Indian Economic Service Paper III (General Economics) full Solution 2018

Find here full solution of the paper- III of IES exam

General Economics- III, 2018

1.     Optimal Taxation:-The standard theory of optimal taxation posits that a tax system should be chosen to maximize a social welfare function subject to a set of constraints. The literature on optimal taxation typically treats the social planner as a utilitarian: that is, the social welfare function is based on the utilities of individuals in the society. In its most general analyses, this literature uses a social welfare function that is a nonlinear function of individual utilities. Nonlinearity allows for a social planner who prefers, for example, more equal distributions of utility.

2.     Existence values are a class of economic value, reflecting the benefit people receive from knowing that a particular environmental resource, such as Antarctica, the Grand Canyon, endangered species, or any other organism or thing exists.

Existence value is a prominent example of non-use value, as they do not require that utility be derived from direct use of the resource: the utility comes from simply knowing the resource exists. The idea was first introduced by John V. Krutilla, though he used the term "sentimental value".

Use Value – Can be split into Direct and Indirect use values:

·       Direct use value: Obtained through a removable product in nature (i.e. timber, fish, water).

·       Indirect use value: Obtained through a non-removable product in nature (i.e. sunset, waterfall).

3.      The Lerner index measures a firm’s level of market power by relating price to marginal cost. When either exact prices or information on the cost structure of the firm are hard to get, the Lerner index uses price elasticity of demand in order to measure market power: the Lerner index is equivalent to the inverse of the elasticity in its absolute value faced by the firm when price is set to maximise profits. Both formulas are equivalent: 

Therefore, Lerner index will always be between 0 and 1: the closer it is to 0, the closer it is to perfect competition; the closer it is to 1, the higher market power the seller has and hence closer to a monopoly. A monopolist seeking to maximise profits will never be on the inelastic part of the demand curve, E < 1, which is why elasticity will always be such as ∞ ≥ E ≥ 1.

4.     What Is Product Differentiation?

Product differentiation is a marketing process that strives to identify and communicate the unique benefits or qualities of a product compared to its competitors.

Successful product differentiation creates a competitive advantage for the product's seller.

Product differentiation raises consumer interest. More importantly, it can increase brand loyalty and even survive a higher price point.

Product differentiation is intended to prod the consumer into choosing one brand over another in a crowded field of competitors. It identifies the qualities that set one product apart from other similar products and uses that difference to drive consumer choice.

5.     What is a Market Economy?

A market economy is an economic system in which economic decisions and the pricing of goods and services are guided by the interactions of a country's individual citizens and businesses. There may be some government intervention or central planning, but usually this term refers to an economy that is more market oriented in general.

Market economies may still engage in some government interventions, such as price fixing, licensing, quotas, and industrial subsidies. Most commonly, market economies feature government production of public goods, often as a government monopoly. But overall, market economies are characterized by decentralized economic decision making by buyers and sellers transacting everyday business.

Although the market economy is clearly the popular system of choice, there is significant debate regarding the amount of government intervention considered optimal for efficient economic operations. Economists mostly believe that more market oriented economies will be rather successful at generating wealth, economic growth, and rising living standards, but often differ on the precise scope, scale, and specific roles for government intervention that are necessarily to provide the fundamental legal and institutional framework that markets might need in order to function well.

6.     REVENUE DEFICIT

Revenue Deficit is a situation where the revenue does not match with the expenses to be incurred. A dissimilarity in the expected revenue and expenditure can result in revenue deficit. The shortage of total revenue receipts compared to total revenue expenditure is defined as Revenue deficit. Example: If you thought you can make 5,000 at the end of the month and you just made 4,000 bucks, you are facing a revenue deficit of 1,000 bucks.

FISCAL DEFICIT

The difference between total revenue and total expenditure of the government is called as fiscal deficit. The Fiscal deficit is also on the same line of the Revenue deficit but with a larger range. it includes revenue deficit and other items which were excluded when calculating revenue deficit. Fiscal deficit is defined as the excess of total budget expenditure over total budget receipts excluding borrowings during a fiscal year. Example: If you plan to spend 5,000 bucks this month but you expect to earn 4,000 bucks you are facing a fiscal deficit of 1,000 bucks.

7.     Environmental taxes have many important advantages, such as environmental effectiveness, economic efficiency, the ability to raise public revenue, and transparency. Also, environmental taxes have been successfully used to address a wide range of issues including waste disposal, water pollution and air emissions. Regardless of the policy area, the design of environmental taxes and political economy considerations in their implementation are crucial determinants of their overall success.

Why use environmental taxes?

 · Taxes can directly address the failure of markets to take environmental impacts into account by incorporating these impacts into prices. · Environmental pricing through taxation leaves consumers and businesses the flexibility to determine how best to reduce their environmental “footprint”. - This enables lowest-cost solutions, provides an incentive for innovation and minimises the need for government to attempt to “pick winners”.

How to design environmental taxes?

· Environmental tax bases should be targeted to the pollutant or polluting behaviour, with few (if any) exceptions. · The scope of an environmental tax should ideally be as broad as the scope of the environmental damage. · The tax rate should be commensurate with the environmental damage. · The tax must be credible and its rate predictable in order to motivate environmental improvements. · Environmental tax revenues can assist fiscal consolidation or help to reduce other taxes. · Distributional impacts can, and generally should, be addressed through other policy instruments. · Competitiveness concerns need to be carefully assessed; coordination and transitional relief can be effective responses. · Clear communication is critical to public acceptance of environmental taxation. · Environmental taxes may need to be combined with other policy instruments to address certain issues.

8.     What is Contestable Market Theory ?

Contestable market theory is an economic concept that refers to a market in which there are only a few companies that, because of the threat of new entrants, behave in a competitive manner. Contestable market theory assumes that even in a monopoly or oligopoly, the existing companies will behave competitively when there is a lack of barriers, such as government regulation and high entry costs, to prevent new companies from entering the market. Considerable criticism surrounds this theory because there are often large entry and exit costs associated with entering a market.

In a truly contestable market:

• There are barriers to entry or exit from a business
• There are no sunk costs. A sunk cost is a cost that has already been incurred and cannot be recovered.
• Access to the same level of technology (to incumbent firms and new entrants

Profits According to Contestable Market Theory

Contestable market theory says firms in a contestable market gravitate toward sales maximization rather than profit maximization. According to the theory, unlimited profits would be pushed down to normal profits in a truly contestable market.

Consequently, even a monopoly may be forced to operate competitively if barriers to entry remain weak. They will realize that if they are too profitable, an entrant could easily come and undercut their business. Typically, in a monopoly market structure, there is only one firm prevailing in a particular industry. For example, Low-cost airlines or courier services.

9.     Trade can have both positive and negative effects on the environment

Economic growth resulting from trade expansion can have an obvious direct impact on the environment by increasing pollution or degrading natural resources. In addition, trade liberalisation may lead to specialisation in pollution-intensive activities in some countries if environmental policy stringency differs across countries – the so-called pollution haven hypothesis.

However, increased trade can in turn, by supporting economic growth, development, and social welfare, contribute to a greater capacity to manage the environment more effectively. More importantly, open markets can improve access to new technologies that make local production processes more efficient by diminishing the use of inputs such as energy, water, and other environmentally harmful substances.

Similarly, trade and investment liberalisation can provide firms with incentives to adopt more stringent environmental standards. As a country becomes more integrated within the world economy, its export sector becomes more exposed to environmental requirements imposed by the leading importers. Changes needed to meet these requirements, in turn, flow backwards along the supply chain, stimulating the use of cleaner production processes and technologies.

Consequences from climate change can disrupt trade

Direct consequences of climate change on trade could come from more frequent extreme weather events and rising sea levels. Supply, transport and distribution chains infrastructure are likely to become more vulnerable to disruptions due to climate change. Maritime shipping, which accounts for around 80% of global trade by volume, could experience negative consequences, for instance from more frequent port closures due to extreme events. More importantly, climate change is expected to decrease the productivity of all production factors (i.e. labor, capital and land), which will ultimately result in output losses and a decrease in the volume of global trade.

At the same time, there could also be positive economic impacts on maritime shipping through the potential further opening of Arctic shipping routes, albeit at the cost of environmental degradation.

How can policymakers optimally combine trade and the environment policies?

Effective environmental policies and institutional frameworks are needed at the local, regional, national, and international levels. The impact of trade liberalisation on a country’s welfare depends on whether appropriate environmental policies are in place within the country in question (e.g. correctly pricing exhaustible environmental resources). Stringent environmental policies are compatible with an open

trade regime as they create markets for environmental goods that can subsequently be exported to countries that follow suit on environmental strandards – the so-called first-mover advantage. This is especially true for complex technologies such as renewable energies.

10.  Principles for taking public Investment decisions:- When done right, public investment can be a powerful tool to boost growth and provide right infrastructure to leverage private investment. In contrast, poor investment choices or badly managed investment waste resources, erode public trust and may hamper growth opportunities.

Co-ordinate across governments and policy areass Invest using an integrated strategy tailored to different places Adopt effective instruments for co-ordinating across national and sub-national levels of government Co-ordinate horizontally among sub-national governments to invest at the relevant scale

Strengthen capacities for public investment and promote learning across levels of government Assess upfront the long-term impacts and risks of public investment Engage with stakeholders throughout the investment cycle Mobilise private actors and financing institutions to diversify sources of funding and strengthen capacities Reinforce the expertise of public officials and institutions involved in public investment Focus on results and promote learning from experience

Ensure sound framework conditions at all levels of government Develop a fiscal framework adapted to the objectives pursued Require sound and transparent financial management at all levels of government Promote transparency and strategic use of public procurement at all levels of government Strive for quality and consistency in regulatory systems across levels of government.

11.   Features of Imperative Planning:

Under this type of planning, economic decisions are made through a central planning authority instead of a market system. Allocation of re­sources, the mix of output and the distribu­tion of output among the people (i.e., ‘What, How and For Whom’ problems) are deter­mined centrally in accordance with the pre­determined plans and targets.

In fact, admin­istrative control and regulation from the cen­tral planning authority flows in all directions. Failure in any front is scanned very meticu­lously and people involved in failing to achieve plan targets of any commodity and services are subject to serious scrutiny and even punishment. Because of control over the available resources of the country by the state, resources are allocated in such a way that pro­duction becomes maximum, people get goods and services in fixed quantities at fixed prices, and welfare of the nation gets maximised.

Under imperative planning, there is the ab­sence of institutions of private property, com­petition and profit motive of industrialists, etc. It is because of the absence of these institu­tions and the presence of the state in directing and regulating economic activities, the plan­ning authority formulates and implements plans in the best interests of the country.

The aims of the economy are decided by the state and not by the consumers. “The in­terdependence of all production processes and the complete absence of guidance through price variations make it imperative that op­eration plan should pass the test of mutual consistency of input and output for all enter­prises and collectives. After all, more than anything else, planning means balancing.”

In reality, such type of planning does not exist. Although some people say that impera­tive planning was in operation like the erst­while USSR and Eastern Europe and China till mid-1980s. But we have seen that the So­viet state could not direct the entire produc­tion side of the economy. Further, dilution of imperative planning of the Soviet and the Chi­nese variety took place under the impact of some sort of market-based principles.

(ii) Advantages:

Anyway, imperative plan­ning is comprehensive as it includes the en­tire facet of an economy. Having full control over the available resources, implementation of plan becomes easier and highly effective. As a result, plan targets never remain unful­filled.

Thus, economic activities, under im­perative planning, are carried out so as to maximise production and welfare of the peo­ple. Secondly, the government controls all pro­ductive forces and replaces market mecha­nism and profit motive by central plan and command. Production is carried out not for profit but for the general well-being of the soci­ety.

(iii) Deficiencies:

But imperative planning suffers from some deficiencies. It is often ar­gued that under this kind of planning neither consumers nor producers enjoy any freedom and sovereignty. They behave in the way the state wants. Further, imperative planning based on bureaucratic controls and regulations and direction is undemocratic in character.

Often force and repressive measures are taken by the state for not failing to fulfil the plan targets. Perhaps the proximate reason for the relatively poor working of imperative plan­ning is the enormous size of the central plan­ning which is not easily manageable through centralisation.

2. Indicative Planning:

(i) Features of Indicative Planning:

Indica­tive planning or planning by inducement is found in capitalist countries as well as in mixed economies, like India. After the termi­nation of the Second World War (1939-45), indicative method of planning was advocated in capitalist countries. Indicative planning was attempted first in France. French planning had some sort of success as it attempted to fulfil the desires and expectations of the people with no force or compulsion.

Thus, the essence of indicative planning is that it recognises not only consumers’ sovereignty but also produc­ers’ freedom so that the targets and priorities of the plans are achieved. It then involves a middle path of planning mechanism and mar­ket mechanism—a kind of coordination be­tween private and public activities.

India’s Eighth Plan was unique in the sense that it attempted to manage the transition from a centrally planned economy to a market-ori­ented economy without tearing the socio-cultural framework of the country, or to be more specific, our social commitments to the under- previliged sections. The Eighth Plan men­tioned that planning would have to be reoriented so as to make it indicative.

Under indicative planning those industries and sectors are identified where future growth is to be encouraged. Its endavour will be to develop the core sector through allocation and optimal utilisation of funds. The plan must provide the broad blueprint for achieving the essential social and economic objectives and indicate the direction in which the entire economy as well as its various sectors and sub- sectors should be moving.

Thus, identification of these areas and channelling the resources to those areas are an integral part of planning. The Eighth Plan concentrated on building a long term strategic vision of the future and set forth the priorities of the country.

On the one hand, for the public sector, the Eighth Plan in­tended to examine in details the alternatives and identify the specific projects in various sectors. On the other hand, for the rest of the economy, it worked out sectoral targeted and tended to provide promotional stimulus to the economy to grow in the desired direction.

This means that under indicative planning, the central planning authority in India’s case, the Planning Commission plays an in­tegrative role and helps in the development of a holistic approach to policy formulation in certain critical areas of development like en­ergy, human resource development, manage­ment of balance of payments, etc. But indica­tive planning does not intend to reduce the importance of the role of the state.

The state shoulders primary responsibility for the de­velopment of both physical infrastructures and social infrastructures. Besides, central plans are linked up with the state plans since both the partners have responsibilities in all the areas. This indicative planning is tanta­mount to corporate planning. Finally, the plan­ning authority plays a mediatory and facilitating role for managing the economy.

Keeping all these features of indicative planning in mind, we can say that India’s Eighth Plan is unique in relation to earlier plans. It assigns a special role and respon­sibility to planning. “It is a plan to salvage the process of planning and to reorient it to meet the needs of a vastly changed national and international scenario. It is more a manager’s plan than an abstract economist’s plan of cli­ches and pious wishes.” This kind of planning goes on and the Eleventh Plan is in progress.

(ii) Advantages:

Indicative planning has one distinct advantage. It supposedly increases productivity because each sector of the economy pushes its own contribution to a point that previously would have been con­sidered too dangerous. This is achieved with­out abolition of the private enterprise, with­out command and without sacrificing any one of the advantages of the market economy.

Indicative planning is, thus, a perfect compro­mise a system between freedom and planning that enjoys the advantages of both the market and the planned economies, while successfully avoiding the disadvantages usually connected with these pure systems.

We now conclude our discussion by pin­pointing the essential features of Indian plan­ning system:

(1) It is centralised in its formu­lation.

(2) It is decentralised as far as execu­tion of plans is concerned.

 (3) It is partly di­rective and partly indicative.

(4) It is demo­cratic in character.

(5) It is developmental in character.

(6) Finally, the planning process is a continuous one.

(iii) Weaknesses:

The basic weakness of this type of indicative planning has been pointed out by an expert. He says; “Every branch of activity is promised the possibility of acquir­ing its production factors and selling its goods on a balanced market. The promise, however, is only kept if everybody plays the game. The promise acts merely as an incentive. It is not binding on everybody. Firms are not dis­pensed from working out their valuations and choosing their own attitudes. But they cannot do so in a better informed manner.”

In short, indicative planning has not yet been proved to be a perfect compromise be­tween market and plan. The danger exists that it may do more harm than good through in­flation, unemployment, monopolistic trends and direct controls.

12.  Why firms wish to grow?

Most firms seek to become bigger – increasing sales and market share. Firms can grow through internal expansion, external growth (merger) or diversification into related industries. The motives for increasing in size can include:

·       Greater sales lead to greater profit, making the firm more attractive to shareholders

·       Successful, growing firms are likely to increase salaries/pay bonuses to managers.

·       Increasing output enables economies of scale, greater efficiency and lower average costs.

·       Increased prestige for managers seeing the firm become more influential and powerful.

·       Greater risk diversification, e.g. when growth comes from product diversification.

·       Growing in size enables growth in market share and monopoly power, enabling even greater profitability.

·       Owners having a passion for their product and wanting to see it do well.

·       Globalisation has enabled firms to sell product in global market.

13.  The Regulated Economy

Regulation is a rule or law designed to control the behavior of those to whom it applies. Those who fail to follow these rules are subject to fines and imprisonment and could have their property or businesses seized. The United States is a mixed economy where both the free market and government play important roles.

A regulated economy provides the following advantages:

• It looks out for the safety of consumers.
• It protects the safety and health of the general public as well as the environment.
• It looks after the stability of the economy.

The following are disadvantages to regulation:

• It creates a huge government bureaucracy that stifles growth.
• It can create huge monopolies that cause consumers to pay more.
• It squashes innovation by over-regulating.

Free Market Economy

In its purest form, a free market economy is when the allocation of resources is determined by supply and demand, without any government intervention.

Supporters of a free market economy claim that the system has the following advantages:

• It contributes to political and civil freedom.
• It contributes to economic freedom and transparency.
• It ensures competitive markets.
• Consumers' voices are heard in that their decisions determine what products or services are in demand.
• Supply and demand create competition, which helps ensure that the best goods or services are provided to consumers at a lower price.

Critics of a free market economy claim the following disadvantages to this system:

• A competitive environment creates an atmosphere of survival of the fittest. This causes many businesses to disregard the safety of the general public to increase the bottom line.
• Wealth is not distributed equally – a small percentage of society has the wealth while the majority lives in poverty.
• There is no economic stability because greed and overproduction cause the economy to have wild swings ranging from times of robust growth to cataclysmic recessions.

14.  Important Indicators of sustainable development

·       Indicators are quantified information which help to explain how things are changing over time. For many years, a limited number of key economic measures has been used to judge how the economy is performing - for example, output, the level of employment, the rate of inflation, the balance of payments, public sector borrowing, etc. These statistics give an overall picture but do not explain why particular trends are occurring, and do not necessarily reflect the situation of a particular industry, society or area. They do, however, provide policy-makers and the public reasonable indicators of changes in the economy, assisting economic policy decision making and allowing the public to judge for themselves how the economy is performing overall.

15.  balanced and unbalanced growth need not be conflicting and an optimal http://www.economicsdiscussion.net/unbalanced-growth-theory/balanced-vs-unbalanced-growth-for-economic-development/4636

16.  Common pool resources are resources that are collectively owned or shared by many people. This could be forests, grazing lands, lakes, rivers, irrigation systems, oceans, and the atmosphere. If these resources are not owned by anybody in particular, they are referred to as ‘open access’ resources.

Consider important environmental resources such as air and water. Air and water are resources that are typically not bounded by individual properties and are commonly managed by groups of people. Looking at this globally, there are many resources that are found outside of one country which are managed internationally as common pool resources where groups of people collectively manage these resources. Private property represents goods that can be bought and sold usually by individuals. The idea of private property assumes the existence and functioning of a market. In addition, the idea and philosophy of private property is very entrenched and rooted in the history, politics and legal systems of Europe and the United States. Private property emerges out of the 18th century and goes through many changes all the way up through current neo-liberalistic ideas of private property that we will learn about later in this module. Private property always assumes the role of government, even if it is just a minimal role in which it serves to regulate markets and the exchange of property.

In the area of sustainability we think of private property as a type of governance system, or one main way of governing the use of resources. For instance, private property is a foundation for environmental governance in most societies world-wide. Basically, people who own property are relatively free to use it as they see fit, subject to laws and their own cultural beliefs and social values. Private property represents goods that can be bought and sold usually by individuals. The idea of private property assumes the existence and functioning of a market. In addition, the idea and philosophy of private property is very entrenched and rooted in the history, politics and legal systems of Europe and the United States. Private property emerges out of the 18th century and goes through many changes all the way up through current neo-liberalistic ideas of private property that we will learn about later in this module. Private property always assumes the role of government, even if it is just a minimal role in which it serves to regulate markets and the exchange of property.

In the area of sustainability we think of private property as a type of governance system, or one main way of governing the use of resources. For instance, private property is a foundation for environmental governance in most societies world-wide. Basically, people who own property are relatively free to use it as they see fit, subject to laws and their own cultural beliefs and social values.

17.  What is Barrier to Entry?

A barrier to entry is a high cost or other type of barrier that prevents a business startup from entering a market and competing with other businesses. Barriers to entry can include government regulations, the need for licenses, and having to compete with a large corporation as a small business startup.

As an example, the large company is able to produce a large amount of products efficiently and more cost-effectively than a company with fewer resources. They have lower costs because they are able to purchase materials in bulk, and they have lower overhead because they are able to produce more under one roof. The smaller company would simply have a hard time keeping up with that, which can result in them avoiding entering the market altogether.

Barriers to entry can have a negative effect on prices since the playing field is not level and competition is restricted. It’s not really an ideal situation for anyone except the large company that holds the monopoly. However, barriers to entry are not always completely prohibitive. In fact, many business startups encounter some sort of barrier to entry that they must overcome, whether that’s initial investments, acquiring licenses, or obtaining a patent – it’s just part of doing business.

Sources of Barriers to Entry

Barriers to entry come from seven sources:

·       Economies of scale: the decline in the cost of operations due to higher production volume

·       Product differentiation: the brand strength of the product as a result of effective communication of its benefits to the target market

·       Capital requirements: financial resources required for operating the business

·       Switching costs: one-time costs the buyer must incur for making the switch to a different product

·       Access to distribution channels: does one business control all of them, or are they open?

·       Cost disadvantages independent of scale: when a company has advantages that cannot be replicated by the competition, such as proprietary technology

·       Government policy: controls the government has placed on the market, such as licensing requirements

Building Barriers to Entry

Some businesses want there to be high barriers to entry in their market because they want to limit competition or hold on to their place at the top. Therefore, they will try to maintain their competitive advantage any way they can, which can make entry even more difficult for new businesses. They might do something like spend an excessive amount of money on advertising (in other words, on product differentiation), because they have it and they can, and any new entrant would not be able to do that, giving them a significant disadvantage.

When starting a business, evaluating all potential barriers to entry is a crucial step in deciding whether or not to enter a chosen market.

Thank you for reading... Keep on studying

SHARE

Vivek Sharma

Hi. I’m Vivek Sharma. I do write Blog on different issues and topics related to Economy, Exams and Political issues. Inspired to make things looks better.

• 
• 
• 
• 
•