NCERT Solutions for Class 12 Economics (Macroeconomics) Chapter 5 Government Budget and the Economy

NCERT
SOLUTIONS
CLASS - 12th

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Book : Introductory Macroeconomics Ncert Solutions | Chapter - 5 Economics

Class : 12th

Subject : Economics

Chapter : 5

Chapter Name : Government budget and the economy

Q1 Explain why public goods must be provided by the government.

Answer. Public goods are those goods which are not provided by the market forces of demand
and supply. These goods include defence, infrastructural facilities etc. They aren't provided by
the private sector because they are provided to all the citizens irrespective of their purchasing
power while the private sector provides goods to only those people who have the purchasing
power.

Page : 83 , Block Name : Exercises

Q2 Distinguish between revenue expenditure and capital expenditure.

Answer. The budget expenditure of the government is divided into two categories - revenue and
capital expenditure. The key differences between the two are as follows -

Basis Revenue expenditure Capital expenditure

1. Definition It is the expenditure incurred It is the expenditure incurred
on the day to day working of on purchasing of the financial
the government. assets or disposing of loan.

2. Nature It occurs again and again i.e. They are non - recurring in
They are recurring in nature. nature. Once incurred, they
provide long term benefits.

3. Purpose They are incurred for day to They are incurred for
day operations and not for acquisition of a financial
purchasing any asset. asset or to dispose off the
liability.

4. Examples Payment of salaries, interest Payment of loans, acquisition
payments etc. of asset etc.

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Book : Introductory Macroeconomics Ncert Solutions | Chapter - 5 Economics

Page : 83 , Block Name : Exercises

Q3 ‘The fiscal deficit gives the borrowing requirement of the government’. Elucidate.

Answer. The fiscal deficit is the difference between the government expenditure and the
government receipts (excluding borrowings). Hence it calculates the borrowing of the
government. If this will increase, then it means that the government borrowings will also rise. It
means that the fiscal deficit will rise. It will thereby increase the burden of the loan and its
interest.

Page : 83 , Block Name : Exercises

Q4 Give the relationship between the revenue deficit and fiscal deficit.

Answer. Revenue deficit is the difference between revenue expenditure and revenue receipts of
the government.
Fiscal deficit is the difference between government expenditure and government receipts except
borrowings.
If the fiscal deficit will increase, then it means that the government borrowings will rise. Hence,
the funds available with the government for revenue expenditure will fall and it will have to
borrow more money.
Hence, with the rise in the fiscal deficit, the revenue deficit also increases.

Page : 83 , Block Name : Exercises

Q5 Suppose that for a particular economy, investment is equal to 200, government purchases
are 150, net taxes (that is lump-sum taxes minus transfers) is 100 and consumption is given by
C = 100 + 0.75Y (a) What is the level of equilibrium income? (b) Calculate the value of the
government expenditure multiplier and the tax multiplier. (c) If government expenditure
increases by 200, find the change in equilibrium income.

Answer. Given that the investment (I) = 200,
Government purchases (G) = 150,
Net taxes (T) = 100,
Consumption function - 100 + 0. 75Y
Hence, autonomous consumption(C) = 100, MPC(b) = 0.75.

a) Equilibrium income

=

=

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Book : Introductory Macroeconomics Ncert Solutions | Chapter - 5 Economics

= ₹1500.

b) Government investment multiplier =

Government tax multiplier =

c) If the government expenditure(G) increases by 200,New equilibrium income will be -

= ₹2300.
Hence change in income = 2300 - 1500 = ₹800.

Page : 83 , Block Name : Exercises

Q6 Consider an economy described by the following functions: C = 20 + 0.80Y, I = 30, G = 50,
TR = 100 (a) Find the equilibrium level of income and the autonomous expenditure multiplier in
the model. (b) If government
expenditure increases by 30, what is the impact on equilibrium income? (c) If a lump-sum tax of
30 is added to pay for the increase in government purchases, how will equilibrium income
change?

Answer. Given that the investment (I) = 30,
Government purchases (G) = 50,
Net transfers (TR) = 100,
Consumption function = 20 + 0. 80Y
Hence, autonomous consumption(C) = 20, MPC(b) = 0.80.

a) Equilibrium income =
= \left(\dfrac{1}{0.2}\right)\times 180 = 900 900 $
Autonomous expenditure multiplier(m) =

=

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Book : Introductory Macroeconomics Ncert Solutions | Chapter - 5 Economics

=5
b) If the government expenditure increases by 30,

new equilibrium income =

=
= = 1050.

c) Tax multiplier =

=
= - 4.
Change in income due to change in tax = - 4 30 =
New equilibrium income = 900 - 120 = 780.

Q7 In the above question, calculate the effect on output of a 10 per cent increase in transfers,
and a 10 per cent increase in lump-sum taxes. Compare the effects of the two.

Answer. Given that the investment (I) = 30,
Government purchases (G) = 50,
Transfers (TR) = 100,
Consumption function = 20 + 0. 80Y
Hence, autonomous consumption(C) = 20, MPC(b) = 0.80.
Change in transfers

New equilibrium income =

=
Hence, change in income = 940 - 900 = 40.
Again change in taxes

So, change in income =

=
=-4 10
= - 40.

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Book : Introductory Macroeconomics Ncert Solutions | Chapter - 5 Economics

Q8 We suppose that C = 70 + 0.70Y D, I = 90, G = 100, T = 0.10Y (a) Find the equilibrium
income. (b) What are tax revenues at equilibrium income? Does the government have a
balanced budget?

Answer. Given - Autonomous consumption (.C) = 70,
MPC (b) = 0.70, I = 90, G = 100, T = 0.10Y
A) Equilibrium income (Y) = C + I + G + bY
Y = 70 +90+ 100 + 0.7
Y = 260 + 0.7
Y = 260 + 0.63Y
0.37Y = 260
Y = 702.7
B) Tax = 0.10 702.7 = 70.27.
Now we can see that the government expenditure = 100 while the tax revenue generated is only
70.27.
For a government budget to be balanced, the revenue of the government must be equal to the
expenditure of the government. But here, they aren't equal and hence, the budget isn't
balanced. It is a deficit budget.

Q9 Suppose marginal propensity to consume is 0.75 and there is a 20 percent proportional
income tax. Find the change in equilibrium income for the following
(a) Government purchases increase by 20 (b) Transfers
decrease by 20.

Answer. Given that MPC (.c) = 0.75, change in tax (t) = , change in government
purchases , decrease in transfers

Change in income =

= 50.

Change in income due to transfers =

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Book : Introductory Macroeconomics Ncert Solutions | Chapter - 5 Economics

= 60

Q10 Explain why the tax multiplier is smaller in absolute value than the government expenditure
multiplier?

Answer. We can see that the tax multiplier is always smaller than the government expenditure
multiplier in absolute value. It is so because when the government increases its expenditure, the
total aggregate demand rises in the same proportion.
The disposal income of the people is affected by tax multiplier and thereby the consumption
level in the economy changes. The total disposal income which increases due to more
expenditure isn't consumed. Only a portion of it is consumed. This will lead to increase to
increase in tax at lesser rate. Hence the change in the tax multiplier is smaller than the change
in the government expenditure.

Q11 Explain the relation between government deficit and government debt.

Answer. Government deficit is the excess of government expenditure over its receipts in a
financial year. When the government does more expenditure, then it has to borrow funds for
making such expenses.
Hence, government has to raise loans. Then, it has to pay back the loan along with the interest
amount. For this purpose, it takes another loan and this circle goes on. Hence the government
deficits give rise to the government debts.

Q12 Does public debt impose a burden? Explain.

Answer. Public debt is the amount of the loan raised by the government to meet the deficit. It is
a burden on the general public. The government in order to pay back the loan amount, may
borrow money from outside or from RBI.
The government has to pay interest on the external debts, whose burden is shifted on the public
in the form of taxes.
If it borrows funds from RBI, then new currency is issued. Due to the increased money
supply,the inflation in the economy rises which thereby is a burden on the general public.
When the government borrows funds for unproductive purposes, then the money don't provide
any return and hence it proves as a burden.

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Book : Introductory Macroeconomics Ncert Solutions | Chapter - 5 Economics

Q13 Are fiscal deficits inflationary?

Answer. Yes, fiscal deficit is inflationary. Fiscal deficit is equal to the borrowing of the
government. When the government borrows funds from the Reserve Bank of India, then it
issues new currency in the market. Thus leads to increased money supply in the economy
thereby causing inflation. Hence, the fiscal deficit proves to be inflationary.

Q14 Discuss the issue of deficit reduction.

Answer. The deficit reduction is the process of reducing the difference between the government
expenditure and government receipts. It can be done in two ways.
A) By increasing the receipts - The government may impose more taxes on the people to
collect more money and thereby reducing the deficit.
B) By reducing the expenditure - If the give reduces its expenditure on the non-productive
activities, then also it can reduce its deficit.

Page : 83 , Block Name : Exercises

Q15 What do you understand by G.S.T? How good is the system of G.S.T as compared to the
old tax system? State its categories.

Answer. GST(Goods and Services Tax) is the integrated taxation system of India. It has
replaced VAT, Sales tax and other indirect taxes on the countries. It is very beneficial as
compared to old tax system.
A) GST is imposed at the point of consumption. Under the previous systems, the tax was
levied at each stage and the system was not uniform. But under the GST, the system is
uniform.
B) The tax were categorised into many categories under the previous tax laws. But after the
introduction of GST, there is only one centralised taxation system.
C) Due to different taxation rates in all the states and for all categories of taxes, it was very
difficult for the government to account for these taxes. But under GST, the system is
simplified.
GST is divided into three categories -
1) CGST - Central Goods and Services Tax goes to the central government. It has merged
the Central Sales Tax, Central Excise Duty etc.
2) SGST - State Goods & Services Tax (SGST) is the tax levied by the State governments.
Its revenue belongs to the state governments.

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Book : Introductory Macroeconomics Ncert Solutions | Chapter - 5 Economics

3) IGST - Integrated Goods & Services Tax is the tax imposed on the inter-state
transactions. The revenue earned under the IGST is shared by state government and
central government in agreed ratio.

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