TyroCity: Economics Notes

Economics XI Questions

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Meaning

Meaning of Government Finance

Meaning of Government Finance

TyroCity.com — Sun, 18 Aug 2013 05:41:42 +0000

Government finance is the deliberate manipulation of revenues and expenditures of the government. It is the financial plan of the government. The government uses the different types of revenues and expenditures as fiscal tools to achieve different objectives. The main objectives are high economic growth, price stability, favorable balance of trade and payment, equitable distribution of income and wealth, proper allocation of resources, balanced and stable economic growth and so on. The government should avoid inflation and deflation, recession or depression. Improper use of resources, price fluctuation, high inequality and so on. For all these things revenues and expenditures are increased and decreased as per the situation of the country.

Government finance has two sides, they are

Government revenues
Government expenditures

In government revenues, the money received by the government in the form of royalties, taxes, escheats, penalties, fines, cess etc are included. In the government expenditure we include development expenditure, administrative expenditures, diplomatic expenditure, difference expenditure, payments of public debts and interest and miscellaneous expenditure. They are used as fiscal tools to solve different economic problems.

Interest

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Interest
Interest is the amount addition to principal paid by borrower to lender per unit of time. It is paid by borrower because of different reasons. The reasons are

Inconveniency due to lending: The lender feels inconveniency in lending. The lender will have less amount of money after lending some to the borrower. To compensate the inconveniency, the lender should obtain interest.
Decrease in value of money: The value of money decreases with flight of time. The value of money lent is less during the time of repayment than during the time of lending. For compensating this too, the lender should get interest.
Cost of keeping account: The lender keeps the account of money lent to others bearing some cost. In order to compensate the cost of keeping account to the lender should obtain interest.
Risk in repayment: The lender feels risk in the repayment of loan even the lender will honestly repay the loan in time as per the terms of borrowing and lending. Against this risk in repayment to the lender should obtain interest.
Sharing of benefit from the use of money: Borrower takes benefit from the use of money borrowed. Therefore, the benefits must be shared with lender in the form of interest.

Two concepts of interest
Gross interest:
The additional amount over the principal the borrower pays to the kinder for all the reasons is called gross interest. The gross interest includes the payment to the lender for inconveniency due to lending, decrease in value of money, cost of keeping account, risk in repayment and sharing of benefit from the use of money borrowed. Gross interest is the sum of net interest and interest paid and inconveniency due to lending, decrease in value of money, cost of keeping account and risk in repayment.
Mathematically,
Gross interest = net interest + payment for inconveniency due to lending

payment for decrease in value of money + payment for cost of keeping account + payment for risk in repayment.

Net interest:
It is the addition to principal only for the sharing of benefit from the use of money borrowed. For some economists, it is the payment for decrease in value of money too. It doesn’t include payment for cost of keeping account, inconveniency due to lending and risk in repayment. If we subtract the payment for their reasons from gross interest, we obtain net interest. Therefore, net interest is always less than gross profit.
Mathematically,
Net interest = Gross profit – (payment for inconveniency due to lending

payment for decrease in value of money + payment for cost of keeping account + payment for risk in repayment) Net interest = payment for of benefit from the use of money borrowed. Or, Net interest = payment for of benefit from the use of money borrowed + payment for decrease in value of money.

Classical theory of interest
This theory is propounded by classical economists. It is also called real theory of interest. According to classical theory of interest, interest rate is determined by the real factors like demand for capital and supply of capital. The demand for capital means the investment. It is the demand for capital goods like equipment, plants, machines, tools etc which can be used for production of goods and services. The supply of capital means savings. It is the value of goods and services left after consumption out of the income. The interest rate is determined at the point of equality between investment and saving
Mathematically,
Equilibrium interest is given by
Savings = Investment
This theory is based upon following assumptions

Money is veil and is just a medium of exchange
Money is demanded or borrowed only for investment
There is perfect competition in capital market
Both demand for capital and supply of capital are determined by interest rate.

Interest rate (r)	Demand for capital (I)	Supply of capital (S)
4%	Rs 10 billions	Rs 6 billions
6%	Rs 8 billions	Rs 8 billions
8%	Rs 6 billions	Rs 10 billions

Consumer Surplus

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Firstly, this theory was developed by French Engineer A.J. Dupit in 1844. Later on it was reformulated by Professor Marshall. This theory is related to the expenditure of daily life. While buying the commodity the consumer always thinks about the utility that he/she can get from the commodity. If consumer can get higher amount of utility in comparison to sacrifice made for the commodity than consumer have surplus. Consumer surplus is the excess amount of utility over sacrifice made for the commodity.

Consumer surplus is the excess amount of price that the consumer is ready to pay over actual price of commodity. Therefore, Consumer surplus = Ready to pay – Actual price of commodity.

We can explain this concept of commodity on the basis of given table:

Units of Commodity	Ready to pay M.U	Actual Price	Consumer Surplus
1	12	4	8
2	10	4	6
3	8	4	4
4	6	4	2
5	4	4	0
	Total = 40	Total = 20	20

On the above table, when consumer purchase first unit of he/she is ready to pay Rs 12 but actual price is Rs 4. So consumer gets surplus. Similarly, the consumer is trady to pay Rs. 10, 8, 6, 4 for 2, 3, 4, and 5th commodity where actual price is Rs 4 and he/she gets 6, 4, 2, and 0 surpluses respectively. Hence, total consumer surplus = T.U – T.E = 40 – 20 = 20.

The same concept can be explained by given figure:

On the above figure, x and y-axis measures unit of commodity and price/M.U respectively. The shaded area is consumer surplus because it is the excess amount of satisfaction over the actual sacrifice made for the commodity.

Sole trading concern

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Sole trading concern is the simplest, oldest and in some respect, the most natural form of business organization in private sector. According to Professor Henry,” the individual proprietor is the form of business organization at the head of which stands an individual as one who is responsible, who directs its operations and who alone runs the risk of failure.”

In this form a single individual is solely responsible for providing the capital, for bearing the risk and for overall management and control of the enterprise. In is the one man show owned, managed and operated by one person.

Characteristics

Single ownership:
A sole proprietorship is wholly owned by one individual. The individual supplies the total capital from which his own wealth or from borrowed funds. He/she is one to invest, return and fulfill all the requirement of the business.

One man control:
The proprietor all alone takes all the decisions pertaining to the business. He is not required to consult anybody. Ownership and management are vested in a person. There is no specialization or consultant required. It is a small scale business and requires lesser dedication than I other forms.

No legal entity:
A sole proprietorship has no legal entity separate from its owner. The law makes no distinction between the proprietor and the business. The assets and liabilities of the business and its proprietor are not different. Any illegal activity related to business is directly related to owner and vice-versa.

Unlimited liability:
Proprietor is liable for all the debts of the business. In case the assets are insufficient to meet the debts, the personal property of the proprietor can be attached. There is no limited liability like in the case of Joint Stock Company.

No profit sharing:
The proprietor is all alone entitled for all the profits and the losses of the business. He bears the compete risk and there is nobody to share the risks, workload or any profit or losses.

Small size:
The scale of operation carried out by sole proprietor is generally small.

Merits

Easy to start and dissolve:
A sole proprietorship can be setup easily and quickly. No legal formalities and expenditures are involved in the establishment of a proprietorship. There is no need to associate others or to enter any agreement. Only a license may be needed in special cases. The owner can start business operations as and when he desires.

Similarly, a sole proprietorship can be closed down very easily and quickly.

Motivation to work:
The proprietor is all alone entitled for all the profits and the losses of the business. He bears the complete risk and there is nobody to share the risks, workload or any profit or losses. There is direct relationship with efforts and reward. There is an incentive to work hard. The proprietor is motivated to make the best possible use of his skills and resources to maximize the profits.

Quick decisions:
The sole proprietor is completely free to take all decisions and to implement the. He doesn’t need to consult or seek others approval. Quick decisions and prompt actions are helpful to improve the efficiency of business operations.

Independent control:
The proprietor alone takes all the decisions pertaining to the business. He is not required to consult anybody. Ownership and management are vested in a person. There is no governmental intervention in day to day activities.

Business secrets:
The sole proprietor can keep the secrets to himself and these secrets are not known to competitors or others.

Personal contact:
A sole proprietor is in a position to maintain intimate contacts with his customers and employees. He can enter to the requirements of each and every customer. Close personal touch increases the competitive strength of the business.

Flexibility:
A sole proprietorship is small in size and has a simple management functions. Therefore, it can be adapted easily to suit the changing conditions of the market. The line of business can be easily changed or modified.

Economy:
The management of sole proprietorship is inexpensive. As sole proprietor himself is the manager, the cost of management is very low. Borrowing capacity is high owing to the unlimited personal liability of the owner.

Social utility:
Sole proprietorship provides an opportunity for gainful self employment for the people with limited money. It offers a way of earning an honorable living for those who doesn’t want to work under other. It also facilitates equitable distribution of income and wealth.

Demerits

Sole proprietorship has limited capital.
Sole proprietor only uses his ideas and innovation capacity. So there is limited managerial ability.
Sole proprietor must work more to earn more profit .higher profit generation is important. So, there is dull and monotonous wok.
Death of sole proprietor causes death of sole proprietorship.
There is no specialization in decision taking. So there can be chances of taking wrong decisions.
There is low investment resulting in limited areas of operation.

Types of Bank

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Central bank:
Central bank is the monetary authority or nation. It is the controller, regulator, monitor and supervisor of all kinds of financial institutions. CB issues notes. It is the bank of the bank, bank of the government, adviser of the government agent of the government.

Commercial Bank:
Commercial bank is established to provide short term loan to traders so it is called commercial bank. But at present commercial bank has been providing loan to several sectors like agriculture, industry, trade, tourism, etc. It has been providing not only short term loan rather providing medium and long term loan.

Agricultural Bank:
Agricultural bank is established for the development and modernization of agriculture sectors. It provides short term loan to farmers to purchase fertilizers, seeds as well as to pay wages. It also provides long term loan to farmers to purchase land and heavy agricultural equipment.

Industrial Bank:
Industrial bank provides industrial consultancy and loan for the establishment of industries. It also purchases, sales and underwrites the share and debenture of industries. Not only this as per the requirement it also invests in industries.

Exchange Bank:
Exchange bank deals with foreign currency and its objective is to help in international trade. It provides loan for foreign trade and helps in the settlement of debt between two countries. It provides loan to the importers by discounting their bills and remit the money of the importers to their parties.

Saving Bank:
Saving bank is established to collect the scattered saving of low income people and to mobilize their small savings. In this bank people open their account and there is issue of postal cash certifications. On the basis of postal cash certifications depositors can withdrew a definite amount of money once a week.

Cooperative Bank:
The bank which is organized by the people for their own collective benefit is called cooperative bank. Basically, such banks are established in rural area for promotion of agriculture sectors. But now days there are such banks is every sector.

Balance of trade

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

It is defined as net export i.e. relative export to import. It is systematic records of export and import. The difference between total export and total import of a country in a fiscal year gives balance of trade. On the basis of total export and total import, there are three types of balance of trade. They are

1. Favorable balance of trade:
If the total export is greater than total import, the country is said to have favorable balance of trade. In this case, the inflow of money from export is greater than outflow of money due to import. This type of international trade is said to be in surplus.

2. Unfavorable balance of trade:
If the total import is greater than total export, the country is said to have unfavorable balance of trade. In this case, the inflow of money from export is less than outflow of money due to import. This type of international trade is said to be in deficit.

3. Zero balance of trade:
If the total export is equal to total import, the country is said to have zero balance of trade. In this case, the inflow of money from export is equal to outflow of money due to import. This type of international trade is said to be in balance.

Balance of payment

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

It is defined as systematic records of all types of transaction of a country with the rest of the world. It is the records of amount paid to and amount received from the rest of the world. The amount received may be repayable or not and amount paid may be receivable or not. The amount receive are called receipts and amount paid are called payments. There are 2 sides of balance of payment. They are receipts and payments. The transactions recorded in balance of payment may be visible or not, repayable or not, receivable or not. It includes expenditures made by a foreigner in the reporting country and expenditure made by a domestic person in foreign countries, export and import, diplomatic expenditure of foreign countries in the reporting country, factor income earned from and rest of the world and factor income earned by foreigner form the reporting country, foreign lending and borrowing, foreigner’s investment in the reporting county and investing of domestic entrepreneurs in foreign countries etc.

There are two accounts in balance of payment. They are

1. Current account
The systematic records of short term transactions of a country with the rest of the world is called current account. The transactions recorded in this account have effect for less than one year. It includes foreign tourist expenditure in reporting countries, expenditure of domestic people in foreign countries, interest received from and paid to other countries, remittance received and paid, diplomatic expenditures etc. Short term receipts are recorded in receipt side of current account and short term payment are recorded in the payment side of current account.

2. Capital account
The systematic record of long term transactions of a country with the rest of the world is called capital account. The transactions recorded in this account have effect for more than one year. It includes capital inflow and outflow, foreign lending and borrowing, repayment of foreign debt and principle of foreign debt received. Long term receipts are recorded in receipt side of capital account and long term payment are recorded in the payment side of capital account.

There are 3 types of balance of payment. They are as detailed below

1. Favorable balance of payment:
If the total receipts are greater than total payment of a country form rest of the world, the country is said to have favorable balance of payment. It means total inflow of money from the rest of the world in a year is greater than total outflow of money to the rest of the world. Total receipt is the sum of total short term receipt and total long term receipts. Total payment is the sum of total short term payment and total long term payment.

2. Unfavorable balance of payment:
If the total receipts are less than total payment of a country form rest of the world, the country is said to have unfavorable balance of payment. It means total inflow of money from the rest of the world in a year is less than total outflow of money to the rest of the world.

3. Zero balance of payment:
If the total receipts are equal to total payment of a country form rest of the world, the country is said to have zero balance of payment. It means total inflow of money from the rest of the world in a year is equal to total outflow of money to the rest of the world.

Theory of product pricing

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Firm and industry:
Firm is a business unit for a particular commodity and industry ids a group of firms which produces same commodity.

Equilibrium of a firm:
Equilibrium refers to the condition where a firm gets maximum revenue and minimum loss. In this condition, there is no tendency of change of level of output. Firm do not want to increase or decrease the level of output under this condition. In all kinds of market structure, firm gets equilibrium if there are:

a. marginal cost (MC) equal to marginal revenue (MR)
b. marginal cost curve cuts to the marginal revenue curve from below.

Equilibrium of a firm under perfect competition market (MC and MR approach):
Under the perfect competition market MR curve is parallel to x-axis. In this market also, a firm can achieve equilibrium position when given two conditions are fulfilled:

a. when MC = MR
b. MC cuts MR from below

By the help of given figure we can explain equilibrium of a firm under perfect competition market.

On the above figure, output is measured on x-axis whereas price, marginal revenue and marginal cost is measured on y-axis. At point F, MR and MC are equal and MC cuts MR from above so that point F is not the equilibrium point because if the producer produces more than Q1 then profit amount is increased. So, he wants to produce more which is against equilibrium position. But point E is equilibrium position because if he produces more than Q2 there is no chance of profit. So, producer wants to remain at point E by producing Q2 output which gives maximum revenue and MC = MR when MC cuts MR from below.

Poverty line

Economics 11 Notes — Sun, 08 Apr 2012 05:41:42 +0000

The poverty line established the distinction between who is poor and who is not. According to Nepal Living Standard Survey (NLSS) 2010/11 an individual considered as poor if his/her per capita total income is below Rs 19261. According to this approach 25.16% people live below the poverty line where 15.46% urban poor and 27.43% rural poor.

Price elasticity of demand

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Price elasticity of demand (ep)

It refers the percentage change in quality demand due to the certain percentage change in price when other things remaining the same. Mathematically it is explained as:

Where,
ed = elasticity of demand
∆Q = change in quantity demand
∆P = change in price commodity
P = initial price
Q = initial quantity demand

Profit

Economics 12 Notes — Sun, 08 Apr 2012 05:41:42 +0000

Generally, profit is the difference between revenue and cost of production. Revenue is amount obtained from sale. Mathematically,
Profit= total revenue-total cost
Or, Ω= R-C
If R> C then, Ω >0 i.e. profit
If R<C then, Ω < 0 i.e. loss
If R=C then, Ω = 0 i.e. break even point
Cost of production means the total amount paid to inputs used in the production. It includes wage paid to labor, interest paid to capital, rent paid to land, cost of raw materials, fuels, energies and so on. Both revenue and cost depends upon quantity produced and sold.
There are two types of cost. They are

Explicit cost:
The cost of inputs hired or purchased is called explicit cost. It includes wages of labor hired, interest of money borrowed and invested, rent of land and building hired, cost of raw materials, fuels, energies purchased etc. These amounts are not income of the investors. These are cost to them. If we subtract explicit cost from revenue we obtain gross profit.

Implicit cost:
It is the cost of inputs owned by investors themselves which are used in the production. It includes the wage or salary of investors themselves, rent of land and building of investor themselves, interest of money of investors. If we subtract both explicit cost and implicit cost from the revenue we obtain net profit.
Types of profit:
There are 2 types of profit. They are;

Gross profit
Excess revenue over the explicit cost of production is called gross profit. It is the difference between total revenue obtained from sale and explicit cost. Mathematically,
Gross profit = Total revenue – Explicit cost

Net profit
Excess revenue over all types of cost of production is called net profit. It is the difference between total revenue obtained from sale and the sum of explicit cost and implicit cost. Mathematically,
Net profit= Total revenue – (explicit cost +implicit cost)
Gross profit includes cost of inputs owned by entrepreneur too but net profit doesn’t include it, that’s why, net profit is always less than gross profit. If not a single input used is owned by entrepreneur, the gross profit and net profit are equal. In this case, implicit cost is equal to 0.

Causes of profit

Effective combination of other inputs
The organization brings other inputs like land, capital etc. together and combines for production, for it, organization should obtain profit as its remuneration.
Innovation:
Organization brings innovation in type and quality of products, management and technology. For it to the organization should earn profit.
Bargaining power
Every organization has bargaining power due to more or less control in the market, resources, and special skills and so on. For it too organization should earn profit.
Risk involved in business
There is always risk involved in business due to different reasons. For taking risk too, the organization should earn profit as compensation.
Uncertainty
Some economists consider that organization should earn profit for bearing uncertainty due to unforeseeable or non-insurable risk.