NCERT Solutions for Class 12 Macro Economics Chapter 5 Government Budget and The Economy

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

Ans: A non-rival and non-excludable good is referred to as a public good. Non-rival means that one person's consumption has no effect on the consumption of another. Non-excludable, on the other hand, implies that no individual can be barred from using the good. Parks, roads, national defense, government administration, and so on are examples of services that cannot be provided by a market mechanism. These items are required for survival and national development.

The government must provide these goods for the following reasons:

i. The benefits of public goods are easily accessible to anyone without affecting the consumption of others. There arises a failure of the market.

ii. As public commodities are open to everyone, no one can be denied access to them. When the relationship between the producer and the consumer breaks down, the government is forced to intervene through public policies.

2. Distinguish between revenue expenditure and capital expenditure.

Ans: Revenue Expenditure: In simpler terms, Revenue Expenditure refers to any expenditure that neither creates assets nor reduces liabilities, such as employee salaries, interest payments on past debt, subsidies, pensions, and so on. These are funded by revenue receipts. In general, revenue expenditure is defined as any expenditure that does not result in the creation of assets or the reduction of liabilities. It occurs in nature as part of day-to-day activities. Revenue expenditure generally refers to expenses incurred on the day-to-day operations of government departments and the upkeep of services. Salary payments to government employees, interest payments on government loans, pensions, subsidies, grants, rural development, education and health services, and so on are examples of revenue expenditures.

Capital Expenditure: Capital expenditure refers to any expenditure that either creates an asset (e.g., a school building) or reduces liability (e.g., loan repayment). It is a one-time occurrence in nature.

(A) Capital expenditure that results in the creation of assets includes 

(a) expenditure on the purchase of land, buildings, and machinery, 

(b) investment in shares, loans from the Central Government to state governments, foreign governments, and government companies, cash in hand, and 

(c) the acquisition of valuables.

(B) Long-term development programs, real capital assets, and financial assets are examples of such expenditures. This type of spending adds to the economy's capital stock and increases its capacity to produce more in the future.

(C) Loan repayment is also considered capital expenditure because it reduces liability. These expenses are covered by the government's capital receipts, which include capital transfers from the rest of the world. 

3. 'The fiscal deficit gives the borrowing requirement of the government'. Elucidate. 

Ans: (i) The fiscal deficit is defined as the difference between total expenditure and total receipts (revenue and capital receipts), excluding borrowing. As an example, consider the following equation:

$\text { Fiscal Deficit }=\text { Total Budget Expenditure - Total Budget Receipts (Net of borrowing) }$

$=$ Total Expenditure (RevenueExpenditure $+$ Capital Expenditure) $-$

Revenue Receipts (Tax Revenue + Non-Tax Revenue) - Non-Debt

Capital Receipts (Recovery of Loans + Dis-investment Proceeds)

$=$ Revenue Deficit $+$ Capital Deficit (excluding Borrowing)- Borrowing

$=$ Net borrowing at home $+$ Borrowing from RBI $+$ Borrowing from abroad

(ii) The fiscal deficit represents the government's total borrowing needs from all sources.

(iii) As the government borrows more, its future obligation to repay loans with interest grows, resulting in a larger revenue deficit. As a result, the fiscal deficit should be kept as low as possible.. 

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

Ans: (i) The fiscal deficit is always broader than the revenue deficit.

(ii) The revenue deficit is defined as the difference between the government's revenue expenditure and revenue receipts. Regarding the formula:

$\text { Revenue Deficit = Revenue Expenditures (RE) - Revenue Receipts (RR) }$

(iii) In short, a government budget will have a revenue deficit if revenue expenditure exceeds revenue receipts.

(iv) The fiscal deficit is defined as the difference between total expenditure and total receipts net of borrowings.

(v) Initially, the fiscal deficit does not account for all types of receipts. Borrowings are not taken into account. But, in the end, they must rely on borrowing to cover the fiscal deficit. 

$\text{Fiscal Deficit = Revenue Deficit + Capital Deficit (Excluding Borrowing)- Borrowing}$

$=\text{Net borrowing at home }+\text{ Borrowing from RBI }+\text{ Borrowing from abroad}$

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 

$\mathrm{C}=100+0.75 \mathrm{Y}$

(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.

Ans:

$\mathrm{I}=200$

$\mathrm{G}=150$

$\mathrm{~T}=100$

$\mathrm{C}=100+0.75 \mathrm{Y}$

So, C (Autonomous consumption) $=100$ And,

$\operatorname{MPC}(\mathrm{c})=0.75$

(a) Equilibrium level of income

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

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

$=\frac{1}{0.25}\times 375$

$=\operatorname{Rs}1500$

(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) $\Delta \mathrm{G}=200$

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

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

$=\frac{1}{0.25} \times 575$

$=$ Rs 2300

$=\frac{1}{0.25} \times 575$

$=\text { Rs } 2300$

Therefore, the change in equilibrium income is calculated as

$=2300-1500$

$=800$

6. Consider an economy described by the following functions: 

$\mathrm{C}=20+0.80 \mathrm{Y}, \mathrm{I}=30, \mathrm{G}=50, \mathrm{TR}=100$

(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?

Ans: (a)

$\mathrm{C}=20+0.80 \mathrm{Y}[\overline{\mathrm{C}}=20]$

$\mathrm{I}=30$

$\mathrm{c}=0.80$

$\mathrm{G}=50$

$\mathrm{~T}=100$

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

$\Delta \mathrm{G}=30$

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

$=\mathrm{Y}+\Delta \mathrm{Y}$

$=90 \mathrm{O}+(-120)$

$=\operatorname{Rs} 780$

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

Ans: 

$\mathrm{MPC}=0.80$

$\overline{\mathrm{C}}=20$

$\mathrm{I}=30$

$\mathrm{G}=50$

$\mathrm{TR}=100$

$\Delta \mathrm{TR}=10$

Equilibrium level of income is calculated as

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

$=\frac{1}{1-0.80}\{20+80+30+50+0.80 \times 10\}$

$=\frac{188}{20} \times 100$

$=940$

Change in equilibrium $=940-900=$ Rs 40

Increase in lump-sum tax $\Delta \mathrm{T}=10$

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

$=-10 \times \frac{0.80}{0.20}$

$=-40$

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.

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?

Ans: 

(a) $\mathrm{C}=70+0.70 \mathrm{YD}$

$\mathrm{I}=90$

$\mathrm{G} =100$

$\mathrm{~T}=0.10 \mathrm{Y}$

$\mathrm{Y}=\mathrm{C}+\mathrm{I}+\mathrm{G}$

$\mathrm{Y}=70+0.70 \mathrm{YD}+90+100 \mathrm{Y}$

$=70+0.70 \mathrm{D} \mathrm{D}+190$

$=70+0.70(\mathrm{Y}-\mathrm{T})+190$

$\mathrm{Y}=70+0.70 \mathrm{Y}-0.70 \mathrm{~T}+190$

$=70+0.70 \mathrm{Y}-0.70 \times 0.10 \mathrm{Y}+190$

$=70+0.70 \mathrm{Y}-0.0 \mathrm{Y} \mathrm{Y}+190$

$=70+0.63 \mathrm{Y}+190$

$\mathrm{Y}-0.63 \mathrm{Y}=260$

$0.37 \mathrm{Y}=260$

$\mathrm{Y}=\frac{260}{0.37}$

$\mathrm{Y}=702.7$

(b) $\mathrm{T}=0.10 \mathrm{Y}$

$=0.10 \times 702.7$

$=70.27$

Government spending $=100$

Tax revenue $=70.27 \%$

As G $>\mathrm{T}$, the government has a deficit budget rather than a balanced budget. Because government spending outweighs tax revenue.

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 $20 .$

Ans: In case of proportional taxes

(a) $\mathrm{MPC}=0.75$ and $\Delta \mathrm{G}=20$

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

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

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

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

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

$=\frac{0.75}{0.25} \times 20$

$=60$

10. Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier.

Ans: As government expenditure impacts total expenditure and taxes through the multiplier, the tax multiplier is less in absolute magnitude than the government expenditure multiplier. The tax multiplier has an impact on disposable income, which has an impact on overall consumption.

The reason is illustrated by the following example:

Consider the value of MPC be 0.50

The government expenditure multiplier is calculated as

$\text { Government Expenditure }=\frac{1}{1-\mathrm{c}}$

$=\frac{1}{1-0.50}$

$=\frac{100}{50}=2$

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

$=\frac{-0.50}{1-0.50}=-1$

This demonstrates that the government expenditure multiplier is greater than the tax multiplier.

11. Explain the relation between government deficit and government debt. 

Ans: Deficit and debt are intimately connected concepts. Deficit is analogous to a sallow that adds to the debt stock. If the government borrows year after year, the debt grows, and the government is obliged to pay more and more interest. Interest payments are included in the loan. In other terms, the government deficit is the difference between total government expenditure and total government income, and the government debt is the amount of debt owed to public, foreign, and other organisations by the government.

12. Does public debt impose a burden? Explain. 

Ans: The amount or money that a central government owes is referred to as government debt or public debt. This amount may represent government borrowings from banks, public financial institutions, and other external and internal sources. Yes, public debt does impose a burden on the economy as a whole, as illustrated by the following points.

i. Negative Impact on Productivity and Investment: To pay the debt, a government may levy taxes or print money. This, however, reduces people's ability to work, save, and invest, hampereding a country's development.

ii. Burden on Future Generations: The government shifts the burden of lower consumption to future generations. Higher current government borrowings result in higher future taxes levied to repay past obligations. The government taxes the younger generations, reducing their consumption, savings, and investments. As a result, increased public debt has a negative impact on the welfare of future generations.

iii. Lowers the Private Investment: By boosting interest rates on bonds and securities, the government promotes greater investment. As a result, the government obtains a disproportionate share of the savings of residents, crowding out private investments.

iv. Causes a Drain on National Wealth: The wealth of the country is depleted as a result of repaying loans obtained from foreign countries and institutions. 

13. Are Fiscal Deficits Inflationary? 

Ans: Yes, if fiscal deficits are financed by issuing new currency, inflation will rise. It could be worse if the new currency is used to finance the government's current consumption expenditure. When government spending increases while taxation decreases, there is a government deficit, and aggregate demand rises as a result. Fiscal deficits are thus inflationary in this sense. If new funds are used for infrastructure or other capital projects, the fiscal deficit will not cause inflation. In this case, a high fiscal deficit is accompanied by high demand, resulting in a higher output level and a lower inflationary situation. 

14. Discuss the issue of deficit reduction. 

Ans: The following are methods for reducing the government's budget deficit:

(i) Decrease in Expenditures: 

(a) Government expenditures should be reduced by making government activities more planned and effective. It should reduce inefficient and unnecessary administrative tasks.

(b) The government can encourage the private sector to invest in capital projects that will reduce government spending.

(ii) Revenue Growth / Increased Revenue Generation:

(a) Higher taxes imply that the government earns more money. Furthermore, imposing new taxes or raising the rates of existing taxes may increase the government's revenue. 

(b) To increase revenue, the government can sell shares in Public Sector Undertakings (PSU disinvestment).

Important Questions from Government Budget and the Economy (Short, Long & Practice)

Short Answer Type Questions

1. What is the government budget?

2. Give two examples of non-tax revenue receipts.

3. Give two examples of direct tax.

4. Why is repayment of loan a capital expenditure?

Long Answer Type Questions

1. Giving reason, state whether the following is a revenue expenditure or a capital expenditure in a government budget:

(i) Expenditure on scholarships

(ii) Expenditure on building a bridge 

2. Explain the role of the government budget in bringing economic stability.

3. Distinguish between revenue expenditure and capital expenditure in a government budget. Give an example.

Practice Questions

1. On what basis is government expenditure classified into capital expenditure and revenue expenditure? Give an example of each.

2. Give meanings of revenue receipts and capital expenditures with one example for each. 

3. Giving reasons to classify the following into direct tax and indirect tax.

(i) Wealth tax

(ii) Entertainment tax

(iii) Income tax 

Key Features of NCERT Solutions for CBSE Class 12 Macro Economics Chapter 5

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Conclusion

NCERT Solutions for Class 12 Macro Chapter 5 - "Government Budget and the Economy" are indispensable for students delving into the complexities of fiscal policy and government finance. These solutions provide comprehensive explanations, practical examples, and step-by-step guidance to help students grasp the nuances of government budgets, taxation, and their impact on the economy. They serve as essential study aids, fostering a deeper understanding of how government spending and revenue collection influence economic stability and growth.

Vedantu’s NCERT Solutions align seamlessly with the curriculum, ensuring that students have access to accurate and comprehensive resources to excel in their macroeconomics studies. They empower students with the knowledge and analytical skills needed to evaluate budgetary policies and their implications for society.