## Economics Class 12 Chapter 5 questions and answers: Government Budget and the Economy ncert solutions

Textbook | NCERT |

Class | Class 12 |

Subject | Economics |

Chapter | Chapter 5 |

Chapter Name | Government Budget and the Economy class 12 ncert solutions |

Category | Ncert Solutions |

Medium | English |

Are you looking for Ncert Solutions for Class 12 Macro Economics Chapter 5 Government Budget and the Economy? Now you can download economics class 12 chapter 5 questions and answers pdf from here.

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

**Answer 1:** Public goods are those goods where there is no competition, and the use of goods is not restricted to only one individual. This means individuals cannot be prevented from using them, and one person’s use does not reduce availability for others.

The government must provide public goods because they are essential for daily life and national development:

- Non-profit: Private firms are profit-driven and only produce goods they can expect to earn a profit on. Public goods are not profitable.
- Free rider problem: Consumers can enjoy the benefits of public goods without paying for them, which is known as the free rider problem. The government can collect taxes to reduce this problem.
- Market failure: Public goods are non-excludable and non-rival, meaning that anyone can use them without affecting others’ consumption. The government can intervene to solve market failures and ensure citizens benefit.
- Necessity: Public goods are a necessity, and their production is essential for society and the economy.
- Low-income individuals: Governments provide public goods to help people who are unable to access services due to low income.

### Question 2:** **Distinguish between revenue expenditure and capital expenditure.

**Answer 2:** **Revenue Expenditure** refers to the spending on day-to-day operations and maintenance. It covers expenses like wages, utilities, rent, and repairs, which are necessary to maintain the current level of functioning. These expenditures do not create new assets or improve long-term financial value but are essential for running the organization in the short term.

**Capital Expenditure** (CapEx) is the spending on acquiring or upgrading long-term assets such as buildings, equipment, or infrastructure. These expenditures create new assets or increase the value and efficiency of existing assets, contributing to future productivity and growth.

Criteria | Revenue Expenditure | Capital Expenditure |
---|---|---|

Nature | Recurring or short-term expenses | One-time or long-term investments |

Purpose | For the day-to-day operation and maintenance of assets | For acquiring, improving, or expanding fixed assets |

Effect on Profit | Directly affects profit and loss in the current period | Not directly linked to current period profit |

Examples | Salaries, rent, utilities, repairs | Purchase of machinery, buildings, or land |

Accounting Treatment | Fully expensed in the income statement | Recorded as an asset on the balance sheet and depreciated over time |

Time Period | Benefits are consumed within the same accounting period | Benefits extend over multiple accounting periods |

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

**Answer 3:** Fiscal deficit is the excess of total expenditure over total receipts. That is, when total government expenditure is greater that total government receipts, the government faces fiscal deficit.

Fiscal deficit is determined by: Total Expenditure (revenue + capital) − Total Receipts (excluding borrowings).

Fiscal deficit gives an indication to the government about the total borrowing requirements from all sources. Fiscal deficit can be financed through domestic borrowings and/or borrowings from abroad. Greater fiscal deficit implies greater borrowings by the government.

### Question 4:** **Give the relationship between the revenue deficit and the fiscal deficit.

**Answer 4:** Revenue deficit is the difference between a government’s revenue expenditures and revenue receipts. Fiscal deficit is the difference between the government’s total expenditure and total receipts, excluding borrowings.

The relationship between the revenue deficit and the fiscal deficit can be explained through the following points:

Therefore, a **fiscal deficit** can be thought of as the sum of the **revenue deficit** plus additional borrowings for capital expenditure or investments.

The **fiscal deficit** includes the **revenue deficit** as one of its components.

A **revenue deficit** contributes directly to the **fiscal deficit**, since if the government is unable to cover its regular expenses, it needs to borrow more, increasing the fiscal deficit.

### Question 5:** **Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes (that is lump-sum taxes minus transfers) is 100 and consumption is given by C = 100 + 0.75Y (a) What is the level of equilibrium income? (b) Calculate the value of the government expenditure multiplier and the tax multiplier. (c) If government expenditure increases by 200, find the change in equilibrium income.

**Answer 5:** I = 200

G = 150

T = 100

C = 100 + 0.75 Y

So, C (Autonomous consumption) = 100

And, MPC (c) = 0.75

**(a) Equilibrium level of income**

\(\text{Y}=\frac{1}{1-\text{C}}\{\text{C}-(\text{C})\text{T}+\text{I}+\text{G}\}\)

\(=\frac{1}{1-0.75}\) {100 – 0.75 × 100 + 200 + 150}

\(=\frac{1}{0.25}\times 375\)

\(=\operatorname{Rs}1500\)

**(b) Government expenditure multiplier**

\(\frac{\Delta Y}{\Delta G}=\frac{1}{(1-C)}\)

\(=\frac{1}{(1-0.75)}\)

\(=\frac{1}{0.25}\)

= 4

The tax multiplier is calculated as

\(\frac{\Delta Y}{\Delta T}=\frac{-C}{1-C}\)

\(=\frac{-0.75}{1-0.75}\)

\(=\frac{-0.75}{0.25}\)

= -3

**(c) **ΔG = 200

New equilibrium income = \(\frac{1}{1-\mathrm{c}}[\overline{\mathrm{C}}-\mathrm{cT}+\mathrm{I}+\mathrm{G}+\Delta \mathrm{G}]\)

\(=\frac{1}{(1-0.75)(100-0.75 \times 100+200+150+200)}\)

\(=\frac{1}{0.25} \times 575\)

= Rs 2300

\(=\frac{1}{0.25} \times 575\)

= Rs 2300

Therefore, the change in equilibrium income is calculated as

=2300-1500

=800

### Question 6:** **Consider an economy described by the following functions: C = 20 + 0.80Y, I = 30, G = 50, TR = 100 (a) Find the equilibrium level of income and the autonomous expenditure multiplier in the model. (b) If government expenditure increases by 30, what is the impact on equilibrium income? (c) If a lump-sum tax of 30 is added to pay for the increase in government purchases, how will equilibrium income change?

**Answer 6:**

(a) \(\mathrm{C}=20+0.80 \mathrm{Y}[\overline{\mathrm{C}}=20]\)

- I = 30
- c = 0.80
- G = 50
- T = 100

The equilibrium level of income is calculated as:

\(Y=\frac{1}{1-c}[\bar{C}+c T+I+G]\)

\(=\frac{1}{1-0.80}[20+0.80 \times 100+30+50]\)

\(=\frac{1}{0.20} \times 180\)

= 900

The expenditure multiplier is calculated as

Expenditure multiplier \(=\frac{1}{1-\mathrm{c}}\)

\(=\frac{1}{1-0.80}\)

\(=\frac{1}{0.20}\)

= 5

**(b) Increase in government expenditure**

ΔG = 30

New equilibrium expenditure

\(=\frac{1}{1-0.80}\) {20+(0.80) 100+30+50+30}

\(=\frac{1}{1-0.80}\){20+80+30+50+30}

\(=\frac{1}{0.20} \times 210\)

= 1050

Therefore, the equilibrium level of income increases by 150 (1050 − 900).

**(c) Tax multiplier**

\(\frac{\Delta \mathrm{Y}}{\Delta \mathrm{T}}=\frac{-\mathrm{c}}{1-\mathrm{c}}\)

\(\Delta \mathrm{Y}=\frac{-\mathrm{c}}{1-\mathrm{c}} \times \Delta \mathrm{T}\)

Substitute the values,

\(\Delta \mathrm{Y}=\frac{-0.80}{1-0.80} \times 30\)

\(=\frac{-0.80}{0.20} \times 30\)

= -120

New equilibrium level of income is calculated as

= Y + ΔY

= 90O + (−120)

= Rs 780

### Question 7:** **In the above question, calculate the effect on output of a 10 per cent increase in transfers, and a 10 per cent increase in lump-sum taxes. Compare the effects of the two.

**Answer 7:**

- MPC = 0.80
- \(\overline{\mathrm{C}}=20\)
- I = 30
- G = 50
- TR = 100
- ΔTR = 10

Equilibrium level of income is calculated as

\(=\frac{1}{1-0.80}\){20+(0.80) 100+30+50+30}

\(=\frac{1}{1-0.80}\){20+80+30+50+0.80 × 10}

\(=\frac{188}{20} \times 100\)

= 940

Change in equilibrium = 940 − 900 = Rs 40

Increase in lump-sum tax ΔT =10

Change in Income = \(\Delta \mathrm{T} \frac{(-\mathrm{c})}{1-\mathrm{c}}\)

\(=-10 \times \frac{0.80}{0.20}\)

= -10 × 4

= -40

Based on the above results, we can conclude that a 10% increase in transfers will result in a 40% increase in income.

Furthermore, a 10% increase in taxes results in a 40% decrease in income.

### Question 8:** **We suppose that C = 70 + 0.70Y D, I = 90, G = 100, T = 0.10Y (a) Find the equilibrium income. (b) What are tax revenues at equilibrium Income? Does the government have a balanced budget?

**Answer 8:**

- (a) C = 70 + 0.70 YD
- I = 90
- G = 100
- T = 0.10Y
- Y = C + I +G
- Y = 70 + 0.70Y + 90 + 100
- Y = 70 + 0.70YD + 190
- Y = 70 + 0.70 (Y − T) + 190
- Y = 70 + 0.70Y − 0.70 × 0.10 Y + 190
- Y = 70 + 0.70Y − 0.07Y + 190
- Y = 70 + 0.63Y + 190
- Y = 260 + 0.63Y
- Y − 0.634 = 260
- 0.37Y = 260
- Y = \(\frac{260}{0.37}\)
- Y = 702.7

- (b) T = 0.10Y
- = 0.10 × 702.7
- = 70.27
- Government expenditure = 100
- Tax revenue = 70.27
- As, G > T, Government has a deficit budget, not a balanced budget.

### Question 9:** **Suppose marginal propensity to consume is 0.75 and there is a 20 per cent proportional income tax. Find the change in equilibrium income for the following (a) Government purchases increase by 20 (b) Transfers decrease by 20.

**Answer 9:** In case of proportional taxes

(a) MPC = 0.75 and ΔG = 20

\(\Delta \mathrm{Y} =\frac{1}{(1-\mathrm{c}(1-\mathrm{t}))} \times \Delta \mathrm{G}\)

\(=\frac{1}{(1-0.75(1-0.2))} \times 20\)

\(=\frac{1}{(1-0.75) \times 0.8} \times 20=50\)

(b) \(\Delta \mathrm{Y}= \frac{c}{1-c}\times \Delta \mathrm{T}\)

\(=\frac{0.75}{(1-0.75)} \times 20\)

\(=\frac{0.75}{0.25} \times 20\)

= 60

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

**Answer 10:** The tax multiplier is smaller in absolute value than the government expenditure multiplier, as the government expenditure affects the total expenditure and taxes through the multiplier. Tax multiplier also influences disposable income that affects the overall consumption level.

The reason is explained through the following example.

Let’s assume MPC be to 0.80.

Then, the government expenditure multiplier = \(\frac{1}{1-\mathrm{c}}\)

\(=\frac{1}{1-0.80}\)

\(=\frac{1}{0.20}=5\)

\(\text { Tax multiplier }=\frac{-\mathrm{c}}{1-\mathrm{c}}\)

\(=\frac{-0.80}{1-0.80}=-4\)

This shows that government expenditure multiplier is more than tax multiplier.

### Question 11: Explain the relation between government deficit and government debt.** **

**Answer 11:** Government deficit occurs when a government spends more than it earns in revenue during a given period, typically a year. Government debt is the accumulation of past deficits, minus any surpluses, representing the total amount the government owes. In other words, a deficit adds to the total debt, while a surplus can reduce it.

### Question 12:** **Does public debt impose a burden? Explain.

**Answer 12:** Government debt or public debt is the amount or money that a central government owes. Such an amount may be borrowings of the government from banks, public financial institutions and from other external and internal sources. Public debt acts as a burden on the economy as a whole, which is described through the following points.

(i) Adverse effect on productivity and investment: A government can either impose taxes or can get money printed to repay the debt. This however reduces the peoples’ ability to work, save and invest, and therefore the development of a country

(ii) Burden on younger generations: Public debt must eventually be repaid, often by future taxpayers. This can limit the fiscal options for future governments and place a financial burden on future generations if debt levels become unsustainable.

(iii) Lowers the private investment: The government attracts high investment through increased rates of interests on bonds and securities. Resulted to which a major part of savings of citizens is accumulated in the hands of the government, thus crowding out private investments.

(iv) Leads to the drain of National wealth: The wealth of the country is drained out of the nation at the time of repaying loans which were taken from foreign countries and institutions.

### Question 13:** **Are fiscal deficits inflationary?

**Answer 13:** Fiscal deficits can be inflationary, but the extent to which they contribute to inflation depends on various factors. When a government runs a fiscal deficit, it often finances the shortfall by borrowing or increasing money supply, especially if the central bank purchases government bonds.

This influx of money into the economy can lead to higher demand for goods and services, which, if not matched by increased supply, can push prices up, resulting in inflation. Additionally, if the economy is already operating near its full capacity, increased government spending can exacerbate inflationary pressures.

However, if the economy has excess capacity or high unemployment, fiscal deficits may not lead to significant inflation, as the increased spending can stimulate growth without necessarily driving up prices. Therefore, the relationship between fiscal deficits and inflation is complex and influenced by the overall economic context and how the deficit is financed.

### Question 14:** **Discuss the issue of deficit reduction.

**Answer 14:** The ways of government budget deficit reduction are the following:

(i) Decreasing expenditure

(ii) Increasing revenue

**(i) Decreasing expenditure:**

- (a) The expenditure of government has to be decreased by making government activities more planned and effective.
- (b) The government should also encourage private sector to undertake capital projects.

**(ii) Increasing revenue:**

- (a) Higher taxes leads to higher income earned by the government. Also, new taxes may also add to the revenues of the government.
- (b) The government can sell shares of Public Sector Undertakings (PSU disinvestment) in order to increase its revenue.

### Question 15:** **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 15:** **Goods and Services Tax (GST)** is a comprehensive indirect tax system implemented in many countries, aimed at simplifying the tax structure by merging multiple indirect taxes into a single tax. It is designed to be levied at every stage of the supply chain, with credit for taxes paid on inputs allowed to be claimed by the suppliers, ensuring that the final consumer bears the tax burden.

**The system of G.S.T is good as compared to the old tax system in the following ways:**

**Simplicity**: GST replaces a complex web of indirect taxes such as Value Added Tax (VAT), sales tax, excise duty, and service tax with a single tax. This simplification reduces compliance costs and makes it easier for businesses to manage their tax obligations.

**Uniform Tax Rate**: GST introduces a uniform tax rate across the country, which eliminates tax cascading (tax on tax) seen in the old system. This creates a more level playing field for businesses operating in different states.

**Input Tax Credit (ITC)**: Under GST, businesses can claim input tax credits for taxes paid on inputs, reducing the overall tax burden. This feature was limited or absent in many previous tax systems.

**Transparency and Efficiency**: GST enhances transparency in the tax system, as all transactions are recorded electronically. This reduces the scope for tax evasion and corruption, leading to better compliance and increased tax revenue for the government.

**Boost to the Economy**: By reducing the cost of compliance and promoting ease of doing business, GST can enhance economic growth. It encourages businesses to expand and invest, potentially leading to job creation.

**Encouragement of Digital Transactions**: The implementation of GST has promoted digital payments and e-invoicing, further modernizing the tax collection process and increasing transparency.

**GST typically comprises three main categories:**

**Central Goods and Services Tax (CGST)**: Collected by the central government on intra-state sales (sales within a state).

**State Goods and Services Tax (SGST)**: Collected by the state government on intra-state sales. The revenue is shared between the central and state governments.

**Integrated Goods and Services Tax (IGST)**: Levied on inter-state sales (sales between states). IGST is collected by the central government, and the revenue is later distributed between the central and state governments.