Principles of Macroeconomics Short Questions

Short Questions

1. Consumption is that part of disposable Income which is spent on consumer goods and services. The relationship between consumption and income is represented by consumption function written as C=f(Y). The slope of this function is called MPC.
2. Saving is that part of disposable income that is not consumed. This relation between saving and income is represented by saving function written as S=f(Y). The slope of this function is called MPS. 
3. Autonomous consumption is the part of consumption which does not depends on disposable income. It is level of consumption when Y=0. In linear consumption function C = C₀ + cY, it is represented by C_0. It is also called intercept or constant of consumption function.
4. Induced consumption is that part of consumption which depends on disposable income. It is found by multiplying MPC with disposable income. In linear consumption function C = C₀ + cY, cY is the induced consumption.
5. Consumption function shows the relationship between consumption expenditure of households and their disposable income. An increase in income leads to increase in consumption expenditure. Thus, there is positive relationship between them, Linear consumption function is C = C₀ + cY. The slope of this function is MPC.
6. Savings function shows the relationship between savings of households and their disposable income. An increase in income leads to increase in savings. Thus, there is positive relationship between them. It is written as S=f(Y). Linear saving function is S = -S₀ + sY.
7. Autonomous saving is that part of saving that does not depends on disposable income. It is the level of saving when Y=0. In linear saving function S = -S₀ + sY., it is represented by-S_0. It is also called intercept or constant of saving function.
8. Induced savings is that part of savings which depends on disposable income. It is found by multiplying MPS with disposable income. In linear saving function S = -S₀ + sY, sY is the induced savings.
9. Marginal propensity to consume (MPC) shows the change in consumption resulting from a given change in disposable income. MPC=∆C/∆Y. It is the slope of consumption function. It ranges between 0 and 1.
10. Marginal propensity to save (MPS) shows the change in savings due to a given change in disposable income. MPS=∆S/∆Y. It is the slope of saving function. It ranges between 0 and 1.
11. Average propensity to consume (APC) is the portion of disposable income that is consumed. It tells us average consumption. APC=C/Y. As income rises APC tends to fall.
12. Average propensity to save (APS) is the portion of disposable income that is saved. It tells us average savings. APS=S/Y. As income rises APS tends to increase.
13. National incomes the sum of all incomes earned by the four factors of production—land, labour, capital, and entrepreneurship—in the form of rent, wages, interest, and profit for their contribution to producing goods and services during a year.
14. GDP vs GNP: GDP stands for gross domestic product. It is the total final output produced within a country irrespective of nationality. While GNP stands for gross national product. It is the total final output produced by residents of a nation irrespective of geographical boundary. Ex: A Pakistani works in UAE, his income is included in Pakistan’s GNP and UAE`s GDP.
15. Depreciation is the wear and tear on the economy’s stock of equipment, plants, machines, and residential structures. Depreciation represents the cost of capital not a factor income, so it is not included in GNP. It is also called capital consumption or replacement investment.
16. Informal economy or underground economy is that part of economy in which transactions take place and income is generated but remains uncounted in GDP. Such as transaction of illegal items like drugs, unreported income due to tax evasion.
17. Inventories are the goods that firms produce now but intend to sell later. Inventories are made by the firms to meet unexpected demand increase. Inventories are counted as capital because they produce value in the future.
18. In a closed economy there is no international trade, so net exports are zero. A closed economy can be either two sector (households and firms) or three sector (households, firms and govt.).
19. An open economy has international trade relations with other countries so net exports can be either positive or negative. It consists of four sectors, households, firms, govt. and foreign sector.
20. Transfer payments are payments made by the government to individuals for which no goods or services are provided to the government in return. For example, pensions, unemployment allowance, social security etc.
21. Gross domestic product (GDP) is the total market value of all final goods and services produced within a country in a given period of time. It does not include the income received from abroad. It is calculated as: GDP = P₁ × Q₁ + P₂ × Q₂ + … + P_n × Q_n
    • P₁, …, P_n are prices of n goods
    • Q₁, …, Q_n are quantities of n goods produced
22. Double counting occurs when intermediate goods are counted along with final goods in GDP calculation. It results in overestimation of GDP. It can be avoided by:
    • Include only the value of final goods and exclude intermediate goods.
    • Add value added at each stage of production.
23. Net factor income from abroad is the difference between factor incomes earned by domestic residents abroad and factor incomes earned by foreign residents in the domestic country. NFIA = Factor income received from abroad – Factor income paid to foreigners
24. A subsidy is a direct or indirect payment by government to individuals and businesses either in the form of cash or tax cuts. Subsidy is also called negative tax.
25. Budget is an annual financial statement of the revenue and heads of expenditure of the government in the coming fiscal year. There are two types of budgets, revenue budget and capital budget.
26. Revenue budget is a statement of the government’s estimated revenue receipts and revenue expenditure for a period of one financial year. Revenue receipts include tax and non-tax revenues. Revenue expenditure includes salaries of govt. employees, subsidies, transfer payments etc.
27. Capital budget is a statement of the government’s estimated capital receipts and capital expenditure. Capital receipt includes money from borrowing, selling public assets. Capital expenditure includes repayment of debt servicing, infrastructure, education, health etc.
28. Tax is a compulsory payment made by the households or firms to the government. In economic terms tax is the flow of income or wealth from households or firms to the government. Some examples of taxes are excise duty, sales tax, income tax, and custom duty etc.
29. Proportional tax or flat tax is a tax whose rate remains uniform at all income levels. If for example, the tax rate is 10%, then everyone (poor or rich) will pay 10%.
30. Progressive tax or graduated tax is a tax whose rate increases with the increase in income levels. For example, income tax. It is levied based on income tax slabs.
31. A specific tax is a fixed amount changed pee unit on a good or service sold regardless of its price or value. It is also known as per-unit tax. Example, a tax of RS. 20 per pack of cigarette.
32. Ad valorem tax: The term “ad valorem” is a Latin word meaning “according to value”. This tax is levied on the commodities on the basis of their value. Examples are sales tax, property tax, import duty, value-added tax.
33. Value added tax (VAT) is levied on the value added to goods and services at each stage of production or distribution. Ex: If wheat price is 100 Rs. per unit and flour price is 180 Rs. per unit, then tax will be levied on Rs. 80 which is value added.
34. Public debt is the total amount that the government has borrowed from both internal and external sources. A government budget deficit increases government debt.
35. Current or non-development expenditure are those made for normal day to day working of the government departments and services provided by it. They are recurring in nature. Such as expenses on defense, law and order, civil administration, salaries of govt. employees, subsidies, transfer payments etc.
36. Development expenditures are those made by govt. that increase the productive capacity of the economy. They are non-recurring in nature such as expenses on health, education, transportation, energy projects and other Public Sector Development Programe.