Question

1. Define GDP and Calculate GDP as expenditures, and as income.

2. What is Misallocation of Resources? Give Examples to justify your answer.

3. What do you understand by the term Deadweight Loss?

4. Explain the impact of price floors and price ceilings.

Answer 1

1. GDP is the market value of final goods and services which are produced within the domestic territory of a country during one year. Components of GDP are C, I, G and NX.

a) Private Final Consumption Expenditure (C): It refers to expenditure on final goods and services by the individuals, households, and non-profit private institutions serving society. It includes: consumer services, consumer non durable goods and consumer durable goods.

b) Government final consumption expenditure (G): It refers to expenditure on final goods and services by the Government like expenditure on purchase of goods for consumption by the defence personnel.

c) Investment expenditure (I): It refers to expenditure on final goods and services by the producers. Example: expenditure by the farmers on the purchase of tractors or thrashers. It includes fixed investment and inventory investment.

d) Net exports refers to the difference between exports and imports during an accounting year. Exports are an expenditure by the foreigners on the domestically produced final goods and services while imports are an expenditure on the goods and services produced abroad.

Income Method:

Domestic income is also estimated as the sum of factor incomes generated within the domestic territory of country during an accounting year. A factor income is the income earned by a person as a reward for rendering his factor service. Factor income is broadly classified as:

a) Compensation of employees: It includes wages and salaries in cash, payment in kind, employer's contribution to social security schemes, pension on retirement.

b) Operating surplus: it refers to income from property and entrepreneurship. It includes rent, interest and profit.

Profit is further classified as: (i) dividends (ii) Corporate profit tax and (iii) Undistributed profit

c) Mixed income: It refers to the incomes of the self-employed persons using their own labor, land, capital and entrepreneurship to produce goods and services. Mixed incomes are a mixture of wages, rent, interest and profit.

2. Mis-allocation of resources occurs when labor, land, capital and entrepreneur are not used in optimal way.

Example: Taxable revenue of country is used for the body check-up of old women rather than spending it on other productive areas.

3. Dead-weight loss is a loss of economic efficiency which occurs because equilibrium is not attained by the economy. Imposition of tax on good creates dead-weight loss. Tariff on imports generates dead-weight loss.

4. Price Ceiling: When government fixed price of a product at a level lower than the equilibrium price, the price is called control price or price control by the government. This is done to control the interest of the consumers. The implication or consequence of price control are as follows:

a) Rationing: It is a system of distributing essential goods in limited quantities at control prices. It is reported when due to a shortage, a certain good is not available at reasonable price. Government establishes Public Distribution System as a tool to help the consumers.

b) Black market: Another result of price control can be an emergence of a black market in which the commodity is sold at a price higher than the government's fixed price. The reason is that on the one side, sellers are not ready to sell at a lower price fixed by the government and on the other side, some consumers are ready to offer a higher price to satisfy their demand for a commodity. A black market is that market situation in which goods are sold at prices higher than the price fixed by the government by law.

Price Floor: When government fixes the price of a product at a level higher than equilibrium price, it is called support price. As a result, the supply becomes in excess of demand. Support price is the minimum guaranteed price at which producers can sell their output to the government if so desired. The main consequence of support price is that consumers have to pay a higher price for the good. On the other hand, the income of the producers goes up. The aim of support price is to insulate the farmers from fluctuations in their income which are caused by price variations in the free market.