NCERT Notes for Class 12 Economics Chapter 5 GOVERNMENT BUDGET AND THE ECONOMY


NCERT Notes for Class 12 Economics Chapter 5 GOVERNMENT BUDGET AND THE ECONOMY, (Economics) exam are Students are taught thru NCERT books in some of the state board and CBSE Schools. As the chapter involves an end, there is an exercise provided to assist students to prepare for evaluation. Students need to clear up those exercises very well because the questions inside the very last asked from those.

Sometimes, students get stuck inside the exercises and are not able to clear up all of the questions.  To assist students, solve all of the questions, and maintain their studies without a doubt, we have provided step-by-step NCERT Notes for the students for all classes.  These answers will similarly help students in scoring better marks with the assist of properly illustrated Notes as a way to similarly assist the students and answer the questions right.

NCERT Notes for Class 12 Economics Chapter 5 GOVERNMENT BUDGET AND THE ECONOMY



A Government performs three distinct economic functions. They are the following.

Allocation Function. Allocation function refers to making available to all public goods to distributing effectively among all the people of the economy. Public goods are those goods which cannot bought and sold in the market. Eg. Roads, parks, street lights. Etc. Public goods must be provided by the government because of the following reasons

Non Excludability : No one can be excluded from the consumption of such goods.

Non rivalry : There is no rivalry exist in the economy for providing public goods.

Difficulty in charging price : It is very difficult to charging price for charging price for consumption of public goods.

Distribution function : Distribution function refers to the activities of government to reduce inequality in income and wealth in the economy.

Stabilization function : It refers to the activities of government to maintain price and economic stability in the economy.

GOVERNMENT BUDGET AND IT’S COMPONENTS: It is the official financial statement of a government which shows ex ante receipts and expenditure over a financial year.Its main components are shown by the following flowchart.


Components of Government Budget : Government budget, comprises of two parts—(a) Revenue Budget and (b) Capital Budget.

  1. Revenue Budget: Revenue Budget contains both types of the revenue receipts of the government, i.e., Tax revenue and Non tax revenue ; and the Revenue expenditure.
  2. Revenue Receipts: These are the receipts that neither create any liability nor reduction in assets of the government. It includes tax revenues like income tax, corporation tax and non-tax revenue like fines and penalties, special assessment, escheat etc.
  3. Revenue Expenditure: An expenditure that neither creates any assets nor cause reduction of liability is called revenue expenditure.
  4. Capital Budget: Capital budget contains capital receipts and capital expenditure of the government.
  5. Capital Receipts: Government receipts that either creates liabilities (of payment of loan) or reduce assets (on disinvestment) are called capital receipts. Capital receipts include items, which are non-repetitive and non- routine in nature.
  6. Capital Expenditure: This expenditure of the government either creates physical or financial assets or reduction of its liability. Acquisition of assets like land, machinery, equipment, its loans and advances to state governments etc. are its examples.

TYPES OF BUDGET : According to Receipts and Expenditure Budgets are three types. They are the following. Surplus Budget : When Receipts exceeds Expenditure, Such type of budget is called Surplus budget.

Surplus Budget → Receipts > Expenditure

Deficit Budget When Expenditure exceeds , Such type of budget is called Surplus budget.

Deficit Budget → Receipts < Expenditure

Balanced Budget : When Receipts and Expenditure are equal, Such type of budget is called Balanced Budget.

Balanced Budget → Receipts = Expenditure


Revenue Deficit: The revenue deficit refers to the excess of government’s revenue expenditure over revenue receipts

Revenue deficit = Revenue expenditure – Revenue receipts.

Fiscal Deficit: Fiscal deficit is the difference between the government’s total expenditure and its total receipts excluding borrowing

Gross fiscal deficit = Total expenditure – (Revenue receipts + Non-debt creating capital receipts) Primary Deficit: It is the difference between fiscal deficit and the interest payments

Gross primary deficit = Gross fiscal deficit – net interest liabilities

FISCAL POLICY : Fiscal policy is an important instrument to stabilize the economy, that is, to overcome recession and control inflation in the economy. Fiscal policy through variations in government expenditure and taxation profoundly affects national income, employment, output and prices. The main instruments of fiscal policy are the following.


Government Expenditure.

Public borrowings.

The main objectives of fiscal policy are Creation of employment opportunities, stabilize the economy, Control inflation and deflation etc.


Equilibrium is a situation inwhich aggregate demand and aggregate supply of an economy are equal. In a three sector economy Aggregate demand is the sum of Consumption expenditure, Investment Expenditure and Government Expenditure. It can be written as follows.

AD = C + I + G, C = 𝐂 + 𝐜(𝐲 − 𝐓 + 𝐓𝐑)𝐈 = 𝐈, 𝐆 = 𝐆

AS = Y

So the equilibrium can be written as follows

Y = 𝐂 + 𝐜(𝐘 – 𝐓 + 𝐓𝐑) + 𝐈 + 𝐆

Y = 𝐂 + 𝐜𝐘 – 𝐜𝐓 + 𝐜𝐓𝐑 + 𝐈 + 𝐆

Y – cY = 𝐂 – 𝐜𝐓 + 𝐜𝐓𝐑 + 𝐈 + 𝐆

𝐂 – 𝐜𝐓 + 𝐜𝐓𝐑 + 𝐈 + 𝐆 = 𝑨

Y(1-c) = 𝐀 .. . 𝐘 = 𝐀‾/𝟏−𝐜

The equilibrium situation can be illustrated by the following diagram.


It is the ratio between change in income and change in government expenditure. It can be written as the follows.

The effect of government expenditure multiplier can be diagrammatically shown as follows.

When government expenditure increases


When government expenditure increase


TAX MULTIPLIER : It is the ratio between change in income and change in Tax. It can be written as follows.

∆Y/∆T = −c/1−c .. . ∆Y = −c/1−c  × ∆T 

TRANSFER RETURNS MULTIPLIER: It is the ratio between change in income and change in transfer returns. It can be written as follows.

Proportional tax

Proportional tax is the taxing mechanism in which the taxing authority charges the same rate of tax from each taxpayer, irrespective of income. This means that lower class, or middle class, or upper class people pay the same amount of tax. Since the tax is charged at a flat rate for everyone, whether earning higher income or lower income, it is also called flat tax. In the case of proportional tax equilibrium income of an economy can be written as follows. Proportional tax multiplier act as an automatic stabilizer in the economy. It is the part of non discretionary fiscal policy. But government expenditure, Transfer returns etc. Are called discretionary fiscal policy.

Relation between government deficit and government debt

The relation between government deficit and government debt can be explained through the following points.

  1. Government deficit is the excess of total expenditure over total receipt of the government; whereas, government debt is the amount of liability, owed by the government to the public, foreign and other institutions.
  2. The term government deficit implies increase in the debt of the government. In other words, if the government continues to borrow to finance deficit, it leads to additional debt.

Does public debt impose a burden? Explain.

Government debt or public debt refers to the amount or money that a central government owes. This amount may be borrowings of the government from banks, public financial institutions and from other external and internal sources. Public debt definitely imposes a burden on the economy as a whole, which is described through the following points.

  1. Adverse effect on productivity and investment
    • A government may impose taxes or get money printed to repay the debt. This however reduces the peoples’ ability to work, save and invest, thus hampering the development of a country.
  2. Burden on younger generations
    • The government transfers the burden of reduced consumption on future generations. Higher government borrowings in the present leads to higher taxes levied in future in order to repay the past obligations. The government imposes taxes on the younger generations, lowering their consumption, savings and investments. Hence, higher public debt has negative effect on the welfare of the younger
    • generations. But some economists argue that government debt is not a burden to future generation. This explained by Ricardian equivalence it means when government deficit increases income of the people also increases, then savings of people increases, the present savings is used by the future generation so the increase in future is not affected by future generation.
  1. Lowers the private investment
  2. The government attracts more investment by raising rates of interests on bonds and securities. As a result, a major part of savings of citizens goes in the hands of the government, thus crowding out private investments.
  3. Leads to the drain of National wealth
  4. The wealth of the country is drained out at the time of repaying loans taken from foreign countries and institutions.

Are fiscal deficits inflationary?

Fiscal deficits are not necessarily inflationary; though, they are generally regarded as inflationary. When the government expenditure increases and tax reduces, there is a government deficit and there will be a corresponding increase in the aggregate demand. However, the firms might not be able to meet the growing demands, forcing the price to rise. Hence fiscal deficits are inflationary in this sense.

But on the other hand, initially if the resources are underutilised (due to insufficient demand) and output is below full employment level, then with the increase in government expenditure, more factor resources will be employed to cater to the increasing demand without exerting much pressure on price to rise. In this situation, a high fiscal deficit is accompanied by high demand, greater output level and lesser inflationary situation. Hence, whether the fiscal deficits are inflationary or not depends on how close is the original output level to the full employment leve


  1. In an economy, if marginal propensity to consume (MPC) = 0.6 calculate :
    1. Tax Multiplier Govt. B) Expenditure Multiplier
  2. Classify the following items into Revenue Receipts and Capital Receipts.
  3. Government collected 20 crores as Goods and Service Tax (GST).
  4. Govt. borrowed `50 crores from RBI by selling treasury bills.
  5. Govt. raised an amount of 10 crores through disinvestment.
  6. Govt. received 5 crores as interest receipts of loans given by Central Govt.
  7. Governments have mostly depend on borrowings for meeting its budgetary deficits. But this govt. debt act as a burden on future generation. Do you agree with this statement ? Substantiate.

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