CBSE Class 12 Economics Balance of Payment Revision Notes

Balance of Payment. :Balance of payments is an accounting statement that provides a systematic record of all the economics transactions between the residents of a country and the crore rest of the world in a given period of time.

A country exported goods worth Rs. 2600 crore whereas its imports amounted to Rs.1700 crore. Calculate the volume of balance of trade.

Ans. BOT=Exports –Imports=Rs. 2600 crore –Rs. 1700crore =Rs. 900 crore.

Distinguish between balance of trade and balance of payments.

Ans.

Distinguish between BOP current account and BOP capital account.

Components of current account of BOP.

The main components of current account of BOP are as follows:

a)  Visible trade or Merchandise transactions---In foreign trade, there will be inflow and outflow of foreign exchange on account of  export and import of visible goods respectively. Receipts from exports and payments for imports are shown on credit and debit items respectively.

b)  Invisible Trade----There will be receipts and payments of foreign exchange for services (invisible items) sold and purchased by the residents of a country to and from the rest of the world respectively.

c)  Unilateral or unrequited transfers---These refer to those receipts and payments which take place without any corresponding service in return in the current period like gifts, donations, remittances and other one way transactions. Receipts and payments of unilateral transfers from and to abroad is shown on the credit and debit side respectively.

Explain the main components of capital account of BOP.

Ans. Capital account is related to assets and liabilities of the residents of the country or its government and the components are as follows:

a)  Private transactions--- Private sector of the country receives short -term and long-term foreign loans. Receipts of such loans are recorded as credit items and their repayment is recorded as debit item.

b)  Official transactions---Government borrows loans from foreign government and international organizations to finance the deficit in the balance of payments. Receipts of such loans are recorded on the credit side and repayment of loans is recorded on the debit side.

c)  Foreign Direct Investment---It refers to purchase of an asset in the rest of the world which gives full control to the buyer over the asset. Purchase and sale of assets abroad is recorded on the debit and credit side of BOP respectively.

d)  Portfolio Investment------It refers to purchase of an asset in the rest of the world which does not give full control over the asset. Purchase of shares of a foreign firm gives only partial control over the asset. Purchase of assets abroad is recorded on the debit side and sale of assets abroad is recorded on credit side of BOP.

Differentiate between autonomous and accommodating items.

FOREIGN EXCHANGE RATE

Ques 1: What is foreign exchange rate?

Ans: Foreign exchange rate is the rate at which the currency of one country is exchanged with the currency of another country.

Ques 2: Define fixed exchange rate.

Ans: Fixed exchange rate is the rate which is fixed in terms of gold or any other currency by the government and remains fixed till it is changed by the government or monetary authority.

Ques 3: What is flexible exchange rate?

Ans: Flexible exchange rate is the rate which is determined by the interaction of demand and supply of foreign exchange in the foreign exchange market.

Ques 4: What are the sources /determinants of demand for foreign exchange ?

Ans: The demand of foreign exchange arises in order to make payment in foreign currency.The sources are

a)   Import of goods and services

b)   Tourism

c)    Remittances by foreigners working in India

d)   Repayment of interest and loans.

e)   Extension of loans to foreigners.

Ques 5: What are sources /determinants of supply for foreign exchange?

Ans: The major sources of supply of foreign exchange are as follows:

a)   Export of goods and services

b)   Foreign tourist in India

c)    Remittances by Indians working abroad.

d)   Foreign direct investment

e)   Purchase of shares by foreign investors (portfolio investment)

f)    Deposits by non- resident Indians 

Ques 6: How is equilibrium exchange rate determined?

Ans: Equilibrium exchange rate is determined at a point where the quantity demanded and the quantity supplied of foreign exchange are equal. Negatively sloped demand curve  and positively sloped supply curve of foreign exchange intersect each other at point E. Point E shows equilibrium between demand and supply of foreign exchange. Equilibrium rate of exchange is E at which the quantity demanded and the quantity supplied are equal.

Ques 7: Define depreciation of currency.

Ans: Depreciation of currency means that there is a fall in the value of domestic currency in terms of foreign currency.

Ques 8: Define appreciation of currency.

Ans: Appreciation of currency means that there is a rise in the value of domestic currency in terms of foreign currency.

Ques 9: Define managed floating rate system.

Ans: Managed floating rate system is a system in which foreign exchange rate is determined by market forces and stabilizes the exchange rate in case of appreciation or depreciation of domestic currency.

Ques 10: Define a Bank

Ans: Bank is an institution which borrows and lends money.

Ques 11: Write the one main function of commercial bank in an economy.

Ans: One main function of bank in an economy is – Acceptance of  deposits :- The bank accepts three types of deposits from the public  1) Current account deposits 2) Fixed/term deposit 3) Saving account deposits.

Ques 12: Define Central Bank. Write the name of Central Bank of India.

Ans: Central Bank designs and controls the monetary policy of the country. The name of Central Bank is Reserve Bank of India.

Ques 13: Why are all financial institutions not commercial bank?

Ans: A financial institution becomes a commercial bank only when it  performs both the activities of a) Accepting deposits from the people and b) Making loan to the people.

Ques 14: Which institution is responsible for the monetary policy of the   country?

Ans: The Central bank is responsible for the monetary policy of the Country.

Ques 15: Name the institution which issued the currency notes of the  country.

Ans: The Central Bank(Reserve Bank of India) issues the currency note of the country.

Ques 16: Write the main functions of the Commercial Bank.

Ans: The main functions of the Commercial bank are:-

A) Acceptance of deposits :- The bank accepts three types of deposits from the public 1) Current account deposits 2) Fixed/term deposit 3) Saving account deposits.

B) Advancing Loans :- The different types of loans and advances  made by banks are as follows – cash credit, demand loans, and short term loans and over draft.

C)Credit Creation :- Banks create credit by giving more loan than  their cash reserves.

Ques 17: Write the functions of Central Bank.

Ans: 1) Currency Authority

        2) Banker to the government

        3) Bankers Bank and supervisor

        4) Controller of Money Supply and Credit

Ques 18:  What is the meaning of Banking?

Ans: Banking is defined as the accepting for the purpose of landing or investment of deposits.

Ques 19: How the Bank rate controls the credit?

Ans: Bank rate is the rate of interest at which Central bank lends to Commercial banks. By raising the bank rate central bank raises the  cost of borrowing. This forces the Commercial banks to raise in turn the rate of interest from the public. As lending rate rises demand for loan for investment and other purposes falls.

Ques 20: Which are the Quantitative instrument to control the money supply and credit in the economy?

Ans: The Quantitative instrument to control the money supply and credit in the  economy are

1) Bank Rate policy – the bank rate is the rate at which the control bank lends funds as a lender of last resort to banks against approved securities.

2) Open market operation :- Open market operation is the buying and selling of government securities by the Central Bank from/to the public and bank on its own account.

3) Varying Reserve Requirements :- Banks are obliged to maintain reserves with the Central bank on two account. One is the cash reserve ratio and the other is  Statutory Liquidity Ratio. Varing CRR and SLR are tools of monetary and credit control.

Ques 21: Write the Qualitative instruments to control the credit of the Central Bank.

Ans: The Qualitative instruments to control the credit of the Central

        Banks are :

A) Imposing margin requirement on secured loans:- A margin is the difference between the amount of the loan and market value of   the security offered by the borrower against the loan.

B) Moral Suasion :- This is a combination of persuasion and pressure that the Central Bank applies on the other banks in order to get them to fall in line with its policy.

C) Selective credit controls :- These can be applied in both positive as well as a negative manner.

Ques 22: Write the two function of each Central Bank and Commercial  Bank.

Ans: Function of Central Bank :-       

   1) Currency Authority :- The central Bank is the sole authority for the issue of currency in the country. All the currency issued by the central bank is its monetary liability. This means that the central bank is obliged to back the currency with assets of equal value.           

   2) Banker to the government :- The central bank acts as a banker to the government both central as well as state governments. It carries out all the banking business of the government and the government keeps its cash balances on current account with the central bank.

Functions of the Commercial Bank:-

 A) Acceptance of deposits :- The bank accepts three types of deposits from the public 1) Current account deposits 2) Fixed/term deposit 3) Saving account deposits.

 B) Advancing Loans :- The different types of loans and advances made by banks are as follows – cash credit, demand loans, and short term loans and over draft.

Ques 1: What is aggregate demand in macroeconomics?  

Ans: It is aggregate expenditure on ex-ante (planned) consumption and ex-ante (planned) investment that all sectors of the economy are willing to incur at each income level.

Ques 2: What is aggregate supply in macroeconomics?              

Ans: Aggregate supply is the total amount of money value of goods and services, (which is paid to the factor of production against their factor services) that all the producers are willing to supply in an economy.

Ques 3: What is consumption function?                                        

Ans: Consumption function expresses functional relationship between aggregate consumption and national income. C=f(Y)

Ques 4: Explain savings function.                                                 

Ans: (i) Propensity to save (or saving function ) shows the functional relationship between savings and income.

S=f(Y)

S=-C+(1-b)Y 

Ques 5: Can the value of APC be less than zero?                         

Ans: No, because even at zero level of income, we will consume something i.e., autonomous consumption.

Ques 6: Why can value of MPC be not greater than one?   

Ans: It is so because Keynes’ psychological law of consumption state that when income increases, consumption all increases but at a lesser rate .So, increases in consumption is always less than increase in income , i.e., 

MPC= ∆C/ ∆Y=  is always less than one. 

Ques 7: Can the value of average propensity to save be negative? If yes, when?

Ans: Yes, the value of average propensity to save can be negative when consumption is more than national income, i.e. , before the break-even point.

Ques 8: What can be the maximum value of marginal propensity to save?    

Ans: The maximum value of marginal propensity to save is one. It is possible only when MPC= 0 i.e., the entire additional income is save.

Ques 9: What is the relationship between APC &APS?                          

Ans:  The sum of APC & APS is equal to one i.e.,  APC+APS = 1.

Ques 10: What is the relationship between marginal propensity to save and marginal propensity to consume?                           

Ans: The sum total of MPC and MPS is equals to one i.e., MPC+MPS=1.

Ques 11: Why APC falls with the increase in income?                  

Ans: APC falls continuously with the increase in income because the proportion of income spent on consumption keeps on decreasing.

Ques 12: What can be the maximum value of marginal propensity to save?           

Ans: The maximum value of marginal propensity to save is 1. It is possible only when MPC=0 , i.e., the entire additional income is saved.

Ques 13: Give the meaning of autonomous consumption.            

 Ans: It refers to minimum level of consumption (i.e. C) ,which is needed for survival i.e., consumption at zero level of national income .

Ques 14: Define the term ‘multiplier’. How do we measure it?     

Ans: the ratio of change in national income ( ∆Y) due to change in investment (∆I)is known as multiplier (K).

                                             (k)=∆Y/∆I

Ques 15: What is meant by excess demand in macroeconomics?

Ans:  When economy aggregate demand exceeds “aggregate supply at full employment level”, the demand is said to be an excess demand.

Ques 16: Define deflationary gap.                                                  

Ans: When in an economy aggregate demand falls short of aggregate supply at full employment level the demand is said to be deficient demand and the gap is called deflationary gap.

Ques 17: Give the meaning of full employment.                                      

Ans: full employment equilibrium refers to the situation where aggregate demand is equals to aggregate supply and all those who are able to work and willing to work (at the existing wage rate) are getting work.

Ques 18: What is Marginal Propensity to Consume? How is it related to Marginal Propensity to save?                                                     

Ans: The ratio of change in consumption(C) to change in income(Y) is known as Marginal Propensity to Consume. It indicates the proportion of additional income that is being spent on consumption.

                          MPC=∆C/∆Y

                          MPC+MPS=1

Ques 19: In an economy plan saving is greater than plan investment. Explain the how the economy achieves equilibrium level of national income.                          

Ans: It refers to the point that has come to be established under the given condition of aggregate demand and aggregate supply, and has tendency to stick to the level under this given condition.

Therefore,  AD=AS

                 C+I = C+S

                  I= C+S-C =S

As given in the examination problem, when planned saving is greater than plan investment, then national income will decrease .

When saving > investment (at Y1), then there would be stock-pilling and producer will produce less. National will fall and as we know positive relation exists between national income and saving, then saving will star falling until it becomes equal to investment. It is here the equilibrium level of income is derived.

Ques 20: What happens to the level of national income when aggregate demand falls short of aggregate supply?   

Ans: As we know that equilibrium level of national income is determined under the given condition of aggregate demand and aggregate supply, and has tendency to stick to that level i.e., where aggregate demand is equal to aggregate supply.

As is given in the examination problem that when aggregate demand falls short off aggregate supply, than national income will decrease as shown in the above mentioned diagram.

When AD<AS(at Y1),then there would be stockpiling and producers will produce less. National income will fall and as we know positive relationship exists between national income and consumption, so consumption will fall, which will thereby decrease the aggregate demand till we reach the equilibrium.

Ques 21: What are the reasons or causes for deficient demand ?        

Ans: The main reasons for deficient demand are apparently the decrease in the four components of aggregate demand :

• Decrease in household consumption demand due to fall in propensity to consume.
• Decrease in private investment demand because of fall in credit facilities.
• Decrease in public (government) expenditure.
• Decrease in export demand.
• Decrease in money supply or decrease in disposable income.

Ques 22: What are impacts or effects of excess demand on price,   output, employment?

Ans: 1. Effect on General Price Level: Excess demand gives a rise to general price level because it arises when aggregate demand is more than aggregate supply at a full employment level. There is inflation in economy showing inflationary gap.

2. Effect on output: excess demand has no effect on the level of output. Economy is at full employment level and there is no idle capacity in the economy. Hence, output cannot increase.

3. Effect on employment: there will be no change in the level of employment also. The economy is already operating at full employment equilibrium, and hence there is no unemployment.