• Fees
• Grants/donations

Question 3.
What do you mean by an indirect tax? (All India 2019)
Or
Define an indirect tax. (All India (C) 2014)
Answer:
An indirect tax is one in which the burden of the tax can be shifted to another person.

Question 4.
Define the term ‘tax’. (Delhi 2019)
Or
What is a tax? (All India (C) 2014; Delhi (C) 2012)
Or
Define tax. (Delhi 2012: All India 2010)
Answer:
Tax is a compulsory payment made by an individual, household or a firm to the government without reference to anything in return.

Question 5.
Define government budget. (All India (C) 2017,2014; Delhi 2014)
Or
What is government budget? (Delhi 2014,2013, All India (C) 2012)
Answer:
Government budget is a statement of expected receipts and expenditures of the government over the period of a financial year, i.e. from 1st April to 31st March.

Question 6.
What are revenue receipts in a government budget? (Delhi, All India 2016)
Or
Define revenue receipts in a government budget. (All India 2010)
Answer:
The receipts which neither create any corresponding liability for the government nor create any reduction in assets, are termed as revenue receipts, e.g. tax receipts of government.

Question 7.
What is revenue expenditure? (Delhi 2016)
Or
What is revenue expenditure in government budget? (Delhi (C) 2010)
Answer:
The expenditure of the government which neither cause any increase in the government assets nor cause any reduction in government liabilities, are termed as revenue expenditures, e.g. expenditure on old age pensions, salaries etc.

Question 8.
Give two examples of indirect taxes. (Delhi (C) 2014, 2013)
Answer:
Sales Tax and Value Added Tax

Question 9.
Give two examples of revenue expenditure. (All Indio (C) 2014)
Answer:
Salaries of government employees and administration expenses.

Question 10.
Give two examples of capital receipts in a government budget. (All India 2012)
Answer:
Two examples of capital receipts are

• Proceeds from disinvestment of public sector units.
• Loan from World Bank.

Question 11.
Give two examples of direct tax.AII India 2010
Answer:
Two examples of direct tax are

• Income tax
• Corporation tax

Question 12.
Define capital expenditure. (Delhi (C) 2010)
Answer:
The expenditure of the government which leads to an increase in government assets or reduction in government liabilities, is termed as capital expenditure, e.g. expenses on the construction of national highways, dams and re-payment of loans etc.

Question 13.
Explain the basis of classifying taxes into direct and indirect tax. Give examples. (Delhi 2017)
Or
Explain the basis of classifying taxes into direct and indirect tax. Give two examples of each. (All India (C) 2016)
Answer:
The basis of classifying taxes into direct and indirect taxes is ‘shifting the impact of tax’. Direct taxes are those taxes for which the incidence and impact of tax falls on the same person, i.e. actual burden of taxes cannot be shifted, e.g. income tax, corporation tax etc. Whereas indirect taxes are those taxes for which the incidence and impact fall on separate persons, i.e. burden of these taxes can be shifted to others, e.g. service tax, entertainment tax etc.

Question 14.
Distinguish between direct taxes and indirect taxes. Give an example of each. (All India 2017)
Or
Distinguish between direct tax and indirect tax. (All India 2011)
Or
Explain the distinction between direct tax and indirect tax. Give one example of each. (Delhi (C) 2012)
Answer:
Differences between direct tax and indirect tax are

Basis	Direct Tax	Indirect Tax
Meaning	A direct tax is one in which the burden of tax cannot be shifted.	An indirect tax is one in which the burden of tax can be shifted.
Nature	Progressive nature	Regressive nature
Example	Income tax and corporation tax are examples of direct tax.	Value Added Tax and Goods and Service Tax are examples of indirect tax.

Question 15.
Is the following a revenue receipt or a capital receipt in the context of government budget and why?
(i) Tax receipts
(ii) Disinvestment (All India 2014)
Answer:
(i) Tax receipts are revenue receipts for the government because neither they create a liability nor they lead to reduction in any assets.

(ii) Disinvestment refers to the withdrawal of existing investment, e.g. the government of ‘ India is undertaking disinvestment by selling its shares in Maruti Udyog Ltd. It is a capital receipt for the governments as it reduces the assets of the government.

Question 16.
Is the following revenue expenditure or capital expenditure in the context of government budget? Give reason.
(i) Expenditure on collection of taxes.
(ii) Expenditure on purchasing computers. (Delhi 2014)
Answer:
(i) Expenditure on collection of taxes is a revenue expenditure for the government as it neither adds to the assets nor reduces the liabilities.

(ii) Expenditure on purchasing computers is a capital expenditure for the government as it results in increase in assets.

Question 16.
Giving reason, state whether the following is a revenue expenditure or a capital expenditure in a government budget
(i) Expenditure on scholarships
(ii) Expenditure on building a bridge (Foreign 2014)
Answer:
(i) Expenditure on scholarships is a revenue expenditure because neither it leads to decrease in liabilities nor leads to an increase in assets.

(ii) Expenditure on building a bridge is a capital expenditure because it increases the assets of the country.

Question 17.
State three sources each of revenue receipts and capital receipts in government budget. (All India 2013)
Answer:
Sources of revenue receipts are

• Income from public enterprises
• Tax revenue
• Fees and fines

Sources of capital receipts are

• Recovery of loans
• Borrowings
• Disinvestment

Question 18.
Explain any one objective of government budget. (Delhi 2013)
Answer:
One of the objectives of government budget is ‘Generation of Employment’. Government takes steps to promote labour intensive technology, public works programme like construction of roads, dams, canals, bridges etc. to promote employment generation in the economy. Several programmes are initiated through budget to reduce the problem of poverty and unemployment. MNREGA is one such example.

Question 19.
Distinguish between revenue expenditure and capital expenditure in a government budget. Give an example of each. (Delhi 2013; All India 2013)
Or
Distinguish between revenue expenditure and capital expenditure in a budget. Give examples. (Delhi 2012)
Or
Distinguish between revenue expenditure and capital expenditure. (All India 2010)
Or
Distinguish between the following Revenue receipts and capital receipts.
Answer:
Differences between revenue expenditure and capital expenditure are

Basis	Revenue Expenditure	Capital Expenditure
Meaning	Revenue expenditure is the expenditure of government which neither cause increase in government assets nor cause any reduction in government liabilities.	Capital expenditure is the expenditure of government which leads to increase in government assets or reduction in government liabilities.
Purpose	Revenue expenditure is spent on normal functioning of government departments and for providing various provisions for social welfare.	Capital expenditure is spent on acquisition of assets, re-payment of borrowings and granting of loans and advances.
Example	Expenditure on old age pensions, expense on administrative services, expense on national security, expense on health and education etc.	Expenditure on the construction of national highways, re-payment of government loans, establishment of factories etc.

Question 20.
Distinguish between revenue receipts and capital receipts in a government budget. (All India 2013, Delhi (C) 2010)
Or
Distinguish between revenue receipts and capital receipts in a government budget. Give example in each case. (All India 2012)
Or
How are capital receipts different from revenue receipts? Discuss briefly. (Delhi 2019)
Or
Distinguish between revenue receipts and capital receipts. Give two examples of each. (All India 2011)
Answer:
Differences between revenue receipts and capital receipts are

Basis	Revenue Receipts	Capital Receipts
Meaning	The receipts which neither create any corresponding liability for the government nor do they create any reduction in assets, are termed as revenue receipts.	The receipts which create corresponding liability for the government or which lead to reduction in assets of the government are termed as capital receipts.
Nature	Revenue receipts are recurring in nature.	Capital receipts are non-recurring in nature.
Example	Tax receipts and non-tax receipts, i.e. fees, grants, donations etc.	Loans taken by the government and disinvestment of PSUs etc.

Question 21.
Explain the basis of classifying government receipts into revenue receipts and capital receipts. Which type of these receipts are ‘borrowings by government’ and why? (All India 2013)
Answer:
The basis of classifying government receipts into capital and revenue receipts is ‘reduction in assets’ or ‘increase in liabilities’.
The receipts which result in reducing the assets of the government or increasing its liabilities are referred to as capital receipts. The receipts which neither reduce government’s assets or increase it’s liabilities are revenue receipts. Borrowings by government are capital receipts as they increase the liability of the government.

Question 22.
State three objectives of a government budget. (Delhi (C) 2011)
Answer:
Objectives of a government budget are as follows

• Re-distribution of income and wealth.
• Re-allocation of resources.
• Economic stability.

Question 23.
On what basis is government expenditure classified into capital expenditure and revenue expenditure? Give an example of each. (Delhi (C) 2011)
Answer:
Government expenditures are aimed at providing benefits to the people and enhancing the development of the country. On the basis of causing a change in the assets and liabilities position of the country, these expenditures can be classified as
(i) Capital expenditure: The expenditure of the government which leads to an increase in government assets or reduction in government liabilities, is termed as capital expenditure, e.g. expenses on the construction of national highways, dams and re-payment of loans etc.

(ii) Revenue expenditure: The expenditure of the government which neither cause any increase in the government assets nor cause any reduction in government liabilities, are termed as revenue expenditures, e.g. expenditure on old age pensions, salaries etc. Payment of salaries to government employees is revenue expenditure as it neither results in increase in assets or reduction in liabilities.

Question 24.
Explain how the government can use the budgetary policy in reducing inequality of income in the economy? (All India 2019)
Answer:
Reducing inequality is a major objective of government’s budget especially in developing country like India, where inequality of income and wealth is very high.
Government uses its financial tools of taxation and subsidies to enhance equal distribution of income and wealth. In order to ensure equity of income, progressive tax structure is followed in India, which imposes higher burden of taxes on higher income group and lesser burden on lower income group. Also, those who earn below a substantial limit are exempted from payment of taxes. The additional income generated from higher income group is re-distributed by the government in the form of subsidies to the poor sections of the society, to ensure the objective of welfare. LPG subsidy is a good example of such re-distribution of income.

Question 25.
Discuss briefly the role of the government budget in influencing “allocation of resources” in the economy. (All India 2019)
Answer:
The government of a country, through its budgetary policy, directs the allocation of resources in a manner such that there is a balance between the goals of profit maximisation and social welfare by ensuring that there should be production of necessity goods as well .as comfort and luxury goods and the goods which cannot be provided through market mechanism e.g. roads, parks, street lights (public goods) etc are provided by the government.

So, the government levies tax on the richer sections of society. The money collected from taxes is spent on providing public goods and giving subsidies on necessary goods to the poorer section of society.

So, the government re-allocates resources by collecting taxes from the rich and giving subsidies to the poor, and tries to achieve equitable distribution of income.

Question 26.
(a) How are tax receipts different from non-tax receipts? Discuss briefly.
(b) State any two items of revenue expenditure in a Government budget. (Delhi 2019)
Answer:
(a) Differences between tax receipts and non-tax receipts are

Basis	Tax Receipts	Non-tax Receipts
Nature	It is recurring in nautre.	It is non-recuring in nature.
Examples	Goods and Service	Registration fees, penalties and fines etc.

(b) Two items of revenue expenditure in a government budget are as follows

• Salaries of government officials
• Expenditure on defence.

Question 27.
Explain the basis of classifying government expenditure into revenue and capital expenditures. (All India (C) 2012)
Answer:
The basis of classifying government expenditure into revenue and capital is as follows:

• If an expenditure results in increase in the value of assets or decrease in the value of liability, then it is classified as capital expenditure.
• If an expenditure results neither in increase in the value of assets, nor in decrease in the value of liability, then it is classified as revenue expenditure.

Question 28.
Classify the following receipts into revenue receipts and capital receipts. Give reasons in support of your answer.
(i) Recovery of loans.
(ii) Interest received on loans. (Delhi (C) 2012)
Answer:
(i) Recovery of loans is a capital receipt as it will lead to decline in financial assets of government.

(ii) On the other hand, interest received on loans are revenue receipts as they neither create liability nor any reduction in assets of the government.

Question 29.
Giving reasons, classify the following into direct and indirect tax. (Delhi 2010)
(i) Wealth tax
(ii) Value added tax
Answer:
(i) Wealth tax It is a kind of direct tax as it is paid by the same person on which it is levied or imposed, i.e. burden of this tax is not possible to shift to the other person.

(ii) Value added tax It is a kind of indirect tax as it is imposed on one person and its burden shifts to other person.

Question 30.
Explain the following objectives of government budget:
(a) Allocation of resources
(b) Reducing income inequalities (March 2018)
Answer:
(a) The government of a country, through its budgetary policy, directs the allocation of resources in a manner such that there is a balance between the goals of profit maximisation and social welfare by ensuring that there should be production of necessity goods as well .as comfort and luxury goods and the goods which cannot be provided through market mechanism e.g. roads, parks, street lights (public goods) etc are provided by the government.

So, the government levies tax on the richer sections of society. The money collected from taxes is spent on providing public goods and giving subsidies on necessary goods to the poorer section of society.

So, the government re-allocates resources by collecting taxes from the rich and giving subsidies to the poor, and tries to achieve equitable distribution of income.

(b) Reducing income inequalities Reducing inequality is a major objective of government’s budget especially in developing country like India, where inequality of income and wealth is very high.

Government uses its financial tools of taxation and subsidies to enhance equal distribution of income and wealth. In order to ensure equity of income, progressive tax structure is followed in India, which imposes higher burden of taxes on higher income group and lesser burden on lower income group. Also, those who earn below a substantial limit are exempted from payment of taxes. The additional income generated from higher income group is re-distributed by the government in the form of subsidies to the poor sections of the society, to ensure the objective of welfare. LPG subsidy is a good example of such re-distribution of income.

Question 31.
What is government budget? Explain its major components. (April re-exam 2018)
Or
Explain the role of government budget in influencing allocation of resources. (All India 2016)
Answer:
Government budget is a financial statement of estimated receipts and expenditure of the government during a financial year (i.e. 1st April to 31st March).

Components of government budget:
1. Budget receipts It refers to estimated money receipts of the government from all sources during the fiscal year.
These are classified as
(i) Revenue receipts Government receipts which neither create liabilities nor reduce assets are known as revenue receipts. Constituents of revenue receipts

• Tax receipts, i.e. income tax, GST, etc.
• Non-tax receipts, i.e. fees, grants, fines, etc.

(ii) Capital receipts Government receipts which either create liabilities or reduce assets are called capital receipts.
Constituents of capital receipts

• Recovery of loan
• Borrowing
• Dis-investment

2. Budget payment/expenditure:
It refers to estimated expenditure of the government during the fiscal year.
These are classified as:
(i) Revenue expenditure Government expenditure which does not create assets or causes a reduction in liabilities, e.g. interest payment, defence purchases, subsidies, etc.

(ii) Capital expenditure Government’s expenditure which creates assets or causes a reduction in liabilities, e.g. purchase of machine, loans to state government, etc.

(iii) Plan and non-plan expenditure: Government’s expenditure can be planned or non-planned. These are as follows

• Planned expenditure Refers to the expenditure on planned programmes.
• Non-planned expenditure Refers to the expenditure which is not related to specific plan or programmes, e.g. relief funds given to rail accident victims.

Question 32.
Explain
(a) allocation of resources and
(b) economic stability as objectives of government budget. (April re-exam 2018)
Answer:
(a) The government of a country, through its budgetary policy, directs the allocation of resources in a manner such that there is a balance between the goals of profit maximisation and social welfare by ensuring that there should be production of necessity goods as well .as comfort and luxury goods and the goods which cannot be provided through market mechanism e.g. roads, parks, street lights (public goods) etc are provided by the government.

So, the government levies tax on the richer sections of society. The money collected from taxes is spent on providing public goods and giving subsidies on necessary goods to the poorer section of society.

So, the government re-allocates resources by collecting taxes from the rich and giving subsidies to the poor, and tries to achieve equitable distribution of income.

(b) Economic stability Government budget can be helpful in bringing economic stabilisation in the economy by checking inflationary and deflationary tendencies.
To curb the inflationary tendency, the government can prepare a surplus budget. Such a budget reduces the money supply in the economy. With a fall in the money supply, the purchasing power of people also fall, leading to a fall in the level of aggregate demand. As aggregate demand falls, the price level or the rate of inflation also falls. To curb the deflationary tendency, the government can prepare a deficit budget. Such a budget increases the money supply in the economy. With increase in money supply, the purchasing power of people also rise, leading to an increase in the level of aggregate demand. As aggregate demand rises, the price level also rises and rate of deflation begins to fall.

Question 33.
Define revenue receipts in a Government Budget. Explain how Government Budget can used to bring in price stability in the economy? (Delhi 2016)
Answer:
Receipts which do not create a liability for the government or do not lead to reduction in assets, are known as revenue receipts. Revenue receipts are receipts of the government which are non-redeemable, i.e. they cannot be re-claimed from the government. These are divided into tax and non-tax revenues
(i) Tax revenue It consists of the proceeds of taxes and other duties levied by the Central and the State Governments. Tax revenues comprise of direct taxes and indirect taxes.

(ii) Non-tax revenue Non-tax revenue of the government mainly consists of interest receipts on account of loans by the government, dividends and profits on investments made by the government, fees and other receipts for services rendered by the government. Grants-in-aid from foreign countries and international organisations are also a part of non-tax revenue.

The Government Budget is a statement of estimated receipts and expenditures of the government during the financial year. One of the objective of the Government Budget is to achieve ‘economic stability’. Government tries to establish economic stability by its budgetary policies related to income and expenditure. Economic stability refers to a situation without fluctuations in price levels and stability of exchange rate in an economy. Economic stability is achieved by protecting the economy from harmful effects of various trade cycles and its phases, i.e. boom, recession, depression and recovery.

Question 34.
What is government budget? Explain how taxes and subsidies can be used to influence allocation of resources? (Delhi 2016)
Answer:
Government budget is a statement of the estimates of the government’s expected receipts and government’s expected expenditure during the financial year or fiscal year which runs from 1st April to 31st March. One of the important objective of the government budget is ‘re-allocation of resources’.

Allocation of resources:
The government of a country, through its budgetary policy, directs the allocation of resources in a manner such that there is a balance between the goals of profit maximisation and social welfare by ensuring that there should be production of necessity goods as well .as comfort and luxury goods and the goods which cannot be provided through market mechanism e.g. roads, parks, street lights (public goods) etc are provided by the government.

So, the government levies tax on the richer sections of society. The money collected from taxes is spent on providing public goods and giving subsidies on necessary goods to the poorer section of society.

So, the government re-allocates resources by collecting taxes from the rich and giving subsidies to the poor, and tries to achieve equitable distribution of income.

Question 35.
What is the difference between revenue expenditure and capital expenditure? Explain how taxes and government expenditure can be used to influence distribution of income in the society? (All India 2016)
Answer:
Difference between revenue expenditure and capital expenditure:

Basis	Revenue Expenditure	Capital Expenditure
Meaning	Revenue expenditure is the expenditure of government which neither cause increase in government assets nor cause any reduction in government liabilities.	Capital expenditure is the expenditure of government which leads to increase in government assets or reduction in government liabilities.
Purpose	Revenue expenditure is spent on normal functioning of government departments and for providing various provisions for social welfare.	Capital expenditure is spent on acquisition of assets, re-payment of borrowings and granting of loans and advances.
Example	Expenditure on old age pensions, expense on administrative services, expense on national security, expense on health and education etc.	Expenditure on the construction of national highways, re-payment of government loans, establishment of factories etc.

Distribution of income in society:
Reducing income inequalities Reducing inequality is a major objective of government’s budget especially in developing country like India, where inequality of income and wealth is very high.

Government uses its financial tools of taxation and subsidies to enhance equal distribution of income and wealth. In order to ensure equity of income, progressive tax structure is followed in India, which imposes higher burden of taxes on higher income group and lesser burden on lower income group. Also, those who earn below a substantial limit are exempted from payment of taxes. The additional income generated from higher income group is re-distributed by the government in the form of subsidies to the poor sections of the society, to ensure the objective of welfare. LPG subsidy is a good example of such re-distribution of income.

Question 36.
Explain the budgetary measures for achieving the following objectives
(i) Setting up of production units in backward regions.
(ii) Reducing inequalities of income and wealth. (Delhi 2016)
Answer:
(i) The possible budgetary incentives that a government might decide to give to investors for making investments in backward region are as follows:
(a) The government might give a tax-holiday for a stipulated period for such investors The reason behind this is that the incentive of tax-holiday might motivate the investors to invest in backward region.

(b) The government may offer subsidy on loans for such investors The provision of subsidy implies that the investors will not be required to pay back a certain percentage of the loan taken by them. This might induce them to invest.

(c) The government might waive-off the excise duty on goods manufactured by investors in these regions Excise duty is levied on goods manufactured or produced in India. Waiving of the excise duty will ensure that the price of the good is less and this will increase the demand for the good and ensure a ready market for the product. This will motivate the investors to invest in backward region.

(ii) For reducing inequalities of income and wealth, the government can initiate the following budgetary measures:
(a) High taxes on higher income: The government may levy higher taxes on people with higher incomes.

(b) Providing subsidies to lower income groups: To reduce inequalities, the government may provide subsidies on necessary consumption items to lower income groups.

(c) Improving social infrastructure: The government can increase it’s expenditure on social infrastructure, such as construction of schools and hospitals, so that the lower income group can avail of such facilities and improve their standard of living.

Question 37.
Classify the following taxes into direct and indirect tax. Give reasons for your answer.
(i) Corporation tax
(ii) Entertainment tax
(iii) Excise duty
(iv) Income tax (All India (C) 2016)
Answer:
(i) Corporation tax It is a direct tax as its impact and incidence is on the same person (Company).
(ii) Entertainment tax It is an indirect tax as its impact and incidence are on different people.
(iii) Excise duty It is an indirect tax as the burden of its payment can be shifted to another person.
(iv) Income tax It is a direct tax as its impact and incidence are on the same person.

Question 38.
Suppose you are a member of the “Advisory Committee of the Finance Minister of India”. The Finance Minister is concerned about the rising revenue deficit in the budget.
Suggest any one measure to control the rising revenue deficit of the government. (All India 2019)
Answer:
Measures to control revenue deficit are (any one)

• Increased emphasis on tax-based revenues and appropriate measures to reduce tax evasion.
• Disinvestment should be done where assets are not being used effectively.

Question 39.
What is meant by fiscal deficit? (Delhi 2019)
Or
What is fiscal deficit? (Delhi (c) 2017,2012)
Or
Define fiscal deficit. (All India 2016,2014)
Answer:
Fiscal deficit is the difference between the government’s total expenditure and total receipts excluding borrowings.
Fiscal deficit = Total Budget Expenditure – Total Budget Receipts (Excluding borrowings)
Or
Fiscal Deficit = Borrowings

Question 40.
What is meant by primary deficit? (Delhi 2019)
Or
What is ‘primary deficit’? (Delhi (C) 2017,2012; Foreign 2014)
Or
How is primary deficit calculated? (Delhi (C) 2010)
Answer:
The difference between fiscal deficit and interest payment is known as primary deficit.
Primary Deficit = Fiscal Deficit – Interest Payments

Question 41.
What is ‘revenue deficit’? (Delhi 2017: All India 2013)
Or
What is meant by revenue deficit? (All India 2010)
Answer:
When the revenue receipts are less than the revenue expenditures in a government budget, this shortfall is termed as revenue deficit. Revenue Deficit = Revenue Expenditure – Revenue Receipts

Question 42.
What is revenue deficit in government budget? (Delhi 2016)
Answer:
Revenue deficit is defined as the excess of government’s revenue expenditure over revenue receipts. The revenue deficit includes only such transactions that affect the current income and expenditure of the government. It is calculated as
Revenue Deficit = Revenue Expenditure – Revenue Receipts

Question 43.
Distinguish between fiscal deficit and revenue deficit. (Delhi 2013: All India (C) 2012)
Or
Explain the distinction between fiscal deficit and primary deficit. Delhi to 2013
Answer:
Differences between fiscal deficit and revenue deficit are

Basis	Fiscal Deficit	Revenue Deficit
Meaning	It is the difference between total revenue and total expenditure of the government (excluding borrowings).	It results when revenue receipts are less than the revenue expenditure.
Indicator	It is an indicator of the total borrowings needed by the government.	It indicates the dependency on loans in near future.
Arises	It arises due to hike in capital expenditure.	It arises when the government’s actual net receipts are lower than the projected receipts.

Question 44.
Explain the meaning and implications of revenue deficit. (All India 2011)
Answer:
When the revenue receipts are less than the revenue expenditures in the government budget, this short-fall of receipts is known as revenue deficit.
Implications of revenue deficit are as follows:

• High revenue deficit shows accumulated and recurring expenses of government such as expenses on defence, payment of interest etc.
• The revenue deficit is managed by borrowing or by disinvestment. Hence, high revenue deficit either increases government liability or reduces government assets.
• High revenue deficit leads to inflationary situation in the economy, as high government expenditure increases the aggregate demand of the economy.
• High revenue deficit implies high future burden of loan and interest payments on the government.

Question 45.
Distinguish between fiscal deficit and primary deficit. (All India 2010)
Or
Revenue deficit and fiscal deficit. (All India (C) 2014: Delhi (C) 2014)
Answer:
Differences between fiscal deficit and primary deficit are

Basis	Fiscal Deficit	Primary Deficit
Meaning	It is the excess of total budget expenditure over the total budget receipt excluding borrowing.	It is the difference between fiscal deficit and interest payments by the government.
Calculation	It is calculated as, Fiscal Deficit = Total Budget Expenditure – Total Budget Receipt (excluding borrowings)	It is calculated as, Primary Deficit = Fiscal Deficit – Interest Payments
Scope	It is broad or wide in scope.	Primary deficit is the part of fiscal deficit hence, narrow in scope.

Question 46.
Explain revenue deficit in a government budget. What does it indicate? (Delhi 2012)
Or
What is revenue deficit? Explain its implications. (Delhi 2012)
Answer:
When the revenue receipts are less than the revenue expenditures in the government budget, this short-fall of receipts is known as revenue deficit.
Implications of revenue deficit are as follows:

• High revenue deficit shows accumulated and recurring expenses of government such as expenses on defence, payment of interest etc.
• The revenue deficit is managed by borrowing or by disinvestment. Hence, high revenue deficit either increases government liability or reduces government assets.
• High revenue deficit leads to inflationary situation in the economy, as high government expenditure increases the aggregate demand of the economy.
• High revenue deficit implies high future burden of loan and interest payments on the government.

Two measures to reduce revenue deficit are as follows

• Reduction in expenditure The government should take measures to reduce unnecessary and wasteful expenditure.
• Increase in revenue The government should try to increase its revenue by expanding its tax base.

Question 47.
Explain the concept of fiscal deficit in a government budget. What does it indicate? (All India 2012)
Answer:
Fiscal deficit is the difference between the government’s total expenditure and total receipts excluding borrowings.
Fiscal deficit = Total Budget Expenditure – Total Budget Receipts (Excluding borrowings)
Or
Fiscal Deficit = Borrowings

Implications of fiscal deficit are:

• Borrowing requirements of government.
• High interest payments by government.
• High level of inflation due to high government expenditure.
• Increased foreign dependence of the economy.

Question 48.
From the following data about a government budget, find out the following:
(i) Revenue deficit
(ii) Fiscal deficit
(iii) Primary deficit (Delhi 2011)

Contents	₹ (in Arab)
(a) Capital Receipts Net of Borrowings	95
(b) Revenue Expenditure	100
(c) Interest Payments	10
(d) Revenue Receipts	80
(e) Capital Expenditure	110

Answer:
(i) Revenue Deficit = Revenue Expenditure – Revenue Receipts
= 100 – 80 = ₹ 20 Arab

(ii) Fiscal Deficit = (Revenue Expenditure + Capital Expenditure) – (Revenue Receipt + Capital Receipt Net of Borrowing) = (100 + 110) – (80 + 95)
= 210 – 175 = ₹ 35 Arab

(iii) Primary Deficit = Fiscal Deficit – Interest Payments = 35 – 10 = ₹ 25 Arab

Question 49.
From the following data about a government budget, find
(i) Revenue deficit
(ii) Fiscal deficit
(iii) Primary deficit (All India 2011)

Contents	₹ (in Arab)
Tax Revenue	47
Capital Receipts	34
Non-tax Revenue	10
Borrowings	32
Revenue Expenditures	80

Answer:
(i) Revenue Deficit = Revenue Expenditure – (Tax Revenue + Non-tax Revenue)
= 80 – [47 + 10]
= 80 – 57
= ₹ 23 Arab
(ii) Fiscal Deficit = Borrowings Borrowings = ₹ 32 Arab So, Fiscal Deficit = ₹ 32 Arab

(iii) Primary Deficit = Fiscal Deficit – Interest Payments = 32 – 20 = ₹ 12 Arab

Question 50.
Define a government budget. Give meanings of revenue deficit, fiscal deficit and primary deficit. (Delhi 2011)
Or
What is a government budget? Explain the meanings of fiscal deficit and primary deficit. (All India (C) 2010)
Answer:
Government budget is a statement of expected/estimated receipts and expenditure of the government over a period of one financial year, i.e. from 1st April to 31st March. (1)
Revenue deficit:
When the revenue receipts are less than the revenue expenditures in a government budget, this shortfall is termed as revenue deficit. Revenue Deficit = Revenue Expenditure – Revenue Receipts

fiscal deficit:
Fiscal deficit is the difference between the government’s total expenditure and total receipts excluding borrowings.
Fiscal deficit = Total Budget Expenditure – Total Budget Receipts (Excluding borrowings)
Or
Fiscal Deficit = Borrowings

primary deficit:
The difference between fiscal deficit and interest payment is known as primary deficit.
Primary Deficit = Fiscal Deficit – Interest Payments

Question 51.
Explain the meaning of the following:
(a) Revenue deficit
(b) Fiscal deficit
(c) Primary deficit (March 2018)
Answer:
(a) Revenue deficit:
When the revenue receipts are less than the revenue expenditures in a government budget, this shortfall is termed as revenue deficit. Revenue Deficit = Revenue Expenditure – Revenue Receipts

(b) Fiscal deficit:
Fiscal deficit is the difference between the government’s total expenditure and total receipts excluding borrowings.
Fiscal deficit = Total Budget Expenditure – Total Budget Receipts (Excluding borrowings)
Or
Fiscal Deficit = Borrowings

(c) Primary deficit:
The difference between fiscal deficit and interest payment is known as primary deficit.
Primary Deficit = Fiscal Deficit – Interest Payments

Question 52.
Distinguish between Primary deficit and revenue deficit (All India (C) 2014)
Answer:
Differences between primary deficit and revenue deficit are:

Basis	Primary Deficit	Revenue Deficit
Meaning	Primary deficit is the difference between fiscal deficit and interest payments.	Revenue deficit is the difference between revenue expenditure and revenue receipts.
Implications	Primary deficit indicates the borrowing requirement of the government.	Revenue deficit shows the inefficiency of the government to meet its current expenditure.
Scope	It has a narrow scope.	It has a wide scope.

Multiple Choice Questions

Question 1.
Dividends received from Public Sector Undertakings (PSUs) are a part of the governmental (Choose the correct alternative) (All India 2019)
(a) non-tax revenue receipts
(b) tax receipts
(c) capital receipts
(d) capital expenditure
Answer:
(a) non-tax revenue receipts

Question 2.
Which of the following sources of receipts in government budget increases its liabilities? (Delhi (C) 2016)
(a) Direct taxes
(b) Recovery of loans
(c) Borrowings
(d) Dividend from public sector undertakings
Answer:
(c) Borrowings

Question 3.
Which of the following is a direct tax? (Delhi (C) 2016)
(a) Corporation tax
(b) Entertainment tax
(c) Excise duty
(d) Service tax
Answer:
(a) Corporation tax

Question 4.
Which of the following is a source of capital receipt? (All India (C) 2016)
(a) Foreign donations
(b) Dividends
(c) Disinvestment
(d) Indirect taxes
Answer:
(c) Disinvestment

Question 5.
Direct tax is called direct because it is collected directly from ………. (All India 2015)
(a) the producers on goods produced
(b) the sellers on goods sold
(c) the buyers of goods
(d) the income earners
Answer:
(d) the income earners

Question 6.
The non-tax revenue in the following is…….. (Delhi 2015)
(a) export duty
(b) import duty
(c) dividends
(d) excise
Answer:
(c) dividends

Question 7.
Which one of these is a revenue expenditure? (Foreign 2015)
(a) Purchase of shares
(b) Loans advanced
(c) Subsidies
(d) Expenditure on acquisition of land
Answer:
(c) Subsidies

Question 8.
Which of the following is not a revenue receipt? (Choose the correct alternative) (All India (C) 2015)
(a) Recovery of loans
(b) Foreign grants
(c) Profits of public enterprises
(d) Wealth tax
Answer:
(a) Recovery of loans

Question 9.
Which one of the following is a combination of direct taxes? (Choose the correct alternative) (Delhi (C) 2015)
(a) Excise duty and Wealth tax
(b) Service tax and Income tax
(c) Excise duty and Service tax
(d) Wealth tax and Income tax
Answer:
(d) Wealth tax and Income tax

Question 10.
Primary deficit in a government budget will be zero, when ………………….. (All India 2019) (Choose the correct alternative)
(a) revenue deficit is zero
(b) net interest payments are zero
(c) fiscal deficit is zero
(d) fiscal deficit is equal to interest payment
Answer:
(d) fiscal deficit is equal to interest payment

Question 11.
Fiscal deficit equals (Delhi 2016) (Choose the correct alternative)
(a) interest payments
(b) borrowings
(c) interest payments less borrowings
(d) borrowings less interest payments
Answer:
(b) Borrowings

Question 12.
Primary deficit equals (Choose the correct alternative) (All India 2016)
(a) borrowings
(b) interest payments
(c) borrowings less interest payments
(d) both borrowings and interest payments
Answer:
(c) Borrowings less interest payments

Question 13.
Primary deficit is the difference between _________. (All India (C) 2016)
(a) fiscal deficit and revenue deficit
(b) revenue deficit and interest payments
(c) total expenditure and total revenue receipts
(d) fiscal deficit and interest payments
Answer:
(d) Fiscal deficit and interest payments

Question 14.
Primary deficit in a government budget is _________ (All India 2015)
(a) revenue expenditure – revenue receipts
(b) total expenditure – total receipts
(c) revenue deficit – interest payments
(d) fiscal deficit – interest payments
Answer:
(d) fiscal deficit – interest payments

Question 15.
Borrowings in government budget are _________ (Delhi 2015)
(a) revenue deficit
(b) fiscal deficit
(c) primary deficit
(d) deficit in taxes
Answer:
(b) Fiscal deficit

Question 16.
Primary deficit in a government budget equals (Choose the correct alternative) (Foreign 2015)
(a) interest payments
(b) interest payments less borrowings
(c) borrowings less interest payments
(d) None of these
Answer:
(c) Borrowings less interest payments

Question 17.
Which of the following is a correct measure of primary deficit? (All India (C) 2015)
(a) Fiscal deficit minus revenue deficit
(b) Revenue deficit minus interest payments
(c) Fiscal deficit minus interest payments
(d) Capital expenditure minus revenue expenditure
Answer:
(c) Fiscal deficit minus interest payments

Question 18.
Which of the following statements is true? (Delhi (C) 2015)
(a) Fiscal deficit is the difference between total expenditure and total receipts
(b) Primary deficit is the difference between total receipt and interest payments
(c) Fiscal deficit is the sum of primary deficit and interest payments
(d) Primary deficit is the difference between revenue deficit and interest payments
Answer:
(c) Fiscal deficit is the sum of primary deficit and interest payments.

Question 19.
Following are the impacts of government budget on the economy excluding
(a) brings better allocation of resources
(b) implement government welfare programmes
(c) brings aggregate fiscal indiscipline level
(d) better access of public goods
Answer:
(c) brings aggregate fiscal indiscipline level

Question 20.
Goods and Service Tax (GST) is an example of under government receipts.
(a) indirect tax
(b) direct tax
(c) non-tax revenue
(d) income tax
Answer:
(a) indirect tax

Question 21.
An expenditure which is of recurring or non-recurring in nature, and which is based on five year economic plan is called
(a) revenue expenditure
(b) capital expenditure
(c) plan expenditure
(d) non-plan expenditure
Answer:
(c) plan expenditure

Question 22.
Which of the following is capital expenditures?
(a) Subsidies
(b) Interest payments
(c) Purchase of shares
(d) Defince purchases
Answer:
(c) Purchase of shares

Question 23.
The expenditure incurred for smooth functioning of government departments and for day-to-day expenses of the government is called
(a) capital expenditure
(b) non-plan expenditure
(c) revenue expenditure
(d) All of the above
Answer:
(c) revenue expenditure

Question 24.
Which of the following does not form the part of capital receipts of the Union Government?
(a) Non-tax revenue
(b) Loan recoveries
(c) Net external assistance
(d) Net market borrowings
Answer:
(a) Non-tax revenue

Question 25.
Cost of tax collection, cost of audit and printing notes, pension, expenditure on defence and law and order are treated as of the government.
(a) government expenditure
(b) revenue expenditure
(c) non-development expenditure
(d) plan expenditure
Answer:
(c) non-development expenditure

Question 26.
Which of the following budget is more suitable for developing economies like India?
(a) Deficit Budget
(b) Balanced Budget
(c) Surplus Budget
(d) None of these
Answer:
(a) Deficit Budget

Question 27.
Zero primary deficit means that the government has to resort to borrowings only to make
(a) interest payment
(b) fiscal payment
(c) capital payment
(d) primary payment
Answer:
(a) interest payment

Question 28.
From the following, which is not an implication of fiscal deficit?
(a) It determine total borrowing requirements to the government
(b) It increase liability of the government
(c) It increase foreign dependence
(d) Repayment of loan together with interest further decreases the fiscal deficit
Answer:
(d) Repayment of loan together with interest further decreases the fiscal deficit

Question 29.
The government starts selling its securities to private sector. What is this process called?
(a) Open market operation
(b) Disinvestment
(c) Monetary expansion
(d) All of the above
Answer:
(b) Disinvestment

Question 30.
If fiscal deficit is ₹ 550 crore and interest payment is ₹ 200 crore, then primary deficit.
(a) ₹ 200 crore
(b) ₹ 550 crore
(c) ₹ 765 crore
(d) ₹ 350 crore
Answer:
(d) ₹ 350 crore

Question 31.
If government borrowings = ₹ 800 crore and interest payments = ₹ 155 crore, then find fiscal deficit and primary deficit.
(a) Fiscal deficit = ₹ 155 crore and Primary deficit = ₹ 800 crore
(b) Fiscal deficit = ₹ 800 crore and Primary deficit = ₹ 155 crore
(c) Fiscal deficit = ₹ 155 crore and Primary deficit = ₹ 645 crore
(d) Fiscal deficit = ₹ 800 crore and Primary deficit = ₹ 645 crore
Answer:
(d) Fiscal deficit = ₹ 800 crore and Primary deficit = ₹ 645 crore

Question 32.
Primary Deficit = Fiscal Deficit-
(a) Borrowings
(b) Subsidies
(c) Interest payments
(d) Transfer payments
Answer:
(c) Interest payments

We have given these Economics Class 12 Important Questions Macroeconomics Chapter 3 Money and Banking to solve different types of questions in the exam. Go through these Money and Banking Class 12 Important Questions and Answers Solutions & Previous Year Questions to score good marks in the board examination.

Important Questions of Money and Banking Class 12 Macroeconomics Chapter 3

Question 1.
State the two components of M₁ measure of money supply. (April re-exam 2018)
Answer:
M₁ includes, (any 2)

• currency held by public in form of notes and coins.
• net demand deposit held by commercial banks.
• other deposits held by RBI.

Question 2.
Define money supply. (Delhi 2018,2011(C). 2010)
Answer:
The total stock of money in circulation among the public at a particular point of time is called money supply.

Question 3.
State the components of money supply. (Delhi (C) 2015, 2013, 2010: All India 2013)
Or
What is included in money supply? (Delhi (C) 2012,2011)
Or
Name the two components of money supply. All India 2010
Answer:
The following are included in money supply

• Currency notes held by public.
• Demand deposits of Commercial Banks.

Question 4.
What is barter? (Delhi (C) 2013)
Answer:
Barter is a system of exchange, where goods are exchanged for goods.

Question 5.
Define money. (All India (C) 2012.2011)
Or
Give the meaning of money. (All India 2010)
Answer:
Money is defined as an object that is commonly accepted as a medium of exchange. It is an intermediate good which is acceptable to both the parties i.e. buyers and sellers.

Question 6.
Explain the store of value function of money. (Delhi 2017: All India (C) 2014)
Or
Explain the store of value as function of money. (Foreign 2014)
Answer:
Money is an asset that retains its value over time. People store their wealth in the form of money, without fearing for loss in its value. Money overcomes the problem of storing perishable item under barter system of exchange. With money, people hold liquidity and value in a much more convenient manner.

Question 7.
State the meaning and components of money supply. (Delhi 2017)
Or
Explain the concept of money supply. (Delhi (C) 2013)
Or
Define money supply and explain its components. (Delhi 2014, Foreign 2014)
Answer:
The total stock of money in circulation among the public at a particular point of time is called money supply.
Money supply comprises of the following components:

• Currency (notes and coins) held by the public.
• Net demand deposits and time deposits held by the commercial banks.
• Other deposits held by the Central Bank.
• Total deposits with post office (excluding National Saving Certificates).

Question 8.
Explain ‘difficulty in storing wealth problem faced in barter system of exchange. (All India 2017)
Answer:
In barter system of exchange, goods were exchanged for goods. Due to absence of money in barter system, wealth was stored in terms of goods. Storing of goods carried some problems like cost of storage, loss in value of goods due to passage of time, difficulty to transfer from one place to other, etc. So, it was difficult for people to store their purchasing power under barter system of exchange.

Question 9.
Explain the medium of exchange function of money. (All India 2017,2013)
Or
Explain the significance of medium of exchange function of money. (Delhi 2014)
Answer:
The primary function of money is, acting as a medium of exchange between two parties involved in a transaction. It avoids the practical problems of wastage of time and resources, involved in the barter system of an exchange and it improves the transactional efficiency. It also promotes allocational efficiency in the trade and production of goods and services. Hence, it can be said that money has separated the acts of sales and purchases.

Question 10.
Explain the significance of the unit of account function of money. (All India 2014)
Or
Explain the ‘unit of account’ function of money. (All India (C) 2014, 2013)
Answer:
Money serves as a unit of value or common measure of value in terms of which the value of all goods and services are measured. This helps in measuring the exchange values of commodities. The prices of all the goods and services can be fixed in terms of money and the problem of expressing the value of each commodity in terms of quantities of other goods can be avoided.

This function of money makes it possible to measure the value of different goods and services in a common value and facilitates the keeping of business accounts. It would not be possible to keep business account unless all business transaction are expressed in terms of money.

Question 11.
Explain the significance of standard of deferred payment function of money. (All India 2014, 2012)
Answer:
Money simplifies the mechanism of deferred payments significantly. Deferred payments means future payment. When we take a loan from somebody, we not only pay the principal amount but also the interest amount. Under barter system of exchange, it was very difficult to make such transactions. As money maintains a standard value over a period of time, provided price remains constant, deferred payments can be easily made.

Question 12.
Explain the problem of double coincidence of wants faced under barter system. How has money solved it? (Delhi 2013)
Or
Explain how money has solved the problem of double coincidence of wants. (Delhi (C) 2013)
Answer:
Barter system can only work, when both the persons are ready to exchange each other’s goods i.e. person A should have the good person B wants and vice-versa. But usually this type of double coincidence is rare, especially in modem times.

Money eliminates the problem of double coincidence of wants. In modern times, the buyer and the seller exchange goods for money, due to common measure of value function of money. It facilitates exchanges of goods and services and helps in carrying on trade smoothly.

Question 13.
Explain the ‘medium of exchange function of money. How has it solved the related problem created by barter? (All India 2016)
Answer:
Medium of exchange function of money: Money serves as a unit of value or common measure of value in terms of which the value of all goods and services are measured. This helps in measuring the exchange values of commodities. The prices of all the goods and services can be fixed in terms of money and the problem of expressing the value of each commodity in terms of quantities of other goods can be avoided.

This function of money has solved the problem of ‘double co-incidence of wants’ created by the barter system of exchange. Under the barter system, it was very rare when the owner of some goods or services could find someone who wanted his goods or services and at the same time, he possessed that goods or services that the first person wanted, e.g. a man wanting rice in exchange of wheat had to find a man wanting wheat in exchange of rice.

This made the exchange of goods and services difficult. But the evolution of money has solved this problem. A person can sell his wheat in the market for money and from that money he can purchase rice. So, the ‘medium of exchange’ function of money has solved the problem of ‘double co-incidence of wants’ related with the barter system of exchange.

Question 14.
Explain the ‘standard of deferred payment’ function of money. How has it solved the related problem created by barter? (All India 2016)
Answer:
Money simplifies the mechanism of deferred payments significantly. Deferred payments means future payment. When we take a loan from somebody, we not only pay the principal amount but also the interest amount. Under barter system of exchange, it was very difficult to make such transactions. As money maintains a standard value over a period of time, provided price remains constant, deferred payments can be easily made.

The related problem created by the barter system of exchange was ‘lack of standard of deferred payments’. In barter system, it was difficult to return value in future in terms of goods of same quantity and quality. Therefore, future payments regarding interest and loans became difficult. But money has solved this problem. Loans can be re-paid back in money and interest payments can also be made in money.

Question 15.
Explain the ‘store of value’ function of money. How has it solved the related problem created by barter? (Delhi 2016)
Answer:
Money is an asset that retains its value over time. People store their wealth in the form of money, without fearing for loss in its value. Money overcomes the problem of storing perishable item under barter system of exchange. With money, people hold liquidity and value in a much more convenient manner.

The related problem of barter which this function of money has solved is the problem of ‘lack of store of value’. Due to absence of money in barter system, wealth was stored in terms of goods. Storing of goods carried sortie problems like cost of storage, loss of value, difficult to transfer from one place to other etc. So, it was difficult for people to store their purchasing power, under the barter system of exchange. But this problem was solved with the emergence of money as a medium of exchange.

Question 16.
Explain the ‘unit of account’ function of money. How has it solved the related problem created by barter? Delhi 2016
Answer:
Money serves as a unit of value or common measure of value in terms of which the value of all goods and services are measured. This helps in measuring the exchange values of commodities. The prices of all the goods and services can be fixed in terms of money and the problem of expressing the value of each commodity in terms of quantities of other goods can be avoided.

The related problem of barter which this function of money has solved is the problem of Tack of common measure of value’.In barter system, there was absence of a common unit of measurement in which the value of goods and services can be measured. In the absence of common unit, proper valuation was not possible.

e.g. cloth is measured in metre (i.e. length) while milk is measured in litre (i.e. capacity), hence both cannot be measured in a single unit, thereby complicating the process of exchange. But the evolution of money has solved this problem, and now every good or service can be measured in terms of money.

Question 17.
How does money overcome the problems of barter system? Explain briefly. (All India 2011)
Answer:
Money overcomes the problem of barter system by replacing the C-C economy with monetary economy, as is explained below.

• In barter system, there was a problem of double coincidence of wants. It was very difficult to match the expectations of two different individuals. Thus, money was evolved to overcome the problem of coincidence of wants, as it was very difficult to find two persons having goods needed by each other in the barter system of exchange.
• When there was no money, it was difficult to give common unit of value to measure goods or services but when money evolved it gave a common unit of account to every goods and services.
• Money facilitates the contractual and future payments i.e. deferred payments which, were very difficult to pay under the barter system.
• Money is also a legal tender which has a general acceptance which was not the case under the barter system.

Question 18.
Define ‘money multiplier’. (All India 2019)
Answer:
Money multiplier refer to the fraction by which money get multiplied in the process by the commerical banks.

Question 19.
Define demand deposits. (All India 2019, 2015 (C). 2014, 2012, 2011, 2010; Delhi 2014, 2013, 2012)
Answer:
Demand deposits are current and savings account deposits with banks or other financial institutions, which are payable on demand.

Question 20.
State the role played by the Central Bank as the “lender of last resort”. (All India 2019)
Answer:
Central Bank functions as a lender of last resort which means, when commercial banks fails to get credit from any other source, Central Bank help commercial banks by lending money.

Question 21.
What is reverse repo rate? (All India (C) 2016)
Answer:
It is the rate at which the Central Bank accepts deposits of commercial banks.

Question 22.
Give the meaning of cash reserve ratio. (Delhi (C) 2016)
Or
What is meant by cash reserve ratio? (All India (C) 2015; All India (C) 2014)
Or
Define cash reserve ratio. (Delhi 2011)
Answer:
The percentage of total deposits, which a Commercial Bank needs to keep as reserve with the Central Bank, is termed as Cash Reserve Ratio.

Question 23.
What are time deposits? (All India 2014, All India (C) 2013,2012; Delhi (C) 2014, 2010)
Or
What are time deposits in banks? (All India (C) 2013)
Answer:
Time deposits are fixed term and recurring deposits having a fixed period of maturity, where the term of deposit may vary. Cheques cannot be issued against them and they are not payable on demand but these deposits yield interests for the depositor.

Question 24.
What is a Central Bank? (Foreign 2014)
Answer:
The Central Bank is an apex banking institution which controls the entire banking system and money supply of a country. Reserve Bank of India is the Central Bank of India.

Question 25.
What is statutory liquidity ratio? (All India (C) 2014)
Or
Define statutory liquidity ratio. (All India 2011)
Answer:
Commercial Bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets. This is termed as Statutory Liquidity Ratio.

Question 26.
What is meant by bank rate? (All India (C) 2014)
Or
What is bank rate? (Delhi (C) 2012)
Answer:
The rate at which Commercial Banks can borrow funds from Central Bank without any collateral security.

Question 27.
Explain the bankers’ bank function of the Central Bank. All India 2017
Or
Explain the role of Central Bank as banker’s bank. (All India (C) 2014)
Or
Explain the banker’s bank function of Central Bank. (Foreign 2016: All India 2015,2014: Delhi (C) 2013, Delhi 2012, All India (C) 2013)
Answer:
Central Bank keeps the cash balances of Commercial Banks and issues loans to them on requirements in the same manner as the Commercial Bank does for its customers. A Central Bank has almost the same relation with the other Commercial Banks of the country that the Commercial Banks have with the common public. That is why the Central Bank is also called as banker’s bank.

Question 28.
Explain the process of credit creation by commercial banks. (All India 2017)
Or
Explain the process of money creation by bank. (Delhi 2010)
Or
Explain the process of money creation by Commercial Banks with the help of a numerical example. (Delhi 2011; All India (C) 2010,2010)
Answer:
Commercial banks create credit out of their total deposits which are many more times greater than their initial level of deposits. Money created by commercial banks can be ascertrained by using the given formula
Money Creation = Initial Deposits × \(\frac { 1 }{ LRR }\)
For example, let the LRR be 20% and Initial deposits = Rs 10,000
As required, the banks keep 20%, i.e. Rs 2,000 as cash and lend the remaining amount of Rs 8,000. Further, it is also assumed that, persons receiving the debt will deposit the amount in the bank. This will result in banks receiving fresh deposits of Rs 8,000. The banks again keep ? 1,600 as cash and lend Rs 6,400, which is also 80% of the last deposit, this money also comes back to the banks leading to a fresh deposit of Rs 6,400. In this way, the money goes on multiplying and ultimately, total money creation according to the formula, will be
Money Creation = 10,000 × \(\frac { 1 }{ 20% }\)
= Rs 50,000

Question 29.
Explain the currency authority function of Central Bank. (Foreign 2014)
Or
Explain the ‘bank of issue’ function of the Central Bank. (All India 2016; Delhi 2016)
Answer:
Central Bank of the country has the sole authority of currency issue in the country, which gives it a monopoly in issuing currency. As in India RBI issues the currency, while currency notes are printed by the subsidiaries of RBI and coins are minted by the Central Government of the country. However both currency notes and coins are circulated by RBI, which gives RBI the power to control, supervise and enhance the money supply in the economy.

Question 30.
Explain lender of the last resort function of the Central Bank. (Delhi 2014,2010: All India 2013, 2010)
Or
Explain the role of Reserve Bank of India as lender of last resort. (March 2018: Delhi 2014; All India 2012)
Answer:
When a Commercial Bank fails to accommodate its financial requirements then it can approach the Central Bank and the Central Bank acts as the lender of last resort. The Central Bank issues loans to a Commercial Bank against specified and approved securities of the bank. In this way, the Central Bank ensures the smooth functioning of Commercial Banks and appropriate flow of credit in the economy.

Question 31.
Explain the role of Central Bank as a ‘Banker to the government’. (Delhi (C) 2014)
Or
Explain the banker to the government function of the Central Bank. (Delhi 2013,2010: All India 2010)
Or
Explain ‘banker to the government’ function of the Central Bank. (Delhi 2017)
Answer:
Central Bank acts as a banker, advisor and agent to the Central and State Governments. As the common public keep their cash balance, demand deposits and time deposits with Commercial Banks, in the same way the Central Bank manages the cash reserves and demand deposits of governments in current accounts. It carries out the exchange, remittance and other banking operations on behalf of the government, i.e. the Central Bank maintains same relation with the government as Commerical Banks has with the general public.

Question 32.
Explain the meaning of cash reserve ratio and statutory liquidity ratio. (All India 2010)
Answer:
Cash reserve ratio: The percentage of total deposits, which a Commercial Bank needs to keep as reserve with the Central Bank, is termed as Cash Reserve Ratio.
Statutory liquidity ratio: Commercial Bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets. This is termed as Statutory Liquidity Ratio.

Question 33.
Distinguish between ‘Qualitative and Quantitative tools’ of credit control as may be used by a Central Bank. (All India 2019)
Answer:
Central Bank uses different instrument to control money supply. These tools can be broadly classified as
(i) Quantitative tools These are those which directly impacts the quantity of money supply in the economy. These tools are very effective to either increase or decrease money supply. These tools includes

• Bank rate
• Legal reserve ratio
• Open market operations
• Repo and reverse repo rate

(ii) Qualitative tools These on the other hand, are those which impacts the quality of money supply not volume. These are not much effective tool to control money supply. It includes

• Margin requirement
• Moral suasion
• Selective credit control.

Question 34.
Discuss briefly the following functions of a Central Bank. (All India 2019)
(i) Banker’s bank
(ii) Lender of last resort
Answer:
(i) Central Bank keeps the cash balances of Commercial Banks and issues loans to them on requirements in the same manner as the Commercial Bank does for its customers. A Central Bank has almost the same relation with the other Commercial Banks of the country that the Commercial Banks have with the common public. That is why the Central Bank is also called as banker’s bank.

(ii) When a Commercial Bank fails to accommodate its financial requirements then it can approach the Central Bank and the Central Bank acts as the lender of last resort. The Central Bank issues loans to a Commercial Bank against specified and approved securities of the bank. In this way, the Central Bank ensures the smooth functioning of Commercial Banks and appropriate flow of credit in the economy.

Question 35.
Discuss briefly the ‘credit controller’ function of a Central Bank. (All India 2019)
Answer:
By credit control, it is meant that flow of credit can be regulated in such a way that it may rise or fall according to the needs of the economy. This is done by the Central Bank by using two types of tools which are stated below
(i) Quantitative tools These are those which directly impacts the quantity of money supply in the economy. These tools are very effective to either increase or decrease money supply. These tools includes

• Bank rate
• Legal reserve ratio
• Open market operations
• Repo and reverse repo rate

(ii) Qualitative tools These on the other hand, are those which impacts the quality of money supply not volume. These are not much effective tool to control money supply. It includes

• Margin requirement
• Moral suasion
• Selective credit control.

Question 36.
Explain, using a numerical example, how a reduction in reserve deposit ratio, affects the credit creation power of the banking svstem. (All India 2019)
Answer:
An increase in bank lending due to decrease in legal reserves should translate to an expansion of a country’s money supply. The size of the multiplier depends on the percentage of deposits that banks are required to hold as reserves. In other words, it is the money used to create more money and is calculated by dividing total bank deposits by the reserve requirement.

To calculate this, start with the amount banks initially take in through deposits and divide this by the reserve ratio. If, for example, the reserve requirement is 20% for every Rs 100, a customer deposits into a bank (from say earlier 25%), Rs 20 must be kept in reserve out of each Rs 100 deposited. However, the remaining Rs 80 can be loaned out to other bank customers. This Rs 80 is then deposited by the customers into another bank account, which in turn must also keep 20% or Rs 16 in reserve, but can lend out the remaining Rs 64.

This cycle continues as more people deposit money and more banks continue lending it until finally the Rs 100 initially deposited creates a total of Rs 500 (Rs 100/0.2) in deposits. As money multiplier is inversely associated with legal reserves ratio, i.e. money multiplier = \(\frac { 1 }{ LRR }\) and money created = Initial Bank Deposits × Money Multiplier.

So, if LRR is 25%, banks will create 4 time more money while if LRR falls to 20%, banks will create 5 times more money and so on.

Question 37.
Discuss briefly the credit creation process of the banking system using a hypothetical numerical example. (All India 2019)
Or
Explain the credit creation role of Commercial Banks with the help of a numerical example. (All India (C) 2014,2013: Delhi (C) 2014)
Or
How do Commercial Banks create deposits? Explain. Delhi 2013
Or
How does a Commercial Bank create money? All India 2010
Answer:
Commercial banks create credit out of their total deposits which are many more times greater than their initial level of deposits. Money created by commercial banks can be ascertrained by using the given formula
Money Creation = Initial Deposits × \(\frac { 1 }{ LRR }\)
For example, let the LRR be 20% and Initial deposits = Rs 10,000
As required, the banks keep 20%, i.e. Rs 2,000 as cash and lend the remaining amount of Rs 8,000. Further, it is also assumed that, persons receiving the debt will deposit the amount in the bank. This will result in banks receiving fresh deposits of Rs 8,000. The banks again keep ? 1,600 as cash and lend Rs 6,400, which is also 80% of the last deposit, this money also comes back to the banks leading to a fresh deposit of Rs 6,400. In this way, the money goes on multiplying and ultimately, total money creation according to the formula, will be
Money Creation = 10,000 × \(\frac { 1 }{ 20% }\)
= Rs 50,000

Question 38.
Explain, using a numerical example, how an increase in reserve deposit ratio affects the credit creation power of the banking system. (All India 2019)
Answer:
Reverse deposit ratio is the rate of interest at which commercial banks can park their surplus funds with the Central Banks for a short period of time. Increase in reverse deposit rate will reduce the credit supply and vice-versa. The following numerical example will make this clear Suppose the reverse deposit ratio is 3%. At this rate, commercial banks are willing to deposit Rs 10 crore with the Central Bank out of total deposits of Rs 50 crore. Assuming legal reserve ratio to be 10%, then
Money creation = 40 × \(\frac { 1 }{ 0.1 }\) = Rs 400 crore
Now, reverse deposit ratio rises to 5% and at this rate commercial banks are willing to deposit Rs 20 crore with the Central Bank out of total deposits of Rs 50 crore. Now, money creation = 30 × \(\frac { 1 }{ 0.1 }\) = Rs 300 crore.
So, we see that as reverse deposit ratio rises, then credit creation falls.

Question 39.
Explain the role of reverse repo rate in controlling money supply. (Delhi 2017)
Answer:
Reverse repo is the rate of interest at which commercial banks can deposit their surplus funds with the Central Bank for a short period of time.

It is an important quantitative tool for controlling money supply in the economy. If the Central Bank wants to increase money supply in the economy, then it reduces the reverse repo rate. With fall in reverse repo rate, the commercial banks reduce the deposits of surplus funds with the Central Bank, thereby increasing the money supply. On the other hand, if the Central Bank wants to decrease money supply, then it increases the reverse repo rate. With rise in reverse repo rate, the commercial banks increase the deposits of surplus funds with the Central Bank, thereby decreasing the money supply.

Thus, reverse repo rate plays an important role in controlling money supply.

Question 40.
Explain how repo rate can be helpful in controlling credit creation? (All India 2016)
Answer:
Repo rate is the rate at which Reserve Bank of India (RBI) lends funds to commercial banks for a period ranging from 1 day to 14 days. It is quite an effective quantitative tool in controlling credit creation. If the RBI wants to decrease the level of credit creation in the country, then it increases the Repo Rate which makes the credit dearer. As the cost of borrowings increase, the people’s demand for credit goes down. This also leads to a fall in liquidity. All this leads to fall in the rate of credit creation.

On the other hand, if the RBI wants to increase the level of credit creation in the economy then it decreases the repo rate which makes the credit cheaper. As the cost of borrowings fall, people’s demand for credit goes up. This leads to increase in the rate of credit creation.

Question 41.
Explain the role of cash reserve ratio in controlling credit creation. (All India 2016)
Answer:
Cash Reserve Ratio (CRR) is the fraction of total deposits that each commercial bank must keep with the Central Bank of the country, as a part of fractional reserve system.

CRR is an important quantitative tool in controlling the credit creation in the country. When the Central Bank wants to decrease the level of credit creation in the economy, it increases the CRR. As the CRR increases, the loanable deposits left with the commercial bank decreases. This reduces the lending powers of the bank and as a result, the process of credit creation falls.

If on the other hand, the Central Bank wants to increase the level of credit creation in the country, it lowers the CRR. As the CRR decreases, the loanable deposits left with the commercial banks increases. This increases the lending powers of the banks and as a result, the level of credit creation in the country rises.

Question 42.
Explain how ‘margin requirements’ are helpful in controlling credit creation? (Delhi 2016)
Answer:
‘Margin requirements’ refer to the difference between the amount of loan granted and the current value of security offered for loans. It is an important qualitative instrument for controlling credit creation. If the Central Bank of the country wants to expand the process of credit creation, then it lowers the margin requirements. Lowering of margin requirements enables the borrower to borrow more against the security offered. This increases the money supply in the economy and credit creation expands.

On the other hand, if the Central Bank wants to contract the process of credit creation, then it increases the margin requirements. Increasing margin requirements ensures that the borrower is able to borrow less against the security offered. This reduces the money supply in the economy and consequently credit creation contracts.

Question 43.
Explain how bank rate is helpful in contrplling credit creation? (Delhi 2016)
Or
How does the Central Bank control credit creation in the economy through bank rate? Explain. (All India (C) 2014)
Or
How do changes in bank rate affect money creation by Commercial Banks? (Delhi 2010)
Or
How do changes in bank rate affect the money supply in an economy? Explain. (Delhi (C) 2015)
Answer:
The rate at which Commercial Banks can borrow money from RBI, when they run short of reserves, is called bank rate.
When the Central Bank increase the bank rate, it increases the cost of borrowing and hence, discourages the borrowers from taking a loan.

Due to this, the process of credit creation and flow of money also reduces. On the other hand, when the Centred Bank decreases the bank rate, it encourages the borrower to take more and more loan. A high demand of loan increases the credit multiplier and credit creation process of the Commercial Banks.

Question 44.
Explain how open market operations are helpful in controlling credit creation? (Delhi 2016)
Or
How does Central Bank control credit creation by Commercial Banks through open market operations? Explain. (All India 2013)
Or
Explain, how do open market operations by the Central Bank affect money creation by Commercial Banks? (All India 2010)
Or
Explain the meaning of open market operations. How is it used to reduce money supply in the economy? (All India (C) 2016)
Answer:
Under open market operations, RBI purchases or sells government securities to general public for the purpose of increasing or decreasing the stock of money in an economy. The purchase or sale of securities controls the money in the hands of public as they deposit or withdraw the money from Commercial Banks. Thus, money creation by Commercial Banks get affected.

Suppose, the Central Bank purchases securities of Rs 1,000 from a bond holder with issuing a cheque. The seller of the bond produces this cheque of Rs 1,000 to his Commercial Bank. The Commercial Bank credits the account of the seller by Rs 1,000 and the deposits of the bank goes up by Rs 1,000, which increase the credit creation capacity of the banks.

Thus, purchase of security increases the money creation of Commercial Banks and similarly, sale of securities decreases the credit creation of Commercial Banks. Thus, the Central Bank controls the process of money creation by Commercial Banks by open market operations.

Question 45.
What is Legal Reserve Ratio? Explain its components. (All India (C) 2013)
Or
Explain the components of Legal Reserve Ratio. (Delhi 2012)
Answer:
The minimum percentage of a bank’s total demand and time deposits, that is required to be maintained in the form of cash or specified liquid assets by the Commercial Banks with the Central Bank is termed as Legal Reserve Ratio.
The components of Legal Reserve Ratio are as follows

• Cash reserve ratio: The percentage of total deposits, which a Commercial Bank needs to keep as reserve with the Central Bank, is termed as Cash Reserve Ratio.
• Statutory liquidity ratio: Commercial Bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets. This is termed as Statutory Liquidity Ratio.

Question 46.
Explain any two methods of credit control used by Central Bank. (All India 2013)
Answer:
The Central Bank acts as a controller of money supply and credit, using the following methods
(i) Margin requirement It is a qualitative method of credit control. A margin refers to the difference between market value of the security offered for loan and the amount loan offered by the Commercial Banks. During inflation, supply of credit is reduced by raising the requirement of margin. During deflation supply of credit is increased by lowering the requirement of ‘margin’. This measure is often used to discourage the flow of credit into speculative business activities.

(ii) Under open market operations, RBI purchases or sells government securities to general public for the purpose of increasing or decreasing the stock of money in an economy. The purchase or sale of securities controls the money in the hands of public as they deposit or withdraw the money from Commercial Banks. Thus, money creation by Commercial Banks get affected.

Question 47.
(a) State any two components of M₁ measure of money supply.
(b) Elaborate any two instruments of credit control, as exercised by the Reserve Bank of India. Delhi 2019
Answer:
(a) Components of Money Supply:
The total stock of money in circulation among the public at a particular point of time is called money supply.
Money supply comprises of the following components:

• Currency (notes and coins) held by the public.
• Net demand deposits and time deposits held by the commercial banks.
• Other deposits held by the Central Bank.
• Total deposits with post office (excluding National Saving Certificates).

(b) Two instrument of credit control are as follows
(i) Repo rate: Repo rate is the rate at which Reserve Bank of India (RBI) lends funds to commercial banks for a period ranging from 1 day to 14 days. It is quite an effective quantitative tool in controlling credit creation. If the RBI wants to decrease the level of credit creation in the country, then it increases the Repo Rate which makes the credit dearer. As the cost of borrowings increase, the people’s demand for credit goes down. This also leads to a fall in liquidity. All this leads to fall in the rate of credit creation.

On the other hand, if the RBI wants to increase the level of credit creation in the economy then it decreases the repo rate which makes the credit cheaper. As the cost of borrowings fall, people’s demand for credit goes up. This leads to increase in the rate of credit creation.

(ii) Cash reserve ratio: The percentage of total deposits, which a Commercial Bank needs to keep as reserve with the Central Bank, is termed as Cash Reserve Ratio.

Question 48.
Define credit multiplier. What role does it play in determining the credit creation power of the banking system? Use a numerical illustration to explain. (Delhi 2019)
Answer:
Credit or money multiplier refers to the fraction by which commercial banks would be able to multiply money from their initial level of deposits. It is obtained by the following formula Credit/Money
Multiplier = \(\frac { 1 }{ Legal Reserve Rato (LRR) }\)

Commercial banks create credit out of their total deposits which are many more times greater than their initial level of deposits. Money created by commercial banks can be ascertrained by using the given formula
Money Creation = Initial Deposits × \(\frac { 1 }{ LRR }\)
For example, let the LRR be 20% and Initial deposits = Rs 10,000
As required, the banks keep 20%, i.e. Rs 2,000 as cash and lend the remaining amount of Rs 8,000. Further, it is also assumed that, persons receiving the debt will deposit the amount in the bank. This will result in banks receiving fresh deposits of Rs 8,000. The banks again keep ? 1,600 as cash and lend Rs 6,400, which is also 80% of the last deposit, this money also comes back to the banks leading to a fresh deposit of Rs 6,400. In this way, the money goes on multiplying and ultimately, total money creation according to the formula, will be
Money Creation = 10,000 × \(\frac { 1 }{ 20% }\)
= Rs 50,000

Question 49.
Describe any two methods by which Reserve Bank of India can regulate money supply. (Delhi (C) 2016)
Answer:
(i) Reverse repo rate: It is the rate at which the Central Bank accepts deposits of commercial banks.

(ii) Repo rate: Repo rate is the rate at which Reserve Bank of India (RBI) lends funds to commercial banks for a period ranging from 1 day to 14 days. It is quite an effective quantitative tool in controlling credit creation. If the RBI wants to decrease the level of credit creation in the country, then it increases the Repo Rate which makes the credit dearer. As the cost of borrowings increase, the people’s demand for credit goes down. This also leads to a fall in liquidity. All this leads to fall in the rate of credit creation.

On the other hand, if the RBI wants to increase the level of credit creation in the economy then it decreases the repo rate which makes the credit cheaper. As the cost of borrowings fall, people’s demand for credit goes up. This leads to increase in the rate of credit creation.

Question 50.
Describe any two functions of Central Bank. (Delhi (C) 2016)
Or
Explain any two main functions of a Central Bank. (All India (C) 2015: Delhi (C) 2015, Delhi (C) 2012)
Or
Explain any two functions of Central Bank. (All India (C) 2012)
Or
Explain the following functions of the Central Bank. (All India 2011)
(i) Bank of issue
(ii) Banker’s bank
Answer:
(i) Central Bank of the country has the sole authority of currency issue in the country, which gives it a monopoly in issuing currency. As in India RBI issues the currency, while currency notes are printed by the subsidiaries of RBI and coins are minted by the Central Government of the country. However both currency notes and coins are circulated by RBI, which gives RBI the power to control, supervise and enhance the money supply in the economy.

(ii) Central Bank keeps the cash balances of Commercial Banks and issues loans to them on requirements in the same manner as the Commercial Bank does for its customers. A Central Bank has almost the same relation with the other Commercial Banks of the country that the Commercial Banks have with the common public. That is why the Central Bank is also called as banker’s bank.

Multiple Choice Questions

Question 1.
Money supply includes (Choose the correct alternative) (All India (C) 2016)
(a) all deposits in banks
(b) only demand deposits in banks
(c) only time deposits in banks
(d) currency with the banks
Answer:
(b) Only demand deposits in banks

Question 2.
Who regulates money supply? (Choose the correct alternative) (All India (C) 2016)
(a) Government of India
(b) Reserve Bank of India
(c) Commercial Banks
(d) Planning Commission
Answer:
(b) Reserve Bank of India

Question 3.
Which of the following is not a function of money? (Delhi (C) 2015) (Choose the correct alternative)
(a) Medium of exchange
(b) Price stability
(c) Store of value
(d) Unit of account
Answer:
(b) Price stability

Question 4.
Which of the following is not a problem of barter system of exchange? (Delhi (C) 2015)
(a) Store of value
(b) Double coincidence of wants
(c) Unit of account
(d) Unemployment
Answer:
(d) Unemployment

Question 5.
In order to encourage investment in the economy, the Central Bank may (Choose the correct alternative) (All India 2019)
(a) Reduce Cash Reserve Ratio
(b) Increase Cash Reserve Ratio
(c) Sell Government securities in open market
(d) Increase Bank Rate
Answer:
(a) Reduce Cash Reserve Ratio

Question 6.
Credit creation by commercial banks is determined by (April re-exam 2018) (Choose the correct alternative)
(a) Cash Reserve Ratio (CRR)
(b) Statutory Liquidity Ratio (SLR)
(c) Initial deposits
(d) All of the above
Answer:
(d) All of the above

Question 7.
The Central Bank can increase availability of credit by (Choose the correct alternative) (March 2018)
(a) Raising repo rate
(b) Raising reverse repo rate
(c) Buying government securities
(d) Selling government securities
Answer:
(c) Buying government securities

Question 8.
The ratio of total deposits that a commercial bank has to keep with Reserve Bank of India is called (Choose the correct alternative) (Delhi 2017)
(a) Statutory liquidity ratio
(b) Deposit ratio
(c) Cash reserve ratio
(d) Legal reserve ratio
Answer:
(c) Cash reserve ratio

Question 9.
Demand deposits include (Choose the correct alternative). (All India 2017)
(a) saving account deposits and fixed deposits
(b) saving account deposits and current account deposits
(c) current account deposits and fixed deposits
(d) All types of deposits
Answer:
(b) Saving account deposits and current account deposits

Question 10.
The definition of money includes
(a) currency and foreign exchanges
(b) currency demand deposit and other financial assets
(c) only currency and coins
(d) currency and demand deposits
Answer:
(b) currency demand deposit and other financial assets

Question 11.
Which of the following is an example of plastic money?
(a) Prepaid gift card
(b) Traveller’s cheque
(c) Currency note
(d) Demand draft
Answer:
(a) Prepaid gift card

Question 12.
Supply of money is concept.
(a) stock
(b) flow
(c) income
(d) All of these
Answer:
(a) stock

Question 13.
measures of money supply issued by RBI are known as broad money.
(a) M₁ and M₁
(b) M₂ and M₃
(c) M₃ and M₄
(d) High powered money
Answer:
(c) M₃ and M₄

Question 14.
The difference between lending rates and borrowing rates of a commercial bank, is called
(a) capital
(b) reserves
(c) profits
(d) All of the above
Answer:
(c) profits

Question 15.
LRR (Legal Reserve Ratio) includes
(a) CRR (Cash Reserve Ratio)
(b) Repo
(c) SLR (Statutory Liquidity Ratio)
(d) Both (a) and (c)
Answer:
(d) Both (a) and (c)

Question 16.
The process of credit/money creation in an economy is affected by
(a) initial deposits amount
(b) LRR
(c) bank rate
(d) Both (a) and (b)
Answer:
(d) Both (a) and (b)

Question 17.
If LRR is 20% and initial deposit is Rs 10,000 in a commercial bank, find total money creation amount.
(a) Rs 5,000
(b) Rs 5,00,000
(c) Rs 50,000
(d) Rs 2,000
Answer:
(c) Rs 50,000

Question 18.
Which is not a feature of fixed deposit accounts?
(a) Specific period of time
(b) Higher interest rate
(c) Payable on demand
(d) Tax benefit
Answer:
(c) Payable on demand

Question 19.
Central Bank is a banker to
(a) State Government
(b) Other banks
(c) Central Government
(d) All of the above
Answer:
(d) All of the above

Question 20.
Commercial banks maintain for liquidity and to honour the demand of cash withdrawals by their customers.
(a) SLR
(b) margin requirements
(c) CRR
(d) repo
Answer:
(a) SLR

Question 21.
What can RBI do, if it wants to increase credit in the economy?
(a) Decrease repo and CRR
(b) Increase repo and CRR
(c) Increase repo and decrease CRR
(d) Decrease repo and increase CRR
Answer:
(a) Decrease repo and CRR

Question 22.
Functions performed by Central Bank related to government does not include which of the following?
(a) RBI manages public debt
(b) RBI also sells treasury bills
(c) RBI make advances which are repayable within 90 days
(d) RBI comes to rescue the other banks in times of financial crises
Answer:
(d) RBI comes to rescue the other banks in times of financial crises

We have given these Economics Class 12 Important Questions Macroeconomics Chapter 1 Introduction to Macroeconomics to solve different types of questions in the exam. Go through these Introduction to Macroeconomics Class 12 Important Questions and Answers Solutions & Previous Year Questions to score good marks in the board examination.

Important Questions of Introduction to Macroeconomics Class 12 Macroeconomics Chapter 1

Question 1.
Give any two examples of flow concept. (Delhi 2019)
Answer:
Income and savings

Question 2.
Define stocks. (Delhi 2016)
Or
Give meaning of stock variables. (Delhi (C) 2013)
Or
Define stock variable. (Delhi 2012; All India 2011)
Answer:
Stock variables are defined as any quantity measured at a particular point of time. e.g. number of machines in a plant on 31st March amount in the bank account on 1st July.

Question 3.
Define flows. (All India 2016)
Or
Give meaning of flow variables. (Delhi (C) 2013)
Or
Define flow variable. (All India 2012; Delhi 2011)
Answer:
Flow variables are defined as any quantity measured per unit at a particular period of time, e.g. income or expenditure over a time period of one month or one year.

Question 4.
Define investment. (Delhi (C) 2014; Delhi (C) 2013)
Answer:
It is the process of capital formation by a firm or increase in the existing stock of capital.

Question 5.
Give the meaning of capital goods. (Delhi (C) 2014)
Or
Define capital goods. (Delhi 2012; All India 2010)
Answer:
The goods which are repeatedly used in the process of production are known as capital goods. They are the fixed assets of the producer, e.g. building, plant and machinery etc. They help to convert intermediate goods into final goods.

Question 6.
Give two examples of intermediate goods. (Delhi (C) 2014; All India 2013)
Answer:
Two examples of intermediate goods are

• Steel used in the production of car.
• Mobile sets purchased by a mobile dealer.

Question 7.
Define consumption goods. (Delhi (C) 2014; All India 2012)
Answer:
Goods which are directly used for satisfaction of human wants and which are not used in production of other goods are known as consumer goods or consumption goods, e.g. ice-cream and milk consumed by the households.

Question 8.
What is macroeconomics? (All India (C) 2013)
Answer:
Macroeconomics studies economic problems at the level of an economy as a whole. It is the study of aggregates.

Question 9.
Define final goods. (All India (C) 2013)
Or
Define final product. Delhi (C) 2010
Answer:
The goods, which have crossed the boundary line of production and are ready for use by their final users are known as final goods, e.g. clothes, milk consumed by a consumer.

Question 10.
Define depreciation. (All India 2011)
Answer:
It is the loss in the value of fixed assets in use on account of normal wear and tear, normal rate of accidental damages and expected or foreseen obsolescence. Depreciation is also called consumption of fixed capital.

Question 11.
Define intermediate goods. (Delhi (C) 2011)
Answer:
The goods purchased by a firm for the use in production of other goods or for the purpose of reselling are known as intermediate goods, e.g. steel used in the production of cars or milk purchased by a milk seller.

Question 12.
Distinguish between stock and flow variables with suitable examples. (April re-exom 2018)
Or
Distinguish between stocks and flows. Give an example of each. (All India (C) 2014)
Or
Distinguish between stock and flow. Give two examples of each. (All India 2013)
Answer:
Differences between stock and flow are (any three)

Basis	Stock	Flow
Time elements	It relates to a point of time.	It relates to the period of time.
Dimension	It is not time dimensional.	It is time dimensional as per hour, per month, per year.
Impact	It influences the flow. Greater the stock of capital greater is the flow of goods and services.	It influences the stock e.g. monthly increase in the supply of money leads to an increase in the quantity of money.
Concept	Static concept.	Dynamic concept.
Example	Money in bank account as on 31st March, 2016.	Number of births during the month of March 2016.

Question 13.
What are capital goods? How are they different from consumption goods? (April re-exam 2018)
Or
Consumption goods and capital goods (All India (C) 2016)
Answer:
The goods which are repeatedly used in the process of production are known as capital goods. They are the fixed assets of the producer, e.g. building, plant and machinery etc. They help to convert intermediate goods into final goods.

Differences between consumer goods and capital goods are:

Basis	Consumer Goods	Capital Goods
Meaning	These goods are purchased by consumers for the satisfaction of their wants and not for resale.	These goods are purchased by manufacturers and producers for the production of other goods. These goods are not meant for resale.
Use	These are for own use.	These are used for production of goods and services.
Demand	High	Comparatively less
Examples	Bread, butter, jam, etc.	Machinery, equipment, etc.

Question 14.
Which among the following are final goods and which are intermediate goods? Give reasons.
(a) Milk purchased by a tea stall
(b) Bus purchased by a school
(c) Juice purchased by a student from the school canteen (March 2018)
Answer:
(a) ‘Milk purchased by a tea stall’ is intermediate goods.
Reason: It will be used for making tea as a raw material and involved value addition.
(b) ‘Bus purchased by a school is final good.
Reason: School purchase bus as long-term durable product and make investment for school i.e. not for re-sale.
(c) ‘Juice purchased by a student from school canteen’ is final good.
Reason: Here, juice is purchased for direct satisfaction of student’s need. i.e. juice is consumed by its end user.

Question 15.
Explain with the help of an example, the basis of classifying goods into final goods and intermediate goods. (All India 2017)
Answer:
The basis of classification is the end-use of the product. Goods which are used by the producers in the process of production such as raw material or goods purchased for resale, are known as intermediate goods, e.g. shirt purchased by a firm for resale. These goods are still within the production boundary. Goods which are outside the boundary line of production and are ready for use by their final users are called final goods, e.g. shirt purchased by a consumer.

Question 16.
Distinguish between final goods and intermediate goods. Give an example of each. (All India 2017)
Or
Distinguish between Final goods and intermediate goods.
Or
Distinguish between intermediate and final goods. Give two examples of each. (All India 2010)
Answer:
Differences between intermediate goods and final goods are (any three)

Basis	Intermediate Goods	Final Goods
Meaning	These goods may be used as raw materials for the production of other goods during the accounting year.	These goods are not used as raw materials for the production of other goods during the accounting year.
Purpose	These goods may be resold by the firms to make profits during an accounting year.	These goods are not resold by the firms to make profits during an accounting year.
Production boundary	These goods remain within the boundary line of production and are not ready for use by their final users.	These goods are outside the boundary line of production and are ready for use by their final users.
Examples	(i) Steel used in the production of cars. (ii) Sugar used in the making of candies.	(i) A microwave oven sold to consumers. (ii) A mixer grinder sold to consumers.

Question 17.
Explain the circular flow of income. (All India 2017; Delhi (C) 2014, 2012; All India (C) 2012)
Answer:
Circular flow of income refers to the unending flows of production of goods and services and income and expenditure in an economy. It shows the redistribution of income in a circular manner between production units (firms) and households. It can be better understood with the diagram given below

Question 18.
Explain the circular flow of income. (All India (C) 2016,2015; Delhi (C) 2015,2013)
Answer:
Circular flow of income refers to the unending flows of production of goods and services and income and expenditure in an economy. It shows the redistribution of income in a circular manner between production units (firms) and households. It can be better understood with the diagram given below

Phases of circular flow of income There are three different phases of generation, distribution and disposal in circular flow of income, as shown in the given diagram.

Income is first generated in production units, then, distributed to households and finally spent on goods and services produced by these units to make the circular flow complete its course.

Question 19.
Define intermediate goods and final goods. Can milk be an intermediate good? Give reason for your answer. (All India (C) 2015)
Answer:
Intermediate goods: The goods purchased by a firm for the use in production of other goods or for the purpose of reselling are known as intermediate goods, e.g. steel used in the production of cars or milk purchased by a milk seller.

Final goods: The goods, which have crossed the boundary line of production and are ready for use by their final users are known as final goods, e.g. clothes, milk consumed by a consumer.

Milk can be final good as well as intermediate good. It totally depends upon end use of milk.
Milk can be a final good if it is being consumed by a household and it can be a intermediate good for a firm which makes ice-creams.

Question 20.
Give reasons and categorise the following into stock and flow. (Delhi 2013)
(i) Capital
(ii) Saving
(iii) Gross Domestic Product
(iv) Wealth
Answer:
(i) Capital: It is a man made means of production. It is a stock because it is measured at given point of time.
(ii) Saving: It is the surplus of income over consumption. It is a flow as it is measured with reference to period of time.
(iii) Gross domestic product: It is a flow as it is the market value of final goods and services produced within the domestic territory during a period of time.
(iv) Wealth: It is a stock as it is measured at a particular point of time.

Question 21.
Should the following be treated as final expenditure or intermediate expenditure? Give reasons for your answer. (All India 2012)
(i) Purchase of furniture by a firm.
(ii) Expenditure on maintenance by a firm.
Answer:
(i) Purchase of furniture by a firm Final expenditure
Reason: A firm purchases furniture for long-term usp as an investment and not for re-sale,
(ii) Expenditure on maintenance by a firm Intermediate expenditure.
Reason: Expenditure on maintenance is a recurring expense and is undertaken to facilitate the production process.

Question 22.
Giving reasons, classify following into intermediate products and final products. (Delhi 2012)
(i) Furniture purchased by a school.
(ii) Chalks, dusters etc purchased by school.
Answer:
(i) Furniture purchased by school Final product
Reason: Schools buy furnitures for long-term use and it can be considered as an investment.
(ii) Chalks, dusters etc purchased by school Intermediate good.
Reason: Chalks, dusters etc; are purchased by a school for use in their day-to-day work. This is meant for further production in the form of services.

Question 23.
Give reason and identify whether the following are final expenditures or intermediate expenditure. (All India 2012)
(i) Expenditure on maintenance of an office building.
(ii) Expenditure on improvement of machine in a factory.
Answer:
(i) Expenditure on maintenance of an office building Intermediate expenditure Reason Expenditure on maintenance of office building is for production purpose.
(ii) Expenditure on improvement of machine in a factory Final expenditure Reason Expenditure on improvement of machine in a factory is a kind of capital investment, so it should be considered as final expenditure.

Question 24.
Giving reasons, classify following into intermediate products and final products.
(i) Computers installed in an office.
(ii) Mobile sets purchased by a mobile dealer. (Delhi 2011)
Answer:
(i) Computers installed in an office Final product.
Reason: Offices buy computers as long-term durable products and are investment for them.
(ii) Mobile sets purchased by a mobile dealer Intermediate products.
Reason: A mobile dealer purchases mobile sets for reselling purpose. That’s why it is considered as intermediate product.

Question 25.
Give reasons and categorise the following into stock and flow.
(i) Profits
(ii) Capital
(iii) Savings
(iv) Balance in bank account (All India 2011)
Answer:
(i) Profits: These are flow variables as it is measured over a period of time.
(ii) Capital: It is a man made means of production. It is a stock because it is measured at given point of time.
(iii) Savings: It is the surplus of income over consumption. It is a flow as it is measured with reference to period of time.
(iv) Balance in bank account: This is a stock variable which is measured on a specific date, i.e. point of time.

Question 26.
Give reasons and categorise the following in stock and flow. (Delhi (C) 2011)
(i) Losses
(ii) Capital
(iii) Production
(iv) Wealth
Answer:
(i) Losses: These are flows as they are measured over a period of time.
(ii) Capital: It is a man made means of production. It is a stock because it is measured at given point of time.
(iii) Production: It is a flow as it is measured over a period of time.
(iv) Wealth: It is a stock as it is measured at a particular point of time.

Question 27.
Giving reasons, classify the following into intermediate and final goods. (All India 2010)
(i) Machine purchased by a dealer of machines.
(ii) A car purchased by a household.
Answer:
(i) Machine purchased by a dealer of machines Intermediate goods.
Reason: A dealer purchases machines for reselling purpose, so it is an example of intermediate good.
(ii) A car purchased by a household Final goods
Reason: A household purchases a car for consumption purpose, so it is an example of final good.

Multiple Choice Questions

Question 1.
Which of the following is a flow? (Choose the correct alternative)
(a) Deposits in a bank
(b) Capital
(c) Depreciation
(d) Wealth (Delhi (C) 2016)
Answer:
(c) Depreciation

Question 2.
Which of the following is a stock? (Choose the correct alternative). All Indin [Cl 2016
(a) Savings
(b) Production
(c) Consumption of fixed capital
(d) Capital
Answer:
(d) Capital

Question 3.
Which of the following is not a flow? (Choose the correct alternative) (Delhi (C) 2015)
(a) Capital
(b) Income
(c) Investment
(d) Depreciation
Answer:
(a) Capital

Question 4.
Which of the following is a stock? (Choose the correct alternative) (All India (C) 2015)
(a) Wealth
(b) Saving
(c) Exports
(d) Profits
Answer:
(a) Wealth

Question 5.
Macroeconomics study the economy as a whole or in aggregates. Which of the following are the macroeconomics study aggregates/variables?
(a) Aggregate demand, aggregate supply, individual income and price level
(b) Individual demand, individual supply, national income and price level
(c) Aggregate demand, aggregate supply, national income and price level
(d) None of the above
Answer:
(c) Aggregate demand, aggregate supply, national income and price level

Question 6.
A study of how increase in the Goods and Service Tax (GST) rate will affect the national unemployment rate is an example of
(a) microeconomics
(b) descriptive economics
(c) macroeconomics
(d) None of the above
Answer:
(c) macroeconomics

Question 7.
From the following, which type of goods are ready for the use by their final users?
(a) Intermediate goods
(b) Final goods
(c) Capital goods
(d) All of the above
Answer:
(b) Final goods

Question 8.
The goods in which value to be added or used for resale are known as
(a) intermediate goods
(b) value added goods
(c) capital goods
(d) None of the above
Answer:
(a) intermediate goods

Question 9.
Purchase of computers, equipments, tools, power and raw materials, etc is a part of
(a) gross investment
(b) fixed investment
(c) inventory investment
(d) All of the above
Answer:
(a) gross investment

Question 10.
Which of the following is the reason of depreciation of fixed assets?
(a) Normal wear and tear and unforeseen obsolescence
(b) Normal wear and tear and foreseen obsolescence
(c) Abnormal wear and tear and foreseen obsolescence
(d) Abnormal wear and tear and unforeseen obsolescence
Answer:
(b) Normal wear and tear and foreseen obsolescence

Question 11.
Stock variable is defined as any quantity which is measured
(a) over a period of time
(b) at a particular point of time
(c) in a financial year
(d) All of the above
Answer:
(b) at a particular point of time

Question 12.
The quantity of a variable which is measured over a period of time, is known as
(a) stock
(b) flow
(c) goods
(d) All of the above
Answer:
(b) flow

Question 13.
Real flow includes
(a) factor services and production of goods and services
(b) factor payments and production of goods and services
(c) factor services and expenditure on goods and services
(d) factor payments and expenditure on goods and services
Answer:
(a) factor services and production of goods and services

Question 14.
From the following, which is not the part of injection?’
(a) Investment
(b) Savings
(c) Exports
(d) None of these
Answer:
(b) Savings

Question 15.
Money flow includes
(a) factor services and production of goods and services
(b) factor services and expenditure of goods and services
(c) factor payment and production of goods and services
(d) factor payment and expenditure on goods and services
Answer:
(d) factor payment and expenditure on goods and services

Question 16.
The services of doctors, lawyers, teachers, domestic maids, etc are
(a) final services
(b) intermediate services
(c) Both (a) and (b)
(d) None of the above
Answer:
(c) Both (a) and (b)

Question 17.
Macroeconomics study economic activities and problems as a whole. Macroeconomics does not include
(a) aggregates
(b) economic equilibrium
(c) consumer equilibrium
(d) All of the above
Answer:
(c) consumer equilibrium