Economics 4 Marks Question

The Inflationary Gap: is the amount by which the aggregate demand exceeds aggregate supply at the full employment level. It is called inflationary because it leads to rise in price level.
Repo Rate: is the rate of interest at which central bank lends to commercial banks for a short period. When central bank raises Repo Rate, the borrowings by the commercial banks become costly. This forces the commercial banks to raise their lending rates. People borrow less, and therefore spend less. This helps in reducing inflationary gap.

Deflationary Gap: Is the amount by which the aggregate demand falls short of aggregate supply at the full employment level. It is called deflationary because it leads to a fall in price level.
Open Market Operations: Refer to buying and selling of government securities by the central bank in the open market. Central bank can reduce deflationary gap by buying securities. Those who sell receive payments by cheques from the central bank. The money flows out from Central bank into the commercial banks. This raises lending capacity of commercial banks. Banks lend more. Spending rises which reduces deflationary gap.

In layman terms, the domestic territory of a nation is understood to be the territory lying within the political frontiers (or boundaries) of a country. But in national income accounting, the term domestic territory is used in a wider sense. Based on 'freedom' criterion, the scope of economic territory is defined to cover:

1. Ships and aircrafts owned and operated by normal residents between two or more countries.

For example: Indian Ships moving between China and India regularly are part of domestic territory of India. Similarly, planes operated by Air India between Russia and Japan are part of the domestic territory of India. Similarly, planes operated by Malaysian Airlines between India and Japan are a part of the domestic territory of Malaysia.

2. Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country in the international waters where they have exclusive rights of operation.

For example: Fishing boats operated by Indian fishermen in international waters of Indian Ocean will be considered a part of domestic territory of India.

3. Embassies, consulates and military establishments of a country located abroad.

For example: Indian Embassy in Russia is a part of the domestic territory of India. ‘Consulate' is an office or building used by consul (an officer commissioned by the government to reside in a foreign country to promote the interest of the country to which he belongs).

The Great Depression was a severe economic crisis that started in the year 1929. It was the longest and deepest and most widespread depression of 20th century. In 21st century, the Great Depression is commonly used as an example of how far an economy can decline. It originated in the United States of America when the stock market crashed which results in the beginning of a decade of high unemployment, poverty, low profit and deflation and it gradually spread to other countries of the world. The worldwide GDP fell by 15% as compared to less than 1% during the Great Recession in 2008-2009. The main cause behind this crisis was the fall in aggregate demand due to under consumption and over investment. Aggregate supply was greater than aggregate demand which resulted into depressing activities. Due to under consumption and over investment the stock of finished goods started piling up, which resulted in low price level and consequently the low profit level. The money in the economy was converted into unsold stock of finished goods that lead to an acute fall in employment and hence income level fell drastically. The demand for goods in the economy was so low that the production was lowered leading to the unemployment. In USA, the rate of unemployment increased from 3% to 25%.
The Great depression has its own implications and importance in economics, as it leads to the failure of the classical approach of economics. Those who believed in the market forces of demand and supply, paved the way for emergence of the Keynesian approach. It was this incident that provided the economists with sufficient evidence to recognize macroeconomics as a separate branch of economics.
The cause and effect relationship of the Great Depression can be summed up in this flow chart.
Low demand → over investment → low level of employment → low level of output → low income → low demand.

The four major sectors of an economy according to the macroeconomic point of view are:

1. Households.
2. Firms.
3. Government.
4. External sector.

These can be represented in the following flow chart:

1. Households:

Households buy goods and services for consumption and also supply factors of production like land, labour, capital, and entrepreneur. Households provide the market for the output of the firms.

2. Firms:

Firms are economic units that carry out the production. They employ and organise factors of production and undertake production process for the motive of profit making.

3. Government:

A state/ government provides law and order, maintains growth and stability and provides administrative services. The main motive of a government is to undertake developmental projects such as dams, roads, heavy industries that usually have long gestation periods. The government invests in education, health sector and provides these services at nominal price. The motive of a government is to serve and not to make profits.

4. External sector:

​​​​​​​This sector is engaged in export and import (external trade) of goods and services. If domestically produced goods and services are sold to the rest of the world, then it is called export. If the goods and services are purchased from the rest of the world, then it is called import.