Chapter 2: Basic Economic Entities in an Economy

Question 1

What is an economy?

Answer 1

The institutions and organisations that help to produce goods and services which directly and indirectly satisfy human wants, may be collectively called an economy.

Economy is a system which provides people with goods and services which directly or indirectly satisfy their wants.

Question 2

What are the essential or vital processes of an economy?

Answer 2

For the smooth functioning of the economy, the processes of production, consumption, distribution and exchange are essential. They are called essentials or vital processes of an economy.

Question 3

What are the 2 main functions of an economy?

Answer 3

1. To produce goods and services to satisfy human wants.

2. To provide employment or income earning opportunities to people.

Question 4

What are the 2 different way by which an economy can be described?

Answer 4

A system of cooperation among producers

A system of mutual exchange

Question 5

What are the 3 main sectors of an economy?

Answer 5

Production sector, Consumption sector and the Govt. sector.

Question 6

What is the production sector?

Answer 6

It is the sector where goods and services are produced. It produces goods and services by hiring the services of various factors of production (land, capital, organisation, labour)

Question 7

What is the consumption sector?

Answer 7

It is also known as the household sector. People in this sector spend their incomes on the consumption of goods and services produced by the production sector.

Question 8

What is the Government sector?

Answer 8

This sector acts both as a consumer and as well as producer. As producer, the government hires the services of various factors of production and produces goods and services for the consumption of the whole society. As consumer, the government purchases goods and services from the production sector and these goods and services are consumed collectively by the society.

Question 9

What is an economic entity and what are the activities that it can independently perform?

Answer 9

An institutional unit which is capable of doing economic activities independently is called an economic entity.

An economic entity can independently perform these activities:

• acquiring assets
• taking up responsibilities and incur liabilities
• participating in economic activities
• undertaking transactions with other economic entities in the economy.

Question 10

What are the 4 basic economic entities?

Answer 10

consumers, producers, households and government

Question 11

Who are consumers?

Answer 11

They consume various goods and services. Their objective is to maximise their satisfaction from the consumption of goods and services.

Question 12

What are households?

Answer 12

A household refers to a group of people living under a single roof and taking economic decisions only. The main objective of every household is to maximise satisfaction with its limited income or means.

Question 13

What are the functions of a household?

Answer 13

• they supply factor services to firms and earn their income.
• they purchase different consumer goods and services.

Question 14

Mention 4 importances of households

Answer 14

• As owners of factors of production, they supply factor services to the firms.
• As a consumer, they provide market for various goods and services produced in the economy.
• Households are also tax payers. They contribute revenue to the government.
• Households save a part of their income which becomes the basis of capital formation.

Question 15

What are Firms (Producers)?

Answer 15

The term firm refers to a particular unit producing a commodity or service with a view to earn profit. It undertakes the activity of creating value by combining and organising the factors of production. Firms produce goods and services by employing the factors of production and sell the same to the consumers, other firms and the governments.

Question 16

What are the functions of firms?

Answer 16

• They produce and sell various goods and services in exchange for money
• They purchase different factors of production by paying factor prices.

Question 17

What role does the government play when it comes to the economy?

Answer 17

• The term government includes all regulatory bodies by which it exercises its control over behaviour of households and the firms.
• It acts as a consumer as well as a producer
• Like households, a government incurs expenditure on various consumer goods and also provides various services to the people.
• The main aim of the government is to provide maximum social welfare.

Question 18

What leads to a circular flow of income and expenditure in an economy? (Exchange relationship between households and firms)

Answer 18

Households purchase various goods and services produced by the firms. They pay prices for purchasing these commodities. So, the expenditure of the households would become an income of the firms. On the other hand, the firms purchase different factors of production from the households, and pay prices for purchasing these factor services. Thus, an exchange relationship is established between the households and the firms. This leads to a circular flow of income and expenditure in the society.

Question 19

What are the 3 types of consumers? Explain.

Answer 19

Direct consumers: The first producers in history produced only for themselves and their families. The food they ate, the clothes they wore, the houses they constructed were all goods they produced for self-consumption. The producers for self-consumption are called direct producers/direct consumers.

Consumers by exchange: Gradually with the passage of time, people understood the advantage of specialisation in the production of one or a few commodities and exchanging them for one another’s products. They exchanged their surplus food with each other.

Modern consumers: Producers produce goods and services and make them available in the market for the consumers. Modern consumers make purchases of various goods and services form the market who offer them best bargain. All these purchases are made in terms of money.

Question 20

Mention 3 importances of consumers

Answer 20

1. Source of demand: consumers are the biggest source of demand for various goods and services produced in an economy.
2. Diversification in Production: Different consumers have different preferences or likings. Therefore, producers are encouraged to diversify their products.
3. Demand for services: Services too, say like transport services, banking services, health, education, etc.

Question 21

What are the 3 types of Producers?

Answer 21

Primary producers, Secondary producers, Tertiary producers

Question 22

Mention 4 importances of producers.

Answer 22

1. Supply of goods and services: Source of supply of goods and services in an economy.
2. Efficient Utilisation of Resources: The producers through their productive activities can make use of resources efficiently.
3. Expansion of Income and Employment Opportunities: A large number of persons are employed in the production sector.
4. Increase in Export Earnings: The export earnings of a country would depend upon the number of producers who are engaged in the production of exportable items.

Question 23

Mention the 2 different roles of the government

Answer 23

Direct role, Indirect role

Question 24

What are the direct roles of the government?

Answer 24

1. Development of infrastructure
2. Removal of inequalities of income and health
3. To direct market forces
4. Industrial development
5. Agricultural development
6. To raise investment
7. Maintenance of Law and order

Question 25

What are 3 methods by which government can remove inequalities in income and wealth?

Answer 25

The government can adopt a progressive tax system. A progressive tax system is one where the rate of tax increases as income increases.

The government of a country may benefit the poor through its expenditure policy. It can spend more on social security schemes such as unemployment allowance, medical benefits to the poor, pensions, etc.

Nationalisation of industries is yet another method that a state can adopt to check concentration of economic power in a few hands.

Question 26

How can government direct market forces?

Answer 26

The government can allocate resources for collective goods through its annual budget. This will ensure that not too many luxury items are produced in developing nations.

Question 27

How can the government use industrial development to help backward classes?

Answer 27

State can also help the development of backward areas by starting public enterprises in these areas and also by encouraging private enterprises to set up industries. Defence industries should be set up only by the state.

Question 28

What are the 4 methods by which the state can initiate agricultural development?

Answer 28

State can introduce various institutional and technological measures to raise agricultural productivity and production.

The state can also make necessary arrangements for supplying institutional credit to small farmers on easy terms.

The state can also take steps for providing necessary storage and marketing facilities to small farmers.

It can also introduce a crop insurance scheme to safeguard poor farmers from any crop failure due to natural calamities.

Question 29

How can the government raise the rate of investment?

Answer 29

The government can force the people to save more through its various schemes such as compulsory saving schemes, taxation or inflation.

Question 30

What are the indirect roles of the Government in the economy?

Answer 30

Fiscal Policy
Monetary Policy
Foreign Trade Policy
Price Policy

Question 31

What is the Fiscal Policy?

Answer 31

Fiscal policy refers to the revenue and expenditure policy of the government. Through its fiscal policy, the government tries to correct the inequalities of income and wealth that increase with development in underdeveloped countries.

Question 32

How is the fiscal policy capable of affecting the process of development?

Answer 32

Fiscal policy is capable of affecting the process of development in the following ways:

Increasing saving and capital accumulation by restricting consumption.

Helping in the reduction of income and wealth inequalities.

Controlling inflation.

Helping in correcting the situations of excess demand and deficient demand.

Question 33

What is the Monetary policy?

Answer 33

Monetary policy is the policy of the government regarding controlling and regulating the supply of money and availability of credit. Too much or too less of money in the market is not good for the economic progress of the nation. The surplus supply of money causes inflation and less supply causes deflation.

Question 34

What is the Foreign Trade Policy?

Answer 34

The government can solve problems of balance of payment deficit by adopting measures like export promotion and import substitution. It can help the exporters by timely import of raw materials and capital equipments needed for the production of exportable goods, by removing export restrictions, providing credit, insurance and transport facilities to them.

Question 35

What is the Price Policy?

Answer 35

The government can create the atmosphere of economic stability in the economy. Economic fluctuations should be reduced to the minimum so as to encourage the process of development. The government, through its price policy, can keep the prices stable within a narrow range.