NCERT Solutions for class 12th Economics Part A Chapter 5 The Government: Budget and the Economy

NCERT Textbook Questions Solved

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

Ans. Public goods are one of four types of goods differentiated by consumption rivalry (rival or non-rival) and nonpayer excludability (excludable and non-excludable). In particular, these are goods characterized by non-rival consumption, meaning the consumption by one person does not impose an opportunity cost on others, and the inability to exclude non-payers from gaining benefits from consumption.

The exhibit to the right illustrates the four alternative types of goods—private, public, common-property, and near-public—based on the mix of consumption rivalry and nonpayer excludability. Public goods are in the lower left cell of the matrix, with non-rival consumption and the inability to exclude non-payers. Non-rival Consumption Because public goods are non-rival in consumption, the consumption by one person does not prevent the simultaneous consumption by others. Any number of people, potentially EVERYONE, can enjoy the benefits of consuming a public good AT THE SAME TIME. This means consuming a public good does NOT impose an opportunity cost on others. Suppose, for example, that Edgar Millbottom is protected from foreign invasion by the combined military forces of the United States government. The benefit that Edgar derives from this public good does not prevent others from also benefitting. Everyone residing in the country is protected from foreign invasion equally. More to the point, the protection extended to Edgar does exclude his friend Alicia Hyfield from protection, Edgar’s consumption of national defense DOES NOT impose an opportunity cost on anyone else. Nonpayer Non-excludability: Public goods are also characterized by the inability to exclude nonpayers from gaining ownership and control. As such, everyone in society can receive the benefits of consumption. No one can be excluded. In other words, public goods do not have well-defined property rights. Everyone owns a public good, meaning no one in particular can exert exclusive ownership and control.

The Free-Rider Problem: The inability to exclude nonpayers from the consumption of public goods gives rise to what is termed the free-rider problem. As the name suggests the free-rider problem means that people are able to effectively “ride” the benefits of a good for “free,” without paying. This is a problem for the efficient allocation of resources. Therefore, public goods must be provided by the government.

Question 2. Distinguish between revenue expenditure and capital expenditure.

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

Ans. This statement is not technically true, but it is true if a government is going to be prudent.
A fiscal deficit is the difference between what a government spends and what it takes in in revenues. When a government spends more than it takes in, the most responsible thing to do is to borrow the difference. If the government does this, then the fiscal deficit is the amount that the government needs to borrow so that its revenues, added to what it borrows, will equal what it spends. However, it is possible for a government to simply create more money (print it, for example) and use that to fill the deficit. The problem is that this is very irresponsible, particularly if the deficit is large. Doing so will lead to inflation and a lack of public confidence in the currency.
Basically, then, if a government spends more than it “earns” it has to borrow to make up the difference.

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

Question 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.

Note: Not required; not in course now.

Question 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?

Note: Not required; not in course now.

Question 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.

Note: Not required; not in course now.

Question 8.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?

Note: Not required; not in course now.

Question 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.

Note: Not required; not in course now.

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

Note: Not required; not in course now.

Question 11. Explain the relation between government deficit and government debt.
More will be the government deficit, more will be the government debt and vice-versa.

Question 12. Does public debt impose a burden? Explain.

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

1. Adverse effect on productivity and investment A government may impose taxes or get money printed to repay the debt. This however reduces the peoples’ to work, save and invest, thus hampering the development of a country.

2. Burden on younger generations The government transfers the burden of reduced consumption on future generations. Higher government borrowings in the present leads to higher taxes levied in future in order to repay the past obligations. The government imposes taxes on the younger generations, lowering their consumption, savings and investments. Hence, higher public debt has negative effect on the welfare of the younger generations.

3. Lowers the private investment The government attracts more investment by raising rates of interests on bonds and securities. As a result, a major part of savings of citizens goes in the hands of the government, thus crowding out private investments.

4.Leads to the drain of National wealth The wealth of the country is drained out at the time of repaying loans taken from foreign countries and institutions.

Question 13. Are fiscal deficits necessarily inflationary?

Ans. No, fiscal deficits are not always inflationary. Fiscal deficit is defined as the excess of all expenditure over total receipts net of borrowing. Fiscal Deficits are Not necessarily inflationary. But they can be because when government increases its spending or cuts off taxes the aggregate demand in economy increases. Firms may not be able to produce enough to meet the demand at an on-going price. They may instead increase the price to control or accommodate the demand. This increase in price may lead to inflation. But these not necessary if proper fiscal policies are undertaken by the government and the problem of inflation can be avoided.

Question 14. Discuss the issue of deficit reduction.

Ans. Budget deficit occurs when a government spending is much greater than tax revenues. This leads to an accumulation of public sector debt. If the deficits are unsustainable, this can cause rising bond yields (higher interest payments) and in the worse case, lead to a loss of confidence in the government. If deficits are unsustainable, the government may be forced to default.The obvious way to reduce a budget deficit is to increase tax rates, and cut government spending. However, the difficulty is that this fiscal tightening can cause lower economic growth – which in turn can cause a higher cyclical deficit (government get less tax revenue in a recession). The best way to reduce fiscal deficits depends on the situation a country is in.

Following policies can be adopted to solve the issue of deficit reduction:

(a) Cut Spending: If we reduce the government spending, then as per the principle of multiplier, income will decrease by a multiple of it. it will reduce aggregate demand but it will also lower the rate of economic growth.

(b) Tax increases: Higher taxes increase revenue and help to reduce the budget deficit. Like spending cuts, they could cause lower spending and lead to a fall in economic growth. Again it depends on the timing of tax increases. In a recession, tax increases could cause a big drop in spending. During high growth, tax increases won’t harm spending as much. It also depends on the type of tax you increase.

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