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| Chapter | 5. Government Budget and Economy Solutions |
| Subject | Economics |
| Textbook | Macro Economics |
| Class | Twelve |
| Category | NCERT Solutions for Class 12 |
The NCERT Solutions for Class 12 Macro Economics cover all the questions pertaining to the subject in a very clear and lucid manner. Apart from being highly accurate, these solutions are also very easy to memorize. These solutions are written as per the latest CBSE syllabus and are helpful in clearing doubts. On this solution page, we have provided you with complete overview of the concepts and methods covered in the Chapter 5 of Macro Economics – Government Budget and Economy Solutions.
NCERT Solutions for Class 12 Macro Economics Chapter 5
Government Budget and Economy Solutions
Q1) Explain why public goods must be provided by the government.
Answer) Public goods are those goods where there is no competition and the use of good is not restricted to only one individual. These goods are for use by all individuals of the society. Such goods are used for welfare of the society.
Therefore, government should provide public goods for the following reasons:
- So that benefits of the public goods can be enjoyed by all members of the society.
- So that the consumption of these goods will not impact consumption of any other individual.
Q2) Distinguish between revenue expenditure and capital expenditure.
Answer)
| Comparison | Capital Expenditure | Revenue Expenditure |
|---|---|---|
| Definition | Expenditure incurred for acquiring assets, to enhance the capacity of an existing asset that results in increasing its lifespan | The expense incurred for maintaining the day to day activities of a business |
| Term | Long Term | Short Term |
| Value addition | Enhances the value of an existing asset | Does not enhance the value of an existing asset |
| Physical Existence | Have a physical presence except for intangible assets | Do not have a physical presence |
| Occurrence | Non-recurring in nature | Recurring in nature |
| Capitalisation | Yes | No |
| Impact on Revenue | Do not reduce business revenue | Reduces business revenue |
| Benefits | Long-term benefits for business | Short-term benefits for business |
| Examples | Highway, tunnel, metro projects | Pension, Salary etc. |
Q3) ‘The fiscal deficit gives the borrowing requirement of the government’. Elucidate.
Answer) Fiscal deficit is referred to as the shortfall in government’s income as compared to its spending. A high fiscal deficit means that the government is borrowing more money than that it is earning. A higher fiscal deficit creates a burden of loan and interest payment for future generation.
Fiscal deficit is determined by,
Total Expenditure – Total Receipts excluding borrowings
Q4) Give the relationship between the revenue deficit and the fiscal deficit.
Answer)
- The fiscal deficit is always broader than the revenue deficit.
- The revenue deficit is defined as the difference between the government’s revenue expenditure and revenue receipts.
- In short, a government budget will have a revenue deficit if revenue expenditure exceeds revenue receipts.
- The fiscal deficit is defined as the difference between total expenditure and total receipts net of borrowings.
- Initially, the fiscal deficit does not account for all types of receipts. Borrowings are not taken into account. But, in the end, they must rely on borrowing to cover the fiscal deficit.
Fiscal Deficit = Revenue Deficit + Capital Deficit (Excluding Borrowing) – Borrowing = Net borrowing at home + Borrowing from RBI + Borrowing from abroad
Q5) 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.
Answer) It is given that-
I = 200
G = 150
T = 100
C = 100 + 0.75Y
Now, C (Autonomous consumption) = 100
and, MPC (c) = 0.75
a) Equilibrium level of income:
b) Government expenditure multiplier
c)
Q6) 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?
Answer) As per the question,
C = 20 + 0.80Y
I = 30
c = 0.80
G = 50
T = 100
a) The equilibrium level of income is calculated as:
b) Increase in government expenditure:
c) Tax multiplier
Q7) 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.
Based on the above results, we can conclude that a 10% increase in transfers will result in a 40% increase in income.
Furthermore, a 10% increase in taxes results in a 40% decrease in income.
Q8) We suppose that C = 70 + 0.70Y D, I = 90, G = 100, T = 0.10Y
(a) Find the equilibrium income.
(b) What are tax revenues at equilibrium Income? Does the government have a balanced budget?
Answer a)
C = 70 + 0.70YD
I = 90
G = 100
T = 0.10Y
Y = C + I + G
Y = 70 + 0.70YD + 90 + 100Y
= 70 + 0.70DD + 190
= 70 +0.70(Y − T) + 190
Y = 70 + 0.70Y − 0.70 T + 190
= 70 + 0.70Y − 0.70 × 0.10Y + 190
= 70 + 0.70Y − 0.0YY + 190
= 70 + 0.63Y + 190
Y − 0.63Y = 260
0.37Y = 260
Y = 260/0.37
Y = 702.7
Answer b)
T = 0.10Y
= 0.10 × 702.7
=70.27
Government spending = 100
Tax revenue = 70.27%
As G >T, the government has a deficit budget rather than a balanced budget. Because government spending outweighs tax revenue.
Q9) 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.
Answer a) In case of proportional taxes
Answer b)
Q10) Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier.
Answer) The tax multiplier is always having negative value and therefore is smaller in absolute value than the government expenditure multiplier. The government expenditure creates an impact on the total expenditure and the taxes through the multiplier. It also influences disposable income which impacts overall consumption level.
The following example will help in understanding:
Assume MPC be to 0.50.
Now, the government expenditure multiplier = 1 / 1 – c
= 1 / 1 – 0.50
= 1 / 0.50
=2
Tax multiplier = – c / 1- c
= -0.50 / 1 – 0.50
= −1
This shows that government expenditure multiplier is always more than the tax multiplier.
Q11) Explain the relation between government deficit and government debt.
Answer) A government in order to adjust the government deficit which is created due to borrowings by the government seeks more borrowings, these borrowings create further debt for the government in the form of interest payment. Therefore increase in deficit will lead to increase in debt.
Q12) Does public debt impose a burden? Explain.
Answer) The amount or money that a central government owes is referred to as government debt or public debt. This amount may represent government borrowings from banks, public financial institutions, and other external and internal sources. Yes, public debt does impose a burden on the economy as a whole, as illustrated by the following points.
- Negative Impact on Productivity and Investment: To pay the debt, a government may levy taxes or print money. This, however, reduces people’s ability to work, save, and invest, hampering a country’s development.
- Burden on Future Generations: The government shifts the burden of lower consumption to future generations. Higher current government borrowings result in higher future taxes levied to repay past obligations. The government taxes the younger generations, reducing their consumption, savings, and investments. As a result, increased public debt has a negative impact on the welfare of future generations.
- Lowers the Private Investment: By boosting interest rates on bonds and securities, the government promotes greater investment. As a result, the government obtains a disproportionate share of the savings of residents, crowding out private investments.
- Causes a Drain on National Wealth: The wealth of the country is depleted as a result of repaying loans obtained from foreign countries and institutions.
Q13) Are Fiscal Deficits Inflationary?
Answer) Fiscal deficit will not always result in inflation. If a situation arises when the government expenditure increases and tax reduction is seen, it will cause deficit in the government which leads to increase in aggregate demand. Firms will not be able to meet the demand thus generated which will result in price increase. Therefore fiscal deficits can become inflationary, but it will not be inflationary in the case when resources are less utilized due to insufficient demand and less output, then if the government is spending more also, more resources will be employed in order to meet the growing demand and there will be no pressure on price rise. In such a situation a high fiscal deficit along with high demand and greater output will not create an inflationary situation.
Q14) Discuss the issue of deficit reduction.
Answer) The following are methods for reducing the government’s budget deficit:
Decrease in Expenditures:
- Government expenditures should be reduced by making government activities more planned and effective. It should reduce inefficient and unnecessary administrative tasks.
- The government can encourage the private sector to invest in capital projects that will reduce government spending.
Revenue Growth:
- Higher taxes imply that the government earns more money. Furthermore, imposing new taxes or raising the rates of existing taxes may increase the government’s revenue.
- To increase revenue, the government can sell shares in Public Sector Undertakings (PSU disinvestment).
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