Model wise important questions and answers

Module 1.

Question1.Explain the significance of macro economics in business decisions?

OR Explain the interface of macro economics with business and Industry.
Answer:

1. It explains price determination and the allocation of resources.

2. It has direct relevance in business decision-making.

3. It serves as a guide for business’ production planning.

4. It serves as a basis for prediction.

5. It teaches the art of economizing.

6. It is useful in determination of economic policies of the Government.

7. It serves as the basis for welfare economics.

8. It explains the phenomena of International Trade.

Managerial Economists act as operations researchers and systems analysts in the

management services department of large business firms usually in the private
sector. Their job lies in designing the course of operations to maintain and improve
the ‘systems’ of the firm in terms of productivity, market share, load factor
percentage and so on and prepare reports for helping the decision makers to cope
with current as well as anticipated future problems. In modern business, managers
constantly face the major problem of choice among alternative ways of producing
goods and allied business decisions. Managerial economists assist them in making
a rational choice.

A Managerial economist is an economic adviser to a firm or businessman. A

firm or entrepreneur, in the course of its/his business operations, has to take a
number of decisions which are vital to the survival and growth of the business.
Such decisions may pertain to the nature of the product to be produced, the
quantity, quality, cost, price and its distribution, planning and diversification of
business, renewal of worn out equipments and machinery, modernization, etc. The
Managerial economist helps the businessman or the manager in arriving at correct
decisions. In short, the business economist while helping in the decision making
process, measures a number of micro and macro variables by applying intelligently
certain quantitative and qualitative techniques to the practical aspects and problems
encountered by a business firm in its business activity. Forecasting is a
fundamental activity of the Managerial economist. Indeed a business economist is
greatly helpful to the management by virtue of his studies of economic analysis.
He is an effective model builder. He deals with the business problems in a sharp
manner with a deep probing.

A Managerial economist in a business firm may carry on a wide range of duties,

such as:

• Demand estimation and forecasting.

• Preparation of business forecasts; to provide forecasts of changes in costs and

business conditions based on market research and policy analysis.

• Analysis of the market survey to determine the nature and extent of competition.

• Analysing the issues and problems of the concerned industry.

• Assisting the business planning process of the firm.

• Discovering new and possible fields of business endeavour and its cost-benefit
analysis as well as feasibility studies.

• Advising on pricing, investment and capital budgeting policies.

• Evaluation of capital budgets.

• Building micro and macro economic models of particular aspects of the firm’s
activities that are useful in solving specific business problems. Most models may
be prediction oriented.

• Directing economic research activity.

• Briefing the management on current domestic and global economic issues and
challenges.
Question2. Explain the meaning and scope of macro economics?

Answer: Macro economics is a branch of economics that studies the economic

behavior not of an individual but the economic system as a whole. It studies the
overall conditions of the economy such as total consumption, total national
income, aggregate supply and demand, general price level.

Instead of studying the income employment, output of a particular firm or

industry. In macro economics we are studying aggregates like total income, total
employment, total output in the economy.

Here, we study how these aggregates and averages of the economy as a whole
are determined and what causes fluctuations in them. Having understood the
determinants, the aim is how to ensure the maximum level of income and
employment in a country.
In short, macroeconomics is the study of national aggregates or economy-wide
aggregates. In a way it is like study of economic forest as distinguished from
trees that comprise the forest. Main tools of its analysis are aggregate demand
and aggregate supply.
Since the subject matter of macroeconomics revolves around determination of
the level of income and employment, therefore, it is also known as ‘Theory of
Income and Employment:
These days when the study of lakhs of individual units has become almost
impossible and when government’s participation through monetary and fiscal
measures in the economy has increased very much, use of macro analysis has
become indispensable.
Correct economic policies formulated at macro level have made it possible to
control business cycles (inflation and deflation) and as a result violent booms and
depressions have become things of the past.
In a suitably modified form, macroeconomics is the basis of all plans of
economic development of underdeveloped economies. Economists are now
confidently exploring the possibilities and ways of maintaining economic growth
and full employment. More than anything else, macroeconomic thought has
enabled us to properly organise, collect and analyse the data about national
income and coordinate international economic policies.
The scope of macroeconomics includes the following parts:

Clearly, the study of the problem of unemployment in India or general price level
or problem of balance of payment is macroeconomic study because these relate
to the economy as a whole.
Question3. Explain the linkage between macro economics and business
planning and decision making?
Answer: Importance of Decision Making in Business
Decision making is an important job of corporate managers. They have to take
decisions regarding the employment of land, labor, and capital in such a manner
that output may be maximized at least possible cost. Hence, they are always in
search of optimum combination of resources which would maximize corporate
profit.
Appropriate decision making is the strength of business. Success in business
depends on proper and correct decision making. Location, scale of operation,
quantum of resources to be employed, marketing etc are some of the important
problems calling for decisions in business where macroeconomics may be applied
for better results.
Macro Economic Analysis
Macroeconomics is concerned with the study of aggregate economic variables. It is
concerned with the whole economy and studies the level and the growth of national
income, the levels of employment, the level of private and government spending,
the balance of payments, the consumption & the investment, saving functions and
oscillations in business cycles. The objective of macroeconomics is to maintain
macro equilibrium of the economy. According to Edwin Mansfield, ‘Macro
economics deals with the behavior of aggregates like gross national product and
the level of employment. A. koutsoyiannis says, ‘the aggregate econometric
models are relevant for the study and prediction of aggregate magnitudes, such as
total output of any economy, total employment, consumption, investment etc.
In all the economies of the world whether free or controlled, business and
macroeconomics have become same. In the business decisions, tracking of
macroeconomic variables has become an important element. (Macroeconomics,
2002) Managers face difficulty in decision making, understanding of
macroeconomics helps CEO’s in running the business. Overall economic activity,
economic policies (industrial policy, trade policy, monetary policy, fiscal policy),
inflation affects the business. Decisions of CEO’s or managers are affected by this
aggregate which makes up the overall environment of business. Future demand and
investment depends upon the growth and the state of the economy.
Role of Macroeconomic Analysis in formulation of Business Policies
Macro economics helps the business in in-depth knowledge of macro economic
environment of business relating to industrial policy, licensing policy, economic
planning monetary and fiscal framework and overall economic policy. (Mathur,
2002)The role of macro economics in business policy formulation is being
discussed in the following points:
1. Macro economic policy
Macro economics helps in formulation of economic policy. The subjects of an
economic policy are monetary policy, fiscal policy, incomes policies and policy on
balance of payment. Economic policy should be such that it promotes the business
environment and provides impetus to business activities. (Mathur, 2002)
2. Economic planning
A serious attempt towards self sustained growth of business is only possible by
efficient planning. Planning is now a days synonymous with growth and
development. Identification of priority areas, estimation of resources and
coordination among various sectors of economy can be done through proper
planning. Planning directs the growth in desirable corners.
3. Solving macro paradoxes: Macro economics helps in solving macro paradoxes
like paradox of thrift related to savings, paradox of assumption by commercial
banks that all depositors would not withdraw their money on any particular day
and their right to withdrawal.
4. Tracing effect of government policy on business
Macro economics helps in tracing the implications of government policy changes
on existing business activity.
5. Help in solving problem of general unemployment
Effective demand is the focal point of macro economics. Reduction in effective
demand brings economic depression and thereby general unemployment. Hence,
the level of effective demand should be increased in order to increase the level of
employment. (Mathur, 2002)
6. Analysis of trade cycles
Macro economics tries to know about the behavior and occurrence of booms and
slumps and their implication on business activity. This analysis is very useful for a
free enterprise economy. Business cycles are bound to occur. Macro economics
helps the business in facing booms and slumps so that negative impact is
minimized.
7. Macro analysis helps in development of micro analysis
In the deductive method process of logic goes from general to particular. We go on
deducting to draw specific conclusions. Many of micro economic conclusions are
outcome of macro conclusion. The assumption that consumer is rational has been
decided only after knowing about the behavior of a group. A medico is allowed to
specialize in some part of human body from surgical view point only when he has
understood the anatomy and physiology of human body.
8. Inability of micro economics to study some areas
Micro economics is not able to study monetary problems, fiscal problems, financial
sector problems, foreign exchange regulation problems and inflationary and
recessionary situations problems. Business needs to be protected from these
ticklish problems and therefore, needs the help of macro economics.
9. Macro economic models
Macro economics helps in building or constructing macro economic models. The
major objective function of a macro economic model is to maintain the macro
equilibrium in the country at the full employment level. The role of government
through its monetary and fiscal operations becomes important as independent
variables i.e. these policies are used to explain the dependent variable i.e.
maintaining macro equilibrium.
Macroeconomic Variables and Business Decisions are highly linked
Business depends on the growth rate, when economic growth slows down; the
overall economic environment becomes unfavorable to business. In a period of
slow growth, the aggregate demand is very much reduced and the business has no
choice but to curtail its operations. (Misra & Puri, 2007) Business depends on the
inflation rate. Inflation of a mild sort increase aggregate demand which, in turn,
opens up fresh opportunities for business growth. In such an environment, not only
the demand for existing goods increases but the business can also introduce new
items for which demand may be created through dynamic marketing. Savings and
investment in a country determine its business potential. Investment can be
undertaken in directly productive activities or in infrastructure.
Excessive current account deficit in a country’s balance of payments is not
desirable for business activity. Such a situation leads to a shortage of foreign
exchange, which in turn forces restriction on imports. (Misra & Puri, 2007)This
may have serious implications for the efficiency in production. In the interest of
business the current account position has to be comfortable.
In addition, the net inflows from external assistance and direct foreign investment
should be fairly large, but this should not be allowed to result in an overvalued
exchange rate.
In case the situation is otherwise, the country’s exports will fall and the business
firms will feel seriously constrained account of it.
Phase of economy is highly significant for the business. From the point of view of
business, the prosperity phase of business cycle is ideal. In this phase, the economy
expands in response to growing aggregate demand and the business firm has many
options. There is expectation of rise in prices which induces managers to expand
the scope of their activities. A company can introduce new products in this period
and markets can be created for these products.
Forces of recession get strengthened during recession. The recession usually gets
reflected in the form of stock market crash and some fall in prices. The aggregate
demand gradually declines and thus incentive for investment is killed. (Misra &
Puri, 2007) At this time managers abandon new projects, resulting in a sharp
reduction in demand for capital equipment.
Since, finance is a basic requirement of business, the level of development of the
financial system is of crucial importance for business. The basic function of
financial markets – both money and capital market is the collection of savings and
their transfer to business enterprises for investment purposes and thereby
stimulating capital formation which in turn accelerates and process of business
growth. The effective channel of domestic savings and obtaining finance from
abroad are the important activities in the transfer process. In the transfer process,
the principal activity is allocation of funds from the savings surplus to the savings
deficit units. Financial markets, if they are well developed, allocate financial
resources efficiently among the various business enterprises. (Misra & Puri, 2007)
Question4. Discuss the components of an economic system?

Answer: An economic system is an organized way in which a country allocates

resources and distributes goods and services across the whole nation or a given
geographic area. It is includes the combination of several institutions, entities,
agencies, decision-making processes and patterns of consumption that make up the
economic structure of a specific community. Hence it is a type of social system.

An economic system defines how all the entities in an economy interact. Defining
them today is much more complicated than it used to be. Ancient systems were
relatively simple – trade was carried out using barter and there were very few
treaties and rules of engagement.

Types of economic system are :

Economic systems can be divided by the way they allocate economic inputs
and how they make decisions regarding the use of inputs. The various types of
economic systems are:

1. Capitalism

2. Socialism

3. Mixed economy

1. Capitalism : Capitalism is an economic system in which means of

production are privately owned and operated for profit,usually in
competitive markets.

Subject to certain restrictions,individuals are free to decide where to invest,

what to produce or sell, and what prices to charge.there is no limit tot the range of
their efforts in terms of assets, sales, and profits, or the number of
customers,employees, and investors or whether they operate in local,
regional,national or international markets.
Note: A capitalist economic system is one characterized by free
markets and the absence of government intervention in the economy.

Main features of capitalist economy:

(i) Private Property:

In this economy private property is allowed. All means of production like

machines, implements, mines and factories etc. come under private property.

(ii) Price Mechanism:

Capitalist economy is gained by price mechanism. Here prices are determined by

the interaction of demand and supply without the interference of any kind by the
government or any other external forces.

(iii) Freedom of Enterprise:

In this system every individual is independent to his means of production in any

occupation that one likes.

(iv) Sovereignty of that consumer:

Under this system, consumer plays the most vital role. The entire production
pattern is based on the desires, wishes and the demand of the consumer.

(v) Profit Motive:

The maximisation of profit is the main motive of the producer. Profit guides the
production in this type of economy.

(vi) No Government Interference:

Under capitalistic system, government does not interfere in day-to-day economic

activities. This means producers and consumers are free to take decisions.

(vii) Democratic:

The capitalistic system is more democratic in comparison to other economic

systems as there are more changes to chancel according to new environments of
the economy.
(viii) Self-Interest:

The inspiring force in this system is self-interest. It leads to hard work and to earn
maximum income by satisfying their consumers.

2. Socialism:socialism is an economic system where everyone in the society

equally owns the factors of production. The ownership is acquired through a
democratically elected government.

“Socialism refers to the government ownership of the means of production,

planning by the government and income distribution”-Samuelson.

Socialist means the system under which economic system is controlled and
regulated by the government so as to ensure welfare and equal opportunity to the
people in a society.

It is applied to an economic system in which property is held in common and not

individually, and relationships are governed by a political hierarchy. Individuals in
positions of authority make decisions in the name of the collective group.

Socialism's mantra is, “From each according to his ability to each according
to his contribution”.

Everyone in the society receives a share of the production based on how much
each has contributed. That motivates them to work long hours if they want to
receive more.workers receive their share after a percentage has been deducted for
the common good.

Features of Socialism

(i) Collective Ownership:

In socialism, all means of production are owned by the community, i.e.,

Government, and no individual can hold private property beyond certain limit.
Therefore, it is government who utilises these resources in the interest of social
welfare.

(ii) Economic, Social and Political Equality:

Under socialism, there is almost equality between rich and poor. There is no
problem of class struggle.
(iii) Economic Planning:

Under socialism, government fixes certain objectives. In order to achieve these

objectives, government adopts economic planning. All types of decisions regarding
the central problems of an economy are taken in the economic plans. There is a
Central Planning Authority, who plans for the economy.

(iv) No Competition:

Unlike capitalistic economy, there is no cut throat competition. It means lack of

competition as state is the sole entrepreneur.

(v) Positive Role of Government:

In socialism, government plays significant role in decision making. Thus,

government has complete control over economic activities like distribution,
exchange, consumption, investment and foreign trade etc.

(vi) Work and Wages According to Ability and Needs:

In socialistic economy, work is according to ability and wage according to need. It

is said that under socialism “from each according to his ability to each according to
his needs, is socialism.”

(vi) Maximum Social Welfare:

The sole objective of socialism is the maximum social welfare of the society. It
means that there is no scope of exploitation of labour class. Government keeps a
close eye on the needs of the poor masses while formulating plans.

3. Mixed Economy: Any economy in which private corporate enterprises and

public sector enterprises exist side-by-side, and decisions taken through
market mechanism are supplemented by some form of partial planning, is to
be described as mixed economy.

Mixed economy refers to the economic system where the economic activities
are directed by both private and the government.

“Mixed economy is that economy in which both government and private

individuals exercise economic control.” –Murad.
It is a golden mixture of capitalism and socialism. Under this system there is
freedom of economic activities and government interferences for the social
welfare. Hence it is a blend of both the economies. The concept of mixed economy
is of recent origin.

The developing countries like India have adopted mixed economy to accelerate the
pace of economic development. Even the developed countries like UK, USA, etc.
have also adopted ‘Mixed Capitalist System’. According to Prof. Samuelson,
“Mixed economy is that economy in which both public and private sectors
cooperate.” According to Murad, “Mixed economy is that economy in which both
government and private individuals exercise economic control.”

Features of Mixed Economy:

(i) Co-existence of Private and Public Sector:

Under this system there is co-existence of public and private sectors. In public
sector, industries like defence, power, energy, basic industries etc., are set up. On
the other hand, in private sector all the consumer goods industries, agriculture,
small-scale industries are developed. The government encourages both the sectors
to develop simultaneously.

(ii) Personal Freedom:

Under mixed economy, there is full freedom of choice of occupation, although

consumer does not get complete liberty but at the same time government can
regulate prices in public interest through public distribution system.

(iii) Private Property is allowed:

In mixed economy, private property is allowed. However, here it must be

remembered that there must be equal distribution of wealth and income. It must be
ensured that the profit and property may not concentrate in a few pockets.

(iv) Economic Planning:

In a mixed economy, government always tries to promote economic development

of the country. For this purpose, economic planning is adopted. Thus, economic
planning is very essential under this system.
(v) Price Mechanism and Controlled Price:

Under this system, price mechanism and regulated price operate simultaneously. In
consumer goods industries price mechanism is generally followed. However, at the
time of big shortages or during national emergencies prices are controlled and
public distribution system has to be made effective.

(vi) Profit Motive and Social Welfare:

In mixed economy system, there are both profit motive like capitalism and social
welfare as in socialist economy.

(vii) Check on Economic Inequalities:

In this system, government takes several measures to reduce the gap between rich
and poor through progressive taxation on income and wealth. The subsidies are
given to the poor people and also job opportunities are provided to them. Other
steps like concessions, old age pension, free medical facilities and free education
are also taken to improve the standard of poor people. Hence, all these help to
reduce economic inequalities.

(viii) Control of Monopoly Power:

Under this system, government takes huge initiatives to control monopoly practices
among the private entrepreneurs through effective legislative measures. Besides,
government can also fake over these services in the public interest.

I prefer Capitalism system of economy:

Capitalism is an economic model where there is private ownership of the means of

production and their operation is for profit. Some characteristics of capitalistic
societies are competitive markets, private property, capital accumulation, price
system, voluntary exchange of goods and services. It is also called a free market
enterprise.

While many countries like UK, USA follow capitalism, the government does have
some control or say over the markets and the way they operate. An unbridled
capitalism have taken extreme cases of private ownership of means of production
and have had some negative effects on the social aspects of many societies. Things
such as slavery and colonialism are examples of unbridled or uncontrolled or
unregulated capitalistic activities.

I’m a fan of a capitalist society. I believe the government should not overly control
the means of production, but I do believe that the government has to regulate it and
ensure that it doesn’t adversely affect the social aspects of a nation.

The type of economy to be followed is best determined by the respective nations. It

will depend on their history, their populations, the distribution of wealth and
resources and the cultural situations of a nation. India follows a mix of socialism
and capitalism where the latter is becoming more prominent since India’s
liberalization in 1991. But India does retain some aspects of socialism as the Indian
citizens feel that some aspects of it are important for the social cohesion and
progress of the nation.
Question.5. Discuss the various factors affecting National Income?

Answer: Difficulties involved in measurement of national income:

1. Difficulty in defining the Nation:

National income of a country does not mean only income earned within a
country. It also includes the income earned from abroad.

2. Lack of statistical data:

The up to date, accurate, adequate and reliable data regarding the value
and volume of goods and services produced are not available in backward
countries.

3. Absence of proper records:

Many people due to illiteracy, ignorance and indifferent attitudes do not
have the habit of keeping proper accounting data on production, income
and expenditures.

4. Existence of non monetary transactions:

The national income must be calculated in monetary terms. There are
certain non monetary transactions which are not included in the value of a
product for e, g, unpaid personal service of Housewife.

In our country all the goods and services produced are not exchanged for
money, part of goods and services may be bartered or consumed at home
by producers themselves. The exclusion of such value of goods would
give us a wrong picture of the national income.

5. Absence of occupational specialization:

Many people are engaged in more than one occupation for earning their
livelihood. Many people work as part time workers and such they do not
 give complete information about sources of their income.

For e.g. an individual may be working as a clerk in a government office

but he may be getting some additional income from his own farm and
small grocery shop. It becomes difficult to collect information about their
income under such circumstances.

6. Danger of double counting:

While calculating National income we have to take into account the value
of final goods and services but many times the value of intermediate goods
is included in the national income.

For e.g. the value of oil or oil seeds taken into account and not the value of
both.

7. Existence of illegal learnings:

There is huge volume of incomes earned through illegal activities like
gambling, smuggling, black marketing, adulteration etc.. but these items
cannot be included in calculation of national income.

8. Treatment of profits from foreign firms:

Profit from foreign firms is treated as income of parent country or income of
Host country.

9. Imperfect instrument to measure national income:

Value of goods and services measured in terms of money. But the values
of money itself change due to inflation or deflation.

10.Incomes earned through lottery, dowry, pensions, unemployment relief, etc

should be excluded from the calculation of national income because the
above items aregratis.
 11.Goods kept for self consumption:
The values of these goods are to be included in the calculation of national
income.

12.Existence of non market transactions:

Many people stitch their own clothes, grow vegetables in their own
gardens the value of such activities does not enter the market transactions
and hence are not included in the national income estimates.

13. Existence of different methods to calculate depreciation charges:

14. Coverage of commodities and services:

Value of all unpaid work on account of love, affection, mercy, kindness
friendship etc should be excluded in the calculation of national income

Question 6. Discuss the role of National Income in business decisions?

Answer:

Question7.Explain the difference between Micro Economics and Macro

Economics.
Answer:
Parameter Micro Economics Macro Economics
Economic Unit It is the study of It is the study of economy as
individual economic units a whole
of an economy
and its aggregates.

Scope It deals with individual It deals with aggregates like

income, national
 individual prices and income, general price level
individual and national

output, etc. output, etc.

Central Problem Its Central problem is price Its central problem is

determination of
determination and allocation
of level of income and
employment.
resources

Main tools Its main tools are demand Its main tools are aggregate
and supply of a particular demand and
commodity/factor.
aggregate supply of economy
as a

whole.

Use It helps to solve the central It helps to solve the central

problem problem of

of what, how and for whom full employment of resources

to in the

produce in the economy economy.

Equilibrium It discusses how It is concerned with the

Analysis equilibrium of a determination of

consumer, a producer or an equilibrium level of income

industry
 is attained. and

employment of the economy

Determinants Price is the main Price is the main determinant

determinant of of

Micro economic problems Micro economic problems

Limitation It is based on unrealistic it is assumed that there is a

full
assumptions, i.e. In
microeconomics employment in the society
which is

not at all possible.

It has been analyzed that

'Fallacy of

Composition' involves,
which

sometimes doesn't proves

true because it

is possible that what is true

for

aggregate may not be true for

individuals too.

Approach While analyzing any The macroeconomics takes a

economy, top-down

microeconomics takes a approach into the

 bottom-up consideration.

approach,

Example Examples are: individual Examples are: National

income, income, national

individual savings, price savings, general price level,

aggregate
determination of a
commodity, demand, aggregate supply,
poverty,
individual firm's output,
consumer's unemployment etc.

equilibrium

Question 7.“Free market economy enables better allocation of resources,

promotes innovation and injects dynamism in the industry”. Substantiate this
statement highlighting the significance of free market economy.
Answer: Free market economy enables allocation of resources promotes innovation
and injects dynamism in the industry.

free market economics has been the most powerful, nonreligious force for good in
the history of the world. Free market economics has lifted billions of people
worldwide out of poverty in the past two generations alone. It has brought
consumers an embarrassment of riches worth of product variety. It rewards talented
people for talents that dictators or central planners would never have even thought
to exploit. This column reviews ten great reasons to be very thankful for the
wonders of free market economics.

1. Median income is really rising

Claims of stagnant middle class wages generally rely on either the use of very
flawed data rather than official government statistics, or misuse of government
statistics. As the Manhattan Institute’s Scott Winship has repeatedly shown,
properly measured incomes have risen rather steadily with labor productivity, as
would be expected. Using data from the Current Population Survey and the
Congressional Budget Office, Winship shows that from 1967 to 2009 median
household income rose by more than $20,000. Given that median income growth
was slowly positive since 2009 until growing rapidly in 2015, the $20,000 gain has
increased since 2009, so that when more updated data are released, the cumulative
gain since 1967 will be more like $22,000 for the median household. These rising
wages are thanks to a free labor market where employers have to compete for
workers by offering competitive wages.

2. Free trade saves us trillions

While free trade is currently a losing issue politically, the economic reality is that
allowing the free market to extend past national boundaries allows people in both
trading partners to increase the benefits of free markets. By exploiting more
differences in comparative advantage and the differences in tastes, preferences,
resources, and talents worldwide, American consumers save hundreds of billions of
dollars per year on the goods we purchase. In addition, we gain variety in our
purchases, such as the ability of buy fresh fruit in the winter. Yes, some workers
may temporarily lose jobs and see wages rise more slowly thanks to the increased
competition trade brings, but on average we save much more in lower prices than
we lose in lower wages.

3. Free markets know what we want

Free markets miraculously supply almost all our wants without an obvious
mechanism that lets them know what to make and where to deliver it. Through the
wonder of the infamous invisible hand, we vote with our dollars every day by how
we spend our money and the market continually adjusts to meet those needs as
efficiently and inexpensively as possible. The average supermarket, for example,
contains 50,000 different items for sale and has an inventory control system and
supply chain so responsive to consumer demand that on any given day 99.8 percent
or more of those items are there waiting for you to buy them.
4. Innovators are rewarded, consumers benefit

Economic rewards to innovators encourage businesses to invent things consumers

don’t even know we need. Nobody knew she needed an iPhone, Velcro, Post-It
notes, blind-spot warning systems, or fitness trackers until somebody invented
them. More innovations than we can recall proved to be things that we didn’t need
and those innovators did not receive an economic reward. However, the rewards to
those who correctly guess the mood of enough consumers are sufficient to make
many of them rich. This encourages innovation and enriches consumers by much
more than any financial rewards to the innovators themselves.

5. Failed businesses are punished, economic growth accelerated

Economic judgments also put out of business those making things consumers don’t
want. This is a benefit of free markets because when a business disappears it frees
up resources to be redeployed to the production of things society values more
highly. This is exactly what the government frequently gets wrong when it bails out
failing businesses under the mistaken pretext of protecting jobs. Bailing out failing
companies traps resources and capital in a low growth sector that could have been
more profitably used in higher growth areas of the economy. In other words,
stopping business failures slows down economic growth; let them die and watch
new businesses rise from the ashes.

6. Free markets match buyers and sellers

Free markets automatically pair up sellers and buyers. In a free market system,
producers rarely have to know, find, or ever meet the sellers of their products.
Retailers stand between producers and consumers. Banks stand between savers and
borrowers. Stockbrokers and real estate agents serve to match up those who want
to sell and buy shares of stock or a piece of property. Because some money can be
made through performing these matchmaking services, a free market allows
customers to find the products they want without finding the people making those
products. This greatly lowers the transaction costs for both buyers and sellers,
making markets more efficient. The internet has only accelerated the benefits
gained in this regard, shrinking transaction costs ever further.

7. Competition keeps prices low

Competition among competing businesses keeps prices low. Inflation is mostly a
problem in the industries with the most government involvement (e.g., healthcare,
education) while industries that have more free market competition find businesses
reluctant to raise prices and always looking for cost efficiencies to gain an
advantage over those competitors. Just think about prices for computers, food, and
clothes to realize the gains consumers capture from robust competition in a free
market.

8. Price signals work

Price signals tell people and businesses where to allocate their skills and efforts. A
nursing shortage is signaled to the labor market through employers advertising
higher wages for nurses, hopefully leading more people to go into that profession.
High demand for a popular product will lead businesses to bid higher to get a share
of the limited supply, encouraging producers to make more. Similarly, falling
prices and wages tell producers and workers what products and fields some of
them should abandon. When you think about how rarely the store is out of the item
you want or has a huge overstock lingering on the shelves for months on end, you
realize how well price signals in a free market work.

9. Freedom

Free markets let you choose what work you want to do, who to work for, where to
shop, what to buy. Without free markets, some government agency or benevolent
dictator would have to match workers with jobs, producers with retailers, and
retailers with customers. Without free markets, you have no free choice. Thus,
when we restrict free markets with government regulations, people lose freedom:
over what work to do, where and when to shop, what to buy. Free markets, in
contrast to government-controlled ones, let over one hundred million workers
choose from thousands of professions and three hundred million consumers choose
from millions of goods and services for sale every day.

10. Free markets make things work

Think about sectors of our society where things are not working: many government
agencies (like the DMV), healthcare, transportation systems, and K-12 education,
for example. Those areas are where we have the fewest markets and the most
government intervention. If you want low prices and high quality, keep
government out of the way and let free markets work.

Question8. What is national Income? What are the methods of measuring

national income? OR Critically examine the different approaches advocated for
measuring the national Income.

Answer: National income means the total value of goods and services
produced annually in a country.
In other words, the total amount of income accruing to a country from
economic activities in a year’s time is known as national income. It
includes payments made to all resources in the form of wages, interest,
rent and profits.

1. Value added method/ output method:

In this method, only value added by each producing unit at various stages
of production is taken into account for the estimation of national income.

Value added by the manufacture is the difference between value of output

produced and value of inputs used.
This can be better understood by the following example:

Stages Industry Selling price Cost price Value added

(value of (value of (output-input)
output) input)
1 A 80 00 80
(wood seller)
2 B 150 80 70
(manufactures
of chairs)
3 C 250 150 100
(dealers in
chairs)
Total 480 230 250
2. Income method:
According to this method national income obtained by adding up of
incomes of all individuals in the country.

National income is calculated by adding all the incomes earned in the form
of rent, wages, salaries, interest on capital, profit from business, income of
self employed people.
In India this method is used in service sectors like:
a. Transport, communication
b. Electricity, gas and water supply
c. Banking. Finance and insurance
d. Real estate
e. Public administration and defense

3. Expenditure method:
In this method National income is calculated by adding up of all the
expenditure made on goods and services during a year.

If we add the total expenditure incurred by all individuals, households,

business units and the government in a year then we get total national
income of the country.
The following expenditures to be added to calculate National income
a. Expenditure by individuals and households on goods and services denoted
by C
b. Expenditure by private business peoples on capital goods denoted by I
c. Government expenditure i.e. government purchase denoted by G
d. Expenditure made by foreigners on goods and

services denoted by (X-M) Y = C + I + G +(X-M)

1. Explain the difficulties encountered in computation of N.I.? OR

Enumerate the difficulties which an underdeveloped economy faces in the
 calculation of national income.

Answer: Difficulties involved in measurement of national income:

Difficulty in defining the Nation:

National income of a country does not mean only income earned within a
country. It also includes the income earned from abroad.

Lack of statistical data:

The up to date, accurate, adequate and reliable data regarding the value
and volume of goods and services produced are not available in backward
countries.

Absence of proper records:

Many people due to illiteracy, ignorance and indifferent attitudes do not

have the habit of keeping proper accounting data on production, income
and expenditures.

Existence of non monetary transactions:

The national income must be calculated in monetary terms. There are

certain non monetary transactions which are not included in the value of a
product for e, g, unpaid personal service of Housewife.

In our country all the goods and services produced are not exchanged for
money, part of goods and services may be bartered or consumed at home
by producers themselves. The exclusion of such value of goods would
give us a wrong picture of the national income.

Absence of occupational specialization:

Many people are engaged in more than one occupation for earning their
livelihood. Many people work as part time workers and such they do not
 give complete information about sources of their income.

For e.g. an individual may be working as a clerk in a government office

but he may be getting some additional income from his own farm and
small grocery shop. It becomes difficult to collect information about their
income under such circumstances.

Danger of double counting:

While calculating National income we have to take into account the value
of final goods and services but many times the value of intermediate goods
is included in the national income.

For e.g. the value of oil or oil seeds taken into account and not the value of
both.

Existence of illegal learnings:

There is huge volume of incomes earned through illegal activities like

gambling, smuggling, black marketing, adulteration etc.. but these items
cannot be included in calculation of national income.

Treatment of profits from foreign firms:

Profit from foreign firms is treated as income of parent country or income of

Host country.

Imperfect instrument to measure national income:

Value of goods and services measured in terms of money. But the values
of money itself change due to inflation or deflation.

Incomes earned through lottery, dowry, pensions, unemployment relief, etc

should be excluded from the calculation of national income because the above
items are gratis.
Goods kept for self consumption:

The values of these goods are to be included in the calculation of national

income.

Existence of non market transactions:

Many people stitch their own clothes, grow vegetables in their own
gardens the value of such activities does not enter the market transactions
and hence are not included in the national income estimates.

Existence of different methods to calculate depreciation charges:

Coverage of commodities and services:

Value of all unpaid work on account of love, affection, mercy, kindness

friendship etc should be excluded in the calculation of national income.

Question 9. Define national income. Explain the variables included in national

income.

Answer: A National Sample Survey has therefore defined national income

as “The money measures of the net aggregate of all commodities and services
accruing to the inhabitants of community during a specific period.”

There are various concepts of National Income, such as GDP, GNP, NNP, NI, PI,
DI, and PCI which explain the facts of economic activities.

GDP at market price: Is money value of all goods and services produced within
the domestic domain with the available resources during a year.

GDP = (P*Q)
Where,
GDP = gross domestic product
P = Price of goods and services
Q= Quantity of goods and services
GDP is made up of 4 Components
consumption
investment
government expenditure
net foreign exports of a country
GDP = C+I+G+(X-M)
Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import

Gross National Product (GNP): Is market value of final goods and services
produced in a year by the residents of the country within the domestic
territory as well as abroad. GNP is the value of goods and services that the
country's citizens produce regardless of their location.
GNP=GDP+NFIA or,

GNP=C+I+G+(X-M) +NFIA

Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import
NFIA= Net factor income from abroad.

Net National Product (NNP) at MP: Is market value of net output of final
goods and services produced by an economy during a year and net factor
income from abroad.
NNP=GNP-Depreciation
or, NNP=C+I+G+(X-M) +NFIA- IT-Depreciation
Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import
NFIA= Net factor income from abroad.
IT= Indirect Taxes

National Income (NI): Is also known as National Income at factor cost which
means total income earned by resources for their contribution of land,
labour, capital and organisational ability. Hence, the sum of the income
received by factors of production in the form of rent, wages, interest and
profit is called National Income.
Symbolically,
NI=NNP +Subsidies-Interest Taxes
or, GNP-Depreciation +Subsidies-Indirect Taxes
or, NI=C+G+I+(X-M) +NFIA-Depreciation-Indirect Taxes +Subsidies

Personal Income (PI): Is the total money income received by individuals and
households of a country from all possible sources before direct taxes.
Therefore, personal income can be expressed as follows:
PI=NI-Corporate Income Taxes-Undistributed Corporate Profits- Social
Security Contribution +Transfer Payments.
Disposable Income (DI) : It is the income left with the individuals after the
payment of direct taxes from personal income. It is the actual income left
for disposal or that can be spent for consumption by individuals.
Thus, it can be expressed as:

DI=PI-Direct Taxes

Per Capita Income (PCI): Is calculated by dividing the national income of the
country by the total population of a country.
Thus, PCI=Total National Income/Total National Population
Question 10: Distinguish between GNP and NNP.

Answer: GNP (Gross National Product)

It is the GDP of a country added with its income from abroad.

GNP= GDP + Income from Abroad

Or,
GNP = GDP – Income from abroad

Income from abroad= trade balance + interest on External Loans+ Private

Remittance

Private remittance= inflows and outflows on account of private transfer e.g. NRI

Trade balance = net outcome at the year end of the total import and export.

Interest on external loans= balance of the inflow of interest payment (on money
lend out of economy) – outflow of interest payment (on the money borrowed by
the economy)

In case of India, GNP is negative. This is because of heavy outflows on account of

Trade Deficit and interest payment on foreign loans.

NNP or Net National Product

NNP= GNP – Depreciation

Or,
NNP= GDP+ income from abroad- depreciation

NNP or Net National Product is the purest form of Income

Q12.What are the various resources of an economic system?