ECONOMICS

Chapter Title: Concept of Macroeconomics

(A) Very Short Answer Questions
1) What is macroeconomics?
Answer: Macroeconomics is a branch of economics that studies how an overall economy—the market systems that operate
on a large scale—behaves. Macroeconomics studies economy-wide phenomena such as inflation, price levels, rate of
economic growth, national income, gross domestic product (GDP), and changes in unemployment.

2) Who used the word or term “Macroeconomics” for the first time?
Answer: Ragnar Frisch is a Norwegian economist who first created the term 'Macroeconomics" for the first time in the year
1933 AD.

3) Point out the scope of macroeconomics.

Answer: Scope of Macroeconomics:
1. Theory of National Income
2. Theory of Employment
3. Theory of Money
4. Theory of General price Level
5. Theory of Economic Growth
6. Theory of International Trade

4) Define Closed Economy.

Answer: A closed economy is one that has no trading activity with outside economies. The closed economy is therefore
entirely self-sufficient, which means no imports come into the country and no exports leave the country.

5) Define Open Economy.

Answer: An open economy is a type of economy where not only domestic actors but also entities in other countries engage
in trade of products. Trade can take the form of managerial exchange, technology transfers, and all kinds of goods and
services.

6) What do you mean by Macroeconomic Variables?

Answer: Macroeconomic variables are indicators or main signposts signaling the current trends in the economy. Like all
experts, the government, in order to do a good job of macro-managing the economy, must study, analyze, and understand
the major variables that determine the current behavior of the macro-economy.

7) Point out any four Macroeconomic Variables.

Answer: Any four Macroeconomic Variables:
1. GDP
2. Public Expenditures
3. Overall Taxes
4. Private Consumption

(B) Short Answer Questions

1) Explain the concept of Macroeconomics.
Answer: Macroeconomics is a branch of economics that studies how an overall economy—the market systems that operate
on a large scale—behaves. Macroeconomics studies economy-wide phenomena such as inflation, price levels, rate
of economic growth, national income, gross domestic product (GDP), and changes in unemployment.
Some of the key questions addressed by macroeconomics include: What causes unemployment? What causes inflation?
What creates or stimulates economic growth? Macroeconomics attempts to measure how well an economy is performing, to
understand what forces drive it, and to project how performance can improve.
 Macroeconomics deals with the performance, structure, and behavior of the entire economy, in contrast to microeconomics,
which is more focused on the choices made by individual actors in the economy (like people, households, industries, etc.).
There are two sides to the study of economics: macroeconomics and microeconomics. As the term implies, macroeconomics
looks at the overall, big-picture scenario of the economy. Put simply, it focuses on the way the economy performs as a
whole and then analyzes how different sectors of the economy relate to one another to understand how the aggregate
functions. This includes looking at variables like unemployment, GDP, and inflation. Macroeconomists develop models
explaining relationships between these factors. Such macroeconomic models, and the forecasts they produce, are used by
government entities to aid in the construction and evaluation of economic, monetary and fiscal policy; by businesses to set
strategy in domestic and global markets; and by investors to predict and plan for movements in various asset classes.
Given the enormous scale of government budgets and the impact of economic policy on consumers and businesses,
macroeconomics clearly concerns itself with significant issues. Properly applied, economic theories can offer illuminating
insights on how economies function and the long-term consequences of particular policies and decisions. Macroeconomic
theory can also help individual businesses and investors make better decisions through a more thorough understanding of
what motivates and arties and how to best maximize utility and scarce resources.
2) Describe the scope of Macroeconomics.
Answer:
1. To Understand the Working of the Economy:
The study of macroeconomic variables is indispensable for understanding the working of the economy. Our main
economic problems are related to the behavior of total income, output, employment and the general price level in the
economy. These variables are statistically measurable, thereby facilitating the possibilities of analyzing the effects on
the functioning of the economy. As Tinbergen observes, macroeconomic concepts help in “making the elimination
process understandable and transparent”. For instance, one may not agree on the best method of measuring different
prices, but the general price level is helpful in understanding the nature of the economy.
2. In Economic Policies:
Macroeconomics is extremely useful from the point of view of economic policy. Modern governments, especially of the
underdeveloped economies, are confronted with innumerable national problems. They are the problems of
overpopulation, inflation, balance of payments, general underproduction, etc. The main responsibility of these
governments rests in the regulation and control of overpopulation, general prices, general volume of trade, general
outputs, etc. Tinbergen says: “Working with macroeconomic concepts is a bare necessity in order to contribute to the
solutions of the great problems of our times.” No government can solve these problems in terms of individual behavior.
Let us analyze the use of macroeconomic study in the solution of certain complex economic problems.
i. In General Unemployment:
The Keynesian theory of employment is an exercise in macroeconomics. The general level of employment in an
economy depends upon effective demand which in turn depends on aggregate demand and aggregate supply
functions. Unemployment is thus caused by deficiency of effective demand. In order to eliminate it, effective
demand should be raised by increasing total investment, total output, total income and total consumption. Thus,
macroeconomics has special significance in studying the causes, effects and remedies of general unemployment.
ii. In National Income:
The study of macroeconomics is very important for evaluating the overall performance of the economy in terms of
national income. With the advent of the Great Depression of the 1930s, it became necessary to analyze the causes of
general overproduction and general unemployment. This led to the construction of the data on national income.
National income data help in forecasting the level of economic activity and to understand the distribution of income
among different groups of people in the economy.
iii. In Economic Growth:
The economics of growth is also a study in macroeconomics. It is on the basis of macroeconomics that the resources
and capabilities of an economy are evaluated. Plans for the overall increase in national income, output, and
employment are framed and implemented so as to raise the level of economic development of the economy as a
whole.
iv. In Monetary Problems:
 It is in terms of macroeconomics that monetary problems can be analyzed and understood properly. Frequent
changes in the value of money, inflation or deflation, affect the economy adversely. They can be counteracted by
adopting monetary, fiscal and direct control measures for the economy as a whole.
v. In Business Cycles:
Further macroeconomics as an approach to economic problems started after the Great Depression. Thus its
importance lies in analyzing the causes of economic fluctuations and in providing remedies.
3. For Understanding the Behavior of Individual Units:
For understanding the behavior of individual units, the study of macroeconomics is imperative. Demand for individual
products depends upon aggregate demand in the economy. Unless the causes of deficiency in aggregate demand are
analyzed, it is not possible to understand fully the reasons for a fall in the demand of individual products. The reasons
for increase in costs of a particular firm or industry cannot be analyzed without knowing the average cost conditions of
the whole economy. Thus, the study of individual units is not possible without macroeconomics.

3) Define Closed Economy. What are its features?

Answer: A closed economy is one that has no trading activity with outside economies. The closed economy is therefore
entirely self-sufficient, which means no imports come into the country and no exports leave the country. The goal of a
closed economy is to provide domestic consumers with everything they need from within the country's borders.
Features of a Closed Economy:
1. Absence of Foreign Trade
2. Absence of Labor Movement in Foreign Countries
3. Absence of Lending and Borrowing from Foreign Countries
4. Government Intervention
5. Less Freedom of Choice of Consumers

4) Define Open Economy. What are its features?

Answer: An open economy is a type of economy where not only domestic actors but also entities in other countries engage
in trade of products (goods and services). Trade can take the form of managerial exchange, technology transfers, and all
kinds of goods and services. (However, certain exceptions exist that cannot be exchanged; the railway services of a country,
for example, cannot be traded with another country to avail the service.)
Features of an Open Economy:
1. Existence of Foreign Trade
2. Labor Movement in Foreign Countries
3. Lending and Borrowing from Foreign Countries
4. Less Government Intervention
5. Freedom of Choice of Costumers

5) Distinguish between Closed and Open Economy.

Answer:

Closed Economy Open Economy

1) Does not have economic relations with the rest of 1) Has economic relations with other nations.
the world.
2) Activities taking place outside the domestic 2) Economic activities are affected by international
territory does not affect the economic activities inside the fluctuations and/or economic activities outside the
domestic nation. domestic territory.
3) There is no difference between National Income 3) The size of National Income may be greater than
and Domestic Income. Domestic Income.
4) It is an imaginary concept. 4) It is a realistic concept.

6) What do you mean by Macroeconomic Variables? List out the major Macroeconomic Variables.
Answer: Macroeconomic variables are indicators or main signposts signaling the current trends in the economy. Like all
experts, the government, in order to do a good job of macro-managing the economy, must study, analyze, and understand
the major variables that determine the current behavior of the macro-economy.
 Major Macroeconomic Variables:
1. Aggregate Demand and Supply
2. Gross Domestic Product (GDP)
a. Real GDP
b. Nominal GDP
3. Per Capita Income (PCI)
4. Economic growth rate
5. Price level
6. Rate of employment and unemployment
7. Balance of trade and payment
8. Demand for and Supply of Money
9. Trade Cycle (Business Cycle)
a. Depression
b. Recovery
c. Prosperity
d. Recession
10. Government Budget
11. Consumption, Saving and Investment

Chapter Title: Public/Government Finance

(A) Long Answer Questions
1) What is Government Finance? Explain its importance.
Answer: Government finance is the deliberate manipulation of revenues and expenditures of the government. It is
the financial plan of the government. The government uses the different types of revenues and expenditures as fiscal tools to
achieve different objectives.

1. Steady state economic growth:

Government finance is important to achieve sustainable high economic growth rate. The government uses the fiscal
tools in order to bring increase in both aggregate demand and aggregate supply. The tools are taxes, public debt, and
public expenditure and so on.

2. Price stability:
The government uses the public finance in order to overcome form inflation and deflation. During inflation, it reduces
the indirect taxes and genera expenditures but increases direct taxes and capital expenditure. It collects internal public
debt and mobilizes for investment. In case of deflation, the policy is just reversed.

3. Economic stability:
The government uses the fiscal tools to stabilize the economy. During prosperity, the government imposes more tax and
raises the internal public debt. The amount is used to repay foreign debt and invention. The internal expenditures are
reduced. During recession, the case is just reversed.

4. Equitable distribution:
The government uses the revenues and expenditures of itself in order to reduce inequality. If there is high disparity it
imposes more taxes on income, profit and properties of rich people and on the goods they consume. The money
collected is used for the benefit of poor people through subsidies, allowance, and other types of direct and indirect
benefits to them.

5. Proper allocation of resources:

The government finance is important for proper utilization of natural, man-made and human resources. For it, on the
production and sales of less desirable goods, the government imposes more taxes and provides subsidies or imposes
taxes lightly on more desirable goods.

6. Balanced development:
The government uses the revenues and expenditures in order to erase the gap between urban and rural and agricultural
and industrial sectors. For it, the government allocates the budget for infrastructural development in rural areas and
direct economic benefits to the rural people.
 7. Promotion of export:
The government promotes the export imposing less tax or exempting from the taxes or providing subsidies to the export
oriented goods. It may supply the inputs at the subsidized prices. It imposes more taxes on imports and so on.

8. Infrastructural development:
The government collects revenues and spends for the construction of infrastructures. It has to keep peace, justice and
security too. It has to bring socio-economic reformation too. For all these things it uses the revenues and expenditures as
fiscal tools.

2) What is government expenditure? Describe its importance.

Answer: The government promotes the export imposing less tax or exempting from the taxes or providing subsidies to the
export oriented goods. It may supply the inputs at the subsidized prices. It imposes more taxes on imports and so on.
The major importance of government expenditure are as follows:

1. To maintain law and order

Maintaining law and order is the main function of government. Without law and order, government are misplaced with
their activities. To maintain the law and order, government needs a huge amount of budget every year.

2. To invest on social and economic overheads

For economic progress, firstly, there must be the development of socio-economic infrastructure like road, electricity,
transportation, school, hospital, etc. It is possible with the public expenditure because to develop such infrastructures,
there should be a huge amount of capital.

3. Utilization of Natural Resources

Natural resources are the essential for the economic development of a country which needs a huge amount of capital.
This is not possible by the private sector. So, public expenditure helps to explore and utilize the natural resources for the
development of a country.

4. Development of Agriculture and Industrial Sector

For the development of agricultural sector such as irrigation and power, seed farms, fertilizer factories, warehouses, etc.
the government has to incur a lot of expenditure. To establish a larger industry, it requires a huge amount of capital.
This is possible through government expenditure.

5. Redistribution of income
Government expenditure provides subsides, free education and healthcare facilities to the poor people. So, government
expenditure is used as a powerful fiscal instrument to bring about an equitable distribution of income and wealth.

6. Provide administrative service

The government needs to allocate its budget to carry out administrative service of different agencies, department,
ministries and concerned offices. The government provides various types of services to its citizens.

7. Balanced Regional Growth

Public expenditure can correct regional disparities. By diverting resources in backward regions, government can bring
about all-round development there so as to compete with the advanced regions of the country. It is necessary to ensure
that the government’s expenditure is made solely in the public interest and does not serve any individual’s interest or
that of any political party or a group of persons.

3) Explain the source of government revenue in reference to Nepal.

Answer: Governments do not have their own money. Money spent by a government is all collected from the source like
Tax. The revenue collected from the various source by a government is called Government Revenue.
There are various sources of government revenue. They are explained below:

1. Tax revenue:
Tax is the most source of government revenue. Tax is the compulsory charge imposed by public authority. There are
various types of tax like Income tax, Value Added Tax (VAT), Land revenue tax, etc. Tax revenue consists the
following sources:

 Custom duties
It is an indirect tax imposed on imported and exported goods and services.
  Tax on consumption and production of goods and services
It is also similar to indirect tax which consists of an excise tax, sales tax, value added tax, entertainment tax,
contract tax, road and bridge tax.

 Tax on property, profit and income

It is a direct tax which includes the tax income from corporations, vehicle tax and interest on tax.

 Land revenue and registration tax

It is similar to direct tax imposed on land revenue, house and land registration changes.

2. Non-tax revenue:
Non-Tax Revenue is the recurring income earned by the government from sources other than taxes.

 Fees
The fee is the actual amount paid to the government for the services to the beneficiaries. However, fees are usually
paid by those individuals who received some benefits from services given by the government such as education fee,
training fee registration fee etc.

 Fines and penalties

Fines and penalties are actually imposed by the government for the violation of a certain law. The main goal of the
fine and penalty is to prevent and reduce the crime and repetition mistake.

 Special assessment
The government charges special assessment to those people, who directly got benefit from the construction of roads,
bridges, street lightening, electricity, irrigation, and infrastructure etc.

 Escheats
The amount claimed by the government on the death of a person without any heir or does not have any legal
inheritance is called escheats .The government also increases revenue from the source.

 Profit of public sector enterprises

The government can earn income from the sales of goods and services by the public enterprises. Besides this, the
government also earns profit public utility industries like drinking water, electricity, telecommunication,
transportation, post offices, public sector bank etc.

 Foreign Grants
A government receives grants for the development programs, security expense and to meet even regular expenses
from the foreign government and international instructions Most of the developing countries depend upon the
foreign grants to fulfill their deficit.

4) Define direct and indirect tax. Explain its merits and demerits.
Answer:
(I) Direct Tax
If an individual has to pay the tax, it is called direct tax. When a person buys land, house, etc. he/she has to pay tax and
this cannot be transferred to another. Income tax, salary tax, land tax, house tax, etc. are examples of direct tax. The
rates of this tax can be more or less depending on the time.

(A) Merits:
1. Equity
3. Certainty
4. Elasticity
4. Productive
5. People’s Consciousness
6. Progressive
7. Certainty
8. Economic
9. Educative
10. Anti- Inflationary
 (B) Demerits:
1. Lack of Popularity
2. Evasion
3. People’s Indifference
4. Disincentive to Work and Save
5. Uneconomical
6. Inconvenient
7. Arbitrary
8. Limited Scope
9. Disincentive Effect on Work Effort and Saving
10. Tax on Honesty

(II) Indirect Tax:

An indirect tax is one in which the burden can be shifted to others. The tax payer is not the tax bearer. The impact and
incidence of indirect taxes are on different persons. An indirect tax is levied on and collected from a person who
manages to pass it on to some other person or persons on whom the real burden of tax falls. For e.g. commodity taxes or
sales tax, excise duty, custom duties, etc. are indirect taxes.

(A) Merits:
1. Convenient
2. Difficult to Evade
3. Universality
4. Elastic
5. Wide Coverage
6. Influence on Pattern of Production
7. Flexibility and Buoyancy
8. Social Welfare
9. Does not affect motivation to work or save
10. Popularity
(B) Demerits:
1. Regressive
2. Administrative Difficulties
3. Uncertain
4. Unproductive
5. Lack of Civic Consciousness
6. Wage-Price Push
7. Possibility of Evasion
8. Unreasonable Price Rise
9. Inflationary
10. Decrease in Consumption

5) What is meant by tax? Explain the characteristics of a good tax system.

Answer: Tax is the fixed amount rate taken by the government from its citizens. There is no direct profit to the citizens by
paying tax. This is the main source of revenue as well. Customs tax, service tax, land tax, income tax, admission tax, etc. are
some of the taxes that make up the revenue.
Some of the most important principles or characteristics of a good tax system are as follows: 1. Productivity or Fiscal
Adequacy 2. Elasticity of Taxation 3. Diversity 4. Taxation as in Instrument of Economic Growth 5. Taxation as an
Instrument for Improving Income Distribution 6. Taxation for Ensuring Economic Stability.
Adam Smith viewed the problem of devising a good tax system chiefly from the viewpoint of devising good tax payers.
Taxation system should also be such that it meets the requirements of increasing state activity and achieves the objectives
the society has placed before it.

1. Productivity or Fiscal Adequacy:

An important principle of a good tax system for a developing country is that it should yield adequate amount of
resources for the Government so that it should be able to perform its increasing welfare and developmental activities. If
the tax system fails to yield enough resources, the Government will resort to deficit financing. An excessive dose of
deficit financing is bound to raise prices which are harmful for the society. To make the tax system sufficiently
 productive it should be broad-based and both direct and indirect taxes find place in it. Moreover, taxes should be
progressive so that the revenue from them rises with the increase in income of the people.
2. Elasticity of Taxation:
Another principle of taxation suitable for the developing countries is the principle of elasticity of taxation. According to
the concept of elasticity of the taxation system, as national income increases as a result of economic growth, the
Government revenue from taxes should also increase. In developing countries, the share of tax revenue as a proportion
of national income is low as compared to the developed countries. This share of tax revenue will rise as national income
increases, if the tax system is sufficiently elastic. Progressive taxation of income and wealth provides this elasticity to
the tax system. Impositions of higher indirect (axes on luxury goods having a high income elasticity of demand also
makes the tax system elastic.
3. Diversity:
A good tax system should follow the principle of diversity. This implies that there should not be a single or a few taxes
from which Government seeks to raise large revenue. This is because if a Government tries to get large revenue from a
single tax or few taxes, it will have to raise the rates of taxation too high which will not only adversely affect the
incentives to work, save and invest but also encourage evasion of taxes. Therefore, the tax system should be a multiple
tax system with a large variety of taxes so that all those who can contribute to the public revenue should be made to do
so. This calls for a mix of various direct and indirect taxes. With the diverse tax system, the principles of fiscal
adequacy and equity will also be better satisfied. Commending diversity in the tax system Arthur Young writes, “If I
were to define a good system of taxation, it should be that of bearing lightly on an infinite number of points, heavily on
none”. Similarly, another expert of public finance writes, “Excessive reliance on any one base may produce adverse
economic effects because the rates may become too high. Therefore, a tax system may do less economic damage if it
raises moderate amounts from several bases rather than large amounts from one or two.”
4. Taxation as in Instrument of Economic Growth:
In a developing economy such as ours, taxation should serve as an instrument of economic growth. Economic growth is
primarily a function of rate of capital formation. If in the development strategy public sector has been assigned an
eminent place, then capital formation in the public sector must occur at a relatively higher rate. This calls for
mobilization of resources by the Government so as to finance capital formation in public sector. Therefore, a good tax
system for a developing country will be such as will enable the Government to mobilize adequate resources for capital
formation or economic growth.
5. Taxation as an Instrument for Improving Income Distribution:
A good tax system for a developing economy should also serve as an instrument for reducing economic inequalities.
The purpose of a good tax system for a developing economy is not merely to raise revenue for the Government but also
to ensure that burden of taxes falls more on the rich. This requires that the rates of progressive direct taxes on income,
wealth, expenditure, capital gains etc., must be sufficiently high. This objective of reducing income inequalities will be
better served if a good part of the tax revenue is used for poverty alleviation programs.
6. Taxation for Ensuring Economic Stability:
A tax system must also ensure economic stability. Economic fluctuations have been a big problem in the developed
countries and for reducing these fluctuations taxation can play a useful role. For this purpose, tax system must have
built-in-flexibility. To have built-in-flexibility, the taxation system must be progressive in relation in the changes in
national income. This will ensure that when national income rises, an increasing part of the rise in income should
automatically accrue to the Government. On the other hand, when national income falls, as in a recession or depression,
the revenue obtained progressive from taxes will fall more rapidly than the decline in national income. Built-in-flexi-
bility attained through progressive taxation ensures that when incomes are increasing during the period of boom or
inflation, the relatively greater amount of tax revenue accruing to Government will moderate the increase in purchasing
power with the people and aggregate demand and thus help in keeping prices under check. Likewise, under progressive
taxation at times of depression or recession, tax revenue will fall faster than the income so that purchasing power of the
people does not fall as fast as their pre-tax income. This will serve to check decline in economic activity. However, in
developing countries, the problem is more of restraining inflation so as to achieve price stability. By discouraging or
restraining consumption, especially of non-essential or unproductive type, taxation can pay a useful role in controlling
inflation in the developing countries.

6) What is meant by Government Borrowing? Mention its sources.

Answer: Government borrowing refers to the borrowing by a government from within the country or from aboard. In other
words, the loan taken by the government is known as government borrowing. So, government borrowing is the total amount
of money that a country's central government has borrowed to fund its spending on public services and benefits.
Its sources are mentioned an explained briefly below:
 (A) Internal Borrowing
When the debt is raised within the country it is called internal debt. This concept of internal borrowing was started in
the 1930s to fight against the depression as recommended by J.M. Keynes. It is taken by the government with the
central bank, commercial bank, financial institute, private and government organization.
The major sources of government internal borrowing are as follows:

 Central Bank
The Central bank is the banker of the government. When the government needs money and issue bonds, the central
bank purchase them. The Central bank also deposits the amount in the government account.
 Commercial Bank
The basic function of the central bank is to accept deposit and provide loans. A commercial bank does also provide
loans to the government. They
purchase securities issued by the government.
 Non-Banking Financial Institution
The government also raises the borrowing from the non-banking financial institution by selling their securities to
them.
 Individuals
Individuals also purchase the securities issued by the government. Thus, the purchasing power is shifted from the
general people to the government.

(B) External Borrowing

The government can also borrow the loan from the external sources. It is taken at the time of war, famines, earthquake,
and natural disasters. The main sources of the external sources are foreign government and international government. It
can be explained more as:

 Foreign government
The government can borrow loans from other governments. Such received loan is called the bilateral loan. Usually,
developed country provides such type of loan called soft loan with low-interest rate to the developing countries for
the development of infrastructure of the country.
 International Financial Institutions
International Financial Institutions like World Bank provides funds to different countries. The member countries can
borrow from these institutions for a short term and long term for the development projects.

7) What is government budget? Explain the steps of budget formulation.

Answer: A budget generally is a list of all expenses and revenues. It is an annual financial plan of the government revenue
and expenditure. It is also known as the statement of the financial plan of the government. Budget is the instrument through
which the government controls the entire economy.
Budgeting for the government is an enormously complex process. The process of a budget formulation may vary from the
government to government and country to country. Some of the common steps of the budget formulation are as follow:

1. Estimate of overall income expenditure

In the first stage, the planning authority collects the estimated of expenditure and possible income from concerned
ministries, departments and local offices of the government and then, discuss with the concern ministries.
2. Determination of priorities
It is the second step of budget formulation. After determining the amount expenditure for the next year planning
authorities determines the different priorities area on the basis of available resources and needs
3. Project preparation and Selection
It is the third stage of the budget formulation. The planning authorities after making a review of the project, it selects the
projects to include in coming budget. Planning authorities review the financial cost of the project and submission to the
budget department.
4. Proposal of new taxes
In the fourth stage, new tax policies are proposed by the finance minister of the government with discussing the experts
and stakeholders.
5. Final Document
 In the fifth stage, the budget office gives the final shape of the budget. It is completed before fiscal year commences. It
is presented to parliament by the finance minister and discussed in parliament by its member only after approval from
the parliament budget get final shape, otherwise, it needs amendment.
6. Authorization
The final step of the budget formulation is the authorization of the budget by the legislature. After a long discussion on
a budget, it is passed and authorized by the head of the state. After the authorization, it is distributed under the heading
and development expenditure.

(C) Short Answer Questions

1) Point out the tax and non-tax source of government revenue.
Answer:
1. Tax revenue:
Tax is the most source of government revenue. Tax is the compulsory charge imposed by public authority. There are
various types of tax like Income tax, Value Added Tax (VAT), Land revenue tax, etc. Tax revenue consists the
following sources:

 Custom duties
It is an indirect tax imposed on imported and exported goods and services.
 Tax on consumption and production of goods and services
It is also similar to indirect tax which consists of an excise tax, sales tax, value added tax, entertainment tax, contract
tax, road and bridge tax.
 Tax on property, profit and income
It is a direct tax which includes the tax income from corporations, vehicle tax and interest on tax.
 Land revenue and registration tax
It is similar to direct tax imposed on land revenue, house and land registration changes.

2. Non-tax revenue:
Non-Tax Revenue is the recurring income earned by the government from sources other than taxes.

 Fees
The fee is the actual amount paid to the government for the services to the beneficiaries. However, fees are usually
paid by those individuals who received some benefits from services given by the government such as education fee,
training fee registration fee etc.
 Fines and penalties
Fines and penalties are actually imposed by the government for the violation of a certain law. The main goal of the
fine and penalty is to prevent and reduce the crime and repetition mistake.
 Special assessment
The government charges special assessment to those people, who directly got benefit from the construction of roads,
bridges, street lightening, electricity, irrigation, and infrastructure etc.
 Escheats
The amount claimed by the government on the death of a person without any heir or does not have any legal
inheritance is called escheats .The government also increases revenue from the source.
 Profit of public sector enterprises
The government can earn income from the sales of goods and services by the public enterprises. Besides this, the
government also earns profit public utility industries like drinking water, electricity, telecommunication,
transportation, post offices, public sector bank etc.
 Foreign Grants
A government receives grants for the development programs, security expense and to meet even regular expenses
from the foreign government and international instructions Most of the developing countries depend upon the foreign
grants to fulfill their deficit.
2) Explain progressive tax system.
A progressive tax is a tax in which the tax rate increases as the taxable amount increases. The term "progressive" refers to
the way the tax rate progresses from low to high, with the result that a taxpayer's average tax rate is less than the
person's marginal tax rate. The term can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or
 lifetime. Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability to pay, as
such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is
a regressive tax. An example of a regressive tax would be a sales tax, with a sales tax a larger proportion of income is taxed
to the poor than the rich.
The progressive tax system can be explained with the help of the following example:
Income
Tax Rate (%) Tax Amount (Rs)
(Rs)
10000 5 50
50000 10 5000
100000 15 15000
The above table shows that the rate of tax and income level. Here, when the income is Rs.10000 then the tax rate is
5% and when the income is increased to Rs.50000 then the tax rate is also increased to 10%. Similarly, with the
increase in the income, the tax rate also goes on increasing. Hence, a number of tax increases from Rs.500 to
Rs.15000.
It can be shown from the following figure

In the above figure, OP line shows the progressive rate of taxation. Here,
when the income OY1, the tax rate is OR1. Similarly, when the income is
increased from OY1 to OY2 and OY3 the tax rate also increases from OR1 to
OR2 and OR3.

3) Explain proportional tax system.

A proportional tax is a tax imposed so that the tax rate is fixed, with no change as the taxable base amount increases or
decreases. The amount of the tax is in proportion to the amount subject to taxation. "Proportional" describes a distribution
effect on income or expenditure, referring to the way the rate remains consistent (does not progress from "low to high" or
"high to low" as income or consumption changes), where the marginal tax rate is equal to the average tax rate.
It can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Proportional taxes
maintain equal tax incidence regardless of the ability-to-pay and do not shift the incidence disproportionately to those with a
higher or lower economic well-being.
Flat taxes are defined as levying a fixed (“flat”) fraction of taxable income. They usually exempt from taxation household
income below a statutorily determined level that is a function of the type and size of the household. As a result, such a flat
marginal rate is consistent with a progressive average tax rate. A progressive tax is a tax imposed so that the tax rate
increases as the amount subject to taxation increases. The opposite of a progressive tax is a regressive tax, where the tax rate
decreases as the amount subject to taxation increases.
The French Declaration of the Rights of Man and of the Citizen of 1789 proclaims:
A common contribution is essential for the maintenance of the public forces and for the cost of administration. This should
be equitably distributed among all the citizens in proportion to their means.
4) Explain regressive tax system.
A regressive tax is a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases.
"Regressive" describes a distribution effect on income or expenditure, referring to the way the rate progresses from high to
low, so that the average tax rate exceeds the marginal tax rate. In terms of individual income and wealth, a regressive tax
imposes a greater burden (relative to resources) on the poor than on the rich: there is an inverse relationship between the tax
rate and the taxpayer's ability to pay, as measured by assets, consumption, or income. These taxes tend to reduce the tax
burden of the people with a higher ability to pay, as they shift the relative burden increasingly to those with a lower ability
to pay.
The regressivity of a particular tax can also factor the propensity of the taxpayers to engage in the taxed activity relative to
their resources (the demographics of the tax base). In other words, if the activity being taxed is more likely to be carried out
by the poor and less likely to be carried out by the rich, the tax may be considered regressive. To measure the effect,
 the income elasticity of the good being taxed as well as the income effect on consumption must be considered. The measure
can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime.
The opposite of a regressive tax is a progressive tax, in which the average tax rate increases as the amount subject to
taxation rises In between is a flat or proportional tax, where the tax rate is fixed as the amount subject to taxation increases.
5) Explain digressive tax system.
Answer: Digressive tax is a mix of between the progressive tax and proportional tax. In the case of digressive tax, the tax
rate is increased firstly with increase in income and then, the rate remains flat or constant with further increase in income.
6) What is budget? What are its components?

(D) Very Short Answer Questions

1) What is Government Finance?
Answer: Government Finance is the study of the role of the government in the economy. It is the branch of economics that
assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the
other to achieve desirable effects and avoid undesirable ones.

2) Point out four importance of Government Finance.

Answer: The following are the importance of Government Finance:
1. Price Stability
2. Economic Stability
3. Proper Allocation of Resources
4. Balanced Development

3) Define capital and current expenditure.

Answer: Current Expenses are the necessary purchases that keep a business going from day-to-day, such as rent, utility bills,
and office supplies.
Meanwhile, Capital Expenditures, or CAPEX, are considered asset purchases, or long-term investments made into a
business rather than general business expenses.

4) Write four canons of taxation.

Answer: The four canons of taxation are listed below:
1. Canon of Productivity
2. Canon of Elasticity
3. Canon of Simplicity
4. Canon of Diversity

5) What are the reasons for Government Borrowing?

Answer: The reasons for Government Borrowing are:
1. To Reduce Deficit Budget
2. To Finance A Huge Capital Project
3. To Provide Employment Opportunities
4. To Maintain the Balance of Payment
5. To Produce War Materials

6) What are the internal and external sources of government borrowing?

Answer: The Internal sources of Government Borrowing are:
1. Central Bank
2. Commercial bank
The External sources of Government Borrowing are:
1. Foreign Government
2. International Financial Institutions