Economics - II : Previous Year Questions (2016)

PART – A

Q1. Define Repo Rate.

Ans. The rate at which the RBI lends money to commercial banks for short-term periods against government securities. If the RBI wants to control inflation, it increases the Repo Rate. This makes borrowing expensive for banks, leading to higher interest rates for consumers, which reduces the money supply.

Q2. What do you understand by unfair trade practices?

Ans. An Unfair Trade Practice is defined as any trade practice which, for the purpose of promoting the sale, use, or supply of any goods or services, adopts an unfair method or deceptive practice.

For e.g.: False Representation, Misleading Advertisements etc.

Q3. Write any two poverty alleviation programmes in India.

Ans. Two poverty alleviation programmes in India are:

1. Pradhan Mantri Awas Yojana – Gramin (PMAY – G)
2. Indira Gandhi National Old Age Pension Scheme (IGNOAPS)

Q4. What is National Income?

Ans. National income means the value of goods and services produced by a country during a financial year. Thus, it is the net result of all economic activities of any country during a period of one year and is valued in terms of money.

Q5. Write any two causes of taxation.

Ans. Two causes of inflation are as follows:

1. Revenue Generation: The most fundamental cause is to raise money for public expenditure. This funds essential services that the private sector may not provide efficiently, such as national defence, infrastructure (roads and bridges), public education, and healthcare.
2. Redistribution of Wealth: Governments use taxation to reduce income inequality. By implementing a progressive tax system (where those who earn more pay a higher percentage), the government can collect funds to provide social welfare programs and subsidies for lower-income individuals.

Q6. What do you understand by Fiscal Policy?

Ans. Fiscal policy refers to the budgetary policy of the government, which involves controlling its level of spending and taxation within the economy to regulate aggregate demand. While monetary policy is managed by a country's central bank (like the RBI), fiscal policy is entirely regulated by the government.

Q7. What is hedging?

Ans. Hedging is a risk-management strategy used to offset potential losses from adverse exchange rate movements. It allows traders to protect themselves against the risk of future changes in exchange rates by locking in rates for future transactions.

Q8. Define Foreign aid.

Ans. Foreign aid, or external assistance, is considered a vital element for the advancement of developing countries. It involves the voluntary transfer of resources (financial, material, or technical) from a donor country or international organization to a recipient country to promote economic development and social welfare.

Q9. Write any two objectives of micro financing.

Ans. Two objectives of micro financing are as follows:

1. Financial Inclusion: To provide essential financial services (like small loans, savings, and insurance) to low-income individuals and marginalized groups who are typically excluded from the traditional banking sector.
2. Poverty Alleviation: To empower the poor by providing them with "seed capital" to start or expand small businesses, thereby creating self-employment and improving their standard of living.

Q10. Define land reforms.

Ans. Land reforms refer to the institutional changes made in the ownership, tenure, and distribution of land. These reforms are designed to achieve two primary goals: social justice (by redistributing land to the landless) and economic efficiency (by increasing agricultural productivity).

Common measures include the abolition of intermediaries (like Zamindars), tenancy reforms, fixing land ceilings, and the consolidation of land holdings.

PART – B

Q11. Explain the role of unorganised money market.

Ans. The unorganised money market refers to the part of the financial system that is not regulated by the central bank (like the RBI). It consists of indigenous bankers, money lenders, pawnbrokers, and even friends or relatives.

While often criticized for high interest rates, it plays a vital role in developing economies by providing credit where formal banks fear to tread.

Key Roles of the Unorganised Money Market:

1. Credit to the Agricultural Sector

Farmers often require quick loans for seeds, fertilizers, or emergency needs. Formal banks usually involve lengthy paperwork and collateral requirements that small farmers cannot meet. The unorganised sector provides immediate liquidity, ensuring that the agricultural cycle is not disrupted.

2. Supporting Small-Scale and Cottage Industries

Many micro-enterprises operate on a cash-only basis and lack the formal financial records needed for bank loans. Indigenous bankers and traders provide the necessary working capital to keep these small businesses afloat, which are major employers in the economy.

3. Flexibility and Accessibility

Unlike formal banks with fixed working hours and rigid procedures, the unorganised market is highly flexible. Loans are often given based on personal relationships or social trust; there is no need for collateral. Money lenders are usually accessible in local neighbourhoods at any time. There are no complex forms or "know your customer" (KYC) hurdles.

4. Financial Inclusion in Rural Areas

In many remote regions, the physical presence of formal bank branches is still limited. The unorganised market serves as the primary source of credit for the rural poor, bridging the gap between formal financial institutions and the underserved population.

While this sector is crucial for accessibility, its main drawback is the exploitation of borrowers through high interest rates and "debt traps." This is why governments often try to bring more people into the formal banking fold.

Q12. Describe the role of deficit financing in economic development.

Ans. Deficit financing is a fiscal tool employed by governments when their total expenditure exceeds their total revenue (current income from taxes, fees, and other sources). In simple terms, it is the practice of financing a budgetary gap. While the concept varies across different economies, in the context of developing nations like India, it specifically refers to the measures taken by the government to bridge the gap between "excess expenditure" and "available receipts."

Role of Deficit Financing in Economic Development

Deficit financing is often considered a "necessary evil" for developing economies. Its role in economic development is multifaceted:

A. Mobilization of Resources and Capital Formation

Developing nations often suffer from a "vicious circle of poverty," where low income leads to low savings and low investment. Deficit financing acts as a tool for forced savings. When the government invests newly created money into productive sectors, it mobilizes resources that would otherwise remain idle. This leads to the creation of capital assets like machinery, factories, and infrastructure.

B. Financing Development Plans

Large-scale national plans (like India’s Five-Year Plans) require massive financial outlays. When traditional sources like taxation and public borrowing reach their limits, deficit financing provides the necessary "extra" funds to ensure that development projects are not stalled due to a lack of liquidity.

C. Infrastructure and Basic Industries

Infrastructure projects (transport, communication, energy) have long gestation periods and require huge capital. Deficit financing allows the state to invest in these "Social Overhead Capitals," which are essential for private industry to flourish later.

D. Promotion of Industrialization

By providing subsidies, setting up industrial estates, and investing in heavy industries (steel, chemicals), the government uses deficit-financed funds to diversify the economy. This reduces dependence on agriculture and increases the overall productivity of the nation.

E. Employment Generation

Investment in public works programs through deficit financing creates direct employment. As money flows into the hands of workers, their consumption increases, leading to a multiplier effect that creates secondary employment in the consumer goods sector.

F. "Pump Priming" during Depression

During an economic slowdown, private investment dries up. Deficit financing serves as "pump priming", a small amount of government spending stimulates the economy, boosts demand, and encourages private investors to start spending again.

Q13. Differentiate between fixed and flexible exchange rate.

Ans. The primary difference between fixed and flexible exchange rates lies in how the value of a currency is determined and the extent of government intervention involved.

Q14. Explain the advantages and disadvantages of Globalisation.

Ans. Globalisation is the process of integrating a nation's economy with the world economy. It involves the conscious movement towards greater interaction with other countries through the removal of barriers to trade and investment.

Advantages for a Developing Economy (like India)

Globalisation offers several transformative benefits that can accelerate the development of an emerging economy.

A. Economic Growth and Efficiency

India’s average annual GDP growth rate surged to 6–7% post-1991, at times reaching over 8–9%. Resources are allocated more efficiently as industries specialize in areas where they have a comparative advantage. Increased competition forces domestic industries to improve their productivity and adopt better management practices.

B. Foreign Investment and Infrastructure

With Globalisation comes capital influx. FDI provides the long-term capital necessary for setting up new industries and businesses in previously reserved sectors. It helps in resource transfer as foreign investors bring advanced technologies, managerial expertise, and global best practices. Globalisation helps in building forex reserves; India’s foreign exchange reserves grew from less than $1 billion in 1991 to over $600 billion by 2022.

C. Benefits to Consumers and Sectors

Global brands (e.g., Samsung, Amazon, Hyundai) have made a wide variety of quality goods available at competitive prices. India emerged as a global hub for IT, BPO, and software development, leveraging its skilled, English-speaking workforce. Globalisation opened international markets for Indian auto parts, pharmaceuticals, and textiles.

Disadvantages and Challenges for a Developing Economy

Despite its benefits, globalisation presents significant risks that can impact the socio-economic fabric of a developing nation.

A. Economic Disparities

The benefits often accrue to the urban, educated middle class, leaving rural areas and the poor marginalized. Village and small-scale industries often cannot compete with the massive resources and lower production costs of Multinational Corporations (MNCs).

B. Labour and Employment Issues

While GDP has grown, the creation of formal jobs has been slow, leading to a rise in informal and contractual employment. Rapid automation and technological shifts can lead to job losses in traditional sectors.

C. External and Environmental Risks

Developing economies become susceptible to global financial shocks, such as the 2008 recession. Intense industrial activity and pressure for high productivity can lead to deforestation, resource depletion, and increased pollution. Excessive dependence on foreign capital can potentially undermine a host country's economic independence and policy-making sovereignty.

Conclusion

Globalisation has fundamentally transformed India from a tightly controlled, socialist-oriented system into a vibrant, market-driven global player. While it has brought unparalleled economic growth, technological advancement, and a rise in global status, the challenges of regional inequality and environmental sustainability remain critical areas for future policy intervention.

PART – C

Q15. Define Bank and explain its functions.

Ans. Commercial banks are profit-making financial institutions that act as intermediaries between savers and borrowers. Their core purpose is the mobilization of savings from the public and the disbursement of credit to various sectors of the economy, thereby acting as a pillar of the national financial system. In India, these banks are primarily regulated by the Reserve Bank of India (RBI) under the Banking Regulation Act, 1949, and the RBI Act, 1934.

Functions of Commercial Banks

Commercial bank functions are broadly categorized into primary and secondary roles, alongside modern utility services.

A. Primary Functions

1. Accepting Deposits: This is the most fundamental function where banks collect surplus funds from the public.
   • Savings Accounts: Aimed at encouraging small savings; they offer modest interest and limited withdrawal flexibility.
   • Current Accounts: Used mainly by businesses; these accounts offer high liquidity with no interest and sometimes incur service charges.
   • Fixed Deposits (FDs): Deposits for a specific period with higher interest rates.
   • Recurring Deposits (RDs): Regular monthly deposits for a fixed term.
2. Providing Loans and Advances: Banks lend a portion of their deposits to earn interest income, which is their primary source of profit.
   • Cash Credit: A short-term loan against a bond or other security.
   • Overdraft Facility: Allows customers to withdraw more than their account balance up to a specified limit.
   • Term Loans: Provided for specific periods (short, medium, or long-term) for personal or business use.
3. Credit Creation: This is a unique and vital function. When a bank grants a loan, it does not typically provide cash; instead, it opens a deposit account in the borrower's name. This "derivative deposit" increases the total money supply in the economy beyond the initial cash reserves.

B. Secondary and Agency Functions

1. Discounting Bills of Exchange: Banks provide immediate cash to businesses by purchasing their bills of exchange at a discount before the maturity date.
2. Agency Services: Acting as an agent for customers by collecting cheques, paying insurance premiums, managing dividends, and acting as trustees or executors for wills.
3. General Utility Services: This includes providing safe deposit lockers, issuing traveller’s cheques, and acting as a referee for the financial standing of customers.

C. Modern Functions

1. Digital Banking: Facilitating real-time, cashless transactions through NEFT, RTGS, and UPI.
2. Advisory and Capital Services: Assisting corporations with Mergers and Acquisitions (M&A), Initial Public Offerings (IPOs), and merchant banking.

Q16. What is inflation? Describe the effects of inflation on the economy.

Ans. Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country. But it can also be more narrowly calculated for certain goods, such as food, or for services, such as a haircut, for example. Whatever the context, inflation represents how much more expensive the relevant set of goods and/or services has become over a certain period, most commonly a year.

According to Milton Friedman, “inflation is always and everywhere a monetary phenomenon and can be produced only by increase in the value of money than in output.”

Causes of Inflation –

Inflation arises from demand-pull factors, cost-push factors, supply shocks, increased money supply, wage-price spirals, inflation expectations, and certain fiscal policies. These elements collectively drive price increases, impacting purchasing power.

1. Demand-Pull Factors: When demand for goods and services exceeds supply, prices increase. This often happens when there is an influx of cash or credit in the economy, stimulating purchasing beyond the economy’s capacity.
2. Cost-Push Factors: Rising production costs can also cause inflation. When the costs of inputs like raw materials and labour increase, companies pass these costs on to consumers through higher prices.
3. Supply Shocks: Sudden disruptions to supply, such as natural disasters, conflicts, or pandemics, can significantly reduce the availability of critical goods. For example, supply chain issues during COVID-19 led to price spikes across sectors.
4. Increased Money Supply: A significant increase in the money supply can drive inflation, as more cash circulating in the economy fuels higher demand. With too much money chasing too few goods, prices tend to rise.
5. Wage-Price Spirals: When workers demand higher wages to cope with rising prices, businesses often raise prices to cover these increased labour costs. This cycle, known as the wage-price spiral, can fuel sustained inflation.
6. Inflation Expectations: When people expect inflation to persist, they may demand higher wages and buy goods now to avoid future price increases, reinforcing inflation. Central banks aim to keep these expectations stable to control inflation.
7. Fiscal Policies: Government policies like tax cuts or increased public spending can raise overall demand, leading to inflation if the economy is already operating at full capacity and supply cannot keep pace.

Effects of Inflation

Effects of inflation on production:

Inflation doesn't just change prices; it changes how businesses operate and how resources are used.

1. Misallocation of Resources: Investors shift money away from productive sectors (like manufacturing) into "speculative" assets like gold or real estate, which hold value better during price hikes.
2. Reduced Quality: To maintain profit margins without raising prices too aggressively, producers may resort to "skimpflation", reducing the quality of raw materials or the size of the product.
3. Hoarding and Black Marketing: Anticipating further price rises, traders may hoard essential goods to sell them later at higher prices, creating artificial scarcity.
4. Discouragement of Savings: As the value of money falls, people prefer to spend now rather than save, which reduces the total capital available for long-term industrial investment.

Effects on Distribution of Income and Wealth

Inflation acts as a "hidden tax," but it doesn't affect everyone equally. It creates distinct winners and losers:

Other Macroeconomic & Social Effects

The ripple effects of inflation extend to the government's balance sheet and the moral fabric of society.

1. Balance of Payments (BOP) Crisis: High domestic inflation makes a country's exports more expensive and less competitive abroad. Meanwhile, imports become relatively cheaper, leading to a trade deficit.
2. Currency Depreciation: As the internal purchasing power of a currency falls, its value in the foreign exchange market usually drops as well.
3. Increased Public Expenditure: The government must spend more on public projects, defence, and administration because the cost of materials and labour has increased.
4. Social and Moral Impact: Rapid inflation can lead to social unrest. It often encourages "social evils" such as corruption, adulteration of goods, and a general loss of faith in the monetary system.
5. Risk of Collapse: In extreme cases (hyperinflation), the monetary system can fail entirely as people lose confidence in the currency.

Q17. Write key features of New Economic Policy, 1991.

Ans. The New Economic Policy (NEP) of 1991 was a watershed moment in Indian history. Faced with a severe Balance of Payments (BoP) crisis and soaring inflation, the government moved away from the "License Raj" toward a more market-oriented economy.

The policy is famously summarized by the trio: LPG (Liberalization, Privatization, and Globalisation).

Liberalization: Removing the "License Raj"

Liberalization aimed to end the unnecessary bureaucratic controls that stifled private industry.

• Abolition of Industrial Licensing: Licensing was abolished for almost all industries, except for a few sensitive sectors (e.g., liquor, cigarettes, hazardous chemicals, electronics, and defence equipment).
• Expansion of Production Capacity: Companies no longer needed government permission to expand their production scale or diversify their product lines.
• Financial Sector Reforms: The role of the Central Bank (RBI) shifted from a regulator to a facilitator. This allowed for the entry of private and foreign banks, increasing competition.
• Tax Reforms: Significant reductions in personal income tax and corporate tax rates were implemented to encourage better compliance and higher revenue.

Privatization: Reducing the Role of the Public Sector

Privatization involved giving the private sector a larger role in nation-building while reducing the dominance of Public Sector Undertakings (PSUs).

• Disinvestment: The government sold a portion of its equity in PSUs to the private sector or the general public.
• Reduced Public Sector Reservation: The number of industries reserved exclusively for the public sector was slashed from 17 to just a few (currently limited mainly to Atomic Energy and Railway operations).
• Autonomy to PSUs: To improve efficiency, the government granted "Navratna" and "Maharatna" status to high-performing PSUs, giving them greater financial and operational autonomy.

The Central Public Sector Enterprises are designated with different status. A few examples of public enterprises with their status are as follows:

1. Maharatnas –

• Indian Oil Corporation Limited (IOCL)
• Steel Authority of India Limited (SAIL)

2. Navratnas –

• Hindustan Aeronautics Limited (HAL)
• Mahanagar Telephone Nigam Limited (MTNL)

3. Miniratnas –

• Bharat Sanchar Nigam Limited (BSNL)
• Airport Authority of India (AAI)
• Indian Railway Catering and Tourism Corporation Limited (IRCTC)

Globalisation: Integrating with the World

Globalisation aimed to open the Indian economy to the global market, making it more competitive and technologically advanced.

• Reduction in Tariffs: Import duties and customs taxes were drastically reduced to allow foreign goods to enter the market easily.
• Foreign Investment (FDI & FII): The limit for Foreign Direct Investment (FDI) was raised in many sectors, allowing foreign companies to own a majority stake in Indian ventures.
• Currency Devaluation & Partial Convertibility: The Indian Rupee was devalued to make Indian exports cheaper and more competitive. Later, the rupee was made partially convertible to facilitate easier international trade.
• Removal of Quantitative Restrictions: Limits on the volume of goods that could be imported or exported were largely removed.

Some crucial aspects/outcomes of globalisation are as follows: -

Outsourcing

In outsourcing, a company hires regular service from external sources, mostly from other countries, which was previously provided internally or from within the country (like legal advice, computer service, advertisement etc.) Many of the services such as voice-based business processes (popularly known as BPO or call centres), record keeping, accountancy, banking services, music recording, film editing, book transcription, clinical advice or even teaching are being outsourced by companies in developed countries to India. Most multinational corporations, and even small companies, are outsourcing their services to India where they can be availed at a cheaper cost with reasonable degree of skill and accuracy. The low wage rates and availability of skilled manpower in India have made it a destination for global outsourcing in the post-reform period.

World Trade Organisation (WTO)

The WTO was founded in 1995 as the successor organisation to General Agreement on Trade and Tariff (GATT). GATT was established in 1948 with 23 countries as the global trade organisation to administer all multilateral trade agreements by providing equal opportunities to all countries in the international market for trading purposes. WTO is expected to establish rule-based trading regime in which nations cannot place arbitrary restrictions on trade. Its purpose is also to enlarge production and trade of services, to ensure optimum utilisation of world resources and to protect the environment. The WTO agreements cover trade in goods as well as services to facilitate international trade through removal of tariff as well as non-tariff barriers and providing greater market access to all member countries.

India as a member of WTO, has been in the forefront of framing fair global rules, regulations and safeguards and advocating the interests of the developing world. India has kept its commitments towards liberalisation of trade, made in the WTO, by removing quantitative restrictions on imports and reducing tariff rates.

Major Objectives of the NEP

1. Economic Growth: To increase the GDP growth rate.
2. Modernization: To bring in world-class technology and management practices.
3. Fiscal Discipline: To reduce the fiscal deficit and manage the BoP crisis.
4. Competitive Market: To break domestic monopolies and offer better quality goods to consumers at lower prices.

The NEP 1991 shifted India from a "Command and Control" model to a "Market-Driven" model, paving the way for the high growth rates seen in the subsequent decades.

Conclusion:

The new economic policy of 1991 hauled India out of the license-permit-quota raj, breathing new life to the stagnating economy. It was a significant step taken by the government, which launched India onwards onto the path of globalisation. As the LPG regime unleashed itself, a plethora of changes took place. The stronghold of bureaucracy loosened; public-private partnerships emerged loosening the shackles of government over the suffocated private sector.

The process of Globalisation through liberalisation and privatisation policies has produced positive, as well as, negative results both for India and other countries.

Q18. Differentiate between public and private sector. Explain the role of public sector in the economy.

Ans. The balance between the public and private sectors defines the economic architecture of a nation. In a Mixed Economy like India, both sectors coexist to achieve a synergy between social welfare and economic efficiency.

Public Sector

The public sector consists of various organizations owned, managed, and controlled by the government (Central, State, or Local). Its primary objective is not profit, but the maximization of social welfare and the provision of essential services.

Roles and Objectives

1. Infrastructure Development: The public sector invests in "long-gestation" projects where private capital is often hesitant to enter due to high risks and slow returns (e.g., Railways, National Highways, and Nuclear Power).
2. Correction of Regional Imbalances: By setting up industries in backward areas (as seen in the early Five-Year Plans with steel plants in Bhilai and Rourkela), the government ensures that economic growth is geographically inclusive.
3. Provision of Public Goods: Items like national defence, street lighting, and public parks are non-excludable and non-rivalrous. Since the private sector cannot easily charge for these, the public sector must provide them.
4. Control of Monopolies: To prevent the concentration of economic power in a few hands, the government manages strategic sectors (Atomic Energy, Space) and regulates essential services to protect consumers from exploitation.

The Private Sector

The private sector comprises businesses owned and managed by individuals or groups of individuals. Its primary heartbeat is the profit motive, which inherently drives innovation and resource optimization.

Roles and Contributions

1. Economic Dynamism and Innovation: Competition in the private sector forces firms to innovate constantly. This leads to technological advancement and a wider variety of goods and services for the consumer.
2. Employment Generation: While the public sector provides stability, the private sector (especially MSMEs) is the largest employer in the modern economy, absorbing a significant portion of the labour force.
3. Capital Formation: Through the stock market and private investments, this sector mobilizes public savings into productive economic activities.
4. Global Competitiveness: Private firms are generally more agile in adapting to global market trends, helping the nation improve its export potential and foreign exchange reserves.

Comparative Analysis: Public vs. Private Sector

The Shifting Paradigm: Post-1991 Reforms

Following the LPG (Liberalization, Privatization, and Globalisation) reforms in India, the demarcation between these sectors shifted significantly. 

The government began selling its stakes in Public Sector Undertakings (PSUs) to invite private efficiency and reduce the fiscal deficit. Most sectors previously reserved for the public sector (like telecommunications and mining) were opened to private players. The government’s role evolved from being a "producer" to a "regulator" (e.g., SEBI, TRAI, and CCI).

Public-Private Partnership (PPP)

In the modern context, the debate is no longer "Public vs. Private" but "Public and Private." The PPP model combines the strengths of both. Technical expertise, managerial efficiency, and speed of the Public Sector. And, regulatory backing, land acquisition, and social legitimacy of the Private Sectort. 

Common frameworks include BOT (Build-Operate-Transfer) and the Hybrid Annuity Model (HAM), widely used in Indian highway construction.

Strategic Challenges

Despite their roles, both sectors face inherent challenges. Public Sector faces the "Agency Problem" where managers may lack the incentive to optimize costs, leading to high "Red Tape" and fiscal drains through loss-making PSUs. Whereas Private Sector, when left unregulated, it can lead to market failures, environmental degradation, and widening income inequality (Wealth Concentration).

Note on Economic Rationale: The optimal balance is often found by applying the principle of Subsidiarity: the government should only perform those tasks which cannot be performed effectively by the private sector or the local community.

The synergy of these two sectors ensures that an economy remains both productive (through private enterprise) and just (through public oversight and welfare).