NCERT Solutions for Class 12 Economics Part A Chapter 5 Government Budget and the Economy

NCERT Solutions for Class 12 Economics Chapter 5 Free PDF Download

Please Click on Free PDF Download link to Download the NCERT Solutions for Class 12 Economics Chapter 5 Government Budget and the Economy

The dot mark field are mandatory, So please fill them in carefully
To download the complete Syllabus (PDF File), Please fill & submit the form below.
https://drive.google.com/file/d/14Adw9KjkhEHqusX2YNZLrPqKlVOeve1D/view?usp=sharing

    1. Explain why public goods must be provided by the government.

    Ans. There are certain goods and services which cannot be provided by the market mechanism but by government. i.e., by exchange between individual consumers and producers for example, roads, national defence etc.

    These goods must be provided by the government because of the following reasons:

    (i) The benefits of public goods should be easily enjoyed by anyone without affecting the consumption of other individuals. Otherwise, market failure will arise.

    (ii) No individual should be excluded from using such public goods as it is available to all. The link between the producer and the consumer becomes non-functional, requiring government interference through public provisions.

    2. Distinguish between revenue expenditure and capital expenditure.

    Basis Revenue expenditure Capital expenditure
    Creation of Assets It does not create any assets for the government. It results in the creation of certain assets.
    Reduction of Liability These expenditures do not reduce liability. These expenditures reduces the liability of the government.
    Items (a) Aids given to states and others
    (b) Interest payments
    (c) Expenditure on defence
    (a) Purchase of shares
    (b) Expenditure on land, building, etc.
    (c) Grants by the central government to the state government.

    3. ‘The fiscal deficit gives the borrowing requirement of the government’. Elucidate.

    Fiscal deficit refers to a situation of excess of total expenditure over total receipts.
    Which means, when total government expenditure is greater than the total government receipts, the government faces fiscal deficit.
    Fiscal deficit is estimated as:
    Total Expenditure (revenue + capital) – Total Receipts (excluding borrowings).
    Fiscal deficit acts as an indicator to the government about the requirements of total borrowing from all the sources. Fiscal deficit is usually financed through domestic borrowings and/or borrowings from abroad. Greater fiscal deficit implies greater borrowings by the government.

    4. Give the relationship between the revenue deficit and the fiscal deficit.

    The relationship between the revenue deficit and the fiscal deficit is explained through the following points:

    (i) Revenue deficit is the difference between the revenue expenditures of the government and the receipts of the government.
    Revenue deficit = Revenue expenditures – Revenue receipts

    On the other hand, fiscal deficit is defined as the difference between the total expenditure and the total receipt of the government.
    Fiscal deficit = Total Expenditure – Total Receipts (excluding borrowings)

    (ii) The term ‘fiscal deficit’ is used comparatively in a broader sense than the term ‘revenue deficit’.

    (iii) As revenue deficit increases, the proportion of fiscal deficit also increases.

    5. Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes (that is lump-sum taxes minus transfers) is 100 and consumption is given by C = 100 + 0.75Y
    (a) What is the level of equilibrium income?
    (b) Calculate the value of the government expenditure multiplier and the tax multiplier.
    (c) If government expenditure increases by 200, find the change in equilibrium income.

    Ans. Given, I = 200
    G = 150
    T = 100
    C = 100 + 0.75 Y
    So, C (Autonomous consumption) = 100
    And   MPC (c) = 0.75
    (a) Equilibrium level of income

    $$\text{Y}=\frac{1}{1-C}(\bar{C}-cT+1+G)$$$$=\frac{1}{1-0.75}(100 – 0.75 × 100 + 200 + 150)$$$$=\frac{1}{1-0.25}×375$$$$=\frac{1}{0.25}×375$$$$=\frac{375}{0.25}×100=₹1500$$

    (b) Government expenditure multiplier
    $$\frac{\varDelta Y}{\varDelta G}=\frac{1}{1-c}=\frac{1}{1-0.75}=\frac{1}{0.25}$$
    $$=\frac{1}{25}×100\\=4$$
    $$\text{Tax multiplier}=\frac{\varDelta Y}{\varDelta T}=\frac{-c}{1-c}$$$$=\frac{-0.75}{1-0.75}=\frac{-0.75}{0.25}\\=-3$$

    (c) ΔG = 200
    New equilibrium income
    $$\frac{1}{1-c}[\bar C-cT+I+G+{\varDelta G}]$$
    $$\frac{1}{1-0.75}[100 – 0.75 × 100 + 200 + 150 + 200]$$
    $$=\frac{1}{0.25}×575$$
    $$=\frac{100×575}{25}=₹2300$$
    Therefore, change in equilibrium income
    = 2300 – 1500 = ₹800.

    6. Consider an economy described by the following functions: C = 20 + 0.80Y, I = 30, G = 50, TR = 100
    (a) Find the equilibrium level of income and the autonomous expenditure multiplier in the model.
    (b) If government expenditure increases by 30, what is the impact on equilibrium income?
    (c) If a lump-sum tax of 30 is added to pay for the increase in government purchases, how will equilibrium income change?

    Ans. 
    $$(a) Given C = 20 + 0.80 Y [\bar C=20]$$
    I = 30
    c = 0.80
    G = 50
    T = 100
    Equilibrium level of income
    $$Y=\frac{1}{1-C} [\bar C+cT+I+G]$$
    $$=\frac{1}{1-0.80} [20 + 0.80 × 100 + 30 + 50]$$
    $$=\frac{1}{0.20}×180=\frac{180}{20}×100=900$$
    $$\text{Expenditure multiplier =}\frac{1}{1-c}$$
    $$=\frac{1}{1-0.80}=\frac{1}{0.20}=\frac{100}{20}=5$$

    (b) Increase in government expenditure
    ΔG = 30
    New equilibrium expenditure
    $$=\frac{1}{1-c}[\bar C+cT+I+G+{\varDelta G}]$$
    $$=\frac{1}{1-0.80}[20 + 0.80 × 100 + 30 + 50 + 30]$$
    $$=\frac{1}{0.20}×120$$
    $$=\frac{210}{20}×100=1050$$
    Equilibrium level of income increases by 150(1050 – 900).

    $$\text{(c) Tax multiplier}=\frac{-c}{1-c}$$
    $$\frac{\varDelta Y}{\varDelta T} =\frac{-c}{1-c}$$
    $$\text{So,}\space\varDelta Y=\frac{-c}{1-c} ×\varDelta T$$
    $$=\frac{-0.80}{1-0.80} ×30=\frac{-0.80}{0.20} ×30= – 120$$
    New equilibrium level of income = Y + DY
    = 900 + (– 120)
    = ₹780.

    7. In the above question, calculate the effect on output of a 10 per cent increase in transfers, and a 10 per cent increase in lump-sum taxes. Compare the effects of the two.

    Ans. Given, MPC = 0.80
    $$\bar C=20$$
    I = 30
    G = 50
    TR = 100
    ΔTR = 10
    Equilibrium level of income
    $$=\frac{1}{1-c}[\bar C+cT+I+G+{\varDelta TR}]$$
    $$=\frac{1}{1-0.80}[20 + 0.80 + 100 + 30 + 50 + 0.80 × 10]$$
    $$=\frac{188}{0.20}×100 = ₹ 940$$
    Change in income ΔY = 940 – 900 = ₹40
    Increase in lump-sum tax ΔT = 10
    Change in income (due to change in tax)
    $$=\varDelta T×\frac{-c}{1-c}$$
    $$= -10×\frac{0.80}{1-0.20}\\= – 10 × 4\\= – 40$$
    From the above results, one can conclude that increase of 10 percent in transfers will raise the income by 40%.
    And, increase of 10% in tax will lead to a fall in the income by 40%.

    8. We suppose that C = 70 + 0.70 YD, I = 90, G = 100, T = 0.10 Y.
    (a) Find the equilibrium income.
    (b) What are tax revenues at equilibrium Income? Does the government have a balanced budget?

    Ans. Given, C = 70 + 0.70 YD ...(1)
    T = 0.10 Y ...(2)
    (a) I = 90, G = 100
    Y = C + I + G
    Y = 70 + 0.70 Y + 90 + 100
    Y = 260 + 0.70 (Y – T)
    Y = 260 + 0.70(Y – 0.10 Y)
    Y = 260 + 0.70 (0.90 Y)
    Y = 260 + 0.63 Y
    Y – 0.63 Y = 260
    0.37 Y = 260
    $$Y=\frac{260}{0.37}$$
    Y = 702.7

    (b) t = 0.10 × 702.7
    = 70.27
    G = 100, t = 70.27
    As, G > T, Government has a deficit budget, not a balanced budget.

    9. Suppose marginal propensity to consume is 0.75 and there is a 20 per cent proportional income tax. Find the change in equilibrium income for the following:
    (a) Government purchases increase by 20
    (b) Transfers decrease by 20.

    Ans. In case of proportional taxes
    $$(a)\space ΔY =\frac{1}{1-c(1-t)}×ΔT$$
    MPC = 0.75 and ΔG = 20
    $$\frac{1}{1-0.75(1-0.2)}×20$$
    $$\frac{1}{1-0.75×0.8}×20= \frac{20}{1-0.60}$$
    $$=\frac{20}{0.4}=50$$

    (b) Transfer decreases by 20
    $$DY =\frac{1}{1-c}×DT$$$$=\frac{0.75}{1-0.75}×20$$
    $$DY =\frac{0.75}{0.25}\\=60$$

    10. Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier.

    Ans. The tax multiplier is smaller in absolute value as compared to the government expenditure multiplier, because the government expenditure affects the total expenditure and taxes through the multiplier. Tax multiplier also influences the disposable income that affects the overall consumption level.
    This can be explained from the following example:
    Let’s assume MPC to be 0.80.
    Then, the government expenditure multiplier
    $$ =\frac{1}{1-c}=\frac{1}{1-0.80}$$
    $$ =\frac{1}{1-c}=\frac{1}{1-0.80}$$
    $$\text{Tax multiplier} =\frac{-c}{1-c}=\frac{-0.80}{1-0.80}$$
    $$=\frac{-0.80}{1-0.20}=-4$$
    This shows that government expenditure multiplier is more than tax multiplier

    11. Explain the relation between government deficit and government debt.

    Ans. The relation between government deficit and government debt can be explained through the following points.

    (i) Government deficit is said to be the excess of total expenditure over total receipt of the government; whereas, government debt refers to the amount of liability, owed by the government to the public, foreign and other institutions.

    (ii) The term government deficit refers to an increase in the debt of the government. In simple words, if the government continues to borrow to finance the deficit, it leads to further increase in debt.

    12. Does public debt impose a burden? Explain.

    Ans. Government debt or public debt is the amount or money that a central government owes. Such an amount may be borrowings of the government from banks, public financial institutions and from other external and internal sources. Public debt acts as a burden on the economy as a whole, which is described through the following points.

    (i) Adverse effect on productivity and investment: A government can either impose taxes or can get money printed to repay the debt. This however reduces the peoples' ability to work, save and invest, and therefore the development of a country

    (ii) Burden on younger generations: The government shifts the burden of reduced consumption on future generations. Increased government borrowings in the present leads to higher taxes to be imposed in future in order to repay the past obligations. The government imposes taxes on the younger generations, which lowers their consumption, savings and investments. Hence, higher public debt has a negative effect on the welfare of the younger generations.

    (iii) Lowers the private investment: The government attracts high investment through increased rates of interests on bonds and securities. Resulted to which a major part of savings of citizens is accumulated in the hands of the government, thus crowding out private investments.

    (iv) Leads to the drain of National wealth: The wealth of the country is drained out of the nation at the time of repaying loans which were taken from foreign countries and institutions.

    13. Are fiscal deficits inflationary?

    Ans. Fiscal deficits are not necessarily be inflationary; though, they are generally undertaken as inflationary. When the government increases its expenditure and reduces the tax, there is a government deficit due to which there will be a corresponding increase in the aggregate demand. However, the firms might not be able to meet the growing demands, thus forcing the price to rise. Hence fiscal deficits are inflationary in this sense.
    But on the other hand, initially if the resources
    are underutilised (due to insufficient demand) and output is observed to be below full employment level, then with the increase in government expenditure, more factor resources are required to be employed to cater to the increasing demand without exerting much pressure on price to rise. In such a situation, a high fiscal deficit is often accompanied by high demand, greater output level and lesser inflationary situation. Hence, whether the fiscal deficits are inflationary or not depends on how close is the original output level to the full employment level.

    14. Discuss the issue of deficit reduction.

    Ans. The ways of government budget deficit reduction are the following:
    (i) Decreasing expenditure
    (ii) Increasing revenue

    (i) Decreasing expenditure:

    (a) The expenditure of government has to be decreased by making government activities more planned and effective.

    (b) The government should also encourage private sector to undertake capital projects.

    (ii) Increasing revenue:

    (a) Higher taxes leads to higher income earned by the government. Also, new taxes may also add to the revenues of the government.

    (b) The government can sell shares of Public Sector Undertakings (PSU disinvestment) in order to increase its revenue.

    15. What do you understand by GST? How good is the system of GST as compared to the old tax system? State its categories.

    Ans. “Goods and Services Tax (GST) means any tax levied on supply of goods, or services or both except taxes on the supply of the alcoholic liquor for human consumption”. It is an indirect tax which has replaced many indirect taxes like sales tax, Excise Duty, VAT, Service Tax etc., into one single tax for the entire nation. By replacing the various archaic tax structure, GST is levied at every stage of the supply chain of the goods or services from production to the last retail level. It is considered as a single domestic indirect law for the entire country.
    The system of GST is good as compared to the old tax system because of the following reasons:

    (i) Eradication of different tax structures: Taxes imposed by Central Government like Service Tax, Union Excise Duty, Central Sales Tax (collected by states), Customs Duty etc. and taxes imposed by state government like Value Added Tax, Entry Tax, Octroi, Luxury Tax etc., have been abolished with the introduction of GST. Levy of cess, resale tax, additional tax, turnover tax etc. have also been nullified.

    (ii) Widening of tax bases: GST has expanded the tax bases for the governments which results in reduction the administrative cost of governments.

    (iii) Benefit of Input tax credit: Levy of GST is applicable at every stage whether it is manufacturer, intermediary or the end user. The advantage of input tax credit given by assessee which means he needs to pay a difference of Output tax and Input tax only. So, GST has removed the cascading effect of the tax by following the lines of VAT.

    (iv) Neutralisation: Neutralisation to process, business models, structure and location-GST is supposed to lift the economic growth, efficiency and sustainability because of its neutral feature of the tax regime.

    (v) Export Enhancement: GST may lead to the enhancement of the export as of the reduced effect of duties on many items provide an edge to the exporters over the competition being faced by them in the international market.

    (vi) Increased demand and production of goods and services: Due to reduced cost of production, GST would lead to an expansion of manufacturing units and grants increment in demand for goods and services.

    GST is categorized in three ways i.e., Central GST, State GST and Integrated GST.
    Central GST: CGST is levied on intra-state supply of goods and services by the Central Government. It is collected by the Central Government which is 50% of the applicable tax rate. CGST is further classified into:
    (i) Output CGST
    (ii) Input CGST

    State GST: SGST is levied on intra-state supply of goods and services by the State Governments. It is collected by state governments being 50% of the applicable tax rate. SGST is further classified into:
    (i) Output SGST
    (ii) Input SGST
    Integrated
    GST: IGST is levied on interstate supplies of goods and services by the Central Government. It is collected by the Central Government only. IGST is further classified into:
    (i) Output IGST
    (ii) Input IGST

    Share page on