IGNOU BECM-162 Solved Question Paper PDF Download

IGNOU BECM-162 Previous Year Solved Question Paper in Hindi

IGNOU BECM-162 Previous Year Solved Question Paper in English

Q1. Define the concept of national income. Explain how national income is measured by the expenditure method.

Ans. National Income is the total monetary value of all final goods and services produced by a country during a financial year. It is most accurately defined as the Net National Product at Factor Cost (NNP at FC) . This includes the total income (wages, rent, interest, and profit) earned by the normal residents of a country, regardless of whether this income is earned within the domestic territory or from abroad. National income is a crucial indicator of an economy’s performance and economic well-being. The Expenditure Method of measuring national income is based on the principle that the total expenditure on goods and services produced in a year must be equal to the national income of that year. This method sums up the final expenditures in the economy. Its main components are:

• Private Final Consumption Expenditure (C): This is the expenditure by households and non-profit institutions on final goods and services to satisfy their wants. It includes both durable goods (like cars, furniture) and non-durable goods (like food, clothing).
• Gross Domestic Capital Formation or Investment Expenditure (I): This includes expenditure by businesses on new capital assets like plant and machinery, and changes in inventory (stocks). It also includes expenditure by households on new housing.
• Government Final Consumption Expenditure (G): This is the expenditure by the government on goods and services to satisfy the collective needs of the country (e.g., defence, administration, education). It does not include transfer payments (like pensions, subsidies) as they are not related to any productive activity.
• Net Exports (X-M): This is the difference between the value of a country’s exports (X) and the value of its imports (M). Exports are added as they are domestically produced, while imports are subtracted as they are produced abroad.

By adding all these components, we get the

Gross Domestic Product at Market Price (GDP at MP)

:

GDP at MP = C + I + G + (X-M)

To arrive at National Income (NNP at Factor Cost), we subtract Depreciation and Net Indirect Taxes (Indirect Taxes – Subsidies) from GDP at MP and add Net Factor Income from Abroad (NFIA).

Q2. Bring out the salient features of Classical Economics. Explain how Keynesian Economics differs from Classical Economics.

Ans. Classical Economics , led by economists like Adam Smith, David Ricardo, and J.B. Say, was dominant in the 18th and 19th centuries. Its salient features are as follows:

• Say’s Law of Markets: This principle states that “supply creates its own demand.” It means that the income generated in the process of production automatically creates enough demand to purchase the goods and services produced, leaving no possibility of over-production.
• Full Employment Equilibrium: Classical economists believed that the economy always operates at a state of full employment. Any unemployment (like voluntary unemployment) is only a temporary situation.
• Wage-Price Flexibility: They believed that wages, prices, and interest rates are fully flexible. If there is unemployment, the wage rate will fall, increasing the demand for labour and restoring full employment.
• Laissez-Faire Policy: Classical economists were against government intervention. They believed that market forces (demand and supply) were sufficient to run the economy efficiently and achieve equilibrium automatically.
• Quantity Theory of Money: This theory states that the primary function of money is as a medium of exchange, and changes in the quantity of money directly affect the price level, but not real output or employment.

Keynesian Economics

, developed by John Maynard Keynes following the Great Depression of the 1930s, differs from Classical thought in several key ways:

1. Importance of Demand: Keynes rejected Say’s Law and argued that the level of output and employment in an economy depends on Aggregate Demand , not aggregate supply.
2. Underemployment Equilibrium: According to Keynes, an economy can get stuck in an underemployment equilibrium , where high unemployment and low output can persist for a long time.
3. Sticky Prices and Wages: Keynes observed that wages and prices are “sticky downwards.” During a recession, wages and prices do not fall easily, which perpetuates unemployment.
4. Role of Government Intervention: Unlike the classicists, Keynes advocated for active government intervention , especially fiscal policy (increasing government spending or cutting taxes), to pull an economy out of a recession.
5. Savings-Investment Equality: While classicists believed that savings and investment are automatically equated through the interest rate, Keynes argued that they are equated through changes in the level of income.

Q3. Give a brief account of the instruments available to the Reserve Bank of India to implement monetary policy.

Ans. Monetary Policy is the process by which a country’s central bank (in India, the Reserve Bank of India – RBI) controls the supply of money and the cost of credit (interest rates) to achieve objectives like price stability, economic growth, and financial stability. The RBI has several instruments to implement monetary policy, which are broadly classified into two categories: 1. Quantitative Instruments: These tools affect the overall volume of credit in the economy and are general in nature.

• Bank Rate: This is the rate at which the RBI provides long-term loans to commercial banks. An increase in the bank rate makes borrowing costly for banks, leading them to raise their interest rates and reducing the demand for credit.
• Repo Rate: This is the interest rate at which the RBI lends short-term funds to commercial banks against government securities. It is the key monetary policy tool. Increasing the repo rate makes credit expensive, thus helping to control inflation.
• Reverse Repo Rate: This is the rate at which the RBI borrows money from commercial banks. Increasing it encourages banks to park more funds with the RBI, thus reducing liquidity in the market.
• Cash Reserve Ratio (CRR): This is the percentage of a commercial bank’s total deposits that it is mandatory to keep with the RBI in the form of cash. Increasing the CRR reduces the funds available with banks for lending.
• Statutory Liquidity Ratio (SLR): This is the percentage of a bank’s total deposits that it must maintain with itself in the form of liquid assets (like cash, gold, government securities). Increasing the SLR also reduces banks’ lending capacity.
• Open Market Operations (OMOs): This involves the buying and selling of government securities by the RBI in the open market. To reduce liquidity, the RBI sells securities, and to increase liquidity, it buys them.

2. Qualitative Instruments:

These tools are used to direct or restrict the use of credit towards specific sectors.

• Margin Requirements: The RBI prescribes the margin, which is the difference between the value of the property held as collateral for a loan and the amount of loan that can be granted against it. The margin can be increased to discourage speculative activities.
• Moral Suasion: The RBI uses advice and persuasion to make commercial banks follow its monetary policy directives.
• Selective Credit Controls: This is used to encourage or discourage the flow of credit to particular sectors.

Q4. Explain how equilibrium output is determined in the Keynesian model. Use appropriate diagram.

Ans. In the Keynesian model, the equilibrium level of output or income is determined at the point where Aggregate Demand (AD) is equal to Aggregate Supply (AS) . In Keynes’s framework, aggregate demand is the total planned expenditure on goods and services in the economy, while aggregate supply is equal to the total output or national income (Y). The main components of Aggregate Demand (AD) are: Consumption (C), Investment (I), and Government Spending (G) (in a closed economy). Thus, AD = C + I + G . Aggregate Supply (AS) is represented by a 45-degree line, which represents all points where total output (Y) equals total expenditure (AD). That is, AS = Y . Determination of Equilibrium: Equilibrium is achieved when planned total expenditure (AD) equals total output (Y). In a diagram, this is the point (E) where the AD curve intersects the 45-degree line. At this point, everything that is produced in the economy is demanded, and firms have no unplanned changes in their inventories. Explanation with a Diagram: In the “Keynesian Cross” diagram above:

• The X-axis measures National Income (Y) and the Y-axis measures Aggregate Expenditure (AD).
• The 45-degree line is the AS curve, where AD = Y.
• The AD = C + I + G curve is an upward-sloping curve, whose slope depends on the Marginal Propensity to Consume (MPC).
• Point E is the equilibrium point, where the AD curve intersects the 45-degree line. The equilibrium level of output corresponding to this point is Y* .

Situations of Disequilibrium:

• If Y > Y (e.g., at Y2): In this situation, aggregate supply is greater than aggregate demand (AS > AD). This means firms are producing more than what is being sold. As a result, there will be an unplanned increase in firms’ inventories. To get rid of this excess stock, firms will cut back on future production, causing the income level to fall back to Y .
• If Y < Y (e.g., at Y1): Here, aggregate demand is greater than aggregate supply (AD > AS). There is more demand than what firms are producing. To meet this demand, firms will sell from their inventories, leading to an unplanned decrease in inventory. To rebuild their inventories and meet the higher demand, firms will increase their production, causing the income level to rise to Y .

Thus, the adjustment process through unplanned changes in inventories brings the economy back to the equilibrium level Y*.

Q5. Write short notes on the following : (a) Problem of double counting in national income (b) Circular flow of income in an economy

Ans. (a) Problem of Double Counting in National Income The problem of double counting in national income calculation arises when the value of a commodity is counted more than once at different stages of its production. This happens when we include the value of intermediate goods along with final goods in the national income. This leads to an overestimation of the national income. For instance, a farmer grows wheat worth Rs. 100 and sells it to a miller. The miller grinds it into flour and sells it for Rs. 150 to a baker. The baker makes bread from the flour and sells it to the final consumer for Rs. 200. If we add the value at each stage (100 + 150 + 200 = Rs. 450), it would be double counting, as the value of wheat and flour is already included in the final price of the bread. The correct calculation should only be the value of the final good (bread), i.e., Rs. 200. There are two main methods to avoid this problem:

1. Final Product Method: In this method, only the value of final goods and services, which are used for direct consumption or investment, are counted. Intermediate goods (which are used up in the production of other goods) are ignored.
2. Value Added Method: In this method, the value added at each stage of production is summed up. Value Added = Value of Output – Value of Intermediate Consumption. In the example above, the value added would be: Farmer (100) + Miller (150-100=50) + Baker (200-150=50) = Rs. 200. This method eliminates double counting.

(b) Circular Flow of Income in an Economy

The

circular flow of income

is a model that illustrates the continuous flow of money, goods, and services between different sectors of an economy, such as households and firms. It shows how income and expenditure circulate in a cycle.

In a simple

two-sector economy (Households and Firms)

, the flow is as follows:

• Factor Market: Households are the owners of factors of production (land, labour, capital, enterprise). They provide these factors to firms. In return, firms make factor payments (rent, wages, interest, profit) to households. This is the source of income for households.
• Product Market: Firms use these factors to produce goods and services. They sell these products in the product market. Households spend their income on these goods and services. This expenditure becomes revenue for the firms.

Thus, in one flow (real flow), factor services move to firms and goods move to households, while in the other flow (money flow), money moves from households to firms (as expenditure) and from firms to households (as income).

More realistic models (four-sector) also include the

Government

and the

Foreign Sector

. This introduces the concepts of

Leakages

and

Injections

.

• Leakages: Withdrawals of money from the circular flow. These include Savings (S), Taxes (T), and Imports (M).
• Injections: Additions of money into the circular flow. These include Investment (I), Government Spending (G), and Exports (X).

Equilibrium in the economy occurs when total leakages equal total injections (S + T + M = I + G + X).

Q6. Explain how the IS curve is derived. Use appropriate diagram.

Ans. The IS curve represents all combinations of interest rate (r) and income (Y) at which the goods market is in equilibrium. The condition for equilibrium in the goods market is that total output (Y) equals total planned expenditure (AD), or equivalently, when planned investment (I) equals planned savings (S). The term ‘IS’ stands for ‘Investment-Savings’. The IS curve is derived from the Keynesian cross model. The derivation process involves the following steps:

1. Relationship between Investment and Interest Rate: Investment (I) is a decreasing function of the interest rate (r). When the interest rate is low, borrowing is cheaper, which encourages firms to invest more. Conversely, investment is lower at a higher interest rate.
2. Equilibrium in the Keynesian Cross: In the Keynesian cross model, equilibrium occurs where the AD curve intersects the 45-degree line. AD = C + I(r) + G.
3. Effect of a Change in Interest Rate: When the interest rate changes, investment changes, which shifts the AD curve and establishes a new equilibrium level of income.

Derivation with a Diagram:

The IS curve can be derived using a two-panel diagram.

• Upper Panel (Panel A): This shows the Keynesian cross. Let’s assume an initial interest rate r1 . At this rate, investment is I(r1), and the aggregate demand curve is AD1 = C + I(r1) + G . This curve intersects the 45-degree line at point E1 , determining an equilibrium level of income Y1 . This gives us one point on the IS curve (Y1, r1), which we plot in the lower panel.
• A Fall in the Interest Rate: Now, suppose the interest rate falls to r2 (r2 < r1). The decrease in the interest rate causes investment to increase to I(r2). The increased investment shifts the aggregate demand curve upwards to AD2 = C + I(r2) + G .
• New Equilibrium: The new AD2 curve intersects the 45-degree line at a new point E2 , corresponding to a higher equilibrium level of income Y2 . This gives us another point on the IS curve (Y2, r2).
• Constructing the IS Curve: In the lower panel (Panel B), we connect these points (Y1, r1) and (Y2, r2). Joining all such points gives us a downward-sloping IS curve .

This negative slope shows that to maintain equilibrium in the goods market, a decrease in the interest rate must be accompanied by an increase in the level of income (and vice-versa). This is because a lower interest rate stimulates investment, which raises aggregate demand and output.

Q7. In the IS-LM model, explain how the adjustment process takes place, if the economy is not in equilibrium.

Ans. In the IS-LM model, full equilibrium occurs at the point where the IS curve and the LM curve intersect. At this point, both the goods market (represented by IS) and the money market (represented by LM) are simultaneously in equilibrium. If the economy is not at this equilibrium point, market forces work to push it towards equilibrium. The IS-LM diagram can be divided into four quadrants, each representing a specific type of disequilibrium:

1. Quadrant I (Right of IS, Above LM):
   • Goods Market: Here, the level of income is too high for the given interest rate (to the right of the IS curve), which means there is an Excess Supply of Goods (ESG) . Firms will find their inventories piling up, so they will cut production (Y).
   • Money Market: Here, the interest rate is too high for the given level of income (above the LM curve), which means there is an Excess Supply of Money (ESM) . People will use their excess money to buy bonds, pushing up bond prices and causing the interest rate (r) to fall.
   • Adjustment: Y will decrease and r will decrease, moving the economy towards equilibrium.
2. Quadrant II (Left of IS, Above LM):
   • Goods Market: There is an Excess Demand for Goods (EDG) . Firms will increase production (Y).
   • Money Market: There is an Excess Supply of Money (ESM) . The interest rate (r) will fall.
   • Adjustment: Y will increase and r will decrease.
3. Quadrant III (Left of IS, Below LM):
   • Goods Market: There is an Excess Demand for Goods (EDG) . Firms will increase production (Y).
   • Money Market: There is an Excess Demand for Money (EDM) . People will sell bonds, causing bond prices to fall and the interest rate (r) to rise.
   • Adjustment: Y will increase and r will rise.
4. Quadrant IV (Right of IS, Below LM):
   • Goods Market: There is an Excess Supply of Goods (ESG) . Firms will decrease production (Y).
   • Money Market: There is an Excess Demand for Money (EDM) . The interest rate (r) will rise.
   • Adjustment: Y will decrease and r will rise.

Speed of Adjustment:

It is generally assumed that the money market (adjustment of the interest rate) adjusts much faster than the goods market (adjustment of output), as trading financial assets can happen almost instantaneously compared to changing production plans. Therefore, the economy often moves rapidly toward the LM curve and then moves along the IS and LM curves toward equilibrium.

Q8. Explain the factors that influence the Aggregate Demand (AD) curve.

Ans. The Aggregate Demand (AD) curve shows the total quantity of goods and services that households, firms, the government, and foreign buyers are willing to purchase at different price levels in an economy. The AD curve is downward sloping, meaning there is an inverse relationship between the price level (P) and the total demand (Y). Factors influencing the AD curve can be divided into two categories: those that cause a movement along the curve (changes in the price level) and those that shift the entire curve. The question about factors that influence the AD curve typically refers to the factors that shift it. A shift in the AD curve occurs when, at any given price level, any of the components of total expenditure (Consumption, Investment, Government Spending, or Net Exports) change. The main factors are as follows:

1. Changes in Consumption (C):
   • Consumer Confidence: If consumers are optimistic about the future, they will spend more, shifting the AD curve to the right.
   • Wealth: A stock market boom or a rise in property prices makes consumers feel wealthier and spend more (wealth effect), shifting AD to the right.
   • Changes in Taxes: A cut in personal income taxes increases disposable income, leading to higher consumption and shifting AD to the right.
2. Changes in Investment (I):
   • Business Expectations (“Animal Spirits”): If firms are optimistic about future profits, they will invest more in new machinery and factories, shifting AD to the right.
   • Interest Rates (for reasons other than price level): If interest rates fall due to monetary policy, investment is stimulated, shifting AD to the right.
   • Technology: New technologies can create new investment opportunities, increasing AD.
   • Corporate Taxes: Tax credits on investment or lower corporate taxes encourage investment, shifting AD to the right.
3. Changes in Government Spending (G):
   • Fiscal Policy: A direct increase in spending by the government (e.g., on infrastructure, defense) directly increases AD and shifts the curve to the right. A decrease in government spending would shift the AD curve to the left.
4. Changes in Net Exports (X-M):
   • Foreign Income: If income in the countries of our trading partners rises, they will buy more of our exports, increasing net exports and AD.
   • Exchange Rates: If the domestic currency depreciates, our exports become cheaper and imports become more expensive. This increases net exports and shifts AD to the right.

In summary, any event that increases total spending at a given price level will shift the AD curve to the right, and any event that decreases total spending will shift it to the left.

Q9. Describe the effects of inflation on various segments of society.

Ans. Inflation is a sustained increase in the general price level of goods and services and a fall in the purchasing power of currency. Inflation does not affect all segments of society uniformly; it benefits some groups while harming others. Its effects are as follows:

1. Creditors and Debtors:
   • Debtors (Borrowers) gain: Debtors benefit during inflation because the real value of the money they pay back is less than the money they borrowed. Their incomes may rise, but the loan amount remains the same.
   • Creditors (Lenders) lose: Creditors lose because the purchasing power of the money they get back is less than the money they lent.
2. Fixed Income Groups:
   • Salaried class and Pensioners: This group is worst-hit by inflation. Their income (salary, pension) is fixed or rises very slowly, while the prices of goods and services rise rapidly. This leads to a decline in their real income and standard of living.
3. Entrepreneurs and Businessmen:
   • This class usually benefits from inflation . This is because product prices often rise faster than the costs of production (like wages, raw materials). This increases their profit margins. Moreover, they are often debtors, which gives them an additional advantage.
4. Investors:
   • The effect of inflation depends on the type of investment. Those who invest in real assets like equity (shares) or real estate may gain, as the value of these assets often rises with inflation.
   • Conversely, those who invest in fixed-income securities like bonds or fixed deposits lose, as the real value of their returns diminishes.
5. Farmers:
   • The effect on farmers can be mixed. If the prices of agricultural products rise faster than the costs (fertilizers, seeds), they may gain. They are also often debtors, which benefits them.
6. Distribution of Income:
   • Inflation widens the inequality in the distribution of income and wealth. It redistributes income from salaried and fixed-income earners towards profit-earners and entrepreneurs. This can widen the gap between the rich and the poor.

In essence, inflation arbitrarily redistributes wealth and income, often in favour of debtors and producers and against creditors and fixed-income earners.

Q10. Write short notes on the following : (a) Phillips curve (b) Natural rate of unemployment

Ans. (a) Phillips Curve The Phillips Curve is an economic concept developed by A. W. Phillips, which shows an inverse or negative relationship between the rate of inflation and the rate of unemployment . According to the original Phillips curve, when unemployment is low, wages and prices tend to rise more rapidly (high inflation), and when unemployment is high, inflation is low. This relationship suggested a trade-off for policymakers: they could aim for low unemployment but would have to pay the price of higher inflation, or they could achieve low inflation but would have to accept higher unemployment. However, in the 1970s, many countries experienced high inflation and high unemployment simultaneously (a condition called “stagflation”), which contradicted the original Phillips curve. Economists like Milton Friedman and Edmund Phelps argued that this trade-off exists only in the Short-Run . According to them, in the Long-Run , the Phillips curve is a vertical line at the Natural Rate of Unemployment . This means that there is no long-run trade-off between inflation and unemployment. If governments persistently use expansionary policies to keep unemployment below its natural rate, the only result will be higher and accelerating inflation, while unemployment will return to its natural rate. (b) Natural Rate of Unemployment The Natural Rate of Unemployment (NRU) is the minimum rate of unemployment that exists in a state of long-run equilibrium in the economy. It is the rate at which the rate of inflation is stable (i.e., neither accelerating nor decelerating). It is also sometimes called the Non-Accelerating Inflation Rate of Unemployment (NAIRU) . The natural rate does not mean zero unemployment. It always includes two types of unemployment:

1. Frictional Unemployment: This occurs when people are temporarily jobless between jobs, such as when changing jobs or entering the labour force for the first time.
2. Structural Unemployment: This is caused by shifts in the structure of the economy, when there is a mismatch between the skills of workers and the requirements of available jobs (e.g., due to technological change).

The natural rate does not include cyclical unemployment, which is caused by fluctuations in the business cycle (recessions).

The level of the natural rate is influenced by various factors, such as the efficiency of the labour market, government policies (like the generosity of unemployment benefits, minimum wage laws), demographics, and the degree of unionization. Economists believe that if governments try to push unemployment below the natural rate using demand-side policies (like fiscal or monetary policy), the result will only be accelerating inflation with no permanent reduction in unemployment.