Class 12 Economics Chapter 5 The Government: Budget and The Economy

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Class 12 Economics Chapter 5 The Government: Budget and The Economy

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Also, you can read the NCERT book Notes Class 12 Economics Chapter 5 The Government: Budget and The Economy online in these sections Solutions by Expert Teachers as per SCERT Class 12 Economics Chapter 5 The Government: Budget and The Economy (CBSE) Book guidelines. These solutions are part of AHSEC All Subject Solutions. Here we have given Assam Board Class 12 Economics Chapter 5 The Government: Budget and The Economy Solutions for All Subjects, You can practice these here in Class 12 Economics Chapter 5 The Government: Budget and The Economy.

The Government: Budget and The Economy

Chapter: 5

PART – A

VERY SHORT TYPE QUESTIONS ANSWERS

1. State one example of non-tax revenue.

Ans : Fees

2. State on example of capital expenditure.

Ans : Loan to union Territories.

3. When does a government incur budget deficit?

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Ans : When, Expenditure is more than Revenue.

4. What is revenue deficit?

Ans : Revenue deficit is the excess of total revenue expenditure over the total revenue receipts.

5. What is fiscal deficit?

Ans : Excess of total expenditure over revenue receipt and capital receipts excluding borrowing is called fiscal deficit.

6. What is primary deficit?

Ans : Fiscal deficit minus interest payment is primary deficit

7. What is a government budget?

Ans : Budget is an annual financial statement containing estimates of anticipated expenditure and revenue of the government for the coming financial year.

8. What is fiscal policy.

Ans : By fiscal discipline, we mean the central over public expenditure, given the quantum of revenue.

9. Write true or false:

Income tax is an indirect tax.

Ans : False.

10. Fill in the blank:

The excess of revenue expenditure over revenue receipt is called revenue .

Ans : Revenue deficit.

11. State one example of tax revenue.

Ans : Excise duty.

12. Write true or false:

(a) Sale tax is a direct tax. (b) Entertainment tax is an indirect tax.

Ans : (a) False (b) True.

13. Give one example of public goods.

Ans : Public Bank

14. Mention one item of non plan expenditure.

Ans : Interest payments, defence services, subsidies, salaries and pensions.

15. Fill in the blanks:

Post office savings account is and example of ______. (Capital receipt/Capital expenditure)

Ans : Capital receipt.

16. Define budget deficit and trade deficit.

Ans : When a government spends more than it collects by way revenue, it incurs budget deficit. Again, trade deficit means, when import is more than export.

B. SHORT ANSWER QUESTION TYPE-II: (MARKS: 3)

1. Suppose the total government spending G = 150 and tax revenue T = 0.20 Y. Now, if the level of national income (Y) is 2000, what is the condition of government budget?

Ans : Given,

G = 150

T = 0.20 Y

= 0.20(2000) I ∵ Y = 2000, given

∴ T = 400

∴ Govt. Budget = Govt Receipt(T) – Govt. Expt(G)

= 400-150 = 250, ie, surplus budget.

2. Distinguish between public goods and private goods.

Ans : Public goods are free to every individual for consumption some times without paying money. Public goods are enjoyed by all the people of the society.

Private goods are not free to every individual and the consumer has to pay money for it. Private goods are enjoyed by some individual only.

3. What is allocation function of the government.

Ans : Through its budgetary policy, the government of a country directs the allocation of resources in such a manner that there is a balance between the goods of profit maximization and social welfare. Production of goods which are injurious to health, is discouraged through heavy taxation. On the other hand, production of socially useful goods is encouraged through subsidies.

4. Explain the distribution function of the government.

Ans : Gout functions to reduce inequality from the society. Therefore govt. introduce measures like tax policy, subsidies, social security measures etc. from time to time.

5. Define surplus budget and balanced budget.

Ans : (i) A surplus budget is one, where the estimated revenues are greater than he estimated expenditures. It will lower the level of aggregate demand in the economy, which is considered good way to check inflation that arises due to the situation of excess demand.

(ii) A balanced budget is one, where the estimated revenue equals the estimated expenditure. It shows that government is not doing wasteful expenditure. It reflects financial stability in the country. Since the amount of additional tax and additional expenditure are equal, there will be net increase in aggregate demand.

A deficit budget is one, where the estimated revenue is less than estimated expenditure. This means that the tax is less than the expenditure. The reduction in increase in aggregate demand is by an amount equal to the expenditure. The net effect of this will be to increase aggregate demand. The deficit budget is therefore a good policy to combat recession, where the economy is in an under employment equilibrium due to deficit demand.

Merits of deficit budget are:

(i) It is most desirable, where the level of aggregate demand is low in the economy.

(ii) It accelerates growth.

(iii) It would be needed for the monetization of the economy.

Demerits of deficit budget are:

(i) It is not desired during the period of inflation as it adds to the supply of money.

(ii) It would lead to wasteful and unnecessary expenditure on the part of the government.

6. What are the components of government budget?

Ans : In simple word, budget is a document, which contains estimates of the government revenue and expenditure.

The main components of budget are:

(a) Revenue budget and (b) Capital budget.

(a) Revenue budget: The revenue budget shows the current receipts of the government and the expenditure that can be met from these receipts. Revenue receipts and revenue expenditure are shown in revenue account. Revenue receipts are divided into tax and non-tax revenue. Tax revenues consist of the proceeds of taxes and other duties levied by the government. Tax revenue comprise of direct taxes which fall directly on individuals and firms. Examples – personal income tax, corporation tax. And indirect taxes are excise duty, custom duty, service tax etc. non tax revenue of the government includes receipts from sources other than tax. It includes receipts in the form of commercial revenue e.g., revenue in form of prices paid for government supplied commodities, interest and dividend on government investment, administrative revenue etc.

Revenue expenditure refers to all those expenditures of the government, which do not result in creation of physical or financial assets. It relates to those expenses incurred for the normal functioning of the government departments and provision of various services, interest payments on debt incurred by the government. Revenue expenditure is classified into plan and non-plan expenditure. Plan expenditure relates to central plans and central assistance for state and union territory plans. Non-plan expenditure covers a vast range of general, economic and social services of the government. The main items of non-plan expenditure are – interest payments, defence services, subsidies, salaries and pensions.

(b) Capital budget: Capital budget is an account of the assets as well as liabilities of the government. It consist of capital receipts and capital expenditure. Capital receipts are defined as any receipt of the government, which either creates a liability or leads to reduction in assets. Capital receipt includes three items, recovery of loans, other receipts (mainly through disinvestment) and borrowings and other liabilities (e.g. small savings deposits in post offices etc.). capital receipts may be debt creating or non-debt creating. Net borrowing by government at home, loans received from foreign governments, borrowing from RBI are examples of debt creating capital receipts, whereas recovery of loans, proceeds from sale of public enterprises etc. are example of non-debt creating capital receipts.

Again, an expenditure, which either creates an assets or reduce liability is called capital expenditure. Capital expenditure consists mainly of expenditure on acquisition of assets like land, building, machinery, equipment, investment in shares etc. and loans and advances granted by the central government to state and union territory government companies, corporation and other parties. Capital expenditure is again classified into plan capital expenditure and non-plan capital expenditure. Plan capital expenditure refers to that expenditures, which is provided in the budget to be incurred by the government to fulfil its planned development programmes. These include both consumption as well as investment expenditure by the government, expenditure on agriculture, power, communication, industry, transport, health and education etc.

Non-plan expenditure is the all government expenditure, which are provided in the budget on routine functioning of the government. These include both consumption as well as investment expenditure of the government other than plan expenditure.

7. What are the components of capital receipt of government budget.

Ans : Capital budget is an account of the assets as well as liabilities of  the government. It consists of capital receipts and capital expenditure. Capital receipts are defined as any receipt of the government, which either creates a liability or leads to reduction in assets. Capital receipts includes three items, recovery of loans, other receipts (mainly through disinvestment) and borrowings and other liabilities (e.g. small savings deposits in post offices etc.). Capital receipts may be debt creating or non-debt creating. Net borrowing by government at home, loans received from foreign governments, borrowing from RBI are examples of debt creating capital receipts, whereas recovery of loans, proceeds from sale of public enterprises etc. are example of non-debt creating capital receipts. Again, an expenditure, which either creates an assets or reduces liability is called capital expenditure. Capital expenditure consists mainly of expenditure on acquisition of assets like land, building, machinery, equipment, investment in shares etc. and loans and advances granted by the central government to state and union territory government companies, corporation and other parties. Capital expenditure is again classified into plan capital expenditure and non-plan capital expenditure. Plan capital expenditure refers to that expenditures, which is provided in the budget to be incurred by the government to fulfil its planned development programmes. These include both consumption as well as investment expenditure by the government, expenditure on agriculture, power, communication, industry, transport, health and education etc.

Non-plan expenditure is the all government expenditure, which are provided in the budget on routine functioning of the government. These include both consumption as well as investment expenditure of the government other than plan expenditure.

8. Mention three main items of non-plan expenditure of a government budget.

Ans : The three main items of non-plan expenditure of a government budget are:

(a) Expenditure on police.

(b) Expenditure on general administrative.

(c) Expenditure on interest payment.

9. What does the revenue account of a government budget contain?

Ans : See Q. No. 7 (Short Type II).

10 Clarify the redistributive objective of government taxation.

Ans : See Q. No. 5(ii) (Short Type I).

11. State how government deficit can be reduced?

Ans : Government deficit can be reduced by monetary expansion. Borrowing, disinvestment or fiscal discipline.

12. Mention three items of capital expenditure.

Ans : Three items of capital expenditure are:

(i) Expenditure of acquisition of assets like land, building, equipment.

(ii) Loans and advance granted by the central government to state and union territory governments.

(iii) Government companies, corporations and other parties.

13. Explain how “free-rider” problem arises in case of public goods.

Ans : Public good refer to those goods and services which once produced can be consumed by every one in the society. There is no possible way of excluding anyone from enjoying the benefits of a public good even when he doesn’t contribute to the cost of a public good and in this way ‘free-rider’ problem arise in case of such goods.

C. SHORT ANSWER QUESTIONS TYPE – I: (MARKS: 4)

1. Distinguish between plan and non-plan expenditure.

Ans : Development expenditure is the expenditure on activities which are directly related to economic and social development of the country. This includes expenditure on education, health, agriculture and industrial development, rural development, social welfare, scientific research etc. Expenditure incurred on departmental enterprises under the plans and extra budgetary expenditure of non developmental enterprises of the government is also considered as development at expenditure. But non-development expenditure is expenditures incurred on essential general services of the government such expenditure is essential from administrative point of view. Expenditure on police, judiciary, defence, general administrative, interest payment, tax collection, subsidies on food etc. fall under this category. Although non-development expenditure does not contribute directly to national product, it does help indirectly in the process of economic development of a country.

2. What are the sources of government revenue? State briefly.

Ans : The main sources of govt revenue are:

(a) Tax Revenue, (b) Non-Tax Revenue.

The tax revenue are :

Direct tax and indirect tax Again, the non-tax revenue are –fees, fines Gifts, grants etc.

Direct taxes are normally imposed on income, wealth and property, whereas indirect taxes are levied on goods and services which people consume. Direct taxes are compulsory and can not be escape, while a person can avoid paying indirect tax by refraining from entering into the particular transaction.

The basis of classifying taxes into direct tax and indirect tax is whether the burden of the tax is shiftable to other or not. If it is not shiftable, it is an indirect tax.

Primary deficit is defined as fiscal deficit minus interest payment on previous borrowings

Primary deficit = Fiscal deficit – interest payments.

Primary deficits shows the borrowing requirements of the government for meeting expenditure exclusive of interest payment. If primary deficit is zero, then final deficit is equal to interest payment. It thus indicates how much government borrowing is going to finance expenses other than interest payments. It is generally used as basic measure of fiscal responsibility.

3. Distinguish between tax-revenue and non-tax revenue.

Ans : (i) Tax revenue is the income of the government from taxes. Tax payer can not expect any service or benefit from the government in return. Non tax revenue is the income of the government from sources other than taxes. It is in return for any services or benefit from the government.

(ii) Tax revenue is a major part of government income. Non-tax revenue’s share in government revenue is very small.

(iii) The main sources of tax revenue are income tax, corporate taxes, excess duty and sales tax. And non-tax revenue includes fees, fines, dividend, gifts and grants etc.

4. Trace out the relationship between government deficit and government debt.

Ans : The concepts of deficits and debt are closely related. Deficits can be thought of as a flow which add to the stock of debt. If the government continues to borrow year after year, it leads to the accumulation of debt and the government has to pay more and more by way of interest. These interest payments themselves contribute to the debt.

5. What are the basic objectives of a government budget? Explain briefly.

Ans : (i) reallocation of resources: Private sector does not undertake many economic activities due to low profitability and huge investment. As a result, government has to intervene. Through the budgetary policy, government aims to reallocate resources in accordance with the economic and social priorities of the country. For example, government discourages the production of harmful consumption goods through heavy taxes and encourages the use of ‘Khadi products’ by providing subsidies.

(ii) Redistribution Activities: Economic inequality is an inherent part of every economic system. Government aims to reduce such inequalities of income and wealth through its budgetary policy. Fiscal instruments like taxation, subsidies and expenditure on social security, public works etc. are used by the government to achieve this objective.

(iii) Management of public enterprises: There are large numbers of public sector industries, which are established and managed for social welfare of the public. Budget is prepared with the objective of making various provisions for managing such enterprises and providing them financial help.

(iv) Stabilizing Economic activities: Government budget is used to prevent business fluctuations of inflation or deflation and to maintain economic stability. The government aims to control the different phases of business fluctuations through its budgetary policy. Policies of surplus budget during inflation and deficit budget during deflation are adopted to achieve stability in the economy.

(v) Economic growth: Economic growth has been the main objective of every economic at all times. The growth rate of a country depends on rate of saving and investment. For this purpose, budgetary policy aims to mobilize sufficient resources for investment in the public sector. Therefore, the government makes various provisions in the budget to raise overall rate of savings and investments in the economy.

6. Explain the importance of stabilisation requirements of an economy.

Ans : The government budget is used to present economic fluctuations. Economic fluctuations refer to the situations of inflation or deflation. The government of a country is always committed to save the economy from periods of inflation or deflation. Budgetary policy measures are needed to raise the level of aggregate demand in times when expenditures exceed the available output price stability increase growth and development.

7. What is meant by revenue deficit? Explain three implications of revenue deficit.

Ans : Revenue deficit is when the net amount received (revenues less expenditures) falls short of the projected net amount to be received. This occurs when the actual amount of revenue received and/or the actual amount of expenditures do not correspond with predicted revenue and expenditure figures.

Implications of Revenue Deficit:

(a) It indicates the inability of the government to meet its regular and recurring expenditure in the proposed budget.

(b) It implies that government is dissaving, i.e. government is using up savings of other sectors of the economy to finance its consumption expenditure.

(c) It also implies that the government has to make up this deficit from capital receipts, i.e. through borrowings or disinvestments, it means, revenue deficit either leads to an increase in liability in the form of borrowings or reduce the assets through disinvestment.

8. Point out two merits and two demerit of indirect tax.

Ans : Merits and Demerits of Indirect Taxes are:

(A) Merit:

(i) Wide Coverage: The main merit of an indirect tax is that it touches all income groups. Direct tax, like income tax, is imposed on persons having a certain minimum level of income.

(ii) Consumption Control: By imposing an indirect tax, the consumption of an undesirable thing can be discouraged. For example, by imposing excise duties on wine and opium, the government discourages the consumption of such harmful products.

(B) Demerits:

(i) Regressive: Indirect taxes are not equitable. For instance, salt tax in India fell more heavily on the poor than on the rich, as it had to be paid at the same rate by all. Whether a rich man buys a commodity or a poor man, the price in the market is the same for all. The tax is wrapped in the price. Hence, rich and poor pay the same amount, which is obviously unfair. They are thus; regressive.

(ii) Uncertain: Unless indirect taxes are imposed on necessaries, we cannot be sure of the revenue yield. In this case of goods, with an elastic demand, the tax might not bring in much revenue. The tax will raise the price and contract the demand. When the thing is not purchased, the question of the tax payment does not arise.

D. LONG ANSWER QUESTIONS TYPE: (MARKS: 5)

1. Briefly explain the components of a government budget.

Ans : In simple word, budget is a document, which contains estimates of the government revenue and expenditure. A budget shows the planned revenue and planned expenditure.

The main components of budget are:

(a) Revenue budget and

(b) Capital budget.

(a) Revenue budget: The revenue budget shows the current receipts of the government and the expenditure that can be met from these receipts. Revenue receipts and revenue expenditure of the government are shown in revenue account. Revenue receipts are divided into tax and non-tax revenue. Tax revenue consist of the proceeds of taxes and other duties levied by the government. Tax revenue comprise of direct taxes which fall directly on individuals and firms. Examples-personal income tax, corporation tax. And indirect taxes are excise duty, custom duty, service tax etc. non tax revenue of the government includes receipts from sources other than tax. It includes receipts in the form of commercial revenue e.g., revenue in form of prices paid for government supplied commodities, interest and dividend on government investment, administrative revenue etc.

Revenue expenditure refers to all those expenditures of the government, which do not result in creation of physical or financial assets. It relates to those expenses incurred for the normal functioning of the government departments and provision of various services, interest payments on debt incurred by the government. Revenue expenditure is classified into plan and non-plan expenditure. Plan expenditure relates to central plans and central assistance for state and union territory plans. Non-plan expenditure covers a vast range of general, economic and social services of the government. The main items of non-plan expenditure are – interest payments, defence services, subsidies, salaries and pensions.

(b) Capital budget: Capital budget is an account of the assets as well as liabilities of the government. It consist of capital receipts and capital expenditure. Capital receipts are defined as any receipt of the government, which either creates a liability or leads to reduction in assets. Capital receipts includes three items, recovery of loans, other receipts (mainly through disinvestment) and borrowing and other liabilities (e.g. small savings deposits in post offices etc.). capital receipts may be debt creating or non-debt creating. Net borrowing by government at home, loans received from foreign governments, borrowing from RBI are examples of debt creating capital receipts, whereas recovery of loans, proceeds from sale of public enterprises etc. are example of non-debt creating capital receipts.

Again, an expenditure, which either creates an assets or reduce liability is calle4d capital expenditure. Capital expenditure consists mainly of expenditure on acquisition of assets like land, building, machinery, equipment, investment in shares etc. and loans and advances granted by the central government to state and union territory government companies, corporation and other parties. Capital expenditure is again classified into plan capital expenditure and non-plan capital expenditure. Plan capital expenditure refers to that expenditures, which is provided in the budget to be incurred by the government to fulfil its planned development programmes. These include both consumption as well as investment expenditure by the government, expenditure on agriculture, power, communication, industry, transport, health and education etc.

Non-plan expenditure is the all government expenditure, which are provided in the budget on routine functioning of the government. These include both consumption as well as investment expenditure of the government other than plan expenditure.

2. Explain the concepts of revenue deficit, fiscal and primary deficit in regards to a     government budget.

Ans : Revenue deficit is the excess of total revenue expenditure over the total revenue receipts.

Excess of total expenditure over revenue receipt and capital receipts Fiscal deficit minus interest payment is primary deficit.

3. Is government debt a burden? Explain.

Ans : Public debt is burdensome if it reduces growth in output. It has after been argued that ‘debt does not matter because we owe it to ourselves.’ This is because although there is a transfer of resources between generations purchasing power remains within the nation. However, any debt that is owed to foreigners involves a burden since we have to send goods abroad corresponding to the interest payments.

4. The consumption function in an economy is given as C = 300 + 0.75Y, investment expenditure (I) 250 and government pending is 200. Find out

(i) What is the equilibrium level of income?

(ii) If the government expenditure is increased by 100, what will be the change in the equilibrium.

Ans : Given, C = 300+0.75Y I = 250 G = 200

(i) ∴ Equilibrium Income (Y) = C+I+G = 300+0.75Y+250+200

⟹ Y – 0.75Y = 300 + 250 + 200 ⟹ Y (1-0.75) = 750

⟹ Y = 750/1-0.75 = 3000

(ii) Given, government spending increase by 100.

∴ DY = 11-C ∆G = 1/1-0.75 x 100 = 400

∴ New equilibrium income = 3000 + 400 = 3400

5. Suppose in a particular economy the consumption function is C = 150 + 0.6Y, investment is equal to 150, government purchases are 120 and net taxes (i.e. lump-sum taxes minus transfer) is 100. Now, (i) What is the equilibrium level of income?

(ii) Calculate the value of government expenditure multiplier and tax multiplier

(iii) If the government expenditure is increased by 100, find the change in equilibrium income.

Ans : Given, C = 150+0.6Y I = 150 G = 120 T = 100

(i) ∴ Equilibrium Income (y) = 150+0.6Y+150+120 ⟹ Y = 1050.

When net taxes imposed

Y = Y+T = 1050+100 = 1150, ie, new equilibrium income.

(ii) We know that,

(iii) Given, Govt. expenditure increased by 100.

∴ New equilibrium income = 1150+250

∴ Y = 1400

6. Suppose, the consumption function C = 80 + 0.9 Y, government expenditure (a) = 120 and the total tax revenue function T = 0.10 Y.

From the above information,

(i) Find out the equilibrium level of income.

(ii) What is the tax revenue (T) at the equilibrium level of income.

(iii) Does the government have a balanced budget?

Ans : Given, C = 80+0.9Y G = 120 T = 0.10Y

(i) ∴ Equilibrium income (Y) = C+G

⟹ y = 80+0.9y+120 ⟹ Y = 2000

Again, T = 0.10Y = 0.10(2000) = 200

∴ New equilibrium income Y = Y + T = 2000+200 = 2200

(ii) At equilibrium level of income revenue is, T = 200.

(iii) The government budget is balanced, because the government expenditure ( G = 120 ) is less then the tax revenue (T = 200)

7. Suppose, in an economy, the consumption function is C = 100 + 0.80 Y, investment (I) is 50, government expenditure (G) is equal to 100 and the total tax revenue (TR) is 150. Now,

(i) Find out the equilibrium level of income and income multiplier

(ii) If the government expenditure is increased by 50, what will be the impact on equilibrium income?

(iii) If a lump-sum tax of 50 is added to pay for the increase in government expenditure, how will equilibrium income change?

Ans : Same as See 4 & 5 above Long Q. Ans

8. What is a government budget? Explain the concept of revenue budget and capital budget.

Ans : Government budget is a constitutional obligation in India. Budget is a document which contains estimates of the government revenue and expenditure for the coming year. According to the Indian Constitution, “Budget means the annual financial statement containing an estimate of all anticipated revenue and expenditure of the government for the coming financial year”

Revenue budget and capital budget are the two components of Revenue budget.

Revenue budget includes revenue receipts and revenue expenditure of the government. Revenue receipts refer to those receipts of the government which neither create a liability nor tend to reduction in assets. Revenue receipts are divided into tax and non tax revenue. Tax revenue consists of  the proceeds of taxes and other duties levied by the government tax revenue an important component of revenue receipts. Comprise of direct taxes which fall directly on individuals and firms and indirect taxes like excise taxes, custom duties and service tax, non tax revenue of the government includes receipts from sources other then tax, non tax revenue does not create a liability for the government. It includes receipts in the form of commercial revenue e.g. revenue in form of interest and divided on government investment, administrative revenues license fees, registration fees, fines and penalties.

Revenue expenditure refers to all expenditure of the government which do not result in creation of physical or financial assets. It relates to those expenses incurred for the normal functioning of the government departments and provision of various services, interest payments on debt incurred by the government. Revenue expenditure again classified into plan and non plan expenditure. Plan expenditure relates to central plan and central assistance for state and union territory plans. Non plan expenditure covers a vast range of general, economic and social services of the government. The main items of non plan expenditure are interest payments, defence services, subsidies, salaries and pensions.

Capital budget is an account of the assets as well as liabilities of the government. It consists of capital receipts and capital expenditure. Capital receipts are defined as any receipts of the government which either creates a liability or leads to reduction in assets. Capital receipts include three items recovery of loans, other receipts and borrowing and other liabilities. Capital expenditure consists mainly of expenditure on acquisition of assets like land, building, machinery, equipment, investment in shares etc. and loans and advanced granted by the central government to state and union territory governments, government companies, corporations and other parties.

9. Explain the concept of balance budget multiplier.

Ans : A balance budget is one where the estimated revenue equals the estimated expenditure. It shows that government is not doing wasteful expenditure. It reflects financial stability in the country. Since the amount of additional tax and additional expenditure are equal, there will be net increase in aggregate demand. The decrease in aggregate demand is equal to MPC times the tax. Since tax is equal to expenditure, the decrease in aggregate demand is also equal to MPC times the expenditure. Now, the increase in aggregate demand due to the expenditure is equal to the amount of the expenditure. Then, the increase in aggregate demand is greater than the decrease in aggregate demand. The net effect is to increase aggregate demand by an amount equal to the expenditure multiplied by 1 – MPC. This can be illustrated with the help of an example, suppose tax is the only source of revenue and it is Rs. 200 which is equal to government expenditure. Government expenditure of Rs. 200 raises the level of aggregate demand by Rs. 200. Further suppose that MPC = 0.5 then reduction in disposable income by Rs. 200 would increase consumption expenditure by .5 x 200 = 100 which is MPC times decrease in income. Thus due to tax of Rs. 200, aggregate demand would decrease by Rs. 100 only. Aggregate demand increase by Rs. 200 due to government expenditure. Therefore, a net increase in AD is equal to Rs. 100 (200 – 100).

10. Explain two functions operated through government revenue and expenditure measures.

Ans : Revenue: Revenue from fiscal monopolies (liquor and gaming profits) are now considered taxes. They were previously classified under investment income.

The category “Privileges and permits” was deleted. Items such as business licences, motor vehicle licences and all local government licences and permits are treated as taxes while most personal paid licences are classified as sales of goods and services.

Grant in lieu of taxes, which were treated as transfers are now classified under property and related taxes.

The category “Natural resource revenue” was deleted. Natural resource royalties are now considered investment income while mining and logging taxes are now allocated to the income taxes category.

The tax category “Health and social insurance levies” has been split into two new non-tax categories, namely: “Health insurance premiums” and “Contributions to social insurance plans.”

Expenditures: The function “Transfers to own enterprises” was deleted. Services previously classified under that heading are now assigned to other functions, as appropriate.

A new recreation and culture sub-function called “Broadcasting” was created to include cultural services of the Canadian Broadcasting Corporation (CBC).

Evolution in the field of social services has necessitated new sub-groupings of services assigned to the function “Social services.”

Employer contributions to employee benefit plans (the supplementary Labour Income (SLI), the operation and maintenance of government buildings and provision of computer services to various ministries and crown corporations are now assigned to the function to which they relate rather than being totally assigned to the function “General services” per the previous edition of the manual.

Grants in lieu of taxes are now functionalized. They were previously considered general purpose transfers.

11. Write down four differences between Direct Tax and Indirect Tax.

Ans : (i) Direct Tax is referred to as the tax, levied on persons income and wealth and is paid directly to the government.

Indirect Tax is referred to the tax, levied on a person who consumes the goods and services and is paid indirectly to the government.

(ii) Direct Tax falls on the same person.

Indirect Tax Falls on different person.

(iii) Direct Tax helps in reducing the inflation.

Indirect taxes promotes the inflation.

(iv) Direct Tax cannot be shifted.

Indirect Tax can be shifted.

12. Write two differences between revenue expenditure and capital expenditure.

Ans : The following are the two differences between revenue expenditure and capital expenditure:

(a) Revenue expenditures are charged to expense in the current period or shortly thereafter. On the other hand, capital expenditures are charged to expense gradually via depreciation and over a long period of time.

(b) A revenue expenditures is assumed to be consumed within a very short period of time. While, a capital expenditure is assumed to be consumed over the useful life of the related fixed asset.

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