{"id":17530,"date":"2023-03-20T09:56:02","date_gmt":"2023-03-20T04:26:02","guid":{"rendered":"https:\/\/gstguntur.com\/?p=17530"},"modified":"2023-03-20T10:57:57","modified_gmt":"2023-03-20T05:27:57","slug":"public-finance-ca-inter-economics-study-material","status":"publish","type":"post","link":"https:\/\/gstguntur.com\/public-finance-ca-inter-economics-study-material\/","title":{"rendered":"Public Finance \u2013 CA Inter Economics Study Material"},"content":{"rendered":"

Public Finance \u2013 CA Inter Economics Study Material<\/a>\u00a0is designed strictly as per the latest syllabus and exam pattern.<\/p>\n

Public Finance \u2013 CA Inter Economics Study Material<\/h2>\n

Theory Questions<\/strong><\/p>\n

Question 1.
\nExplain the role of Government in a market economy as stated by Richard Musgrave. (3 Marks May 2018)
\nAnswer:
\nRole of government in a market as stated by Richard Musgrave: Richard Musgrave introduced in his classic treatise \u2018The Theory of Public Finance’ (1959), the three branch taxonomy of the role of government in a market economy. The objective of the economic system and the role of government is to improve the well-being of individuals or households.<\/p>\n

According to \u2018Musgrave Three Function Framework\u2019, the functions of government are to be separated into three, namely, resource allocation, (efficiency), income redistribution (fairness) and macroeconomic stabilization. The allocation and distribution functions are primarily microeconomic functions, while stabilization is a macroeconomic function. The allocation function aims to correct the sources of inefficiency in the economic system while the distribution role ensures that the distribution of wealth and income is fair. The stabilization branch is to ensure achievement of macroeconomic stability, maintenance of high levels of employment and price stability.<\/p>\n

\"Public<\/p>\n

Question 2.
\nDescribe the meaning and mechanism of Crowding out\u2019 effect of public expenditure. (3 Marks May 2018, 2 Marks Jan. 2021)
\nAnswer:
\nCrowding Out: Crowding out effect refers to the negative effect of fiscal policy may generate when spending by government in an economy substitutes private spending. For example, if government provides free computers to students, the demand from students for computers may not be forthcoming.<\/p>\n

Crowding Out Mechanism: Private investments are sensitive to interest rates and therefore some private investment spending is discouraged. Similarly, when government increases the budget deficit by selling bonds or treasury bills, the amount of money with the private sector decreases and consequently interest rates will be pushed up.<\/p>\n

As a result, private investments, especially the ones which are interest – sensitive, will be reduced. Fiscal policy becomes ineffective as the decline in private spending partially or completely offset the expansion in demand resulting from an increase in government expenditure.<\/p>\n

Question 3.
\nDescribe features of public goods. (2 Marks May, 2018 Nov. 2020)
\nAnswer:
\nFeatures of public goods :<\/p>\n

    \n
  1. Public goods yield utility and their consumption is essentially collective in nature.<\/li>\n
  2. Public goods are non-rival in consumption i.e. consumption of a public good by one individual does not reduce the quality or quantity available for all other individuals:<\/li>\n
  3. Public goods are non-excludable i.e. consumers cannot (at least at less than prohibitive cost) be excluded from consumption benefits.<\/li>\n
  4. Public goods are characterized bv indivisibility, each individual may consume all of the good i.e. the total amount consumed is the same for each individual.<\/li>\n
  5. Once a public good is provided, the additional resource cost of another person consuming the good is zero. No direct payment by the consumer is involved in the case of pure public goods and these goods are generally more vulnerable to issues such as externalities, inadequate property rights, and free rider problems.<\/li>\n
  6. Competitive private markets will fail to generate economically efficient outputs of public goods. E.g. national defence.<\/li>\n<\/ol>\n

    \"Public<\/p>\n

    Question 4.
    \nWhich types of Government interventions are applied for correcting information failure? (2 Marks May 2018)
    \nAnswer:
    \nTypes of Government Interventions for correcting information failure :<\/p>\n

      \n
    1. Government makes it mandatory to have accurate labelling and content disclosures by producers.<\/li>\n
    2. Public dissemination of information to improve knowledge and subsidizing of initiatives in that direction.<\/li>\n
    3. Regulation of advertising and setting of advertising standards to make advertising more responsible, informative and less persuasive.<\/li>\n<\/ol>\n

      A few examples are : SEBI mandates on accurate information disclosure to prospective buyers of new stocks, mandatory statutory information, licensing of doctors practicing medicine, awareness campaigns and funding of organisations to influence public, media and government attitudes.<\/p>\n

      Question 5.
      \nExplain the objectives of Fiscal Policy. (3 Marks May 2018)
      \nAnswer:
      \nObjectives of Fiscal Policy are :<\/p>\n

        \n
      1. Achievement and maintenance of full employment,<\/li>\n
      2. Maintenance of price stability,<\/li>\n
      3. Acceleration of the rate of economic development,<\/li>\n
      4. Equitable distribution of income and wealth,<\/li>\n
      5. Eradication of poverty, and<\/li>\n
      6. Removal of regional imbalances in different parts of the country.<\/li>\n<\/ol>\n

        The importance and order of priority of these objectives may vary from country to country and from time to time. For instance, while stability and equality may be the priorities of developed nations, economic growth, employment and equity may get higher priority in developing countries. Also, these objectives are not always compatible; for instance the objective of achieving equitable distribution of income may conflict with the objective of economic growth and efficiency.<\/p>\n

        \"Public<\/p>\n

        Question 6.
        \nHow the Government intervenes to ensure stability in price level? (2 Marks Nov. 2018)
        \nAnswer:
        \nGovernment intervenes to ensure price stability and thus regulate aggregate demand with two policy instruments namely, monetary (credit) policy and fiscal (budgetary) policy. Monetary policy attempts to stabilise aggregate demand in the economy by influencing the availability and rate of interest. Fiscal policy, on the other hand, aims at influencing aggregate demand by altering tax, public expenditure and public debt of the government.<\/p>\n

        When total spending is too low, the government may increase its spending and lower taxes to reduce unemployment and the central bank may lower interest rates. When total spending is excessive, the government may cut its spending and raise taxes to foster price stability and the central bank may raise interest rates. In addition, the government may initiate regulatory measures such as price ceiling and price floors.<\/p>\n

        Question 7.
        \nDefine the Contractionary Fiscal Policy. What measures under this policy are to be adopted to eliminate the inflationary gap? (3 Marks Nov. 2018)
        \nAnswer:
        \nContractionary Fiscal Policy: It refers to the deliberate policy of government applied to curtail aggregate demand and consequently the level of economic activity. In other words, it is fiscal policy aimed at eliminating an inflationary gap.
        \nMeasures under this policy are :
        \n1. Decrease in government spending: With decrease in government spending, the total amount of money available in the economy is reduced whic h is turns trim down the aggregate demand.<\/p>\n

        2. Increase in personal income taxes and\/or business taxes : An increase in personal income taxes reduces disposable income leading to fall in consumption spending and aggregate demand. An increase in taxes on business profits reduces the surpluses available to businesses, and as a result, firms\u2019 investments shrink causing aggregate demand to fall. Increased taxes also dampen the prospects of profits of potential entrants who will respond by holding back fresh investments.<\/p>\n

        3. A combination of decrease in government spending and increase in personal income taxes and\/or business taxes.<\/p>\n

        \"Public<\/p>\n

        Question 8.
        \nWhat is allocation function of Fiscal Policy? Or Describe the allocation instruments available to the Government to influence resource allocation in an economy, (2 Marks Nov. 2018, 3 Marks Jan. 2021)
        \nAnswer:
        \nAllocation function .-Allocation function of fiscal policy is concerned with the process by which the total resources of the economy are divided among various uses as well as for provision of an optimum mix of various social goods (both public goods and merit goods). The allocation function also involves the reallocation of society’s resources from private use to public use.<\/p>\n

        The Resource allocation role of the government\u2019s fiscal policy focuses on the potential of the government to improve economic performance through its expenditure and tax policies. The allocative function in budgeting determines who and what will be taxed as well as how and on what the government revenue will be spent. The allocative function also involves the reallocation of society\u2019s resources from private to public use.<\/p>\n

        A variety of allocation instruments are available by which governments can influence resource allocation in the economy. For example :<\/p>\n

          \n
        1. Government may directly produce an economic good.<\/li>\n
        2. Government may influence private allocation through incentives and disincentives.<\/li>\n
        3. Government may influence allocation through its competitive policies, merger policies etc. which affect the structure of industry and commerce.<\/li>\n
        4. Government\u2019s regulatory activities such as licensing control minimum wages and directives on location of industry influence resource allocation.<\/li>\n
        5. Government sets legal and administrative framework and<\/li>\n
        6. Any mixture of intermediate methods may be adopted by the government.<\/li>\n<\/ol>\n

          \"Public<\/p>\n

          Question 9.
          \nDefine the market failure. Why do markets fail? (3 Marks Nov, 2018)
          \nAnswer:
          \nMarket failure : It is a situation in which the free market with an unrestricted price system determined by forces of supply and demand leads to misallocation of society\u2019s scarce resources in the sense that there is either overproduction or underproduction of particular goods and services leading to a less than optimal outcome.<\/p>\n

          Reasons for market failure are :<\/p>\n

            \n
          1. Though perfectly competitive markets work efficiently, most often the prerequisites of competition are unlikely to be present in an economy.<\/li>\n
          2. Market power of firms enables them to act as price makers and keep the level of prices and output that give them positive economic profits.<\/li>\n
          3. Externalities hinder the ability of market prices to convey accurate information about how much to produce and how much to buy.<\/li>\n
          4. Public goods are not produced at all or produced less than optimal quantities due to its special characteristics such as indivisibility, non – excludability and non-rivalry.<\/li>\n
          5. Free rider problem causing overuse, degradation and depletion of common resources.<\/li>\n
          6. Information failure manifest in asymmetric information, adverse selection and moral hazard.<\/li>\n<\/ol>\n

            \"Public<\/p>\n

            Question 10.
            \nHow do Governments correct market failure resulting from demerit Goods? (3 Marks Nov. 2018)
            \nAnswer:
            \nGovernment acts to correct market failure resulting from demerit goods are:<\/p>\n

              \n
            1. At the extreme, the government may enforce complete ban on a demerit good; e.g. intoxicating drugs. In such cases, the possession, trading or consumption of the good is made illegal.<\/li>\n
            2. Impose unusually high taxes on producing or purchasing the demerit goods making them very costly and unaffordable to many.<\/li>\n
            3. Through persuasion which is mainly intended to be achieved by negative advertising campaigns which emphasize the dangers associated with consumption of demerit goods and granting of subsidies for such advertisements.<\/li>\n
            4. Through legislations that prohibit the advertising or promotion of demerit goods in whatsoever manner.<\/li>\n
            5. Strict regulations of the market for the good may be put in place so as to limit access to the good, especially by vulnerable groups such as children and adolescents. Restrictions in terms of a minimum age may be stipulated at which young people are permitted to buy cigarettes and alcohol.<\/li>\n
            6. Regulatory controls in the form of spatial restrictions e.g. smoking in public places, sale of tobacco to be away from schools, and time restrictions under which sale at particular times during the day is banned.<\/li>\n<\/ol>\n

              \"Public<\/p>\n

              Question 11.
              \nExplain the concept of Social Costs. (2 Marks Nov. 2018)
              \nAnswer:
              \nSocial costs : Social costs is the total costs to the society on account of a production or consumption activity. Social costs are private costs borne by individuals directly involved in a transaction together with the external costs borne by third parties not directly involved in the transaction. Social costs represent the true burdens carried by society in monetary and non-monetary terms.<\/p>\n

              Question 12.
              \nDefine \u2018Market power\u2019. What is its disadvantage? (2 Marks May 2019)
              \nAnswer:
              \nMarket power: Market power refers to the ability of a price making firm to profitably raise the market price of a good or service over its marginal cost and thus earn supernormal profits or positive economic profits. Market power is an important cause of market failure. Market failure occurs when the free market outcomes do not maximize net benefits of an economic activity and therefore there is deadweight losses and inefficient allocation of resources.<\/p>\n

              Excess market power causes a single producer or a small number of producers to strategically reduce their supply and charge higher prices compared to competitive market. Market power can cause markets to be inefficient because it keeps price and output away from the equilibrium of supply and demand. Market power thus results in suboptimal outcomes such as deadweight loss, underproduction of goods and services, higher prices and loss of consumer surplus.<\/p>\n

              Question 13.
              \nWhy is there a need for the government to resort to resource allocation? (3 Marks May 2019)
              \nAnswer:
              \nGovernment need to resort to resource allocation during market failure. Market failures are situations in which a particular market, left to itself, is inefficient and leads to misallocation of society\u2019s scarce resources. In the absence of appropriate government intervention in resource allocation, the resources are likely to be misallocated with too much production of certain goods or too little production of certain other goods.<\/p>\n

              The allocation responsibility of the governments involves suitable corrective action when private markets fail to provide the right and desirable combination of goods and services to ensure optimal outcomes in terms of social welfare.<\/p>\n

              \"Public<\/p>\n

              Question 14.
              \nDescribe the limitations of fiscal policy. (3 Marks May 2019)
              \nAnswer:
              \nLimitations of fiscal policy are :
              \n1. One of the biggest problems with using discretionary fiscal policy to counteract fluctuations is the different types of lags involved in fiscal policy action. There are significant lags such as recognition lag, decision lag, implementation lag and impact lag<\/p>\n

              2. Fiscal policy changes may at times be badly timed due to the various lags so that it is highly possible that an expansionary policy is initiated when the economy is already on a path of recovery and vice versa.<\/p>\n

              3. There are difficulties in instantaneously changing governments\u2019 spending and taxation policies.<\/p>\n

              4. It is practically difficult to reduce government spending on various items such as defence and social security as well as on huge capital projects which are already midway.<\/p>\n

              5. Public works cannot be adjusted easily along with movements of the trade cycle because many huge projects such as highways and dams have long gestation period. Besides, some urgent public projects cannot be postponed for reasons of expenditure cut to correct fluctuations caused by business cycles.<\/p>\n

              6. Due to uncertainties, there are difficulties of forecasting when a period of inflation or deflation may set in and also promptly determining the accurate policy to be undertaken.<\/p>\n

              7. There are possible conflicts between different objectives of fiscal policy such that a policy designed to achieve one goal may adversely affect another. For example, an expansionary fiscal policy may worsen inflation in an economy.<\/p>\n

              8. Supply-side economists are of the opinion that certain fiscal measures will cause disincentives. For example, increase in profits tax may adversely affect the incentives of firms to invest and an increase in social security benefits may adversely affect incentives to work and save.<\/p>\n

              \"Public<\/p>\n

              9. Deficit financing increases the purchasing power people. The production of goods and services, especially in under developed countries may not catch up simultaneously to meet the increased demand. This will result in prices spiraling beyond control.<\/p>\n

              10. Increase is government borrowing creates perpetual burden on even future generations as debts have to be repaid. If the economy lags behind in productive utilization of borrowed money, sufficient surpluses will not be generated for servicing debts. External debt burden has been a constant problem for India and many developing countries.<\/p>\n

              11. An increase in the size of government spending during recessions will \u2018crowd out\u2019 private spending in an economy and lead to reduction in an economy\u2019s ability to self-correct from the recession, and possibly also reduce the economy\u2019s prospects of long-run economic growth.<\/p>\n

              12. If governments compete with the private sector to borrow money for spending, it is likely that interest rates will go up, and firms\u2019 willingness to invest may be reduced. Individuals too may be reluctant to borrow and spend and the desired increase in aggregate demand may not be realized.
              \n(Student may write any six)<\/p>\n

              Question 15.
              \nWhat is meant by expansionary fiscal policy? Under what circumstances do government pursue expansionary policy? (3 Marks May 2019)
              \nAnswer:
              \nExpansionary fiscal policy :
              \nAn expansionary fiscal policy is designed to stimulate the economy during the contractionary phase of a business cycle or when there is an anticipation of a business cycle contraction. This is accomplished by increasing aggregate expenditure and aggregate demand through an increase in all types of government spending and\/or a decrease in taxes.<\/p>\n

              The objectives of expansionary fiscal policy are reduction in cyclical unemployment, increase in consumer demand and prevention of recession and possible depression. In other words, it aims to close a \u2018recessionary gap’ or a contractionary gap wherein the aggregate demand is not sufficient to create conditions of full employment. This is accomplished by increasing aggregate expenditure and aggregate demand through an increase in all types of government spending and\/or a decrease in taxes.<\/p>\n

              Government uses subsidies, transfer payments, welfare programmes, corporate and personal income tax cuts and increased spending on public works such as on infrastructure development to put more money into consumers\u2019 hands to give them more purchasing power.<\/p>\n

              \"Public<\/p>\n

              Question 16.
              \nWhat is meant by quasi public goods? (2 Marks May 2019)
              \nAnswer:
              \nQuasi public goods are :
              \n(1) Not completely non rival. For example, public roads wi-fi networks and public parks do not get congested so as to reduce the space available for others when extra consumers use them only up to an optimal point. When more people use it beyond that, the amount others can benefit from these is reduced to some extent, because there will be increased congestion.<\/p>\n

              (2) It is easy to keep people away from quasi public goods by charging a price or fee. For example, it is possible to exclude some users by building toll booths to charge for road usage on congested routes. Other examples are education, and health services. It is easy to keep people away from them by charging a price or fee. However, it is undesirable to keep people away from such goods because the society would be better off if more people consume them. This particular characteristic namely, the combination of virtually infinite benefits and the ability to charge a price results in some quasi-public goods being sold through markets and others being provided by government.<\/p>\n

              Question 17.
              \nWhat do you mean by \u2018Global Public Goods\u2019? Explain in brief. (2 Marks Nov. 2019)
              \nAnswer:
              \nGlobal Public Goods: These are those public goods with benefits or costs that potentially extend to everyone in the world. These goods have widespread impact on different countries and regions, population groups and generations throughout the entire globe. Global Public Goods may be :<\/p>\n

                \n
              1. Final public goods which are \u2018outcomes\u2019 such as ozone layer preservation or climate change prevention, or<\/li>\n
              2. Intermediate public goods, which contribute to the provision of final public goods e.g. International health regulations<\/li>\n<\/ol>\n

                The distinctive characteristic of global public goods is that there is no mechanism (either market or government) to ensure an efficient outcome. The World Bank identifies five areas of global public goods which it seeks to address : namely, the environmental commons (including the prevention of climate change and biodiversity), communicable diseases (including HIV\/ AIDS, tuberculosis, malaria, and avian influenza), international trade, international financial architecture, and global knowledge for development.<\/p>\n

                \"Public<\/p>\n

                Question 18.
                \nDescribe the problems in administering an efficient pollution tax. (3 Marks Nov. 2019)
                \nAnswer:
                \nFollowing are the problems in administering an efficient pollution tax :
                \n(1) Pollution taxes are complex to determine and administer because it is difficult to discover the right level of taxation that would ensure that the private cost plus taxes will exactly equate with the social cost.<\/p>\n

                (2) If the demand for the good on which pollution tax is imposed is inelastic, the tax may only have an insignificant effect in reducing demand. The producers will be able to easily shift the tax burden in the form of higher product prices. This will have an inflationary effect and may reduce consumer welfare.<\/p>\n

                (3) Imposition of pollution tax involves the use of complex and costly administrative procedures for monitoring the polluters.<\/p>\n

                (4) Pollution tax does not provide any genuine solutions to the problem. It only establishes an incentive system for use of methods which are less polluting.<\/p>\n

                (5) Pollution taxes also have potential negative consequences on employment and investments because high pollution taxes in one country may encourage producers to shift their production facilities to those countries with lower pollution taxes.<\/p>\n

                Question 19.
                \nDistinguish between \u2018pump priming\u2019 and \u2018compensatory spending\u2019. (2 Marks Nov. 2019)
                \nAnswer:
                \nPump priming: Pump priming refers to the one shot injection of government expenditure into a depressed economy with the aim of boosting business confidence and encouraging larger private investment. It is a temporary fiscal stimulus in order to set off the multiplier process. The argument is that with a temporary injection of purchasing power into the economy through a rise in government spending financed by borrowing rather than taxes, it is possible for government to bring about permanent recovery from a slump.<\/p>\n

                Compensatory spending: Compensatory spending is said to be resorted to when the government spending is deliberately carried out with the obvious intention to compensate for the deficiency in private investment.<\/p>\n

                \"Public<\/p>\n

                Question 20.
                \nDistinguish between positive and negative externalities. (2 Marks Nov. 2019)
                \nAnswer:
                \nAn externality refers to the uncompensated impact of one person\u2019s production and\/or consumption actions on the well-being of another who is not involved in the activity and such effects are not reflected directly in market prices. If the impact on the third parties\u2019 is adverse, it is called a negative externality. If it is beneficial, it is called a positive externality.<\/p>\n

                When negative externalities are present, the social cost of production or consumption is greater than the private cost. The benefit of a negative externality goes to the agent producing it, while the costs are invariably borne by the society at large.<\/p>\n

                When a positive externality exists, the benefit to the individual or firm is less than the benefit to the society i.e. the social value of the good exceeds the private value. In both cases, the outcome is market failure and inefficient allocation of resources.<\/p>\n

                Question 21.
                \nHow does a discretionary fiscal policy help in correcting instabilities in the economy? (3 Marks Nov. 2019)
                \nAnswer:
                \nDiscretionary fiscal policy helps in correcting instabilities in the economy during inflation by:<\/p>\n

                  \n
                1. Decrease in government spending,<\/li>\n
                2. Increase in personal and business taxes, and introduction of new taxes,<\/li>\n
                3. A combination of decrease in government spending and increase in personal income taxes and\/or business taxes,<\/li>\n
                4. A smaller government budget deficit or a larger budget surplus,<\/li>\n
                5. A reduction in transfer payments,<\/li>\n
                6. Increase in government debt from the domestic economy.<\/li>\n<\/ol>\n

                  \"Public<\/p>\n

                  Discretionary fiscal policy helps in correcting instabilities in the economy during deflation by:<\/p>\n

                    \n
                  1. Increased government spending,<\/li>\n
                  2. decrease in personal and business taxes,<\/li>\n
                  3. A combination of increase in government spending and decrease in personal income taxes and\/or business taxes,<\/li>\n
                  4. A larger government budget deficit or a lower budget surplus,<\/li>\n
                  5. An increase in transfer payments,<\/li>\n
                  6. Repayment of public debt to people.<\/li>\n<\/ol>\n

                    Question 22.
                    \nWhat is \u2018Recessionary Gap\u2019? (2 Marks Nov. 2019)
                    \nAnswer:
                    \nRecessionary Gap or Contractionary Gap: It is said to exist if the existing levels of aggregate production is less than what would be produced with full employment of resources. It is a measure of output that is lost when actual national income falls short of potential income, and represents the difference between the actual aggregate demand and the aggregate demand which is required to establish the equilibrium at full employment level of income.<\/p>\n

                    This gap occurs during the contractionary phase of business cycle and results in higher rates of unemployment. In other words, a recessionary gap occurs when the aggregate demand is not sufficient to create conditions of full employment.<\/p>\n

                    \"Public<\/p>\n

                    Question 23.
                    \nDiscuss the “Fiscal Policy Measures\u201d which are useful for reduction in inequalities of income and wealth. (3 Marks Nov. 2020)
                    \nAnswer:
                    \n\u2018Fiscal Policy Measure\u2019 which are useful for reduction in inequalities of income and wealth are :
                    \n(1) Progressive direct tax system : A progressive system of direct taxes ensures that those who have greater ability to pay contribute more towards defraying the expenses of government and that the tax burden is distributed fairly among the population.<\/p>\n

                    (2) Differential indirect taxes system : The indirect taxes may be designed in such a way that the commodities which are primarily consumed by the richer income groups, such as luxuries, are taxed heavily and the commodities the expenditure on which form a larger proportion of the income of the lower income group, such as necessities, are taxed light.<\/p>\n

                    (3) A carefully planned policy of public expenditure :It helps in redistributing income from the rich to the poorer sections of the society. This is done through spending programmes targeted on welfare measures for the disadvantaged, such as poverty alleviation programmes, free or subsidized medical care, education, housing, essential commodities etc. to improve the quality of living of the poor, infrastructure provision on a selective basis, various social security schemes under which people are entitled to old-age pensions, unemployment relief, sickness allowance etc., subsidized production of products of mass consumption, public production and\/or grant of subsidies to ensure sufficient supply of essential goods, and strengthening of human capital for enhancing employability etc.<\/p>\n

                    \"Public<\/p>\n

                    Question 24.
                    \n\u2018Lemons Problem\u2019 is an important source of market failure. How? (2 Marks Nov. 2020)
                    \nAnswer:
                    \nAsymmetric information between the buyers and sellers is the reason of \u2018Lemon Problem’. The problem exists in many markets, but it was popularized by the used car market in which cars are classified as good from those defined as “lemons\u201d (poor quality vehicles).<\/p>\n

                    The owner of a car knows much more about its quality than anyone else. While placing it for sale, he may not disclose all that he knows about the mechanical defects of the vehicle. Based on the probability that the car on sale is a \u2018lemon\u2019, the buyers\u2019 willingness to pay for any particular car will be based on the \u2018average quality\u2019 of used cars.<\/p>\n

                    Not knowing the honesty of the seller means, the price offered for the vehicle is likely to be less to account for this risk. If buyers were aware as to which car is good, they would pay the price they feel reasonable for a good car. Since the price offered in the used car market is lower than the acceptable one, sellers of good cars will not be inclined to sell. The market becomes flooded with \u2018lemons\u2019 and eventually the market may offer nothing but lemons\u2019. The good -quality cars disappear because they are kept by their owners or sold only to friends.<\/p>\n

                    The result is : the proportion of good products that is actually offered falls further and there will be market distortion with lower prices and lower average quality of cars. Low quality cars can drive high quality cars out of the market. Eventually, this process may lead to a complete breakdown of the market.<\/p>\n

                    \"Public<\/p>\n

                    Question 25.
                    \nExplain the various types of externalities. (3 Marks Nov. 2020)
                    \nAnswer:
                    \nThere are four types of externalities which are :
                    \n(1) Negative Production Externalities : A negative production externality initiated in production which imposes an external cost on others may be received by another in consumption or production. As an example, a negative production externality occurs when a factory discharges untreated waste water into a nearby river and pollutes the water.<\/p>\n

                    (2) Positive production externalities : A positive production externality initiated in production that confers external benefits on others may be received in production or in consumption. For example, positive production externality occurs when a firm offers training to its employees for increasing their skills. Training generates positive benefits on the productive efficiency of other firms when they hire such workers as they change their jobs.<\/p>\n

                    (3) Negative consumption externalities .’Negative consumption externalities initiated in consumption confer external costs on others that may be received in production or in consumption. For example, smoking cigarettes by one person in public place causes passive smoking by others. These external costs affect consumption of others by causing consumption of poor quality air or by creating litter and diminishing the aesthetic value of the place.<\/p>\n

                    (4) Positive consumption externalities: A positive consumption externality occurs when an individual’s consumption increases the well-being of others but the individual is not compensated by those others. For example, if people get immunized against contagious diseases, they would confer a social benefit on others as well by preventing others from getting infected.<\/p>\n

                    Question 26.
                    \nExplain the market outcome of price ceiling through diagram. (2 Marks Nov. 2020)
                    \nAnswer:
                    \nThe market outcome of price ceiling or maximum price through diagram:<\/p>\n

                    In case of prices of certain essential commodities rise excessively, government may resort to controls in the form of price ceilings for making a resource or commodity available to all at reasonable prices. For example : maximum prices of food grains and essential items are set by government during times of scarcity. The market outcome of price ceiling can be explained with the help of the following diagram.<\/p>\n

                    Market Outcome of Price Ceiling
                    \n\"Public
                    \nThe intersection of demand and supply curves set the market price of the commodity in question at \u20b9 150. Since the market determined equilibrium price is considered high considering the welfare of people, the government intervenes in the market and a price ceiling is set at \u20b9 75 which is below the prevailing market clearing price.<\/p>\n

                    At price \u20b9 75, the quantity demanded is Q2 and the quantity supplied is only Ql. In other words, there is excess demand equal to Q1-Q2. Thus the market outcome a price ceiling which is below the market determined price leads to generation of excess demand over supply.<\/p>\n

                    \"Public<\/p>\n

                    Question 27.
                    \nCalculate the Fiscal Deficit and Primary Deficit from the data given below: (3 Marks Jan. 2021)<\/p>\n\n\n\n\n\n\n\n
                    <\/td>\n(\u20b9 in Crores)<\/td>\n<\/tr>\n
                    Total Expenditure on Revenue Account and Capital Account<\/td>\n547.62<\/td>\n<\/tr>\n
                    Revenue Receipts<\/td>\n226.82<\/td>\n<\/tr>\n
                    Non-debt Capital Receipts<\/td>\n103.00<\/td>\n<\/tr>\n
                    Interest Payments<\/td>\n84.00<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

                    Answer:
                    \nFiscal Deficit = Total Expenditure on Revenue Account and Capital Account – Revenue Receipts – Non-debt Capital Receipts
                    \n= 547.2 – 226.82 – 103.00
                    \n= 217.8 Crores
                    \nPrimary Deficit = Fiscal Deficit – Interest Payments
                    \n= 217.8 – 84.00
                    \n= 133.8 Crores<\/p>\n

                    Question 28.
                    \nExplain the significance of public debt as an instrument of fiscal policy. (2 Marks Jan 2021)
                    \nAnswer:
                    \nPublic Debt and its significance \/ When a government has borrowed money over the years to finance its deficits and has not paid it back through accumulated surpluses then it is said to be in debt. Public debt may be internal or external, when the government borrows from its own people in the country, it is called internal debt. On the other hand, when the government borrows from outside sources, the debt is called external debt.<\/p>\n

                    Public debt takes two forms namely, market loans and small savings. A national policy of public borrowing and debt repayment is a potent weapon to fight inflation and deflation. Borrowing from the public through the sale of bonds and securities curtails the aggregate demand in the economy. Repayment of debt by government increases the availability of money in the economy and increase aggregate demand.<\/p>\n

                    \"Public<\/p>\n

                    Question 29.
                    \nExplain the concept of \u2018private cost’. (2 Marks Jan 2021)
                    \nAnswer:
                    \nPrivate cost: Private cost is the cost faced by the producer or consumer directly involved in a transaction. If we take the case of a producer his private cost includes direct cost of labour, materials, energy, and other indirect overheads.
                    \nPrivate Cost = Social cost – External Cost<\/p>\n

                    Important Questions<\/strong><\/p>\n

                    Question 1.
                    \nIf country X has a marginal propensity to consume of 0, what is the value of fiscal multiplier?
                    \nAnswer:
                    \nGiven MPC = 0;
                    \nMPS = (1 – 0) = 1
                    \nThe spending multiplier = 1
                    \nThere is no multiplier effect.<\/p>\n

                    Question 2.
                    \nAverage per capita income of country Y rose from 42,300 to 50,000 and the corresponding figures for per capita consumption rose from 35,400 to 42,500.
                    \nFind the spending multiplier for this economy.
                    \nAnswer:
                    \nSpending multiplier = 1\/(1 – MPC)
                    \nMPC = Increase in Consumption\/Increase in Income (42,500\u201435,400)\/(50,000 – 42,300) = 0.922
                    \nMultiplier = 1\/(1 -0.922) = 12.82
                    \n= 1\/(0.078)<\/p>\n

                    \"Public<\/p>\n

                    Question 3.
                    \nAssume that the MPC is equal to 0.6.
                    \n(a) What is the value of government spending multiplier?
                    \n(b) What impact would a 50 billion increase in government spending have on equilibrium GDP?
                    \n(c) What about a 50 billion decrease in government spending?
                    \nAnswer:
                    \n(a) \\(\\frac{1}{1-\\mathrm{MPC}}\\) = \\(\\frac{1}{1-0.6}\\) = 2.5<\/p>\n

                    (b) Change in GDP = Initial Change in Spending \u00d7 \\(\\frac{1}{1-\\mathrm{MPC}}\\)
                    \nChange in GDP = 50 \u00d7 2.5 = 125 billion<\/p>\n

                    (c) Change in GDP = Initial Change in Spending \u00d7 \\(\\frac{1}{1-\\mathrm{MPC}}\\)
                    \nChange in GDP = -50 \u00d7 2.5 = -125 billion<\/p>\n

                    Question 4.
                    \nWhat would be the impact on GDP if both government spending and taxes are increased by 5 billion when the MPC is 0.9?
                    \nAnswer:
                    \nI I
                    \nSpending Multiplier = \\(\\frac{1}{1-\\mathrm{MPC}}\\) = \\(\\frac{1}{1-0.9}\\) = 10<\/p>\n

                    Change in GDP = Initial Change in Spending \u00d7 10
                    \n= 5 \u00d7 10 = 50 billion<\/p>\n

                    \"Public<\/p>\n

                    Tax multiplier = \\(\\frac{-b}{1-b}\\) = \\(\\frac{-0.9}{1-0.9}\\) = -9
                    \nChange in GDP = Initial Change in Tax \u00d7 -9 = -45 billion
                    \nThe net result is that output increases by 5 billion.<\/p>\n","protected":false},"excerpt":{"rendered":"

                    Public Finance \u2013 CA Inter Economics Study Material\u00a0is designed strictly as per the latest syllabus and exam pattern. Public Finance \u2013 CA Inter Economics Study Material Theory Questions Question 1. Explain the role of Government in a market economy as stated by Richard Musgrave. (3 Marks May 2018) Answer: Role of government in a market …<\/p>\n

                    Public Finance \u2013 CA Inter Economics Study Material<\/span> Read More »<\/a><\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"spay_email":"","footnotes":""},"categories":[167],"tags":[],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/17530"}],"collection":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/comments?post=17530"}],"version-history":[{"count":1,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/17530\/revisions"}],"predecessor-version":[{"id":17569,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/posts\/17530\/revisions\/17569"}],"wp:attachment":[{"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/media?parent=17530"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/categories?post=17530"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/gstguntur.com\/wp-json\/wp\/v2\/tags?post=17530"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}