Business Economics

Part 2

By - Jasmeet Sir
 Topic : MEANING OF NATIONAL INCOME

National Income Accounting, pioneered by the Nobel prize-winning economists Simon

Kuznets and Richard Stone, is the system of macro-economic accounts from the stage
of production of goods and services to the stage of their final disposal.

National Income is defined as the net value of all economic goods and services
produced within the domestic territory of a country in an accounting year plus the net
factor income from abroad.
 Topic : USEFULNESS AND SIGNIFICANCE OF NATIONAL INCOME
ESTIMATES

• Framework for analyzing and evaluating the short-run performance of an

economy
• Pattern of demand for goods and services
• Economic welfare
• Quantitative basis for assessing and choosing economic policies
• Throw light on income distribution
• Assist in determining eligibility for loans etc.
• A guide to make policies for growth and inflation
• Forecasting about the future development trends of the economy
 Topic : DIFFERENT CONCEPTS OF NATIONAL INCOME

1. Gross vs Net
Gross Net
(-) Depreciation

2. Domestic Product vs National Product

Domestic National
+ Net Factor Income From Abroad
Or - Net Factor Income TO Abroad
 Topic : DIFFERENT CONCEPTS OF NATIONAL INCOME

3. Market Price Vs Factor Cost

Market Price Factor Cost

}
+ Indirect Taxes
(-) Net Indirect Tax
- Subsidies
 Topic : Real GDP VS Nominal GDP

Real GDP or GDP At Constant Prices Nominal GDP or GDP At Current Prices

Measurement of Value of Output at the Measurement of Value of Output at the

Price Level of a selected "Base Year". Price Level of the "Current Year".

National Income is affected only by National Income is affected by changes in

changes in Output levels. Price levels and Output levels.

National Income changes only when National Income changes even if prices
production / physical output changes. change, without any change in production
/ physical output. .
 Topic : GDP Deflator

It is the ratio of Nominal GDP (at Current Prices) to Real GDP (at Constant
Prices)

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
GDP Deflator = × 100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃

GDP deflator is the price index used to convert nominal GDP to real GDP
 Topic : PER CAPITA INCOME

GDP𝐹𝐶 per capita = GDPFC ÷ Population

 Topic : Methods Of Calculating National Income

Method 1: Value Added Method

Particulars Amount
Gross Value Added by Primary Sector -
Add: Gross Value Added by Secondary Sector -
Add: Gross Value Added by Tertiary Sector -
GDPMP -
Less: Depreciation -
Add: NFIA -
Less: Net Indirect Tax -
NNPFC
 Topic : Methods Of Calculating National Income

Gross Value Added (GDPMP) = Value Of Output – Intermediate

Consumption
Value Of Output = Sales + Change in stock
 Topic : Methods Of Calculating National Income

# Question
Calculate National Income by Value Added Method with the help of following data:
• Sales 700;
• Opening stock 500;
• Intermediate Consumption 350;
• Closing Stock 400;
• Net Factor Income from Abroad 30;
• Depreciation 150;
• Excise Tax 110;
• Subsidies 50.
 Topic : Methods Of Calculating National Income

Method 2: Income Method (NDPFC)

Particulars Amount Amount
Compensation Of Employees
Wages & Salaries In Cash + KIND -
Employer Contribution to social security schemes - -
Operating Surplus
(i) Income From Property -
Rent + Royalty + Interest Income -
(ii) Income From Entrepreneurship (Profits)
Corporate Tax + Dividend + Retained Earnings -
Mixed Income -
NDPFC -
 Topic : Methods Of Calculating National Income

Method 2: Income Method (NDPFC)

Particulars Amount Amount
Add: NFIA -
NNPFC -
 Topic : Methods Of Calculating National Income

# Question
From the following data, calculate NNPFC, NNPMP, GNPMP and GDPMP.
• Operating surplus 2000;
• Mixed income of self-employed 1100;
• Rent 550; Profit 800;
• Net indirect tax 450;
• Consumption of fixed capital 400;
• Net factor income from abroad -50;
• Compensation of employees 1000.
 Topic : Methods Of Calculating National Income

Method 3: Expenditure Method (GDPMP)

Particulars Amount Amount
Private Final Consumption Expenditure -
Government Final Consumption Expenditure -
Gross Domestic Capital Formation
(i) Gross Fixed Capital Formation
• Gross Business Fixed Investment -
• Gross Residential Construction Investment -
• Gross Public Investment - -
(ii) Inventory Investment (Change In Stock) -
Net Exports -
GDPMP -
 Topic : Methods Of Calculating National Income

# Question
Calculate GNP at FC:
(i) Net domestic fixed capital formation 350
(ii) Closing stock 100
(iii) Government final consumption expenditure 200
(iv) Net indirect taxes 40
(v) Opening stock 60
(vi) Consumption of fixed capital 50
(vii) Net exports (-)10
(viii) Private final consumption expenditure 1,500
(ix) Imports 20
(x) Net factor income from abroad (-) 30
 Topic : Private Income / Personal Income / Personal
Disposable Income
Particulars Amount
NNPFC -
Less: Income from Property and Entrepreneurship accruing to -
Government Administrative Departments (Railways, Post Office etc)
Less: Savings of Non-departmental Enterprises. -
Income From Domestic Product Accruing To Private Sector -
Add: National Debt Interest -
Add: Current Transfers from Government -
Add: Net Current Transfers from rest of the world. -
Private Income -
 Topic : Private Income / Personal Income / Personal
Disposable Income
Private Income -
Less: Undistributed profits -
Less: Corporate Tax -
Personal Income -
Less: Personal taxation -
Less: Non tax payments i.e. fees, penalty, fines to government -
Personal Disposable Income -
 Topic : Private Income / Personal Income / Personal
Disposable Income
#Question
From the following data, estimate National Income and Personal Income
• Net national product at market price = 1,891;
• Income from property and entrepreneurship accruing to government
administrative departments = 45;
• Indirect taxes = 175;
• Subsidies = 30;
• Saving of non-departmental enterprises = 10;
• Interest on National debt = 15;
• Current transfers from government = 35;
• Current transfers from rest of the world = 20;
• Saving of private corporate sector = 25;
• Corporate profit tax = 25.
 Topic : Net National Disposable Income (NNDI)

NNDI =
Net National Income
+
other net current transfers from the rest of the world (Receipts -payments)
 Topic : Gross National Disposable Income (GNDI)

GNDI = NNDI + CFC

Unit 2 National Income As Per Keynes
 Topic : NATIONAL INCOME AS PER KEYNES

A comprehensive theory of National Income was first put forward by the

British economist John Maynard Keynes in his masterpiece ‘The General
Theory of Employment Interest and Money’ published in 1936.
The Keynesian theory of income determination is presented in three
models:
1. The two-sector model consisting of the household and the business
sectors,
2. The three-sector model consisting of household, business and
government sectors, and
3. The four-sector model consisting of household, business,
government and foreign sectors.
 Topic : CIRCULAR FLOW IN A SIMPLE TWO-SECTOR MODEL

• Only two sectors in the economy viz., households and firms,

• Only consumption and investment outlays,
• Households own all factors of production,
• They sell their factor services to earn factor incomes,
• They do not save,
• No corporations, corporate savings or retained earnings,
 Topic : CIRCULAR FLOW IN A SIMPLE TWO-SECTOR MODEL

• Y = Yd
• No government, no taxes, no government expenditure or transfer
payments,
• The economy is a closed economy, i.e., foreign trade does not exist.
• Factor Payments = Household Income = Household Expenditure =
Total Receipts of Firms = Value of Output
 Topic : THE AGGREGATE DEMAND FUNCTION (AD): TWO-SECTOR MODEL

Aggregate demand (AD) or aggregate expenditure consists of only two components:

(i) Ex ante aggregate demand for consumer goods (C), and
(ii) Ex ante aggregate demand for investment goods (I)

AD = C + I (Constant Investment)
 Topic : THE CONSUMPTION FUNCTION (C)

Functional relationship between aggregate consumption expenditure and

aggregate disposable income
C = a + bY
Where,
C = Aggregate consumption expenditure;
Y = Total disposable income;
a = Consumption at zero level of disposable income;
b = MPC [The slope of the function = (ΔC/ΔY)]
 Topic : MARGINAL PROPENSITY TO CONSUME (MPC) ‘b’

MPC (b) = Δ𝐂/ΔY

The Keynesian assumption is that consumption increases with an increase
in disposable income, but that the increase in consumption will be less
than the increase in disposable income (b < 1) i.e 0 < b < 1.
 Topic : AVERAGE PROPENSITY TO CONSUME (APC)

APC = Total Consumption/Total Income, or

= 𝐂/𝐘
the proportion of income spent on consumption decreases as income
increases
 Topic : THE SAVING FUNCTION (S)

S = f(Y)
S = (-) a + (1-b)Y
Where;
S = Aggregate Savings;
Y = Total disposable income;
(–) a = Dis-savings at zero level of income;
1–b = MPS
 Topic : THE MARGINAL PROPENSITY TO SAVE (MPS) ‘1 - b’

MPS = Δ𝐒/ΔY, or
=1–b
• MPC is always less than unity, but greater than zero, i.e., 0 < b < 1
• MPC + MPS = 1
 Topic : AVERAGE PROPENSITY TO SAVE (APS)

APS = Total Saving/Total Income, or

= 𝐒/Y
 Topic : Aggregate Supply

• Ex ante or planned aggregate supply is the total supply of goods and

services which firms in a national economy plan on selling during a
specific time period.
• It is equal to the national income of the economy, which is either
consumed or saved.
AS = C + S; or
AS = Y
 Topic : THE TWO-SECTOR MODEL OF NATIONAL INCOME
DETERMINATION

The equilibrium level of income and output in the Keynesian framework is

that level at which
AD =AS (Y), Or
Savings = Investment
Equilibrium equation in 2 sector model
Y = AD
Y=C+I
Y = a + bY + I
 Topic : Equilibrium with Unemployment or Inflation

An important point to remember is that

Keynesian equilibrium with equality of planned
aggregate expenditures and output need not
take place at full employment.

a) Deflationary Gap
• If the AD is for an amount of output less
than the full employment level of output,
then we say there is deficient demand.
• Deficient demand gives rise to a
‘deflationary gap’ or ‘recessionary gap’ or
‘contractionary gap’.
 Topic : Equilibrium with Unemployment or Inflation

b) Inflationary Gap
If the AD is for an amount of
output greater than the full
employment level of output,
then we say there is excess
demand.
Excess demand gives rise to
‘inflationary gap’.
 Topic : THE INVESTMENT MULTIPLIER

• The process of increase in national income due to increase in investment depicts

the investment multiplier
k = ΔY/ΔI or
k = 1 / 1-b or
k = 1/ MPS
• Higher the consumption, higher will be the multiplier.
• The maximum value of multiplier is infinity when the value of MPC is 1
 Topic : DETERMINATION OF EQUILIBRIUM INCOME:
THREE SECTOR MODEL

Aggregate demand in the three sector model:

AD = C + I + G
The consumption function is
C = a + b Yd
Yd = Y – T + TR
T = T̅+ t Y
Where,
T̅ = autonomous constant tax
t = income tax rate
 Topic : TAX MULTIPLIER

Taxes act as leakage from the economic system.

1
Thus, tax multiplier when, T=T̅ -tY, is
1−𝑏(1−𝑡)
 Topic : TAX MULTIPLIER

# Question
Consumption C = 75 + 0.5 (Y-T); Investment I = 80; Total tax T = 25 + 0.1Y;
Government expenditure G = 100.
(a) Find out equilibrium income?
(b) What is the value of multiplier?
(c) Calculate Tax Multiplier
 Topic : DETERMINATION OF EQUILIBRIUM INCOME:
FOUR SECTOR MODEL

Y = C + I + G + (X-M)
Where
C = a + b(Y-T)
M= M̅ + mY
Where,
M = Aggregate Imports
m = Marginal Propensity to import
 Topic : FOREIGN TRADE MULTIPLIER

1
Foreign Trade Multiplier =
1−𝑏+𝑚
 Topic : TRADE BALANCE

Trade Balance = X – M
 Topic : TRADE BALANCE

# Question
An economy is characterised by the following equation
• Consumption C = 60+0.9Yd
• Investment I = 10
• Government expenditure G = 10
• Tax T = 0
• Exports X = 20
• Imports M = 10 +0.05 Y
What is the equilibrium income? Calculate trade balance and foreign trade
multiplier.
Chapter Name

PUBLIC FINANCE
 UNIT – 01
FISCAL FUNCTIONS: AN OVERVIEW
 Topic : WORDS OF ADAM SMITH ON PUBLIC FINANCE

Adam Smith saw an important resource allocation role for government when he
underlined the role of government in national defence, maintenance of justice and the
rule of law, establishment and maintenance of highly beneficial public institutions and
public works which the market may fail to produce on account of lack of sufficient
profits.
 Topic : RICHARD MUSGRAVE’S THREE BRANCH TAXONOMY
ON PUBLIC FINANCE

Richard Musgrave, in his classic treatise ‘The Theory of Public Finance’ (1959),
introduced the three branch taxonomy of the role of government in a market economy:
➢ Resource Allocation (efficiency),
➢ Income Redistribution (fairness) and
➢ Macroeconomic Stabilization.
 Topic : THE ALLOCATION FUNCTION

Resource allocation refers to the way in which the available factors of production are
allocated among the various uses to which they might be put. One of the most
important functions of an economic system is the optimal or efficient allocation of
scarce resources so that the available resources are put to their best use and no
wastages are there.
 Topic : MAIN REASONS OF NEED OF EFFICIENT ALLOCATION

➢ Imperfect competition and presence of monopoly power

➢ Markets typically fail to provide collective goods
➢ Externalities
➢ Factor immobility which causes unemployment and inefficiency
➢ Imperfect information, and
➢ Inequalities in the distribution of income and wealth.
 Topic : STATE OR GOVERNMENT AND ALLOCATION

The allocative function in budgeting determines who and what will be taxed as well as
how and on what the government revenue will be spent. It is concerned with the
provision of public goods and the process by which the total resources of the economy
are divided among various uses and an optimum mix of various social goods (both
public goods and merit goods).
 Topic : ALLOCATION INSTRUMENTS

➢ Government may directly produce the economic good,

➢ Government may influence private allocation through incentives and
disincentives,
➢ Government may influence allocation through its competition policies, merger
policies etc.,
➢ Governments’ regulatory activities such as licensing, controls, minimum wages
etc.,
➢ Government sets legal and administrative frameworks, and
➢ Any of a mixture of intermediate techniques may be adopted by governments.
 Topic : REDISTRIBUTION FUNCTION

It is concerned with the adjustment of the distribution of income and wealth so as to

ensure distributive justice namely, equity and fairness. The distribution function also
relates to the manner in which the effective demand over the economic goods is
divided among the various individual and family spending units of the society.
 Topic : AIM OF REDISTRIBUTUION FUNCTION

➢ To achieve an equitable distribution of societal output among households,

➢ Advancing the well-being of all,
➢ Providing equality in income, wealth and opportunities,
➢ Providing security for people who have hardships, and
➢ Ensuring that everyone enjoys a minimal standard of living.
➢ Progressive taxation of the rich and subsidy to the poor households,
➢ Financing public services, especially those that benefit low-income households,
➢ Employment reservations and preferences,
➢ Regulation of the manufacture and sale of certain products to ensure the health
and well-being of consumers, and
➢ Special schemes for backward regions and for the vulnerable sections.
 Topic : STABILIZATION FUNCTION

The stabilization function is one of the key functions of fiscal policy and aims at
eliminating macroeconomic fluctuations arising from suboptimal allocation.
 Topic : CONCERN OF STABILIZATION FUNCTION

➢ Labour employment and capital utilization,

➢ Overall output and income,
➢ General price levels,
➢ Balance of international payments, and
➢ The rate of economic growth.
QUESTION

#Q. Macroeconomic stabilization may be achieved through

A Free market economy

B Fiscal policy

C Monetary policy

D (b) and (c) above

QUESTION

#Q. Which of the following policies of the government fulfils the redistribution
function
A Parking the army on the northern borders of the country

B Supply of food grains at subsidized prices to the poor people

C Controlling the supply of money through monetary policy

D All of the above

QUESTION

#Q. The justification for government intervention is best described by

A The need to prevent recession and inflation in the economy

B The need to modify the outcomes of private market actions

C The need to bring in justice in distribution of income and wealth

D All the above

QUESTION

#Q. When a government offers unemployment benefits and also resorts to

progressive taxation which function does it seem to fulfill?

A It is trying to establish stability in an economy

B It is trying to redistribute income and wealth

C It is trying to allocate resources to their most efficient use

D It is creating a source of market failure

 UNIT – 02
MARKET FAILURE
 Topic : THE CONCEPT OF MARKET FAILURE

Market failure is a situation in which the free market leads to misallocation of society's
scarce resources in the sense that there is either overproduction or underproduction of
particular goods and services leading to a less than optimal outcome.
There are four major reasons for market failure. They are:
➢ Market power,
➢ Externalities,
➢ Public goods, and
➢ Incomplete information
 Topic : MARKET POWER OR MONOPOLY POWER

Market power or monopoly power is the ability of a firm to profitably raise the market
price of a good or service over its marginal cost.
 Topic : EXTERNALITIES

Sometimes, the actions of either consumers or producers result in costs or benefits

that do not reflect as part of the market price. Such costs or benefits which are not
accounted for by the market price are called externalities because they are “external”
to the market. The four possible types of externalities are:
➢ Negative production externalities
➢ Positive production externalities
➢ Negative consumption externalities ,and
➢ Positive consumption externalities
 Topic : EXTERNALITIES

1. Negative Production Externalities:

“A negative externality initiated in production which imposes an external cost on
others may be received by another in consumption or in production.”

2. Positive production externalities:

“A positive production externality initiated in production that confers external benefits
on others may be received in production or in consumption.”

3. Negative consumption externalities:

“A negative consumption externalities initiated in consumption which imposes an
external cost on others may be received by another in consumption or in production.”

4. Positive consumption externalities:

“A positive consumption externality initiated in consumption that confers external
benefits on others may be received in consumption or in production.”
 Topic : PUBLIC GOODS/COLLECTIVE CONSUMPTION
GOODS/SOCIAL GOODS

Paul A. Samuelson who introduced the concept of ‘collective consumption good’ in his
path-breaking 1954 paper ‘The Pure Theory of Public Expenditure’ is usually
recognized as the first economist to develop the theory of public goods.

A public good (also referred to as collective consumption good or social good) is

defined as one which all enjoy in common in the sense that each individual’s
consumption of such a good leads to no subtraction from any other individuals’
consumption of that good.
 Topic : CLASSIFICATION OF PUBLIC GOODS

Pure Public Goods: ‘Which perfectly satisfy non rivalness and non-excludability’
Eg. Defence, Highways etc

Impure Public Goods:

Hybrid goods that possess some features of both public and private goods. These goods
are partially rivalrous.
Eg. Indian Railways
 Topic : FREE RIDER PROBLEM

‘Free riding is ‘benefiting from the actions of others without paying’

Due to free-rider problem, the following two outcomes are possible:
➢ No public good
➢ Under production public goods
 Topic : INCOMPLETE INFORMATION

Complete information is an important element of competitive market. Perfect

information implies that both buyers and sellers have complete information about
anything that may influence their decision making.

Asymmetric Information and Lemons (poor items in market) Problem

Asymmetric information occurs when there is an imbalance in information between

buyer and seller.
 Topic : INCOMPLETE INFORMATION

Adverse selection
A situation in which asymmetric information about quality eliminates high-quality goods
from a market.

Moral hazard
An informed person’s taking advantage of a less-informed person through an unobserved
action. It arises from lack of information about someone’s future behavior.
 Topic : THE FORMS OF GOVERNMENT INTERVENTION

As supplier Public
Goods/Information
Direct
As buyer /
Government Procurement
Intervention

Taxes /subsidies
to alter costs
Indirect
Regulation
/influence
 Topic : GOVERNMENT INTERVENTION TO MINIMIZE
MARKET POWER
➢ By establishing rules and regulations
For example, in India, we have the Competition Act, 2002 (as amended by the
Competition (Amendment) Act, 2007)
➢ Price regulation in the form of setting maximum prices that firms can charge
➢ Determines an acceptable price, called as rate-of-return regulation
➢ Setting price-caps based on the firm’s variable costs, past prices, and possible
inflation and productivity growth
 Topic : GOVERNMENT INTERVENTION TO CORRECT
EXTERNALITIES
➢ Direct controls
➢ Market-based policies
 Topic : GOVERNMENT INTERVENTION TO CORRECT
EXTERNALITIES
Direct Controls:
➢ Prohibit specific activities or limited to a certain level,
➢ Stringent rules are in place in respect of tobacco advertising, packaging and
labeling etc.,
➢ Governments may pass laws to alleviate the effects of negative externalities,
➢ Government stipulated environmental standards are rules
For example, India has enacted the Environment (Protection) Act, 1986.
 Topic : GOVERNMENT INTERVENTION TO CORRECT
EXTERNALITIES
The Market Based Approaches:
➢ Setting the price directly through a pollution tax (Pigouvian taxes),
➢ Setting the price indirectly through the establishment of a cap-and-trade system
(tradable emissions permits).
 Topic : GOVERNMENT INTERVENTION TO CORRECT
EXTERNALITIES
IN CASE OF POSITIVE EXTERNALITIES:
Subsidies involve government paying part of the cost to the firms in order to promote
the production of goods having positive externalities.
 Topic : GOVERNMENT INTERVENTION IN THE CASE OF MERIT
GOODS

➢ Merit goods are goods which are deemed to be socially desirable

Examples: Education, health care, welfare services, fire protection, waste
management, public libraries, museum and public parks etc.
➢ Free of cost direct provision of merit goods by government.
 Topic : GOVERNMENT INTERVENTION IN THE CASE OF DEMERIT GOODS

➢ At the extreme, government may enforce complete ban,

➢ Negative advertising campaigns,
➢ Prohibit the advertising or promotion of demerit goods,
➢ Strict regulations to limit access to the good,
➢ Regulatory controls in the form of spatial restrictions e.g. smoking in public
places,
➢ Imposing unusually high taxes,
➢ Fix a minimum price.
 Topic : GOVERNMENT INTERVENTION IN THE CASE OF PUBLIC
GOODS

➢ Direct provision of a public good (free of cost),

➢ Excludable public goods can be provided by government and the same can be
financed through entry fees.
➢ Grant licenses to private firms to build a public good facility.
 Topic : PRICE INTERVENTION

Price controls may take the form of either

➢ A price floor (a minimum price buyers are required to pay) or
➢ A price ceiling (a maximum price sellers are allowed to charge for a good or
service)
 Topic : GOVERNMENT INTERVENTION FOR CORRECTING
INFORMATION FAILURE

➢ Accurate labeling and content disclosures by producers,

➢ Public dissemination of information,
➢ Regulation of advertising and setting of advertising standards.
 Topic : GOVERNMENT INTERVENTION FOR EQUITABLE DISTRIBUTION

➢ Progressive income tax,

➢ Targeted budgetary allocations,
➢ Unemployment compensation,
➢ Transfer payments,
➢ Subsidies,
➢ Social security schemes,
➢ Job reservations,
➢ Land reforms,
➢ Gender sensitive budgeting etc.
QUESTION

#Q. Market power

A Makes price equal marginal cost and produce a positive external benefit on
others
B Can cause markets to be inefficient because it keeps price and output away from
equilibrium of supply and demand
C Makes the firms price makers and restrict output so as to make allocation
inefficient
D (B) and (C) above
QUESTION

#Q. The Competition Act, 2002 aims to

A Protect monopoly positions of firms that have developed unique innovations

B To promote and sustain competition in markets

C To determine pricing under natural monopoly

D None of the above

QUESTION

#Q. If governments make it compulsory to avail insurance protection, it is because

A Insurance companies need to he running profitably

B Insurance will generate moral hazard and adverse selection

C Insurance is a merit good and government wants people to consume it

D None of the above

QUESTION

#Q. Smoking in public is a case of

A Negative consumption externality

B Negative production externality

C Internalising externality

D None of the above

QUESTION

#Q. If an individual tends to drive his car in a dangerously high speed because he has
a comprehensive insurance cover, it is a case of

A Free riding

B moral hazard

C Poor upbringing

D Inefficiency
 UNIT – 03
FISCAL POLICY
 Topic : BUDGET CONCEPTS

TYPE OF BUDGETS
1. Balanced budget: A balanced budget is a budget in which revenues are equal to
expenditures. Thus, neither a budget deficit nor a budget surplus exists. Revenue
does not fall short of expenditure. i.e., revenue is equal to expenditure (Revenue =
Expenditure).
 Topic : BUDGET CONCEPTS

2. Unbalanced budget: The budget may either be surplus or deficit.

➢ A surplus budget: when estimated government receipts are more than the
estimated government expenditure it is termed as surplus budget. When the
government spends less than the receipts the budget becomes surplus. Briefly
put, public revenue exceeds public expenditure (R > E.)

➢ A deficit budget: when estimated government receipts are less than the
government expenditure, it is termed as a deficit budget. A deficit budget
increases the liability of the government or decreases its reserves. In modern
economies, most of the countries follow deficit budgeting.
CAPITAL RECEIPTS
Capital receipts are those receipts that lead to a reduction in the assets or an increase
in the liabilities of the government. Examples include recoveries of loans, earnings
from disinvestment and debt.
REVENUE RECEIPTS
Revenue receipts can be defined as those receipts which neither create any liability nor
cause any reduction in the assets of the government. There are two sources of revenue
receipts for the government – tax revenues and non-tax revenues.
REVENUE EXPENDITURE
Revenue expenditure is expenditure incurred for purposes other than creation of
physical or financial assets of the central government. It relates to those expenses
incurred for the normal functioning of the government departments and various
services, interest payments on debt incurred by the government, and grants given to
state governments and other parties (even though some of the grants may be meant
for creation of assets).
CAPITAL EXPENDITURE
There are expenditures of the government which result in creation of physical or
financial assets or reduction in financial liabilities. This includes expenditure on the
acquisition of land, building, machinery and equipment, investment in shares, and
loans and advances by the central government to state and union territory
governments, PSUs and other parties.
When a government spends more than it collects by way of revenue, it incurs a budget
deficit. There are various measures that capture government deficit and they have
their own implications for the economy.
BUDGETARY DEFICIT OR OVERALL DEFICIT Budgetary
Deficit is defined as the excess of total estimated expenditure over total estimated
revenue is the difference between all receipts and expenditure, both revenue and
capital.
REVENUE DEFICIT
The revenue deficit refers to the excess of government’s revenue expenditure over
revenue receipts. It shows the shortfall of government’s current receipts over current
expenditure. It shows the government revenue is insufficient to meet the regular
expenditures in connection with the normal functioning of the government, or the
government is diverting resources from other sectors to finance its current
expenditure.
Revenue deficit = Revenue expenditure – Revenue receipts
FISCAL DEFICIT
• The excess of total expenditure over total receipts excluding borrowings during a
given fiscal year is called the fiscal deficit.
• In other words, fiscal deficit is the difference between the government’s total
expenditure and its total receipts excluding borrowing.
• It is often presented as a percentage of the gross domestic product (GDP).
Fiscal deficit = Total Expenditure – Total Receipts excluding borrowing
Fiscal Deficit = (Revenue Expenditure + Capital Expenditure) – (Revenue Receipts +
Capital Receipts excluding borrowing)
Fiscal Deficit = (Revenue Expenditure- Revenue Receipts) + (Capital Expenditure –
Capital Receipts excluding borrowing)
Fiscal Deficit = Revenue Deficit + (Capital Expenditure - Capital Receipts excluding
borrowing)
PRIMARY DEFICIT
• Primary deficit is defined as fiscal deficit of current year minus interest payments on
previous borrowings.
• In other words whereas fiscal deficit indicates borrowing requirement inclusive of
interest payment, primary deficit indicates borrowing requirement exclusive of
interest payment.
• The goal of measuring primary deficit is to focus on present fiscal imbalances.
Primary deficit = Fiscal deficit – Net Interest liabilities
Net interest liabilities interest payments minus interest receipts by the government on
domestic lending.
GUILLOTINE
The parliament has very limited time for examining the expenditure demands of all the
ministries. So, once the prescribed period for the discussion on demands for grants is
over, the speaker of Lok Sabha puts all the outstanding demands for grants, whether
discussed or not, to the vote of the house. This process is popularly known as
'Guillotine’.
CUT MOTIONS
Motions for reduction to various demands for grants are made in the form of cut
motions seeking to reduce the sums sought by government on grounds of economy or
difference of opinion on matters of policy or just in order to voice a grievance.
CONSOLIDATED FUND OF INDIA
All revenues received, loans raised and all moneys received by the government in
repayment of loans are credited to the Consolidated Fund of India and all expenditures
of the government are incurred from this fund. Money can be spent through this fund
only if appropriated by the parliament. The consolidated Fund has further been
divided into ‘revenue’ and ‘capital’ divisions.
CONTINGENCY FUND OF INDIA
A fund placed at the disposal of the President to enable him/her to make advances to
the executive/Government to meet urgent unforeseen expenditure. Contingency fund
enables the government to meet unforeseen expenditure and does not require prior
legislative approval, unlike with the Consolidated Fund. For meeting such exigencies,
advances are made to the executive from the contingency fund which is subsequently
reported to the Parliament for recoupment from the Consolidated Fund of India.
PUBLIC ACCOUNT
Under provisions of Article 266(1) of the Constitution of India, public account is used
in relation to all the fund flows where government is acting as a banker. Examples
include Provident Funds and Small Savings. This money does not belong to
government but is to be returned to the depositors. The expenditure from this fund
need not be approved by the parliament.
QUESTION

#Q. Corporate tax

A is collected by the union government and can be a capital receipt or revenue

receipt
B may be collected by the respective states and fall under revenue receipts

C may be collected either by the centre or states and fall under revenue receipts

D is collected by the union government and is a revenue receipt

QUESTION

#Q. Government borrowings from foreign governments and institutions

A Capital receipt

B Revenue receipt

C Accounts for fiscal deficit

D Any of the above depending on the purpose of borrowing

QUESTION

#Q. The revenue deficit for country A is.

₹ Crores
A 5,000 Revenue receipts 20,000
Recovery of loans 1,500
B 24,000
Borrowing 15,000
C Other Receipts 5,000
4,500
Expenditure on revenue account 24,500
D None of these Expenditure on capital account 26,000
Interest payments 2,000
QUESTION

#Q. Fisal deficit of country A is.

₹ Crores
A 14,000 Revenue receipts 20,000
Recovery of loans 1,500
B 24,000 Borrowing 15,000
Other Receipts 5,000
C 23,000
Expenditure on revenue account 24,500
Expenditure on capital account 26,000
D None of these
Interest payments 2,000
QUESTION

#Q. Primary deficit of country A is

₹ Crores
A 26,000 Revenue receipts 20,000
Recovery of loans 1,500
B 26,500
Borrowing 15,000
Other Receipts 5,000
C 22,000
Expenditure on revenue account 24,500
D 24,500 Expenditure on capital account 26,000
Interest payments 2,000
QUESTION

#Q. A budget is said to be unbalanced when

A when government's revenue exceeds government's expenditure

B when government's expenditure exceeds government's revenue

C either budget surplus of budget deficit occurs

D All the above

QUESTION

#Q. Budget of the government generally impacts

A the resource allocation in the economy

B redistribution of income and enhance equity

C stability in the economy by measures to control price fluctuations

D all the above

 UNIT – 04
FISCAL POLICY
 Topic : INTRODUCTION (FISCAL POLICY)

Fiscal policy involves the use of government spending, taxation and borrowing to
influence both the pattern of economic activity and level of growth of aggregate
demand, output and employment.
 Topic : OBJECTIVES OF FISCAL POLICY

➢ Achievement and maintenance of full employment,

➢ Maintenance of price stability,
➢ Acceleration of the rate of economic development, and
➢ Equitable distribution of income and wealth,
 Topic : AUTOMATIC STABILIZERS VERSUS DISCRETIONARY
FISCAL POLICY

➢ In automatic or non discretionary fiscal policy, the tax policy and expenditure
pattern are so framed that taxes and government expenditure automatically
change with the change in national income.
➢ Discretionary fiscal policy refers to deliberate policy actions on the part of
government to change the levels of expenditure, taxes to influence the level of
national output, employment and prices.
 Topic : INSTRUMENTS OF FISCAL POLICY

➢ Taxes,
➢ Government expenditure,
➢ Public debt and
➢ Budget.
 Topic : GOVERNMENT EXPENDITURE AS AN INSTRUMENT OF
FISCAL POLICY

Government expenditures include:

➢ Current expenditures to meet the day to day running of the
government,
➢ Capital expenditures (capital equipments and infrastructure), and
➢ Transfer payments.
 Topic : TAXES AS AN INSTRUMENT OF FISCAL POLICY

➢ During recession and depression, the tax policy is framed to encourage private
consumption and investment,
➢ During inflation, new taxes can be levied and the rates of existing taxes are
raised to reduce disposable incomes and to wipe off the surplus purchasing
power.
 Topic : PUBLIC DEBT AS AN INSTRUMENT OF FISCAL POLICY

➢ Borrowing from the public through the sale of bonds and securities curtails the
aggregate demand in the economy,
➢ Repayments of debt by governments increase the availability of money in the
economy and increase aggregate demand.
 Topic : BUDGET AS AN INSTRUMENT OF FISCAL POLICY

➢ A balanced budget will have no net effect on aggregate demand

➢ A budget surplus has a negative net effect on aggregate demand since leakages
exceed injections,
➢ A budget deficit has a positive net effect on aggregate demand since total
injections exceed leakages from the government sector.
 Topic : TYPES OF FISCAL POLICY

➢ Expansionary fiscal policy is designed to stimulate the economy during the

contractionary phase of a business cycle or when there is an anticipation of a
business cycle contraction,
➢ Contractionary fiscal policy is designed to restrain the levels of economic
activity of the economy during an inflationary phase or when there is
anticipation of a business-cycle expansion which is likely to induce inflation.
 Topic : FISCAL POLICY FOR REDUCTION IN INEQUALITIES OF
INCOME AND WEALTH

➢ A progressive direct tax system

➢ Indirect taxes can be differential
➢ A carefully planned policy of public expenditure helps in redistributing income
from the rich to the poorer sections of the society.
 Topic : CROWDING OUT

An increase in the size of government spending during recessions will ‘crowd-out’

private spending in an economy and lead to reduction in an economy’s ability to self-
correct from the recession, and possibly also reduce the economy’s prospects of long-
run economic growth.
QUESTION

#Q. During recession fiscal policy of the government should be directed towards

A Increasing the taxes and reducing the aggregate demand

B Decreasing taxes to ensure higher disposable income

C Increasing government expenditure and increasing taxes

D None of the above

QUESTION

#Q. Name the policy that accords with expenditure and taxation policies decisions of
the government?
A Monetary Policy

B Fiscal Policy

C Labor Market Policies

D Trade Policy
QUESTION

#Q. Which one among the following is a tool of Fiscal Policy?

A Government Research

B Election

C Taxation

D None of the above

QUESTION

#Q. An increase in personal income taxes

Reduces disposable incomes leading to fall in consumption spending and

A
aggregate demand

B Is desirable during inflation or when there is excessive levels of aggregate

demand
C Is to compensate the deficiency in effective demand by boosting aggregate
spending
D Both (a) and (b) are correct
QUESTION

#Q. Fiscal policy refers to the

Use of government spending, taxation and borrowing to influence the level of

A
economic activity

B Government activities related to use of government spending for supply of

essential goods

C Use of government spending, taxation and borrowing for reducing the fiscal
deficits
D (a) and (b) above