Class 12 Economics (Macroeconomics) Chapter 5 Government Budget and the Economy Important Questions with Answers in English

Q. Define the government budget.

Answer: A statement of the estimated receipts and estimated expenditure of the government for a financial year (1 April to 31 March).

Q. Who are free-riders?

Answer: Non-paying users who enjoy the benefits of a public good.

Q. What kind of receipt is disinvestment?

Answer: A capital receipt (non-debt creating), because it reduces the government’s financial assets.

Q. Write the formula for the primary deficit.

Answer: Primary deficit = Fiscal deficit − Net interest liabilities.

Q. If MPC = 0.8, what is the tax multiplier?

Answer: Tax multiplier = −c/(1 − c) = −0.8/0.2 = −4.

Q. Give one example of revenue expenditure.

Answer: Interest payment on government debt (or salaries, pensions, subsidies).

Q. Give two examples of non-debt creating capital receipts.

Answer: Recovery of loans and disinvestment of PSUs.

Q. State two differences between revenue receipts and capital receipts.

Answer: (1) Revenue receipts create no liability for the government; capital receipts create a liability (borrowing) or reduce financial assets (disinvestment).
(2) Revenue receipts are non-redeemable, such as taxes and dividends; capital receipts such as borrowing must be repaid in future.

Q. Give reasons: interest payment on a loan is revenue expenditure, but repayment of the loan principal is capital expenditure.

Answer: Interest payment neither creates an asset nor reduces a liability, so it is revenue expenditure. Repaying the principal reduces the government’s financial liability, so it is capital expenditure.

Q. Why must public goods be provided by the government? Explain.

Answer: • Non-rivalrous: one person’s consumption does not reduce what is available to others, as with a public park. (1)
• Non-excludable: non-payers cannot be excluded; it is difficult or impossible to collect fees from such free-riders. (1)
• Conclusion: people will not voluntarily pay for what they get free, the payment link between producer and consumer breaks, private enterprise will not provide such goods; so the government provides them through the budget. (1)

Q. Explain the redistribution function of the government budget with an example.

Answer: • National income goes to private income and public income; the spendable part of personal income reaching households is personal disposable income. (1)
• The government changes households’ disposable income through taxes and transfers, to bring about a distribution that society considers fair. (1)
• Example: progressive income tax (higher rate on higher income) and pensions or cheap food grain for the poor; heavy taxes on luxuries and low or no tax on necessities. (1)

Q. Explain the stabilisation function of the government budget.

Answer: • Employment and prices depend on aggregate demand, which depends on millions of private decisions. (1)
• If demand is too low, resources lie idle; wages and prices do not fall below a level, so employment does not recover by itself; the government raises demand. (1)
• If demand exceeds output at high employment, inflation may result; the government uses restrictive measures to reduce demand. This intervention is the stabilisation function. (1)

Q. What is a revenue deficit? What are its implications?

Answer: • Revenue deficit = Revenue expenditure − Revenue receipts. (1)
• It means the government is dissaving: financing part of its consumption expenditure with the savings (borrowing) of other sectors. (1)
• Implications: debt and interest liabilities build up; since revenue expenditure is largely committed, productive capital or welfare expenditure is usually cut, lowering growth and welfare. (1)

Q. Why is the tax multiplier smaller in absolute value than the government expenditure multiplier?

Answer: • Government spending G is a direct part of total spending, so the whole of ΔG raises demand in the first round. (1)
• Taxes act only through disposable income and consumption; a tax cut of ΔT raises spending by only cΔT in the first round, the rest is saved. (1)
• So the G multiplier = 1/(1 − c) and the tax multiplier = −c/(1 − c); with c = 0.8, 5 and −4. The absolute value is exactly 1 less. (1)

Q. MPC = 0.75. Find (a) the government expenditure multiplier (b) the tax multiplier (c) the balanced budget multiplier.

Answer: (a) 1/(1 − c) = 1/0.25 = 4 (1)
(b) −c/(1 − c) = −0.75/0.25 = −3 (1)
(c) 4 + (−3) = 1 (1)

Q. Explain the meaning and significance of the primary deficit.

Answer: • Primary deficit = Fiscal deficit − Net interest liabilities; net interest liabilities = interest payments − interest receipts on net domestic lending. (1)
• The borrowing requirement includes interest on accumulated debt; removing it, the primary deficit shows present fiscal imbalances. (1)
• If the primary deficit is zero, borrowing is only to pay interest; in Table 5.1 it is 2.0% of GDP. (1)

Q. Distinguish between the revenue budget and the capital budget.

Answer: • The revenue budget contains revenue receipts (tax, non-tax) and revenue expenditure, the items relating to the current financial year only. (1)
• The capital budget contains capital receipts (borrowing, recovery of loans, disinvestment) and capital expenditure, the items that change the government’s assets and liabilities. (1)
• The budget’s impact lasts into later years, so the two accounts are kept separate. (1)

Q. Distinguish between a balanced, a surplus and a deficit budget.

Answer: • Balanced budget: the government spends an amount equal to the revenue it collects (expenditure = receipts). (1)
• Surplus budget: tax collection exceeds the required expenditure. (1)
• Deficit budget: expenditure exceeds revenue; the book says this is the most common situation, financed by borrowing. (1)

Q. Name the three policy statements that the FRBMA, 2003 requires along with the budget.

Answer: • Medium-term Fiscal Policy Statement: three-year rolling targets for fiscal indicators; whether revenue expenditure can be financed by revenue receipts sustainably. (1)
• Fiscal Policy Strategy Statement: priorities in the fiscal area and justification of any deviation. (1)
• Macroeconomic Framework Statement: prospects of the economy for GDP growth, the Centre’s fiscal balance and the external balance. (1)

Q. Distinguish between revenue expenditure and capital expenditure with examples.

Answer: • Revenue expenditure: expenditure for purposes other than creating physical or financial assets; normal running of departments, interest, grants to states. Examples: salaries, pensions, subsidies, interest. (2)
• Capital expenditure: expenditure that creates physical or financial assets or reduces financial liabilities. Examples: land, buildings, machinery, investment in shares, loans to states and PSUs, repayment of loan principal. (2)

Q. ‘The fiscal deficit gives the borrowing requirement of the government.’ Explain.

Answer: • Fiscal deficit = Total expenditure − (Revenue receipts + Non-debt creating capital receipts). (1)
• Expenditure not met by non-debt receipts can only be met by borrowing, so this deficit equals borrowing. (1)
• From the financing side: fiscal deficit = net borrowing at home (small savings, banks via SLR) + borrowing from RBI + borrowing from abroad. (1)
• In Table 5.1 both are 5.6% of GDP; hence it is a key variable for judging the financial health of the public sector. (1)

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

Answer: • Fiscal deficit = Revenue deficit + Capital expenditure − Non-debt creating capital receipts, so the revenue deficit is a part of the fiscal deficit. (2)
• A large share of revenue deficit in the fiscal deficit means much of the borrowing is for consumption rather than investment. (1)
• Example: in Table 5.1, 2.6 + 3.2 − 0.2 = 5.6. (1)

Q. From the data (₹ crore) find the revenue, fiscal and primary deficits: tax revenue 800; non-tax revenue 150; revenue expenditure 1,200 (including interest 300); capital expenditure 400; recovery of loans 30; disinvestment 20.

Answer: Revenue receipts = 800 + 150 = 950 (½)
Revenue deficit = 1,200 − 950 = ₹250 crore (1)
Fiscal deficit = (1,200 + 400) − (950 + 30 + 20) (½)
= 1,600 − 1,000 = ₹600 crore (1)
Primary deficit = 600 − 300 = ₹300 crore (1)

Q. Why is the balanced budget multiplier unity? Explain with an example.

Answer: • With ΔG = ΔT, ΔY = [1/(1 − c)]ΔG + [−c/(1 − c)]ΔT = [(1 − c)/(1 − c)]ΔG = ΔG. (1)
• In the multiplier chain, the rise in G raises income by ΔG(1 + c + c² + …), while the tax rise lowers it by only ΔT(c + c² + …), since taxes cut consumption by c times; the difference is ΔG. (2)
• Example 5.1 (c = 0.8): G up 100 gives +500, taxes up 100 give −400, net +100 = ΔG. (1)

Q. Why do proportional taxes reduce the multiplier? Give an example.

Answer: • With T = tY, consumption C = C̄ + c(1 − t)Y + cTR; the MPC out of income falls from c to c(1 − t) and AD becomes flatter. (1)
• The multiplier falls from 1/(1 − c) to 1/[1 − c(1 − t)], because part of every rise in income goes in taxes and consumption rises by less. (1)
• Example 5.2: c = 0.8, t = 0.25: c(1 − t) = 0.6; multiplier = 1/0.4 = 2.5 (5 with lump-sum taxes). (1)
• A rise of 100 in G raises income by 250, not 500. (1)

Q. Distinguish between automatic stabilisers and discretionary fiscal policy.

Answer: • Automatic stabilisers: reduce fluctuations by themselves, with no decision-maker taking action. The proportional income tax lets disposable income rise less in a boom and fall less in a recession; welfare transfers sustain consumption in a slump. (2)
• Discretionary policy: deliberate government action, such as raising G from G₀ to G₁ when investment falls from I₀ to I₁ so that autonomous expenditure and equilibrium income stay the same. Automatic stabilisers remove only part of the fluctuation; the rest needs this policy. (2)

Q. What is GST? How is it better than the old tax system?

Answer: • GST, operational from 1 July 2017, is a single comprehensive, destination-based indirect tax on the supply of goods and services, with input tax credit (ITC). (1)
• Earlier, tax at each stage was on the total value including taxes already paid, causing cascading; under GST the credit of the previous stage’s tax is available, so tax falls only on value addition. (1)
• Many Central and State taxes (excise, service tax, VAT, octroi, entertainment tax and others) were subsumed into one tax; one rate across the country and a common market. (1)
• Lower cost of business, more competitive Indian products, online compliance at www.gst.gov.in, wider tax base and more transparency. (1)

Q. Explain the three objectives (functions) of the government budget with examples.

Answer: 1. Allocation function: the government provides public goods the market cannot, such as national defence, roads and government administration. They are non-rivalrous and non-excludable; fees cannot be collected from free-riders, so private enterprise does not provide them. (2)
2. Redistribution function: taxes and transfers change households’ disposable income to make the distribution fair; for example progressive income tax and pensions for the poor. (2)
3. Stabilisation function: raising aggregate demand when it is insufficient (to prevent unemployment) and reducing it when excessive (to prevent inflation), reducing fluctuations in income, employment and prices. (2)

Q. Classify the receipts of the government and explain each class with examples.

Answer: Revenue receipts (no liability, non-redeemable): (3)
• Tax revenue: direct taxes (personal income tax, corporation tax) and indirect taxes (excise, customs, service tax, now GST); wealth and gift taxes are ‘paper taxes’.
• Non-tax revenue: interest receipts on government loans, dividends and profits, fees, cash grants-in-aid from abroad.
Capital receipts (create a liability or reduce financial assets): (3)
• Debt creating: market borrowing, borrowing from RBI and abroad; principal and interest must be repaid in future.
• Non-debt creating: recovery of loans and PSU disinvestment; these do not add to debt but reduce future income or assets.

Q. Explain the different measures of government deficit. Illustrate them with Table 5.1.

Answer: Revenue deficit = Revenue expenditure − Revenue receipts = 11.8 − 9.2 = 2.6% of GDP. Government dissaving; borrowing for consumption. (2)
Fiscal deficit = Total expenditure − (Revenue receipts + Non-debt capital receipts) = 15.0 − 9.4 = 5.6%. The total borrowing requirement (borrowings 5.6). (2)
Primary deficit = Fiscal deficit − Interest payments = 5.6 − 3.6 = 2.0%. Present imbalance, leaving out interest on past debt. (2)

Q. C = 50 + 0.8Y_D, I = 100, G = 70, lump-sum tax T = 50 (no transfers). (a) Find equilibrium income. (b) What is the new equilibrium income if G rises by 20? (c) What is equilibrium income if taxes also rise by 20 along with G?

Answer: (a) Y* = [1/(1 − c)](C̄ − cT + I + G) (½) = (50 − 40 + 100 + 70) ÷ 0.2 (½) = 180 ÷ 0.2 = 900 (1)
(b) G multiplier = 1/0.2 = 5 (½); ΔY = 5 × 20 = 100 (½); new income = 1,000 (1)
(c) Balanced budget multiplier = 1 (½); ΔY = 20 (½); new income = 920 (1)

Q. Does public debt impose a burden? Give arguments on both sides.

Answer: A burden: (3)
• The government borrows today through bonds and may repay some twenty years later by raising taxes on the young; their disposable income and consumption fall, and national savings fall.
• Government borrowing reduces savings available to the private sector; if capital formation and growth fall, future generations bear a burden.
• Debt owed to foreigners is a burden, since goods must be sent abroad to match interest payments.
Not a burden: (3)
• Ricardian equivalence: forward-looking families save more now, fully offsetting government dissaving; national savings do not change.
• ‘We owe it to ourselves’: purchasing power stays within the nation.
• Infrastructure investment with a return above the rate of interest can be paid off by growth. Conclusion (the book’s summary): public debt is burdensome if it reduces future growth in output.

Q. (UP Board 10 marks) Define the three measures of government deficit. From the following data (₹ crore) find all three deficits and interpret the share of the revenue deficit in the fiscal deficit: tax revenue 1,300; non-tax revenue 200; revenue expenditure 2,000 (including interest 400); capital expenditure 700; recovery of loans 60; disinvestment 40.

Answer: 1. Definitions (3 marks)
• Revenue deficit = Revenue expenditure − Revenue receipts; government dissaving.
• Fiscal deficit = Total expenditure − (Revenue receipts + Non-debt capital receipts); total borrowing requirement.
• Primary deficit = Fiscal deficit − Net interest liabilities; present imbalance.
2. Calculation (5 marks)
Revenue receipts = 1,300 + 200 = 1,500 (½)
Revenue deficit = 2,000 − 1,500 = ₹500 crore (1)
Total expenditure = 2,000 + 700 = 2,700; non-debt capital receipts = 60 + 40 = 100 (½)
Fiscal deficit = 2,700 − (1,500 + 100) = ₹1,100 crore (1)
Check: 500 + 700 − 100 = 1,100 (1)
Primary deficit = 1,100 − 400 = ₹700 crore (1)
3. Interpretation (2 marks)
Share of revenue deficit = 500 ÷ 1,100 × 100 ≈ 45.45%. About 45% of borrowing goes into consumption (revenue) spending, not investment; the book says a growing share points to a deterioration in the quality of government expenditure and lower capital formation. Interest of ₹400 crore shows the burden of past debt.