# Bihar Board 12th Business Economics Important Questions Long Answer Type Part 2

BSEB Bihar Board 12th Business Economics Important Questions Long Answer Type Part 2 are the best resource for students which helps in revision.

## Bihar Board 12th Business Economics Important Questions Long Answer Type Part 2

Question 1.
What do you mean by Commercial Bank? Discuss its functions.
A commercial bank is an institution which deals with money and credit. It accepts deposits from the public, makes the funds available to those who need them and helps in remittance of money from one place to another.

Functions of Commercial Banks:
I. Primary Functions:
(a) Accepting Deposits: The primary function of the commercial bank is to accept deposits from bank.
The various types of deposits accepted by the commercial bank are as follows:
1. Current deposits: Deposits in current account are termed as current deposits. A depositor can deposit the amount any member of times he likes and can also withdraw the amount any number of times he wants. Generally, bank does not grant any interest on such accounts, rather bank may take some charges from the depositor.

Such account are useful for traders who need money for daily transactions many times in a day.

2. Saving deposits: Such accounts generally belong to the people having small savings and who do not require withdrawal of money many times. Interest rate in such accounts is low. Savings account is generally opened by households salaried class and people having average income. Banks provide cheque facility to the depositors for the withdrawal of money. Such accounts promote capital formation.

3. Fixed deposits: In fixed accounts, account is deposited for a certain fixed period (which may be 46 days or more), Depositor gets deposit receipt while depositing cash in cash accounts. The receipt indicates the name of the depositor, amount of deposit, rate of interest and period of deposit. This receipt is non-transferable, i.e., the amount written on the receipt can be paid only to the depositor, not to anyone else.

4. Recurring deposit: Recurring deposits are certain type of fixed deposit. Depositor deposits a certain amount every month in this account. The amount cannot be withdrawn before expiry of given period except under exceptional circumstances. Such accounts generally give higher interest rate. Depositor gets deposited amount with interest after expiry of the period.

(b) Granting loans: The second important primary function of commercial banks is advancing of loans. After keeping certain cash reserves, the banks lend their deposits to needy borrowers. However these advances are given for productive purposes against an approved security, with the motive of earning interest. Various types of loans granted by banks are as follows:

1. Cash credit: In cash credit system, bank provides loans to the borrower against bonds or some other types of securities. Businessmen deposit securities with the bank and take the amount of loan as per requirement. The entire loan is not granted at one time, rather an account is opened in the name of borrower and bank allows them a certain limit for withdrawal. Interest is charged only on the amount actually withdrawn from the account.

2. Overdraft: Customers having current account with the bank are granted the facility of withdrawing more money than the amounts lying in their accounts. Bank decides the limit of overdraft and the borrower pays the interest on only overdrawn amount. Banks consider customers credit while giving permission of overdraft.

3. Loans and Advances: A particular amount is given by banks as loan and advances which is deposited in customer’s account. Customers can withdrawn any amount at any time. Banks charge interest on the entire amount sanctioned.

4. Discounting the bills of exchange: Banks discounts the bills of exchange, i.e., after making some marginal deductions, it pays the value of the bill to the holder. Discount rate is generally equal to interest rate. When bill of exchange matures, the bank gets its payments from the party.

5. Investment in Government Securities: Banks also grant loan to the government. The buying of government securities by banks is termed as ‘loaning to the government’. Investment in government securities is more safe and hence, banks prefer such investments.

(c) Credit creation: In present times, credit creation has become the prime function of commercial banks. Banks invite the primary deposits from the public and grant loan many times than these primary deposits on the basis of credit multiplier. All loans are in the form of demand deposits.

II. Secondary functions: (a) Functions as an agent:

• Collection and Payments of various items: Bank collect cheques, rent, interest, etc., on behalf of their customers and also make payment of taxes, insurance premium, etc., on their customer’s behalf.
• Purchase and sale of securities: Bank buy, sell and keep in safe custody the securities on behalf of their customers.
• Remittance of Money: Banks remit money at distant places through bank drafts, cheques, etc.
• Trustee and Executor: Banks also act as trustees and executors of the property of their customers on their advice.
• Purchase and Sale of Foreign Exchange: Banks also buy and sell foreign exchange, promoting international trade. This function is mainly discharged by foreign exchange banks.
• Letter of references: Banks also give information about economic position of their customers to domestic and foreign traders and likewise provide information about economic position of domestic and foreign traders to their customers.

(b) General utility functions:
1. Locker facilities: Banks provide locker facilities to their customers. People can keep their valuable or important documents in these lockers. Their annual rent is very nominal.

2. Traveller’s cheque and letters of credit: Banks issue traveller’s cheque and letters of credit to their customers so as to avoid their risk of carrying cash-during journey.

3. ATM and Credit Card Facilities: In modern times, banks are providing ATM (Automatic Teller Machine) services to their customers for withdrawing the cash round 24 hours. Moreover, banks are providing credit card facility to its customers by which customers can purchase goods throughout the world for a limited amount and no cash payment is required.

4. Collecting business information and statistics: Being familiar with the economic situation of the country, the banks give advice to their customers on financial matters on the basis of business information and statistical data collected by them.

5. Help in transportation of goods: Big businessmen or industrialists after consigning goods to their retailers send railway receipt (consignment note) to the bank. The retailers get this receipt from the bank on payment of the value of the consignment to it and take their consignment from the railway. In this way, bank help in the transportation of goods from the production centres to the consumption centres.

(c) Social functions or, contribution of banks in economic development: In modern times, banks also provide various services related to social welfare and economic development in the country. Banks also provide help in trade, industry, etc., which accelerates the pace of economic development. Such functions of banks are:

1. Increase in capital productivity: Bank collects surplus money from the public and grants loans for productive services which increases the productivity of capital, production and national income in the economy.

2. Investment promotion: In modern times, big industries need huge amount of fixed and working capital which is met by banking system and this promotes investment in the country.

3. Encouragement to capital formation: Commercial banks mobilise idle savings of the people and invest the same in productive activities. Thus, they help in promoting capital formation and accelerating the rate of economic development.

4. Increase in employment: Banking development not only provides employment in banking sector but due to increased investment in trade and industry through bank loaning also increases employment level in the economy.

5. Facility in payment: Extending use of cheques, bank makes the payments easier which has removed the fear of cash loss.

6. Elasticity of monetary system: Banks extend or contract credit as per requirement of the economy. It maintains elasticity in monetary system.

7. Encouragement to foreign trade: Banks help in promoting foreign trade by arranging foreign currency for the traders and providing various assistance to foreign trade.

8. Development of entrepreneurs: In modern times, commercial banks are also providing assistance in development of entrepreneurship in the economy by providing laons to them.

Question 2.
What do you mean by fixed and flexible exchange rate? Distinguish between them.
Exchange rate is mainly of two types:
(i) Fixed exchange rate: Fixed rate of exchange refers to that rate of exchange which is fixed by the government. It generally does not change or the changes can take place within a fixed limit only.

(ii) Flexible exchange rate: Flexible exchange rate is that rate which is determined by market forces. Change in flexible exchange rate occur on account of change in market demand and supply. Flexible exchange rate is also called floating exchange rate.

In foreign money market, the greater supply of money of a country makes its value decline and vice-versa. Government has got no interference in determining the flexible exchange rate.

Difference between fixed and flexible exchange rate:

 Fixed exchange rate Flexible exchange rate 1. It is decided and declared by the government and it is kept stable. 1. It is determincd by demand and supply forces in international market. 2. In this system. the central bank becomes ready to buy or sell its currencies at a fixed rate. 2. Exchange rate is freely dependent on the working or foreign exchange market and the central bank has nothing to do with it. 3. No fluctuation takes place. 3. Fluctuations appear.

Question 3.
State and explain diminishing marginal utility with diagram.
Marginal utility is the addition to the total utility by consuming an extra unit of a commodity by the consumer, symbolically:
MUn = TUn – TUn-1

Law of diminishing marginal utility states that as a consumer consumes more and more of a commodity, the marginal utility obtained from an additional unit of it goes on diminishing, other things remaining the same. The following utility schedule and diagram illustrate the law:

 Quantity Consumed Marginal Utility (Units) 1 10 2 8 3 6 4 4 5 2

The above schedule and diagram show that as the consumer consumes more and more of a commodity, the marginal utility goes an diminishing.

Question 4.
Explain the difficulties of barter system.
The difficulties of barter system are as follows:
1. Lack of double coincidence: The barter system requires a double coincidence of wants on the part of those who want to exchange goods or services. It is necessary for a person who wishes to trade his goods or service to find some other person who is not only willing to buy these goods or services, but also possesses that goods which the former wants. For example, suppose a person possesses rice and wants to exchange it for cloth. In the barter system, he has to find out a person who not only have excess cloth but also wants rice. But, such a double coincidence is a rare possibility.

2. Difficulties in store of value: A major difficulty in barter system appears because store of purchasing power for future cannot be made due to perishable nature of most of the goods. Consequently, capital formation is not made and large scale production does not become possible.

3. Lack of common acceptable unit of value: Due to lack of common acceptable unit of value, it becomes difficult to determine the value of commodity to be exchanged. For example, how will it be determined that how much wheat will be exchanged for one metre of cloth and vice versa.

4. Lack of divisibility in commodities: Another difficulty of barter system relates to the fact that all commodities can not be divided or subdivided. If the commodity is divided, its utility is lost, e.g., living animal. For example, if a person has a goat and he wants both wheat and cloth which are available from different persons. If he cuts the got for getting both goods, he incurs losses.

5. Lack of transfer of value: Barter system faces the problem of transfer of value. Suppose we have a house at Agra and want to get it shifted in Allahabad.
Barter system does not allow this shifting but in present day with development of money, we can sell the house at Agra and buy a new one in Allahabad.

6. Lack of standard of differed payments: Many goods are sold but payment is made on some future date. Barter system does not allow such transactions because problem of price stability arises in barter system.

Question 5.
What do you mean by Central Bank? Explain the main functions of Central Bank.
Meaning of Central Bank: Central Bank of a country is the apex monetary institution which works as a pivot for the entire banking system in the economy. Central Bank as an apex monetary institution not only plays the leadership role in banking system but also puts a control on commercial banks. Central Bank frames and executes the monetary policy and is responsible for maintaining stability and economic growth in the economy.

Definitions: According to Samuelson, “Central Bank has one function. It operates to control economy, supply of money and credit.”

According to De Kock, “A Central Bank is a bank which constitutes the apex of the monetary and banking structure of its country.” According to R. P. Kent, “Central Bank is an institution, charged with the responsibility of imaging the expansion and contraction of volume of money in the interest of general public welfare.”

In modern times, a proper definition of Central Bank can be given as follows:
“Central Bank is an apex institution in a country’s monetary and banking system which develops, regulates and controls the currency and credit in the country with the objective of economic development and economic stability.”

Functions of Central Bank:
(A) Monopoly in Note Issue: In modem times, central bank alone has the exclusive right to issue notes in every country of the world. The notes issued by the central bank are unlimited legal tender throughout the country.

According to Dc Kock, “Almost everywhere the privilege of note issue is associated with the origin and development of central banking.”

Central Bank of the country enjoys monopoly right of note issue which has following merits:

• It imparts uniformity in monetary system.
• Control on paper currency becomes simple.
• Central Bank can change money supply, i.e., maintain the flexibility in money system.
• It raises public confidence in the monetary system in the economy.
• Central bank can easily control the credit creation in the economy.
• It becomes successful in maintaining internal or external price stability.

(B) Banker, Agent and Financial Advisor to the Government: Like general public government also needs various services and the central bank performs the same functions as banker to the government as a commercial bank provides to its customers. As a Banker, Agent and Financial Advisor to the government central bank performs the following functions:

1. As a Banker to the Government: As a banker to the government, central bank performs following functions:

• Accounts: It maintains accounts of government transactions and submits the details to the government from time to time.
• Payments: It makes payments of all government expenses from government account.
• Debt and Loans: It arranges loans from national-international level and deposit them in government account.
• Payments of Debt and Interest: It arranges and makes payments of interest and the amount of matured debts on behalf of the government.
• Loan to Government: It provides short term loans to the government whenever it is required.

2. As an Agent to the Government: It acts as an agent to the government. All dealings of economic transactions are performed by government on behalf of the central bank. Besides, central bank represents the government in various international institutions and conferences.

3. As a Financial Advisor to the Government: Central bank advises to the government on various economic policies like deficit financing, devaluation, trade policy, foreign exchange, etc.

(C) Bank of Banks: It performs the functions of a banker to all other banks in the country. Central bank has almost the same relation with all other banks as a commercial bank has with its customers. Central bank keeps part of the cash balances of all commercial banks as deposit with a view to meeting liabilities of these banks In times of crises. Due to this act of the central bank, it is also called ‘custodian of cash reserves’. These cash balances are kept by the commercial banks in two ways: (a) part of the cash balances with themselves and (b) another part with the central bank as deposit. The balances kept with the central bank are also treated as cash balances by the commercial banks.

(D) Lender of the Last Resort: As banker to the banks, the central bank acts as the lender of the last resort. In other words, in case the commercial banks fail to meet their financial requirements from other sources, they can, as a last resort, approach to the central bank for loans and advances. The central bank assists such banks through discounting of approved securities and bills of exchange.

In reality, due to this discounting function, central bank is also called as ‘banker of banks’. Central bank converts ‘liquid securities’ of commercial banks into cash and provides liquidity to commercial banks through its discounting facility.

(E) Custodian of Foreign Exchange Reserves: Central bank also acts as custodian of foreign exchange reserves. It is helpful in eliminating difficulties of balance of payments and in maintaining stable exchange rate. For minimising fluctuations in foreign exchange rate, central bank buys or sells foreign exchange in the market.

(F) Function of Clearing I louse: Central bank also performs the function of a clearing house. By clearing house function of central bank we mean settling the claims of various banks against each other with least use of cash. Since all the banks have their reserves and accounts with the central bank, therefore, it is an easy and logical step for it to act as a settlement or clearing house for the other banks. The clearing house function of central bank has following advantages:

• It economises the use of cash by banks while settling their claims and counter-claims.
• It increases the commercial relations with bank.
• It keeps central bank fully informed about liquidity position of each bank.

(G) Credit Control: The most important function of the central bank is to control the credit activities of the commercial banks. Credit control refers to the increase or decrease in the volume of credit money in accordance with the monetary requirement of the country. More expansion of credit money than necessary leads to the situation of inflation. Greater contraction of credit money, on the other hand, might create a situation of deflation. Central bank seeks to contain credit money within reasonable limits. With central bank keeping credit under proper control, stability in general price level and increase in output and employment can be achieved in the country.

For credit control, central banks applies various measures which can be classified as ‘quantitative controls’ and ‘qualitative controls’.

(H) Development related Functions: For promoting economic development, central bank performs following functions:

• It extends organised banking system and establishes new financial institutions.
• It ensures sufficient money supply for development activities.
• Adopts cheap money policy for inducing investment.
• With management of agriculture credit, it ensures the fulfilment of loan requirements of the farmers.
• It manages sufficient amount of industrial finance for accelerated industrial development.

(I) Other Functions:
1. Collection of Statistics: Being a supreme financial authority, central bank arranged a variety of statistics concerning finance, banking, currency, prices and foreign exchange. These statistics help in formulating policies at macro level.

2. Relations with International Financial Institutions: Central bank of the country maintains relatiop with various international financial institutions like IMF, IBRD, etc., Central bank sends its representative in annual conferences of these institutions.

3. Survey of Banks: Central bank makes survey operation and control of commercial banks. Central bank issues licenses to banks and grants permission of their extension, mergers and liquidation.

4. Arranging Seminars: Central Bank arranges seminars from time to time for transferring its policies and guidelines to banks and also invites suggestions from banks for future policy making.

Question 6.
Distinguish between Central Bank and Commercial Bank.
Distinction between Central Bank and Commercial Bank:

Question 7.
What is meant by returns to scale? Using a suitable diagram, explain the concepts of increasing, constant and diminishing returns to scale.
Returns to scale: Returns to scale refers to long run production function when none of the factors of production remains fixed. All factors of production become variable and they can be changed also. Scale of production can be changed in the long run Internal and external economies are obtained in production due to technical improvement, division of labour, specialisation, etc. These economies are not permanent and they get converted to diseconomies in the continuous process of production. In the initial stage of production, these internal and external economies give. ‘Increasing returns to scale’, but when they get converted to diseconomies at later stage of production, law of diminishing returns comes into existence.

(i) Increasing returns to scale: Increasing returns to scale occurs when a given percentage increase in all factor inputs (in some constant ratio) causes proportionately greater increase in output. In this way, if factors of production are increased by 10%, then production increases more than 10%. Increasing returns to scale occur due to division of labour and specialisation. Division of labour and specialisation increases productivity of labour. Due to increase in size of the scale, more efficient and specialised machines are used which give increasing returns to scale.

In increasing returns to scale, proportionate increase in production > proportionate increase in factors of production.

Increasing return has been shown in above fig. On increasing factors of production by 10%, production increases by 15%. This condition shows law of increasing returns to scale. It has been shown by scale line OS in fig.

(ii) Constant returns to scale rConstant returns to scale occurs when a given percentage increase in all factor inputs (in some constant ratio) causes equal proportionate increase in output, i.e., If factors of production are increased by 10%, then production also increases 10% and 10% decrease in factors of production causes similar percentage decrease in output.

Constant returns to scale has been shown in fig. OS1 is the scale line which shows constant returns to scale and is at 45° to X-axis.
In constant return to scale, Proportionate increase in production = Proportionate increase in factors of production.

(iii) Diminishing returns to scale: Diminishing returns to scale occurs when given percentage increase in factor of production causes proportionately lesser increase in output. Main reason responsible for it is when production N increases beyond a limit, it becomes difficult for producer to control or regulate production. As a result of it, internal and external economies get converted to internal and external diseconomies and diminishing returns to scale occurs or comes into existence. Diminishing returns to scale has been shown in the fig.

When factors of production arc increased by 15%, then production increases by 10% only OS2 is the scale line showing diminishing return to scale.

In diminishing returns to scale. Proportionate increase in production proportionate increase in factors of production.

Question 8.
Describe the various types of production cost. Explain the mutual relation between Average Cost and Marginal Cost.
1. Production cost in short period:

• Fixed factors: Fixed factors are unalterable during the production process.
• Variable factors: The factors which can be altered during the production process. Amount spent on hiring, fixed factors are termed as ‘fixed cost’ while the rewards given to variable factor are termed as variable cost.

2. Production costs in long period: None of the production factor remains fixed in long period. All factors become variable in long period. Producer can increase the number of all factors of production, i.e., producer can alter its plant size in the long period.

The relation between average cost (AC) and marginal cost (MC) are:
(i) Both are calculated by total cost:

(ii) Initially AC falls, MC also falls but MC starts rising even though AC continues to fall. Hence, in state of falling AC marginal cost in less than average cost (MC < AC).

(iii) When AC becomes minimum, MC cuts AC from below, i.e., minimum average cost is equal to marginal cost (AC = MC).

Question 9.
What do you mean by double counting problem? How can it be avoided? Expain with an illustration.
Double counting means counting of the value of the same product more than once in calculating the national income.

While estimating national income with value added method, there may arise the problem of double counting. The problem of double countirlg is the problem of estimating the value of goods and services more than once. As the original goods goes into different processes and passes many stages to there is always danger that its value may be included at every state and result may be double, triple or manifold counting.

For example, a farmer produces wheat and sells it for Rs. 3,000 in the market to a flour mill. As far as the farmer is concerned, the sale of wheat is a final sale and he gets Rs. 3,000 for it. If he does not incur any expenditure on the cultivation of wheat, Rs. 3,000 becomes the value of his contribution or value added by him. The purchase of wheat by the flourmill is an intermediate goods.

It converts wheat into flour and sells it for Rs. 5,000 to a baker. The flour mill treats the flour as a final product, but the baker uses it as an intermediate goods and manufactures bread. The baker sells bread to the shopkeeper for Rs. 6,500. For the baker, the bread is a final goods but, for the shopkeeper, it is an intermediate goods. The shopkeeper sells the entire stock of bread to the final consumes for Rs. 8,000. Thus,

Value of output = 3,000 + 5,000 + 6,500 + 8,000 = Rs. 22,500

But in this calculation, value added at every stage includes the value added of previous stage because the value of flour contains the value of wheat and the value of bread manufactured contains the value or wheat and value of services of the miller, baker and shopkeeper. Now, the value of the wheat is counted four times, the value of services of the miller thrice and the value of services by the baker twice. In other words, the value of wheat and value of services of the miller and baker have been counted more than once.

The counting of the value of commodity more than once is called double counting. This leads to over estimation of the value of goods and services produced. For, avoiding double counting in product method two methods are used:

1. Final output method: According to this method, for avoiding double counting, the value of intermediate goods is deducted from the value of output! In other words, the value of final goods and services only is included in national income. In the above example, the bread sold to the consumers is the final output. Only the value of final output, i.e., Rs. 8,000 will be included in national income. The value of wheat, flour and baking bread, i.e., Rs. 3,000. Rs. 5.000 and Rs. 6,500 = Rs. 14,500 are the values of intermediate goods. The value of the final output can be calculated by deducting the value of intermediate goods from the value of output. In other words.

Value of final output = Value of output Value of Intermediate Goods = Rs. 22,500 – Rs. 14,500 – Rs. 8,000

2. Value Added Method: Value added refers to the difference between value of output and the value of intermediate consumption of eacn producing unit in the country. Sum total of value added by all the producing units within the domestic territory of the country is equal to domestic product.

In the above example:

• Value added at wheat production level = Rs. 3,000
• Value added at flour making stage = Rs. 5,000 – Rs. 3,000 = Rs. 2,000
• Value added at baker level = Rs. 6,500 – Rs. 5,000 = Rs. 1,500
• Value added at sale of bread = Rs. 8,000 – Rs. 6,500 = Rs. 1,500
• Total value added = Rs. 3,000 + 2,000 + 1,500 + 1,500 = Rs. 8,000

Question 10.
Define investment multitier. What is the relationship between investment multiplier and marginal propensity of consume?
According to Keynes, “Investment multiplier tells us that when there is ah increment of aggregate investment, income will increase by an amount which is K. times the increment of investment.”

Investment Multiplier: Formulae: The formulae of investment multiplier can be expressed as follows:
K = $$\frac{\Delta \mathrm{Y}}{\Delta \mathrm{I}}$$ where, K = Multiplier, ΔY = Change in Income
ΔI = Change in Investment

Relation between Multiplier and MPC: Keynesian investment multiplier depends on marginal propensity to consume (MPC). Higher the marginal propensity to consume, greater will be the size of multiplier. On the contrary, lower the MPC, smaller will be the size of the multiplier.

So, there is direct relation between multiplier and marginal propensity to consume.
Mukiplier = $$\frac{1}{1-\mathrm{MPC}}$$
We know that K = $$\frac{\Delta \mathrm{Y}}{\Delta \mathrm{l}}$$ ……… (1)
Y = C + I …….. (2)
Similarly ΔY = ΔC + ΔI
or. ΔI = ΔY + ΔC ………. (3)
(Here ΔI = change in Investment, ΔY = Change in income and ΔC = change in consumption)
Putting the value of ΔI in equation (1), we have
K = $$\frac{\Delta Y}{\Delta Y-\Delta C}$$

Dividing right hand side of the equation by ΔY,

(Here K = Multiplier, MPC = Marginal Propensity to consume, MPS = Marginal propensity to save).

It is clear that by knowing the value of either MPC or MPS, the value of multiplier can be calculated. Higher the MPC, greater will be the value of multiplier. On the other hand, higher the MPS, smaller will be the value of multiplier. Thus, MPC and multiplier are directly related the MPS and multiplier are inversely related.

If MPC = $$\frac{1}{3}$$

Question 11.
What is the meaning of Reserve Bank of India? Give the main functions of Reserve Bank of India.
Reserve Bank of India: It is the Central Bank of the country. The Reserve Bank of India was established in 1935 with a capital of ₹ 5 crore. This capital of ₹ 5 crore was divided into 5 lakh equity shares of ₹ 100 each. In the beginning the ownership of almost all the share capital was with the non-govemment shareholders. In order to prevent the centralisation of the equity shares in the hands of few people, the Reserve Bank of India was nationalised on January 1, 1949.

Functions of Reserve Bank of India:
(1) Issue of Notes: The Reserve Bank has the monopoly of note issue in country. It has the sole right to issue currency notes of various denominations except one rupee note. The Reserve Bank acts as the only source of legal tender money because the one rupee note issued by Ministry of Finance are also circulated through it. The Reserve Bank has adopted the Minimum Reserve System for the note issue. Since 1957, it maintains gold and foreign exchange reserves of ₹ 200 crore, of which atlcast ₹ 115 crore should be in gold.

(2) Banker to the Government: The second important function of the Reserve Bank is to act as the Banker, Agent and Adviser to the Government. It performs all the banking functions of the State and Central Government and it also tenders useful advice to the Government on matters related to economic and monetary policy. It also manages the public debt for the Government.

(3) Banker’s Bank: The Reserve Bank performs the same function for the other banks as the other banks ordinarily perform for their customers. It is not only a banker to the commercial banks, but it is the lender of the last resort.

(4) Controller of Credit: The Reserve Bank undertakes the responsibility of controlling credit created by the commercial banks. To achieve this objective it makes extensive use of quantitative and qualitative techniques to control and regulate the credit effectively in the country.

(5) Custodian of Foreign Reserves: For the purpose of keeping the foreign exchange rates stable the Reserve Bank buys and sells the foreign currencies and also protects the country’s foreign exchange funds.

(6) Other Functions: The bank performs a number of other developmental works. These works include the function of clearing house arranging credit for agriculture, (which has been transferred to NABARD) collecting and publishing the economic data, buying and selling of Government securities and trade bills, giving loans to the Government buying and selling of valuable commodities etc. It also acts as the representative of Government in I.M.F. and represents the membership of India.

Question 12.
What is meant by Investment Multiplier? Explain the relationship between Investment Multiplier and Marginal Propensity to Consume.
Investment Multiplier: Definitions:
According to Keynes, “Investment multiplier tells us that when there is an increment of aggregate investment, income will increase by an amount which is K times the increment of investment.”

According to Dillard, “investment multiplier is the ratio of an increase of income to given increase in investment.”

Thus, the multiplier is the ratio of change in income to the change in investment. So, Keynesian multiplier is known as investment or income multiplier.

Investment Multiplier: Formula
The formula of investment multiplier can be expressed as follows:
K = $$\frac{\Delta Y}{\Delta I}$$
K = Multiplier
ΔY = Change in Income
ΔI = Change in Investment

Relation between Multiplier and MPC:
Keynesian investment multiplier depends on marginal propensity to consume (MPC). Higher the marginal propensity to consume, greater will be the size of multiplier. On the contrary, lower the MPC, smaller will be the size of multiplier.

So, there is direct relation between multiplier and marginal propensity to consume.
Multiplier = $$\frac{1}{1-M P C}$$
We know that
K = $$\frac{\Delta Y}{\Delta \mathrm{I}}$$ ………… (2)
Y = C + I ………… (2)
Similarly ΔY = ΔC + ΔI
or, ΔI = ΔY – ΔC ………… (3)

(Here ΔI = Change in Investment, ΔY = Change in Income and ΔC = Change in Consumption.)
Putting the value of ΔI in equation (1), we have
K = $$\frac{\Delta V}{\Delta Y-\Delta C}$$
Dividing right hand side of the equation by ΔY,

Here K = Multiplier,
MPC = Marginal Propensity to Consume,
MPS = Marginal Propensity to Save.

It is clear that by knowing the value of either MPC or MPS, the value of multiplier can be calculated. Higher the MPC, greater will be the value of multiplier. On the other hand, higher the MPS, smaller will be the value of multiplier. Thus, MPC and multiplier are directly related while MPS and multiplier are inversely related.

Table: MPC and Value of Multiplier

Thus, when MPC is zero, multiplier is one. Similarly, when MPC is unity (i.e., one), multiplier is infinity (∞). Between these two extremes, value of multiplier may be determined depending on the size of MPC.

Question 13.
What is Government Budget? What are the main objectives of Budget?
Or, Discuss the importance of Government Budget.
Meaning: The word ‘Budget’ is said to have its origin from the French word Bougctt which means ‘a small leather bag’. Budget is a detailed economic statement which includes the details of income (i.e., revenue) and expenditure of the government. A budget is a document which contains estimates of government receipts and expenditure during a financial year (In India, financial year runs between April 1 to March 31).

Budget: Important Definitions:
(1) According to Rene Stern, “The budget is a document containing a preliminary approval plan of public revenue and expenditure.”

(2) According to Findlay Shirras, “A budget in short includes a statement of the receipts and expenditure of the previous year, an estimate of the receipts and expenditure of the ensuring financial year and proposals as to meet ways and means for meeting a deficit or distributing a surplus, if any.”

(3) According to P. F. Taylor, “Budget is a master financial plan of the government. It brings together estimates of anticipated revenue and proposed expenditures for the budget year.”

Objectives of the Budget: Budget is not only an annual statistical statement of government revenue and expenditure but it also reflects government policies and a set of objectives which the government has to fulfil through budget.

Government tries to fulfil the following objectives through budget:
(1) Encouragement to Economic Development: The basic objective of the budget is to accelerate the pace of economic development in the country. For accelerating the pace of economic development: (i) Government may grant tax rebates to productive activities, (ii) government may develop infrastructure like roads, canals, power, bridges etc. by increasing public expenditure and (iii) government may establish public enterprises.

(2) Balanced Regional Development: Through budget, government may promote the development in backward areas for ensuring balanced regional development in the economy. Government may grant tax rebates to these areas, may establish public enterprises in these areas and may allocate more funds for infrastructural development in these backward areas.

(3) Re-distribution of Income and Property: Budget plays a vital role in reducing the economic disparities in the economy. Many steps can be taken in the budget for reducing the economic disparities in the economy. For example,
(i) heavy taxes on higher income group, (ii) tax exemption to lower income group, (iii) higher taxes on goods consumed by higher income group.

(4) Economic Stability: Economy faces the cycles of boom and depression and the budget aims to put a control on these cycles. Government may adopt ‘surplus budget’ during boom and ‘deficit budget’ during depression.

(5) Creation of Employment: Employment creation is one of the important objectives of government budget. Government may promote labour-intensitve techniques in public works programmes and may also initiate various employment generation programmes in the economy.

(6) Management of Public Enterprises: Government may establish public enterprises for ensuring social justice in the economy because the aim of public enterprises is to ensure social welfare and not earning profit.

Question 14.
What is meant by Tax? Distinguish between Direct Tax and Indirect Tax.
Definitions of Tax:
(1) According to Dalton. “A tax is a compulsory contribution imposed by a public authority irrespective of an exact amount of service rendered to the taxpayer in return and not imposed as a penalty for any legal offence.”

(2) According to Buechler, “It is a compulsory contribution, although it may be paid willingly enough, but it is not a penalty for legal offences.”

(3) According to Dc Macro, “The tax is the price which citizen pays to the state to cover his shares of the cost of the general public services which will consume.”

(4) According to Bcstablc, “Tax is compulsory contribution of the wealth of a person or body of persons for the service public power.”
Thus, A tax is a compulsory payment made by a person or a firm to a government without reference to any benefit, the payer may drive from the government.

Characteristics of Tax:

• A tax is a compulsory contribution. Everyone has to pay a tax upon whom it is levied by the state. Refusal to pay a tax is subject to punishment.
• It is the duty of the tax payer to pay the tax if he is liable to pay it.
• Revenue received from tax payers may not be incurred for their benefit alone, but for the general and common benefit.
• Since public expenditure is done for the common benefit and the benefit may not be in proportion of payment of tax.
• A tax may be imposed on an individual or property or commodities, but it is actually paid by individuals.
• It is a legal collection.

Types of Taxes:

1. Direct and Indirect Taxes,
2. Proportional, Progressive and Regressive Taxes,
3. Specific Tax and Ad valorem Tax.

Direct Tax: Direct taxes are those taxes which are paid by the same person on whom they are levied. The person on whom direct tax is levied cannot shift its burden to others. It has to be borne by the tax-payer himself. In other words, when impact and incidence of tax fall on the same person, it is called direct tax. For example, income tax, property tax, profession tax, wealth tax, etc. are regarded as direct taxes.

Indirect Tax: indirect taxes are those taxes whose burden can be shifted, i.c., indirect tax is one which is imposed on one person but it is paid partly or wholly by another person. For example, union excise duties, sales tax, custom duties, etc. When we buy goods from a shopkeeper, we have to pay trade tax with the price of the goods. Shopkeeper pays tax on his sale to the government and diverts it on his consumer. Due to this shifting of the tax, trade tax is called indirect tax.

Distinction between Direct Tax and Indirect Tax:

 Direct Taxes Indirect Taxes 1. They are directly paid to the government by the person on whom it is imposed. 1. They are paid to the government by one person but their burden is borne by another person. 2. They are generally progressive. The rate of tax increases with increase in income. 2. They are generally regressive. The rate of tax decrease as income increases. 3. They cannot be shifted on to others. 3. They can be shifted on to others.

Question 15.
What do you mean by Exchange Rate? Explain the main factors which determine Exchange Rate.
Foreign Exchange Rate:
Foreign exchange rate refers to the rate at which one unit of currency of a country can be exchanged for the number of units of currency of another country. In other words, it is the price paid in domestic currency in order to get one unit of foreign currency. In other words, exchange rate expresses the ratio of exchange between the currencies of two countries. Hence, exchange rate is the price of a currency expressed in terms of another currency.

Important Definitions:

1. According to Sayers, “The price of currencies in terms of each other are called foreign exchange rate.”
2. According to Crowther, “The rate of exchange measures number of units of one currency which is exchanged in the foreign market for one unit or another.”

Causes of Changes in Exchange Rates: The market or the current rate of exchange is subject to fluctuations due to changes in demand and supply of foreign exchange in the foreign exchange market. Some of the important factors which cause fluctuations in the rate of exchange are given as following:

(1) Change in Trade: The demand and supply of foreign exchange is influenced by changes in exports and imports. If exports exceed imports, demand for domestic currency increases so that rate of exchange moves in its favour. But, if imports exceed exports, the demand for foreign exchange increases and the rate of exchange will move against the country.

(2) Capital Movements: Short term or long term capital movements also influence the exchange rate. For example, if there is a capital flow from USA for investment in India, the demand for Indian Currency will increase in the foreign exchange market, As a result, the rate of exchange of Indian rupee in terms of US dollar will rise.

(3) Sale and Purchase of Securities: The stock exchange transactions, i.e., the sale and purchase of foreign securities, debentures, shares, etc., influence the demand for foreign exchange, and thereby, the exchange rate.

(4) Bank Rate: The bank rate also influences the exchange rate. If bank rate is raised, more funds will flow into the country from abroad to earn high interest rate. As a result supply of foreign currency increases and the rate of exchange moves against the foreign exchange. Converse will be the case if the bank rate falls.

(5) Speculative Activities: Speculation in the foreign exchange market, also influences the exchange rate. If the speculators expect a fall in the value of foreign currency, they will sell that currency. As a result, rate of exchange will move against foreign currency and in favour of home currency.

(6) Political Conditions: If there is political stability, strong and efficient administration foreign investment increases in the country. The demand for domestic currency will increase and the exchange rate will move in favour of the country.

Question 16.
Discuss the methods of Exchange Rate Determination.
Determination of Exchange Rate:
Demand-Supply Theory of Exchange Rate: Like price of goods, exchange rate is determined by demand and supply forces working in the exchange market. All nations of the world make transactions of goods, services and capital and for it they need foreign exchange. When payment is made in foreign exchange, demand for foreign exchange appears. Similarly, receipt of foreign exchange refers to the supply of foreign exchange. Demand and supply factors of foreign exchange determine the rate of exchange.

Demand for Foreign Exchange: Demand for foreign exchange arises mainly due to import of goods, investing in foreign countries and giving loans to other nations. Demand for foreign exchange signifies the functional relationship between exchange rate and demanded quantity of foreign exchange. There is an inverse relationship between price of foreign exchange (i.e., rate of exchange) and demand for foreign exchange, e.g., more foreign exchange is demanded at lower exchange rate and vice-versa. That is why demand curve for foreign exchange slopes downward from left to right.

The following factors cause demand for foreign exchange, i.e., foreign exchange is demanded by domestic residents for the following reasons:

• To purchase goods and services from foreign countries.
• To purchase financial assets (i.e., to invest in bonds and equity shares) in a foreign country.
• To invest directly in shops, factories, buildings in foreign countries.
• To speculate on the value of foreign currencies.
• To undertake foreign tours and
• Remittances to their families by foreigners working say in India.

Following fig. shows that at exchange rate OR, OQ dollar is demanded. When dollar’s price (i.e., exchange rate) increases to OR2, demand for dollar comes down to OQ2. Similarly, when price of dollar falls to OR1, the demand of dollar increases to OQ1. Hence, the inverse relationship between exchange rate and demand for foreign exchange is established which makes the foreign exchange demand curve sloping downward from left to right.

Supply of Foreign Exchange: Supply of foreign exchange represents the functional relationship between foreign exchange rate and supply of foreign exchange. There is a direct positive relationship between foreign exchange rate and supply of foreign exchange, e.g., with rise of foreign exchange rate, supply of foreign exchange increases and vice-versa.

The supply of foreign exchange comes from:

• The domestic exporters who receive payments of foreign currency,
• The foreigners who invest and lend in the home country,
• Domestic residents who repatriate capital funds previously sent abroad,
• Direct purchases by the non-residents in the domestic market.

The supply curve SS indicates that at higher exchange rates larger amount of foreign exchange are offered for sale. For example, when rate of exchange goes up from OR to OR2, supply of foreign exchange increases from OQ to OQ2 and on the other hand, when exchange rate comes down to OR1, supply of foreign exchange rate comes OQ1. The positive slope of supply curve shows that when exchange rate of dollar in terms of rupees rises (which also means that exchange rate of rupee in terms of dollar’s falls), the Indian exporters will increase the supply of dollars and vice-versa.

Determination of Equilibrium.
Exchange Rate: Equilibrium exchange rate is determined at the point where demand and supply curves of foreign exchange (DD and SS respectively) cut each other. In following fig., equilibrium exchange rate is determined at the point E, where both demand and supply of foreign exchange are equal to OQ.

Thus, OR is the equilibrium market rate of exchange where the demand for and supply of foreign exchange are equal.

Disequilibrium in Demand and Supply: Self-adjustment:
(1) If the prevailing exchange rate (OR1) becomes greater than market equilibrium rate (OR), the dollar’s supply exceeds its demand by AB which makes exchange rate decline from OR1 to OR.

(2) On the contrary, if prevailing exchange rate (OR2) becomes less than market equilibrium rate (OR), the dollar’s supply falls short of its demand by CD which makes exchange rate rise from OR2 to OR.

Thus, through self-adjustment between demand and supply forces, market equilibrium rate appears at the point where demand for and supply of foreign exchange arc equal.

Change in Exchange Rate Or Effects of Change in Demand and Supply of Exchange Rate: Exchange rate is determined by demand and supply forces of foreign exchange. Hence, change in demand and supply conditions bring change in exchange rate.

(A) When the demand for foreign exchange increases, demand curve shifts upward and consequently exchange rate rises.
(B) Similarly, when the supply of foreign exchange increases, supply curve shifts to the right and consequently exchange rate falls.

Question 17.
Who determines the price under Perfect Competition?
Determination of Equilibrium Price under Perfect Competitions: Before Marshall economics had a diuputc over the issue of price determination in perfect competition. One viewpoint advocated for the price determination, One viewpoint advocated four the price determination by cost of production (i.e., supply side). David Ricardo was the pioneer of this viewpoint and outrightly ignored the pole of demand side in price determination Jevons, Walras etc. on the other hand stressed on demand side in price determination. They advocated that price is determined by marginal utility of the commodity (i.e., the demand side). Both the above viewpoints were contrary to each other.

Marshall ended this dispute by puting the view that price is determined by both the production cost (i.e., supply curve) and utility of the commodity (i.e., demand curve). According to Marshall, “The price is determined at that point where demand and supply of the commodity becomes equal to each other.”

Marshall presented the example of a scissor. According to him, as both the blades of a scissor are essential to cut a piece of paper, similarly both the foce – demand and supply – will be essential in price determination. Price Determination by Equality between Demand and supply: Table and Diagram Representation.

According to Marshall, “Price of a commodity is determined by both demand and supply curves.” Demand curve is related to the consumer and it falls down from left to right which explains the inverse relationship between demand of the commodity and its price. Consumer tries to buy more at lower price. On the other hand, supply curve belongs to producer and it rises upward from left to right which explains the direct relationship between supply of the commodity and its price.

Producer will place higher supply at higher price and vice-versa. So that producer tries to sell more at higher price and vice-versa. Hence, two opposite forces become operational in the market and the price is determined at the point where the demand for the commodity becomes equal to supply of the commodity.

Table shows the demand and suply units of the commodity of various existing prices. Table explains that at price Rs. 10 per unit, the supply exceeds demand (100 > 20). This situation of’excess supply’ will increase competition among sellers who reduce the price to sell its product. The process of this price cut continues till excess supply is elimiated and demand becomes equal to supply. In table, this equality between demand and supply appears at price Rs. 61 per unit which is ‘equilibirum price’ in the market. On the other hand, if price is reduced to Rs. 4 per unit, the situation of ‘excess demand (80 > 40) arises which will push price in the market till the point where demand and supply become equal to each other. Table 1 is represented in fig.

ab = Excess Supply (Supply > Demand)
E = Point of Equilibrium (When Demand = Supply)
cd = Excess Demand (Demand > Supply)

In above fig., DD and SS curves are demand and supply curves respectively. In perfect completition, with ‘price mechanism ’ demand and supply forces determine the price where demand becomes equal to supply. The determined ‘equilibrium price’ satisfy both the consumer and the seller (i.e., where demand for the commodity becomes equal to supply of the commodity). In fig. This equilibrium price is shown at point E.

At equilibrium point E,
Equilibrium Price = OP or EQ
(Demand for the Goods) = (Suply of the Goods)
Equilbrium Quantity = OQ

At this equilibrum price, both the consumer and the seller are satisfied. What a seller wants to sell at a particular price, consumer wants to buy at the price.

If any change appears in this equilibrium price, demand and supply forces make action and reaction so as to re-establish the equality between demand and supply.

Two situations of change in equilibrium price may arise:
(A) first Situation: If the prevailing price exceeds ‘equilibrium price’, price starts declining due to ‘excess supply’ and continues to decline till price becomes gain equal to ‘equilibrium price’.

In fig., if price is OP1
Demand for the Goods = P1a
Supply of the Goods = P1b
Hence, ‘Supply Exceeds Demand’
i.e., P1b > P1a

Distance ab (i.e., P1b – P1a) shows excess supply. This excess supply as brings down the price due to competition among sellers and the equilibrium price OP is retained.

(B) Second Situation: If the prevailing price is less than ‘equilibrium price’, price starts rising due to ‘excess demand’ and contunies to rise till price becomes again equal to ‘equilibrium price’.
In Fig. if price is OP2
Demand for the Goods = P2d
Supply of the Goods = P2c
Hence, ‘demand exceeds supply’
i.e., P2d > P2c
Distance cd (i.e., P2d – P2c) shows excess demand. This excess demand cd raises the price due to competition among buyers and the equilibrium price OP is retained.

Above explanation shows that demand and supply forces are capable enough to maintain the following situation.
Demand for the commodity = Supply of the commodity

Question 18.
Discuss the different types of deposits in Bank.
Bank accepts the deposit of people save their money under the different types of accounts. Thus, there are different types of deposits in bank, which are as follows:
(i) Current A/c Deposits: Deposits in current account are payable on demand. They can be drawn of cheque without any restriction. These accounts arc usually maintained by business and are used for making business payments. No interest is paid on these deposits.

(ii) Fixed/Term Deposits: These are the deposits for a fixed term (period of time) varying from 15 days to a few years. They are not payable on demand and do not enjoy chequing facilities. The money deposited in such accounts are payable of the maturity for fixed period for which the deposit was initially made. However, the depositors can get loans from the banks against their fixed deposits. Higher rates of interest are paid on these fixed deposits.

(iii) Recurring Deposits: A variant of the fixed deposits are recurring deposits. In these accounts, a depositor makes a regular deposit of agreed sum over an agreed period, e.g. Rs. 100 per month for 5 years interest is paid on the deposit in these accounts the money deposited in this account is repaid to the depositors along with interest on maturity.

(iv) Saving Account Deposits: These deposits are mainly made by the general public, salaried class and retired persons who save a small part of their income. Deposit is saving, account are payable on demand and also withdrawable by cheques but with certain restrictions. The interest paid on saving deposits account is less as compared to that of fixed deposits.

Question 19.
What are the different Methods of measuring it?
There are three methods for measuring price elasticity of demand. They are:
(a) Total outlay of Expenditure Method,
(b) Point Method and
(c) Arc Method.

(a) Total Outlay or Expenditure Method:
This method is associated with the name of Marshall. In this method, we consider the change in price and the consequent change in the outlay on the purchase of the commodity. If, for instance, a given change in price does not cause any change in the total amount of money spent on the commodity, i.e., if the total outlay remains constant, elasticity of demand is said to be equal to unity. If, as a result of a given change in price, the total outlay is increased, elasticity of demand is said to be greater than unity. If, on the contrary, as a result of a given change in price, the total outlay is diminished the elasticity of demand is said to be less than unity. These relations can be illustrated with a simple demand schedule.

In the diagram below, we have shown the Total Outlay Curve. We have taken three different price ranges from OM to ON, From ON to OQ and finally

all prices below OQ. The total outlay curve slopes downwards to the right as the price of the commodity falls from OM to ON. It shows an increase in outlay as the price falls. On the contrary, if the price rises from On to OM, the total outlay diminishes as shown by the curve which slopes upwards to the left.

Thus, over the price range On to OM, elasticity od demand is greater than unity. Over the price range, ON to OQ, The outlay curve is perpendicular and parallel to OY showing that the outlay is constant. As the price falls from ON to OQ or rises from OQ to ON, Total inelastic demand remains constant, or the demand is neither elastic nor inelastic. Over the price range OQ that total outlay diminishes as the price falls. The outlay curve slopes downward to the left. On the contrary, the total outlay increases as the price rise to OQ. The outlay curve slopes upward to the right. The elasticity of demand over the price range OQ is less than unity.

Summing up, Elasticity of demand is greater than unity or the demand is elastic when the total outlay increases with a fall in price and decreases with a rise in price. Elasticity of demand is equal to unity or the demand is neither elastic nor inelastic when the total outlay is constant. Elasticity of demand is less than unity or the demand is inelastic when the total outlay decreases with a fall in price and increases with a rise in price.

The main weakness of this method is that it does not measure elasticity in numerical terms. It simply classified price demand into elastic, inelastic and unitary elastic demand.

(b) Point Method:
This method of measuring price elasticity of demand has also been suggested by Marshall. According to this method, we take a straight line demand curve joining the two axes and measure the elasticity between two points Q and Q’, which are assumed to be infinitely close to each other.

Thus, on a straight line demand curve, we can make use of the formula. QP/RQ to find out the price elasticity at any particular point. We can find out even numerical elasticities on different points of the straight line demand curve with the help of this formula QP/RQ. It should be remembered that the point elasticity of demand on a straight line a different at every point. Elasticity to any one point is the ratio of the lower part of the straight line to the upper part. When elasticity is measured at a point on a straight line demand curve, it is called point elasticity of demand.

In the alongside diagram, RP is the straight line demand curve which is 5 cm. in length. Q is the midpoint on the RP curve. Applying the formula QP/RQ = 2.5/2.5 = 1 or unity, price elasticity of demand at the point Q is unity. Now, suppose that we take another point Q’ on the RP curve. Then elasticity at the point Q’ will be 4/1 = 4 or greater than unity (because Q’ P = 4 cm. and RQ’ = 1 cm.). Elasticity at the point where the demand curve meets the Y-axis, i.e., the point Q” will be Q” P/Q” R = 5/0 = infinity. Elasticity at any point lower than the mid-point Q will be less than unity. For example, elasticity at the point Q” will be equal to Q”-P/Q’” R= 1/4, i.e., less than unity. Lastly, elasticity at the point where the demand curve meets the X-axis, i.e, at the point Q”” will be Q”” P/Q”” R = 0/5 = 0.

The point method of measuring elasticity is very useful to the economists. It helps them measure price elasticity when there are very minute changes in the price and quantity demanded of the commodity.

(c) Arc Method:
The main drawback of the point method is that it is applicable only when we possess information about the minutest changes in the price and the quantity demanded of the commodity. But, in actual life, we may come across demand schedules in which there are big gaps in price as well as the quantity demanded. In such cases the point method does not yield satisfactory results. The economists have, therefore, devised another method known as the Arc Method for measuring elasticity. This method uses the mid-point between the old and new data in the case of both price and quantity demanded. This method studies a portion of the demand curve between the two points. An Arc is a portion of a
curved line, hence a portion of a demand curve. Arc elasticity is the elasticity at the mid-point of demand curve. The formula for measuring arc elasticity is c given below.
Ed = $$\frac{q-q_{1}}{q+q_{1}}-\frac{p-p_{1}}{p+p_{1}}$$
where, q = orginal quantity demanded.
q1 = new quantity after the change in price
p = original price.
P1 = new price after change

Suppose that the price of a commodity is Rs. 5 and the quantity demanded at that price is 100 units. Now assume that the price of the commodity falls to Rs. 4 and the quantity demanded rises to 110 units. In terms of the above example, arc elasticity then will be
Ed = $$\frac{100-110}{100+110} \div \frac{5-4}{5+4}$$
= $$\frac{-10}{210} \div \frac{1}{-9}=\frac{-10}{210} \times \frac{9}{1}=-\frac{9}{21}=\frac{9}{21}$$
The negative sign here may be omitted.

The main drawback of the total outlay method is that it does not help us to measure elasticity of demand numerically. It simply tells that the elasticity of demand is equal to, greater than, or less than one. It is advantageous to have a method of calculating elasticity of demand in numberical terms, because then we can easily classify demands into elastic and inelastic. Whenever numerical elasticity is less than 1, e.g, 1/2 or 1/10 etc., the demand is inelastic. On the contrary, whenever numerical elasticity is greater than 1, e.g., 2, 3, 4, etc., demand is elastic. Numerical elasticity, therefore, enables us to say at once whether the demand is elastic or inelastic.

Question 20.
What is excess demand? How can it do controlled?
Excess Demand: It occurs when aggregate demand is greater than aggregate supply corresponding to the full employment level. AD > AS (at full employment level).

Controlled of Excess Demand:
(A) Fiscal Controlled:
(i) Public Expenditure: For controlling excess demand, the government should reduce the public expenditure on public works like constructing roads, dams, bridges, schools, hospitals, etc. and also curtail investments in public enterprises. It will make aggregate demand decline in the economy.

(ii) Taxation: In situation of excess demand, government should impose heavy direct taxes (like income tax) specially on rich class of the society. Besides, taxes on goods used by rich people should also be increased.

(iii) Public debt: In situation of excess demand, government should take more and more loans from the public and collected money should be spent only on productive activities. Consequently, purchasing power with the public will decline and production increase which help in controlling excess demand.

(iv) Surplus budget: Government should make surplus budget in situation. of excess demand. Surplus budget implies a situation where public revenue exceeds public expenditure. Policy of surplus budget will transfer public’s purchasing power to the government which will reduce aggregate demand and control excess demand in the economy.

(B) Monetary controlled:

• Bank rate is increased. Consequently interest rate on which commercial banks grant loan becomes costlier and as a result people demand less credit and aggregate demand declines.
• Securities are sold in open market which reduces the purchasing power in the hands of the public.
• Cash reserve ratio is increased which limits the credit expansion.
• Liquidity ratio is increased which limits the credit creation efficiency of banks.

(C) Other method: (i) Export-Import Policy: When the country faces the problem of excess demand, policy of boosting imports and checking exports should be adopted. Increase in imports will not affect domestic production but will put a control on inflationary tendencies in the economy.

(ii) Wage policy: Money wages should be kept stable in the state of excess demand. Increase in demand can be checked only if wages are increased when productivity increases.

(iii) Increase in production: For controlling excess demand production should be increased. With full utilisation of existing resources, production can be increased and the gap between aggregate demand and aggregate supply can be reduced.