Question Paper Economics – II (122) : October 2003Section A : Basic Concepts (40 Points) • • • • • • 1. This section consists of questions with serial number 1 - 40. Answer all questions. Each question carries one point. < Answer > Japanese economy is facing the prospects of liquidity trap. Which of the following statements is not true about liquidity trap? a. b. c. d. e. Public is willing to hold whatever money is supplied at the current interest rate LM curve is horizontal Fiscal policy is more effective in increasing income Monetary policy is ineffective in affecting interest rate LM curve is vertical. 2. < Answer > With respect to Aggregate Supply (AS), which of the following is true? a. b. c. d. e. AS in the short run is positively sloped and in the long run it is vertical AS is positively sloped both in the short run and in the long run AS is positively sloped in the short run and negatively sloped in the long run AS is vertical both in the short run and in the long run Costs have greater impact on AS in short run than in the long run. < Answer > 3. If Mr. X buys a National Small Savings Certificate, which of the following is likely to happen? a. b. c. d. e. Increase in Government market borrowings Increase in the other liabilities of the Government Increase in forex reserves Increase in Government revenue Decrease in Government liability. < Answer > 4. Which of the following statements is not true with respect to stock and flow variables? a. b. c. d. e. Both variables have time dimension Flow variables are always determined by stock variables Stock variables are usually affected by flow variables All flow variables need not have stock variable counterparts Flow variables are partly determined by stock variables. < Answer > 5. According to Keynes, the actual expenditure in an economy can differ from the planned expenditure. Which of the following is true if the actual expenditure is less than the planned expenditure in the economy? a. b. c. d. e. There will be positive fixed investment in the economy There will be negative fixed investment in the economy There will be positive inventory investment in the economy There will be negative inventory investment in the economy There will be no change in inventory investment in the economy. < Answer > 6. Which of the following is not one of the basic Postulates of the Keynesian Model? a. b. c. d. e. Full employment occurs only by coincidence is an economy Effective demand determines the level of employment and output Since full employment is not always possible, Government intervention is essential Budget deficit is a tool to fight recession Monetary policy is more effective than fiscal policy. 7. Which of the following statements is not true? < Answer > a. b. c. d. e. 8. a. b. c. d. e. 9. a. b. c. d. e. GDP deflator is also known as implicit price deflator GDP deflator reflects the change in overall price level of the economy GDP deflator is the most comprehensive index of prices GDP deflator reflects on the purchasing power of the people GDP deflator measures economic growth. < Answer > Which of the following is most likely to happen during a recession? Decrease in inventory Producers will be cautiously optimistic Capacity under utilization Expansion in bank credit Increasing income levels. Automatic stabilizers refer to Inherent mechanisms in the stock market that automatically cause stock market gains to be cancelled out by losses, which make expected long-run returns equal to zero The invisible hand mechanisms which automatically bring the economy out of a recession Government revenue and expenditure items that change automatically in response to changes in economic activity Discretionary monetary policy maneuvers designed to keep inflation under control automatically None of the above. < Answer > 10. Which of the following better explains the inverse relationship between the interest rate and the demand for money? a. b. c. d. e. 11. The transaction demand for money The speculative demand for money The precautionary demand for money The inflationary expectations None of the above. The relationship between the interest rate and the demand for money is direct, not inverse. < Answer > Which of the following statements is not true about IS-LM Model? a. b. c. d. e. IS function represents the goods market equilibrium LM function represents the money market equilibrium Interest rate is a variable in both IS and LM functions Goods and money markets interact to determine the equilibrium national income IS curve is positively sloped. < Answer > 12. In the standard IS-LM model, which of the following is true if the government raises tax rate and the Reserve Bank of India decides to hold the money supply constant? a. b. c. d. e. Disposable income remains constant IS curve shifts to the right LM curve shifts to the left Interest rate falls Interest rate increases. < Answer > 13. Commercial banks create money through credit creation. Which of the following statements is true with regard to credit creation? a. b. c. d. e. Credit creation by commercial banks is limited by CRR Commercial banks can create as much credit as they want RBI has no control over the credit created by Commercial banks CRR has no impact on credit creation None of the above. < Answer > 14. In the last few months the forex reserves in India have been increasing. Which of the following sterilization policies would the Reserve Bank of India should adopt? a. Increase CRR < Answer > b. c. d. e. a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. a. b. Decrease CRR Decrease discount rate Buy government securities None of the above. < Answer > 15. The Philips curve implies that the goal of price stability is most likely to conflict with the goal of Full employment Economic growth An equitable distribution of income Balance in international trade Removal of poverty. 16. Which of the following statements is/are true about the impact of inflation in the economy? Unanticipated inflation hurts the fixed income earners most Higher than expected inflation hurts creditors but benefits debtors Inflation creates inefficiency in the economy because it forces people to search for prices when they could be doing something else Inflation can lead to a misallocation of resources because people tend to make mistakes when there is inflation in the economy All of the above. < Answer > 17. Which of the following policy measures is/are fiscal policy measure(s)? The government cuts taxes or raises spending to get the economy out of a recession The central bank changes the money supply to affect the price level, interest rates and exchange rates The government restricts imports and stimulates exports Both (a) and (b) above Both (a) and (c) above. < Answer > 18. Which of the following is true if the Government monetizes part of its deficit? Money supply in the economy will increase Interest rate will increase Primary deficit will increase Public debt will increase Revenue deficit will decrease. < Answer > 19. Which of the following does not affect the balance sheet of Reserve Bank of India? Central government’s borrowings from RBI Loan taken by one commercial bank from the other Refinancing of NABARD loans Increase in reserves of commercial banks Increase in net foreign exchange assets. < Answer > 20. Which of the following ratios is not an indicator of financial development of a country? Finance Ratio Financial Interrelations Ratio New Issue Ratio Intermediation Ratio Cost Benefit Ratio. < Answer > 21. The difference between personal disposable income and personal income is Residential investment Indirect taxes Subsidies Transfer payments Personal taxes. < Answer > 22. Which of the following is true if the RBI increases Cash Reserve Ratio (CRR)? Monetary liabilities of the RBI increases High-powered money in the economy decreases < Answer > c. d. e. a. b. c. d. e. The value of money multiplier decreases Aggregate demand in the economy increases Price level in the economy increases. < Answer > 23. Precautionary demand for money varies inversely with Income Rate of interest Wealth Frequency with which income is received Both (b) and (d) above. 24. When the addition to capital goods in an economy is more than the capital consumption allowance, the economy experiences a. b. c. d. e. Negative net investment Zero net investment Positive net investment Negative gross investment Zero gross investment. < Answer > 25. An expansionary fiscal policy combined with a liberal monetary policy results in I. II. III. IV. V. a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. A lower level of output. A higher level of output. A lower interest rate. A higher interest rate. A lower or higher interest rate depending on the relative magnitude of fiscal and monetary policies. (I) and (III) above (I) and (IV) above (II) and (III) above (II) and (V) above (I) and (V) above. < Answer > 26. Which of the following is true if the central bank does not impose any reserve ratio? The banking system can no longer affect the supply of money in the economy The banking sector can create unlimited money supply The lending capacity of banks would narrow down to zero A rupee deposited in a bank reduces the money supply in the economy by one rupee Money supply in the economy will be equivalent to the high-powered money. < Answer > 27. Which of the following ratios best describes the GNP deflator? Nominal GNP to real GNP Real GNP to nominal GNP Nominal GNP to real GDP Real GNP to nominal GDP None of the above. < Answer > 28. The LM curve shows A positive relationship between rate of interest and level of income A negative relationship between rate of interest and level of income A negative relationship between rate of interest and level of investment A positive relationship between rate of interest and level of investment A positive relationship between level of investment and level of income. < Answer > 29. Suppose an economy is experiencing inflation. And at the same time, there is a slowing down of economic activities. This is a case of a. b. c. d. e. Deflation Hyper inflation Recession Depression Stagflation. < Answer > 30. The unemployment in the Keynesian model is caused by a. b. c. d. e Demand deficiency Supply deficiency Demand sufficiency Supply sufficiency Both (a) and (b) above. < Answer > 31. To improve market efficiency, which of the following is not recommended by Supply side economics? a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. Reduce government controls Promote competition Restrict the power of trade unions Remove institutional barriers Increase corporate tax rate. < Answer > 32. If a Government is running surplus in its budget, we can expect that public debt will be Rising Falling Constant Falling if there are tax cuts Falling if the government uses the surplus to repay its past debts. < Answer > 33. According to the Laffer curve, as the tax rate increases, tax revenues Rise continuously Decrease continuously Initially decrease and then increase Initially increase and then decrease Remain constant. < Answer > 34. The difference between M3 and M1 is Demand deposits Post office savings deposits Savings deposits Time deposits M2. < Answer > 35. The Chief Economist to the Government told the Cabinet that the government can no longer fool the people by increasing its spending during election years, as people will anticipate this kind of behavior as previous governments used to do so. The economist is an advocate of a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. Classical economics Rational expectations Keynesian economics Supply-side economics Monetarism. < Answer > 36. An increase in government expenditure will Shift both IS and LM curves to the right Shift both IS and LM curves to the left Not affect the position of LM curve but shift IS curve to the left Not affect the position of IS curve but shift LM curve to the right Not affect the position of LM curve but shift IS curve to the right. < Answer > 37. Which of the following is an example of a government transfer payment? Salary paid to a soldier Purchase of a new car for the Ministry of Finance Funding of a clinic to provide free vaccinations Free food coupons issued to persons in an anti-poverty program Funding of a new bridge in an urban area. < Answer > 38. Which of the following price indices is/are most widely used for determining of inflation in India? a. b. c. d. e. a. b. c. d. e. a. b. c. d. e. Wholesale price index (WPI) GDP deflator Consumer price index (CPI) Both (a) and (b) above Both (b) and (c) above. < Answer > 39. Personal taxes in India best illustrates a Proportional tax system Progressive tax system Indirect tax system Value added tax system Regressive tax system. < Answer > 40. Which of the following policy instruments has the least ‘outside lag’? Cash reserve ratio (CRR) Bank rate Repo rate Taxes Open market operations (OMO). END OF SECTION A < Answer > Section B : Problems (60 Points) • • • • • • This section consists of questions with serial number 41 - 75. Answer all questions. Points are indicated against each question. < Answer > 41. The Planning Commission is targeting a growth rate of 6% p.a. in per capita income for the next 10 years. To achieve the target, the required domestic savings to income ratio is 32%. If the population is expected to grow at the rate of 2% p.a., capital output ratio for the economy is a. b. c. d. e. 3.0 4.5 5.0 4.0 5.5. (2 points) 42. Consumption function for an economy is estimated to be C = 400+0.75Yd, where C and Yd are measured in Rs. cr. The level of consumption at which the savings will be zero is a. b. c. d. e. Rs.1,400 cr Rs.1,500 cr Rs.1,600 cr Rs.1,700 cr Rs.1,300 cr. (1 point) 43. The break-even income of Mr. Ravi is Rs.5,000 and his Marginal Propensity to Consume is 3/4. If his current income is Rs.2,500, how much would Mr. Ravi borrow? a. b. c. d. e. Rs.125 Rs.525 Rs.625 Rs.425 Rs.325. (2 points) 44. In a two sector economy the savings function is S = –60 + 0.25 Yd. If the investment in the economy is 100 Million Units of Currency (MUC), equilibrium income will be a. b. c. d. e. 620 MUC 640 MUC 660 MUC 650 MUC 630 MUC. (1 point) Questions 45 to 47 are based on the following information: Consumption (C) 100+0.75Yd Investment (I) 80 MUC Taxes (T) 0.20Y Government Expenditure (G) 150 MUC 45. The equilibrium income for the economy is a. b. c. d. e. 900 MUC 825 MUC 950 MUC 930 MUC 910 MUC. < Answer > < Answer > < Answer > < Answer > (1 point) 46. Budget deficit/surplus for the economy is a. b. c. d. e. 10 MUC (deficit) 15 MUC (deficit) 15 MUC (surplus) 20 MUC (deficit) 20 MUC (surplus). (1 point) 47. The economy is opened to trade in goods and services with the rest of the world, and imports and exports are as given below: Imports (M) Exports (X) = 0.10Y = 420 MUC < Answer > < Answer > The multiplier for the economy is a. 2.0 b. 3.0 c. 3.5 d. 4.0 e. 4.5. (1 point) 48. The following relations are given for an economy: Savings function (S) – 250 + 0.30Yd Disposable income (Yd) Y–T Tax function (T) 0.25Y Investment function (I) 100 – 11i Government expenditure (G) 500 MUC Exports (E) 40 MUC Imports (M) 0.3Y If the equilibrium output for the economy is to be increased by 100 MUC, investment should be increased by a. b. c. d. e. 60.0 MUC 77.5 MUC 70.0 MUC 95.0 MUC 90.5 MUC. (2 points) 49. For an economy, the Savings function is S = – 300 + 0.2Y and the investment function is I = 200 – 5i. If the equilibrium level of output is 2,250 MUC, interest rate in the economy is a. b. c. d. e. 6% 8% 10% 12% 14%. (1 point) 50. In an economy, demand for money is L = 0.4Y – 10i and supply of money is 300 MUC. If the government intends to decrease the equilibrium interest rate from the current level of 8% to 6%, what will be the change in the equilibrium level of output? a. b. c. d. e. 25 MUC Increase 50 MUC Decrease 75 MUC Decrease 50 MUC Increase No change in the equilibrium level of output. (2 points) < Answer > < Answer > < Answer > 51. The following balances are taken from the balance sheet of the Central Bank: MUC Loans given to the Government 1,200 Reserves maintained by the banks 300 Net worth 80 Loans to the commercial banks 800 Government deposits 200 Other assets 60 Other deposits with the central bank 10 Net foreign exchange assets 1,500 Loans to the commercial sector 20 If the government money is 100 MUC, high-powered money in the economy is a. b. c. d. e. 3,000 MUC 3,050 MUC 3,100 MUC 3,300 MUC 3,400 MUC. (2 points) 52. The following data is taken from National Income Accounts of a country: GNP at market prices Transfer payments Indirect taxes Personal taxes Consumption of capital Undistributed corporate profits Corporate tax Subsidies a. b. c. d. e. Rs.1,363 cr Rs.1,121 cr Rs.1,230 cr Rs.1,296 cr Rs.1,496 cr. (2 points) 53. In an economy the factor income earned within domestic territory for the year 2002-03 is 50,000 MUC. For the year, consumption of capital is 3,000 MUC and the GNP at market prices is 60,000 MUC. If indirect taxes are 2,000MUC and subsidies are 500 MUC, net factor income from abroad is a. 5,000 MUC b. 5,500 MUC c. 6,000 MUC d. 6,500 MUC e. 6,800 MUC. (2 points) Questions 54 and 55 are based on the following information: Production Account Dr. Cr. Rs. Cr. 1,700 242 173 203 190 28 75 20 Personal income in the country is < Answer > < Answer > < Answer > 20 Exports 10 25 15 10 730 Assume that there is no government sector in the economy. 54. For the economy, NDP at market prices is a. Rs.650 cr b. Rs.670 cr c. Rs.695 cr d. Rs.640 cr e. Rs.630 cr. Wages paid to domestic residents Wages paid to foreigners Interest payments on loans taken from foreign banks Retained profits Corporate tax Imports Indirect taxes Depreciation Rs. Cr. 400 240 10 Sales to Households Gross Fixed Investment Changes in stock Rs. Cr. 550 85 55 40 730 < Answer > (2 points) 55. If the Factor Income received from abroad is Rs.200 cr., current account balance for the economy is a. b. c. d. e. Rs.45 cr. (surplus) Rs.35 cr. (surplus) Rs.35 cr. (deficit) Rs.45 cr. (deficit) Rs.55 cr. (deficit). (2 points) 56. For an economy, GDP at market prices for the current year is 1500 MUC. If GDP deflator for the current year is 120, real GDP for the current year would be a. b. c. d. e. 7,500 MUC 1,250 MUC 300 MUC 1,800 MUC 1,100 MUC. (1 point) 57. An economy consists of three sectors: primary, secondary and tertiary sectors. Transactions related to the three sectors are given below: (MUC) Items Sales Closing Stock Intermediate Consumption Opening Stock Indirect taxes Depreciation Subsidies GDP at factor cost for the economy is a. 293 MUC b. 300 MUC c. 271 MUC d. 258 MUC e. 342 MUC. (2 points) Primary Sector 100 15 15 10 12 10 7 Secondary Sector 150 20 25 10 13 12 8 Tertiary Sector 130 25 15 15 17 15 7 < Answer > < Answer > < Answer > Questions 58 to 61 are based on the following information: India’s overall Balance of Payments for the year 2002 – 03 (US $ million) Items Merchandise Services Transfers Income Foreign Direct Investment Portfolio Investment External Assistance Commercial Borrowings (MT & LT) Commercial Borrowings (Short Term) Commercial Banks Others Rupee Debt Service Other Capital Errors & Omissions 58. During the year 2002-03, trade deficit for India is a. b. c. d. e. $ 12,474 million $ 12,574 million $ 12,974 million $ 13,821 million $ 13,980 million. (1 point) 59. During the year 2002-03, current account balance for India is a. b. c. d. e. $ 3,708 million (surplus) $3,708 million (deficit) $3,998 million (deficit) $3,798 million (surplus) $3,888 million (deficit). (2 points) 60. During the year 2002-03, net foreign investment in India is a. b. c. d. e. $ 4,755 million $ 4,595 million $ 4,625 million $ 4,555 million $ 4,825 million. (1 point) 61. During the year 2002-03, over all Balance of Payments position for India is a. b. c. d. e. $18,280 million (surplus) $16,980 million (deficit) $17,280 million (deficit) $17,580 million (surplus) $ 16,980 million (surplus). (3 points) Questions 62 and 63 are based on the following information: Budget Estimate for the year 2003-04 < Answer > < Answer > < Answer > Credit 53000 24986 15225 2826 4790 7535 2773 2737 8189 16926 536 — 6402 634 Debit 65474 18780 367 7708 1179 6591 5233 4435 7210 8973 246 474 2909 — < Answer > Rs. crore Tax Revenue (net to Centre) Non-tax revenue Recoveries of Loans Other Receipts Borrowings and other Liabilities Non-plan Expenditure On Revenue Account (of which Interest Payments is Rs.1,23,223 cr.) On Capital Account Plan Expenditure On Revenue Account On Capital Account 62. The estimated revenue deficit for the year 2003-04 is a. b. c. d. e. Rs.1,13,292 cr Rs.1,12,392 cr Rs.1,12,292 cr Rs.1,19,292 cr Rs.1,19,922 cr. (2 points) 63. The estimated primary deficit for the year 2003-04 is a. b. c. d. e. Rs.31,814 cr Rs.30,814 cr Rs.31,414 cr Rs.30,414 cr Rs.32,414 cr. (1 point) 64. The following information pertains to an economy: Private consumption expenditure Investment in fixed capital Increase in stock Government expenditure Merchandise exports Imports Money supply a. b. c. d. e. 4 5 3 2 1. (2 points) Questions 65 and 66 are based on the following information: LM function Investment function Transaction demand for money Speculative demand for money Supply of money Current equilibrium rate of interest (I) (Mt) (Ma) (Ms) (i) Y = 500 + 200i 200 – 10i 0.50Y 350 – 100i 500 MUC 10% < Answer > < Answer > < Answer > 1,84,169 69,766 18,023 13,200 1,53,637 2,89,384 28,437 76,843 44,131 < Answer > (MUC) 750 250 150 100 50 150 230 The velocity of money in the economy is 65. If expansionary fiscal policies increase the equilibrium rate of interest to 12%, the crowding out in the economy is a. b. c. d. e. 10 MUC 15 MUC 20 MUC 25 MUC 30 MUC. (1 point) 66. If the government would like to avoid the crowding out as in the above question, what should be the new money supply in the economy? a. b. c. d. e. 100 MUC 600 MUC 650 MUC 700 MUC 750 MUC. (2 points) 67. The following relations are derived for an economy: (All macro aggregates are in million units of currency and interest in terms of percent per annum) Savings Function (S) – 50 + .50Yd Disposable income ( Yd) Y–T+R Transfer Payments (R) 80 MUC Tax function (T) 0. 40Y Investment function (I) 1000 – 30i Exogenous government expenditure (G) 800 MUC Import function (M) 20 + 0.20 Y Export (E) 450 MUC Transaction demand for money (Mt / P) 0.50Y Speculative demand for money (Ma / P) 250 – 100i Money supply (Ms / P) 500 MUC The equilibrium level of income in the economy is a. 1,875 MUC b. 1,985 MUC c. 2,062 MUC d. 2,162 MUC e. 2,281 MUC. (3 points) Questions 68 to 69 are based on the following information: The following relationship are given for an economy: Goods market equilibrium Money market equilibrium Exports Import function a. b. c. d. e. 637.5 MUC (surplus) 667.5 MUC (surplus) 687.5 MUC (deficit) 687.5 MUC (surplus) 768.5 MUC (deficit). (2 points) 69. If the government expenditure increases by 475 MUC, the new equilibrium rate of interest will be a. 7.83% < Answer > < Answer > < Answer > 0.5Y = 2925 – 37.5i 0.25Y = 312.5 + 125i 650 MUC 25 + 0.25Y < Answer > 68. The trade balance at equilibrium in the economy is b. c. d. e. 8.01% 8.83% 9.13% 9.65%. (2 points) < Answer > 70. As on September 30, 2003 monetary liabilities of the central bank are 1,200 MUC and government money is 50 MUC. If the currency deposit ratio is 0.20 and the central bank specifies a reserve ratio of 5%, money supply in the economy will be a. b. c. d. e. 5,000 MUC 5,500 MUC 6,000 MUC 6,550 MUC 6,600 MUC. (2 points) 71. In an economy the high powered money is 500MUC. The currency deposit ratio is estimated to be 0.40 and the reserve ratio is 10%. If foreign exchange assets with the central bank increase by 10 MUC what is the new reserve ratio so that the money supply remains at the previous level? a. b. c. d. e. 9% 10% 11% 12% 13%. (3 points) 72. Indicators of financial development of an economy for the year 2002-03 are given below: Finance ratio Financial interrelation ratio 19,200MUC, the total issues will be a. b. c. d. e. 7,800 MUC 8,200 MUC 8,700 MUC 9,000 MUC 9,600 MUC. (1 point) 73. In an economy, the high-powered money and money supply are 4,300 MUC and 17,200 MUC respectively. If the reserve ratio is 10%, currency deposit ratio for the economy is a. b. c. d. e. 0.17 0.20 0.24 0.27 0.29. (2 points) 74. Consider the following data: Particulars Factor income paid abroad by the business sector Factor income received by household sector Transfers to household sector Wages and salaries paid by the business sector Dividends paid by the business sector (of which Rs.10 is paid abroad) Household savings Factor income received from abroad by the household sector MUC 10 160 20 100 20 60 20 0.50 0.32 If the national income for the year 2002-03 is < Answer > < Answer > < Answer > < Answer > The amount paid by the government to the households towards wages and salaries is a. b. c. d. e. 10 MUC 20 MUC 30 MUC 40 MUC 50 MUC. (2 points) 75. Suppose that people hold 50% of their money in currency. If the reserve ratio is 10% and total demand for money is Rs.5,000, then the amount required by banks to meet the reserve requirement is equal to a. b. c. d. e. Rs.250 Rs.2,250 Rs.2,500 Rs.5,000 None of the above. (1 point) END OF SECTION B < Answer > Suggested Answers Economics – II (122) : October 2003 1. Answer : (e) Reason : Liquidity trap occurs when there is no decrease in the interest rate despite an increase in the money supply. This results in an addition to idle balances. (a) Is not the answer because when the economy is facing a situation of liquidity trap, there is no future expectation of rise in the interest rate. So public hold money rather than using for investment. The statement is true. (b) Is not the answer because LM curve gives the combination of income and interest rates which produce equilibrium in the money market. As the interest rate remains at the critical rate, the speculative demand for money is nil. As the interest elasticity of demand is infinity, the LM curve will be horizontal. The statement is true. (c) Is not the answer because as the interest rate doesn’t increase, a sound fiscal policy such as tax and expenditure policy will help in increasing the income. The fiscal policy has a direct bearing on the level of aggregate demand and the level of economic activity. The is a true statement. (d) Is not the answer because monetary policy is ineffective in affecting the interest rate due to the infinite interest elasticity of demand for money. The is a true statement. (e) Is the answer because LM is not vertical rather than horizontal when there is liquidity in the economy. Answer : (a) Reason : The aggregate supply explains the production behavior of an economy. If the actual price achieved is more than the expected price, firms will experience a higher than anticipated level of profits. This will lead to increase in production. That’s why the short run aggregate supply curve slopes upward. But in the long run, the difference between expected and actual price levels is negligible. In the long run, the output of an economy doesn’t depend on the price level, but on factors such as labor import costs, capital stock, technological progress, etc. So aggregate supply curve of an economy in long run is vertical. (a) Is the answer because aggregate supply curve is positively sloped in the short run and vertical in the long run. (b) Is not the answer because aggregate supply curve is not positively sloped in the short run as well as in the long run. (c) Is not the answer because aggregate supply curve is not positively sloped in the short run as well as in the long run. (d) Is not the answer because aggregate supply curve is not positively sloped in the short run and negatively sloped in the long run. (e) Is not the answer because in the long run, output of an economy doesn’t depend on the price level, but on factors such as labor import costs, capital stock, technological progress, etc. Answer : (b) Reason : If somebody buys National Small Saving Certificate, it increases in the other liabilities of the government. (a) Is not the answer because if Mr.X buys a National Small Saving Certificate, it will not increase Government borrowings. (b) Is the answer because if Mr.X buys a National Small Saving Certificate, it will increase in the other liabilities of the Government. (c) Is not the answer because if Mr.X buys a National Small Saving Certificate, it will not increase in forex reserves. (d) Is not the answer because if Mr.X buys a National Small Saving Certificate, it will < TOP > 2. < TOP > 3. < TOP > (e) not increase Government revenue. Is not the answer because if Mr.X buys a National Small Saving Certificate, it will not decrease Government liability. < TOP > 4. Answer : (b) Reason : Stocks and flows variables are very essential in studying macroeconomics. (a) Is not the answer because a stock variable is measured at a specified point of time where as a flow variable is measured for a specified period of time. Both the stock and flow variables have time dimensions. This is a true statement. (b) Is the answer because flow variables are not always determined by stock variables. Although a stock can change only as a result of flows, the flows themselves may be determined in part by changes in stocks. (c) Is not the answer because, stocks variables are usually affected by flow variables. (d) Is not the answer because some macroeconomic variables have a direct counter- part stock macroeconomic variables. Flow variables like, exports, wages, taxes, etc. may not have direct counterparts, and they could indirectly affect other stocks. (e) Is not the answer because flow variables are partly determined by stock variables. Answer : (c) Reason : In the Keynesian model, actual expenditure and planned expenditure is same at the equilibrium level of output. When the actual expenditure is less than the planned expenditure in the economy, there will be a positive inventory investment in the economy. (a) Is not the answer because there will not be a positive fixed investment in the economy. (b) Is not the answer because there will not be a negative fixed investment in the economy. (c) Is the answer because there will be positive inventory investment in the economy. (d) Is not the answer because there will not be negative inventory investment in the economy (e) Is not the answer because there will be change in the inventory investment in the economy. Answer : (e) Reason : (a) Is not the answer because Keynes considered the existence of full employment as a special case. The Keynesian underemployment equilibrium is reflecting real life situations. (b) Is not the answer because aggregate demand or effective demand indicates the total quantity of goods and services that people want to buy. According to Keynes, effective aggregate demand determines the level of employment and output. (c) Is not the answer because Keynes argues that State intervention is essential as full employment is not possible in an economy. (d) Is not the answer because Keynes argues that an economy facing recession, budget deficit is an important tool to overcome recession. (e) Is the answer because in the Keynesian model, monetary policy is not effective as compared to fiscal policy. Rather it is the fiscal policy, which is very effective and powerful. Keynes argues that government should maintain an active stance with a combination of tax and expenditure policies to maintain the desired levels of output and employment through manipulation of effective demand. 5. < TOP > 6. < TOP > 7. Answer : (e) Reason : GDP Deflator is a price index, which is used to measure the average level of the prices of all goods and services that make up GDP. (a) Is not the answer because it is a true statement that GDP deflator is otherwise known as implicit price deflator. (b) Is not the answer because GDP deflator reflects the change in overall price level in < TOP > the economy. (c) Is not the answer because GDP deflator is the most comprehensive index of price. (d) Is not the answer because GDP deflator is used to measure real GNP i.e. GNP in rupees of constant purchasing power. If prices are rising, the nominal GNP during the latter period to account for the effects of inflation. (e) Is the answer because GDP deflator doesn’t measure economic growth. 8. Answer : (c) Reason : In the business cycles theory, after a business peak or boom, the economy enters contraction stage. The sales of most businesses fall and real GNP of an economy grows at a slow pace. There is a large number of unemployment in the labor market. This phase is otherwise known as recession. (a) Is not the answer because the inventory stock increases gradually in recession. (b) Is not the answer because business expectation will be pessimistic with cautious decision-making. (c) Is the answer because there is an underutilization of existing capacity in the economy. (d) Is not the answer because bank credit starts falling in the recession phase of business cycle. (e) Is not the answer because there is a decline in the income levels of the people. Answer : (c) Reason : Every economy goes through cyclical fluctuations in output, employment and prices. This will have an automatic impact on certain government expenditures and revenues. The changes in the government spending and revenues that results automatically as the economy fluctuates are called non-discretionary fiscal policy. Automatic stabilizers are features of the government budget that automatically adjust net taxes to stabilize aggregate demand as the economy expands or contracts. (a) Is not the answer because an automatic stabilizer is not a mechanism in the stock market that automatically cause stock market gains to be cancelled out by losses. (b) Is not the answer because automatic stabilizer is not the invisible hand mechanisms, which automatically bring the economy out of a recession. (c) Is the answer because automatic stabilizer refers to Government revenues and expenditures that change automatically in response to changes in economic activity. When the economy is in a contraction phase, these stabilizers increase transfer payments and reduce tax collections in order to stimulate aggregate demand. On the other hand, when the economy begins to expand, the automatic stabilizers increase tax collections and reduce transfer payments in order to restrain growth in the aggregate demand. (d) Is not the answer because automatic stabilizer is a discretionary fiscal policy. Answer : (b) Reason : The amount of wealth that household or business hold in the form of money balances is referred to as demand for money. Individuals and firms may hold part of their wealth in the form of money to take the advantage of decrease in prices. Speculation can be done on price of stock and bonds. Securities prices are linked to interest rates and inversely proportional to a change in interest rates. With a rise in interest rates, prices of securities fall and the speculative demand for money also comes down. Contrary to this, if the interest rates fall, securities prices rise and demand for speculation purposes also rises. Thus speculative demand is inversely proportional to the rate of interest. (a) Is not the answer because transaction demand for money is largely influenced by level of income and the frequency with which income is received. (b) Is the answer because there is an inverse relationship rate of interest and the speculative demand for money. (c) Is not the answer because the demand for precautionary balances represents money that is held as a precaution for some unforeseen events such as medical emergency, < TOP > 9. < TOP > 10. < TOP > an accident etc. The precautionary demand for money is highly influenced by level of income. (d) Is not the answer because an inflationary expectation doesn’t represent an inverse relationship between the interest rate and the demand for money. (e) (e) Is not the answer because the relationship between the interest rate and the demand for money is inverse, not direct. 11. Answer : (e) Reason : (a) < TOP > Is not the answer because IS curve shows the combinations of income and interest rates which reflects the goods market equilibrium. (b) Is not the answer because LM curve shows the combinations of income and interest rates, which reflect the money market equilibrium. (c) Is not the answer because interest rate is a variable in both the IS and LM model. (d) Is not the answer because the equilibrium level of national income is determined when there is a simultaneous equilibrium in the goods market and money market. (e) Is the answer because IS curve is not positively sloped rather it is negatively sloped. 12. Answer : (d) Reason : If the government raises tax rate, it has an effect on the IS curve because it is a fiscal policy and the IS curve shifts to left. And at the same time the Reserve Bank of India keep the money supply constant. It implies that there is no change in the LM curve. This will result in a fall in the interest rate. (a) Is not the answer because when the Government raises tax rate, disposable income falls. (b) Is not the answer because if the government raises tax rate and the Reserve Bank of India hold the money supply constant, the IS curve shifts to the left. (c) Is not the answer because if the government raises tax rate and the Reserve Bank of India hold the money supply constant, there is no shift in the LM curve. (d) Is the answer because if the government raises tax rate and the Reserve Bank of India hold the money supply constant, the IS curve shifts to the left while LM curve unchanged means that the interest rate falls. (e) Is not the answer because interest rate doesn’t increase. Answer : (a) Reason : Creation of credit is a major function of a commercial bank. When a bank creates credit or advances loans, there tends to be a multiple expansion of credit in the banking systems. (a) Is the answer because credit creation by the commercial bank is limited by the Cash Reserve Ratio(CRR), i.e. every commercial bank must keep on deposit with the Reserve Bank certain amounts of funds equal to a specified percentage of it’s own deposit liabilities. (b) Is not the answer because commercial banks cannot create as much credit as they want. < TOP > 13. < TOP > (c) (c) Is not the answer because RBI has control over the credit created by commercial banks. (d) Is not the answer because CRR has an impact on credit creation. 14. Answer : (a) Reason : In an economy, the high-powered money is the aggregate of monetary liabilities of the central bank and government money. The foreign exchange reserves are the asset of the central bank. When the foreign exchange reserves increases, the monetary liabilities also increase. This in turn increases the high-powered money in the economy and thereby the money supply. If the economy is already affected by inflation, the central bank must step in to curb this expansion of money supply by either contracting its lending its lending to the banking systems (by increasing the discount rate) or by open market operations (sale < TOP > of government securities) or by increasing the cash reserve ratios of the commercial bank. (a) Is the answer because the Reserve Bank of India increase CRR to correct the imbalances created by changes in foreign exchange reserve. (b) Is not the answer because RBI wouldn’t decrease CRR. It will not help in correcting the imbalances created by changes in foreign exchange reserve. (c) Is not the answer because due to increase in foreign exchange reserves, RBI increases the discount rate. (d) Is not the answer because RBI checks the expansion of money supply by open market operations, i.e. sale of government securities. 15. Answer : (a) Reason : Phillips curve indicates the relationship between rate of inflation and unemployment rate. There exists a trade-off between inflation and unemployment. (a) Is the answer because Phillips curve shows that the goal of price stability or inflation and the goal of full employment can never be achieved simultaneously. The policy makers can choose a particular combination of inflation and unemployment. (b) Is not the answer because Phillips curve doesn’t imply the goal of price stability is most likely to conflict with the goal of economic growth. (c) Is not the answer because Phillips curve doesn’t imply the goal of price stability is most likely to conflict with the goal of equitable distribution of income. (d) Is not the answer because Phillips curve doesn’t imply the goal of price stability is most likely to conflict with the goal of balance in international trade. (e) Is not the answer because Phillips curve doesn’t imply the goal of price stability is most likely to conflict with the goal of removal of poverty. Answer : (e) Reason : Inflation is a serious problem on the part of the government worldwide. The effect of inflation is ranging from redistribution of income and wealth of the society to the worsening the balance of payments position of the country. (a) It is true statement that unanticipated inflation hurts the fixed income earners most. Though their monetary income is constant, real income is reduced because of inflation. (b) It is true statement that higher than expected inflation hurts creditors but benefits debtors. Debtors repay the amount, which is fixed in nominal terms. The real values of repayments in the future will decrease with an increase in inflation, leads to an increase in the wealth of the debtors. On the other hand, the wealth of the creditors will decrease with an increase in the rate of inflation. (c) It is a true statement that inflation creates inefficiency in the economy because people spent lot of time to find a reasonable price. (d) It is a true statement that inflation can lead to a misallocation of resources because inflation misleads people to invest logically. (e) Is the answer because all the above statements are correct. Answer : (a) Reason : Fiscal policy refers to policies dealing with taxes and government expenditure including transfer payments. (a) Is the answer because when the government reduces taxes or raises spending to get the economy out of a recession, is a case of fiscal policy measure. (b) Is not the answer because when the central bank changes the money supply to affect the price level, interest rates and exchange rate , it is a monetary policy. (c) Is not the answer because when the government restricts imports and stimulates exports; it is a case of EXIM (Export-Import) policy. (d) Is not the answer because both (a) and (b) cannot be the answer. (e) Is not the answer because both (a) and (c) cannot be the answer. Answer : (a) < TOP > 16. < TOP > 17. < TOP > 18. < TOP Reason : When the government monetizes part of its deficit, it is an increase in net RBI credit to the Government, comprising the net increase in the holdings of Treasury Bills of the RBI and its contribution to the market borrowings of the Government. To meet the needs of the Government, the RBI prints more money. This will lead to excess money supply in the economy. (a) Is the answer because money supply in the economy increases when the Government monetizes part of its deficit. (b) Is not the answer because when there is an excess money supply, interest rate will decline. (c) Is not the answer because when the government monetizes part of its deficit, primary deficit will decrease. Primary deficit is calculated by deducting the interest payments of the government from the gross fiscal deficit. (d) Is not the answer because when the government monetizes part of its deficit, public debt will decrease. (e) Is not the answer because when the government monetizes part of its deficit, revenue deficit will increase. Revenue deficit is the difference between Government’s revenue expenditure and revenue receipts. 19. Answer : (b) Reason : The balance sheet of Reserve Bank of India contains particulars of Bank’s current assets and liabilities. (a) Is not the answer because Central government’s borrowings from RBI constitutes assets of RBI.It will affect the balance sheet. (b) Is the answer because loan taken by one commercial bank from the other is a inter bank loan. It will not affect the balance sheet of the Reserve Bank of India. It is neither a liability nor an asset to the RBI. (c) Is not the answer because refinancing of NABARD loans constitutes assets of RBI. (d) Is not the answer because increase in reserves of commercial banks increases the liabilities of RBI. (e) Is not the answer because increase in net foreign exchange assets increases the assets of RBI. Answer : (e) Reason : A well-developed financial system is vital for the smooth functioning of an economy. The financial development ratios such as Finance Ratio, Financial Interrelation Ratio, New Issues Ratio and Intermediation Ratio are indicators of financial development of a country. (a) Is not the answer because Finance Ratio is an indicator of financial development of a country. (b) Is not the answer because Financial Interrelation Ratio is an indicator of financial development of a country. (c) Is not the answer because New Issues Ratio is an indicator of financial development of a country. (d) Is not the answer because Intermediation Ratio is an indicator of financial development of a country. (e) Is the answer because Cost Benefit Ratio is not an indicator of financial development of a country. Answer : (e) Reason : Personal disposable income = Personal income – Personal taxes. (a) Is not the answer because the difference between personal disposable income and personal income is not residential investment. (b) Is not the answer because the difference between personal disposable income and personal income is not indirect taxes. > < TOP > 20. < TOP > 21. < TOP > (c) Is not the answer because the difference between personal disposable income and personal income is not subsidies. (d) Is not the answer because the difference between personal disposable income and personal income is not transfer payments. (e) Is the answer because the difference between personal disposable income and personal income is personal taxes 22. Answer : (c) Reason : Money supply = H × (1+ Cu / Cu + r) Where, H = Monetary Liabilities of Central Bank + Government Money. Cu = Currency-deposit ratio r = Cash reserve ratio. (a) Is not the answer because When the RBI increases cash reserve ratio (CRR), monetary liabilities of the RBI decreases. (b) Is not the answer because When the RBI increases cash reserve ratio (CRR), high powered money in the economy increases. (c) Is the answer because When the RBI increases cash reserve ratio (CRR), the value of money multiplier decreases. (d) Is not the answer because When the RBI increases cash reserve ratio (CRR), aggregate demand in the economy decreases. (e) Is not the answer because When the RBI increases cash reserve ratio (CRR), price level in the economy decreases. 23. Answer : (e) Reason : The demand for precautionary balances represents money that is held as a precaution against some unforeseen events such as medical emergency, accident etc. This precautionary demand for money is inversely related to rate of interest and frequency with which income is received. Lower the rate of interest and frequency with which income is received, higher is the precautionary demand for money and vice versa. (a) Is not the answer because precautionary demand for money varies directly with the level of income. (b) Precautionary demand for money is inversely related to rate of interest. (c) Is not the answer because precautionary demand for money varies directly with the wealth a person held. (d) Precautionary demand for money is inversely related to frequency with which income is received. (e) Is the answer because precautionary demand for money is inversely related to rate of interest and frequency with which income is received. Answer : (c) Reason : Investment is the flow of expenditures devoted to increasing or maintaining the real capital stock. When the addition to capital goods is more than the capital consumption allowance, it will result in a positive net investment. (a) Is not the answer because when the addition to capital goods is less than the capital consumption allowance, it will result in negative net investment. (b) Is not the answer because when the addition to capital goods is more than the capital consumption allowance, it will not result in zero net investment (c) Is the answer because when the addition to capital goods is more than the capital consumption allowance, it will result in positive net investment (d) Is not the answer because when the addition to capital goods is more than the capital consumption allowance, it will not result in negative gross investment. Because gross investment is the total investment that occurs in the economy within any specific time period. (e) Is not the answer because when the addition to capital goods is more than the capital consumption allowance, it will not result in zero gross investment. < TOP > < TOP > 24. < TOP > 25. Answer : (e) Reason : An expansionary fiscal policy shifts the IS curve to the right. And a liberal monetary plicy shifts the LM curve to the right. It will result in a higher level of output, but the level of interest rate is dependent on the relative magnitude of fiscal and monetary policies < TOP > a. a. Is not the answer, because an expansionary fiscal policy combined with a liberal monetry policy does not result in a lower level of output and a lower interest rate. Is not the answer because an expansionary fiscal policy combined with a liberal monetary policy does not result in a lower level of output and a higher interest rate. Is not the answer because an expansionary fiscal policy combined with a liberal monetary policy results in a higher level of output but not a lower interest rate. Is not the answer because an expansionary fiscal policy combined with a liberal monetary policy results in a higher level of output but we can’t say that it results in a higher interest rate. Is the answer because an expansionary fiscal policy combined with a liberal monetary policy result in higher level of output, but the level of output, but the level of interest rate is dependent on the relative magnitude of fiscal and monetary policies. < TOP > b. b. c. c. d. d. e. e. 26. Answer : (b) Reason : If the central bank doesn’t impose any reserve ratio, the commercial bank need not keep on deposit with the Reserve bank certain amount of funds equal to a specified percentage of its own deposit liabilities. Then the banking sector can create unlimited money supply. (a) Is not the answer because without the imposition of reserve ratio, the banking system can affect the supply of money through credit creation. (b) Is the answer because if the central bank doesn’t impose any reserve ratio, the banking sector can create unlimited money supply. (c) Is not the answer because without reserve ratio, the lending capacity of banks wouldn’t narrow down to zero. (d) Is not the answer because if the central bank doesn’t impose any reserve ratio, a rupee deposited in a bank doesn’t reduce the money supply in the economy by one rupee. (e) Is not the answer because if the central bank doesn’t impose any reserve ratio, money supply in the economy will not be equivalent to high-powered money. Money supply = H × (1+ Cu / Cu + r) Where, H = Monetary Liabilities of Central Bank + Government Money. Cu = Currency-deposit ratio r = Cash reserve ratio. 27. Answer : (a) Reason : GNP deflator is a price index, which is used to reveal the cost of purchasing the items included in GNP during the period relative to the cost of purchasing those items during a base year. GNP deflator is used to measure real GNP i.e. in rupees of constant purchasing power. If there is a rise in prices, the nominal GNP is deflated during the latter period to account for the effects of inflation. (a) Is the answer because GNP deflator is the ratio of Nominal GNP to Real GNP. (b) Is not the answer because GNP deflator is not the ratio of Real GNP to Nominal GNP (c) Is not the answer because GNP deflator is not the ratio of Nominal GNP to Real GDP (d) Is not the answer because GNP deflator is not the ratio of Real GNP to Nominal GDP. Answer : (a) Reason : The LM curves gives the combinations of income and interest rates, which produce < TOP > 28. < TOP > equilibrium in the money market. For all points in the LM curve, the demand for real balances is equal to supply of real balances. The LM curve shows a positive relationship between rate of interest and level of income. (a) Is the answer because the LM curve shows a positive relationship between rate of interest and level of income. (b) Is not the answer because the LM curve doesn’t show a negative relationship between rate of interest and level of income. (c) Is not the answer because the LM curve doesn’t show a negative relationship between rate of interest and level of investment. (d) Is not the answer because the LM curve doesn’t show a positive relationship between rate of interest and level of investment. (e) Is not the answer because the LM curve doesn’t show a positive relationship between level of investment and level of income. 29. Answer : (e) Reason : In case of stagflation, there is stagnation as well as inflation exists in the economy. There is a slowing down of economic activities occurs. (a) Is not the answer because deflation refers to a situation in which there is a decrease in general level of prices in an economy that is sustained over a period of time (b) Is not the answer because in the case of hyperinflation, price rise is very large and accelerating (c) Is not the answer because recession is characterized by the downturn in economic activities in an economy (d) Is not the answer because there is a contraction of economic activities in the depression period. (e) Is the answer because there is a stagnation combined with inflation prevails in the economy in the period of stagflation. Answer : (a) Reason : In the Keynesian model, unemployment could be reduced if the aggregate demand increases. Therefore, unemployment is caused by demand deficiency. The Keynesian theory of unemployment suggests that governments can play an active role in the economy by adjusting the aggregate demand through its fiscal and monetary instruments. (a) Is the answer because unemployment in the Keynesian model is caused by demand deficiency. (b) Is not the answer because unemployment in the Keynesian model is not caused by supply deficiency. (c) Is not the answer because unemployment in the Keynesian model is not caused by demand sufficiency. (d) Is not the answer because unemployment in the Keynesian model is not caused by supply sufficiency. (e) Is not the answer because unemployment in the Keynesian model is not caused by both demand deficiency and supply deficiency. Answer : (e) Reason : Supply side economics advocates to reduce government controls, to promote competition, to restrict the power of trade unions and to remove institutional barriers. Supply side economics doesn’t recommend to increasing corporate tax rate. (a) Is not the answer because supply side economics recommend reducing government controls to improve market efficiency. (b) Is not the answer because supply side economics recommend promoting competition to improve market efficiency. (c) Is not the answer because supply side economics recommend restricting the power of trade unions to improve market efficiency. < TOP > 30. < TOP > 31. < TOP > (d) Is not the answer because supply side economics recommend removing institutional barriers to improve market efficiency. (e) Is the answer because supply side economics doesn’t recommend increasing corporate tax rate to improve market efficiency. 32. Answer : (e) Reason : If a government has a surplus budget, and the government repays its past debts using its surplus budget, public debt will be falling. (a) Is not the answer because if a Government is running surplus in its budget, public debt may not be rising. (b) Is not the answer because if a Government is running surplus in its budget, public debt may not be falling. (c) Is not the answer because if a Government is running surplus in its budget, public debt may not be constant. (d) Is not the answer because if a Government is running surplus in its budget, public debt may not be falling if there are tax cuts. (e) Is the answer because if a Government is running surplus in its budget, public debt will be falling if the Government uses the surplus to repay its past debts. Answer : (d) Reason : The Laffer curve depicts the relationship between tax revenues and tax rates. The shape of the Laffer curve is backward bending indicating that tax revenues initially increase and then decrease as the tax rate increases. (a) Is not the answer because according to Laffer curve, tax revenues do not rise continuously as the tax rate increases. (b) Is not the answer because tax revenues do not decrease continuously as the tax rate increases. (c) Is not the answer because tax revenues do not decrease initially and then increase as the tax rate increases. (d) Is the answer because tax revenues increase initially and then decrease as the tax rate increases. (e) Is not the answer because tax revenues do not remain constant as the tax rate increases Answer : (d) Reason : M = Currency with the public + Demand deposits with the banking system + other deposit with the bank. M = M + Time deposits with the banking systems. (a) Is not the answer because the difference between M and M is not the demand deposits. (b) Is not the answer because the difference between M and M is not the post office savings deposits. (c) Is not the answer because the difference between M and M is not the savings deposits. (d) Is the answer because the difference between M and M is the time deposits. (e) Is not the answer because the difference between M and M is not M 1 3 1 3 1 3 1 3 1 3 1 3 1 2. < TOP > 33. < TOP > 34. < TOP > 35. Answer : (b) Reason : According to rational expectations school, discretionary monetary and fiscal policy cannot be used to stabilize the economy. Proponents of rational expectation argue that consumers and business firms anticipate the implications of rise in government spending. Moneywage rate and prices will rise, but output and employment will remain the same. So government can no longer fool the people by increasing its spending during elections years. So the answer is (b). Answer : (e) < TOP > 36. < TOP > Reason : An increase in government expenditure results in an increase in the level of income and an increase in the interest rate. It will shift the IS curve to the right. But LM curve remain unchanged because an increase in government expenditure, a fiscal policy measure, has no impact initially in the asset markets. (a) Is not the answer because an increase in government will not shift both IS and LM curve to the right. (b) Is not the answer because an increase in government will not shift both IS and LM curve to the left. (c) Is not the answer because an increase in government will not shift IS curve to the left. (d) Is not the answer because an increase in government will affect IS curve. (e) Is the answer because an increase in government will not shift the position of LM curve but shift IS curve to the right. 37. Answer : (d) Reason : Transfer payments are not considered as payment for current services or production. These items are not entered in national income. (a) Is the not the answer because salary paid to a soldier is the payment for current services and hence it is not an examples of government transfer payments. (b) Is the not the answer because purchasing of a new car for the Ministry of Finance is not an examples of government transfer payments. (c) Is the not the answer because funding of a clinic to provide free vaccinations is not an examples of government transfer payments (d) Is the answer because free food coupons issued to a persons in an antipoverty program is not the payment for current services or production and hence it is an examples of government transfer payments. (e) Is the not the answer because funding of a new bridge in an urban area is the payment for current services and hence it is not an examples of government transfer payments. Answer : (a) Reason : In India, Whole Sale Price index (WPI) is widely used for determinime of inflation. Because the Office of the Economic Advisor to the Government of India publishes wholesale price indices for individual commodities, commodity groups and the overall WPI monthly. They are reported in a number of other publications also. (a) Is the answer because Whole Sale Price index (WPI) is widely used for determinime of inflation in India. (b) Is not the answer because GDP deflator is not used for determining inflation in India. GDP deflator is used to reveal the cost of purchasing the items included in GNP during the period relative to the cost of purchasing those items during a base year. And it is difficult to bet the data for the two years for comparisons. (c) Is not the answer because in practice it is difficult to include each and every item for construction of Consumer Price Index. (CPI) (d) Is not the answer because both Whole Sale Price index (WPI) and GDP deflator are not used in measuring inflation. (e) Is not the answer because both GDP deflator and Consumer Price Index. (CPI) are not used in measuring inflation. Answer : (b) Reason : In India, personal taxes is an example of progressive tax system. Progressive tax system implies that higher the level of income, higher will be the volume of tax burden, represented as a percentage of the total income. (a) Is not the answer because personal tax is not a proportional tax system. In proportional tax systems, the tax imposed is of a particular percent of income irrespective of his income level. (b) Is the answer because personal taxes is an example of progressive tax system. < TOP > 38. < TOP > 39. < TOP > (c) Is not the answer because personal tax is not a direct tax system. (d) Is not the answer because personal tax is not a value added tax system.In value added tax system, the tax is on the value added at each stage. (e) Is not the answer because personal tax is not a regressive tax system. In regressive tax system, people with lower levels of income are imposed with higher taxes as a proportion of their income. 40. Answer : (d) Reason : Outside lag ’is the duration involved for output and employment to respond to changes of the implemented of policies.Taxes has the least outside lag. (a) Is not the answer because cash reserve ratio has not the least outside lag. (b) Is not the answer because bank rate has not the least outside lag (c) Is not the answer because repo rate has not the least outside lag (d) Is the answer because tax has the least outside lag. (e) Is not the answer because open market operation has not the least outside lag. Answer : (d) Reason : Target growth rate = 6% p.a. Required domestic savings to income Expected population growth ∴ growth rate = 6 + 2 = 8% ∴ Capital – output ratio = 42. 32 =4 8 < TOP > 41. < TOP > = = 32% 2% Answer : (c) Reason : Consumption function for an economy is estimated to be c = 400 + 0.75 Yd Y=C+S When S = 0, Y = C ∴ Y = 400 + 0.75 Y or, 0.25Y = 400 Yd = 1,600 ∴ c = 400 + 0.75 ( 1,600) = 400 + 1,200 = Rs.1,600 cr. < TOP > 43. Answer : (c) Reason : Y* = Rs.5,000 MPC = Y = 2,500 C =a+bY = 0.75 (2,500) = 1,875 amount 3 = 0.75 4 < TOP > ∴ Borrowed = 2,500 – 1,875 = Rs.625 44. Answer : (b) Reason : S = – 60 + 0.25Yd At equilibrium level of income, S = I : – 60 + 0.25 Yd = 100 or, 0.25Yd = 100 Yd = < TOP > or, 100 = 640MUC 0.25 45. Answer : (b) Reason : Y = C + I + G Or, Y = 100 + 0.75 (Y – 0.20Y ) + 80 + 150 (∴ Yd = Y – T) Or, Y = 0.75Y – 0.15Y + 330 Or, Y = 0.60Y + 300 Or, 0.40 Y = 330 Or, Y = 825 MUC < TOP > 46. Answer : (c) Reason : Budget surplus for the economy = T – G = 0.20 (825) – 150 = 165 – 150 = 15 MUC Answer : (a) Reason : M = 0.10Y X = 420MUC ∴ When the economy is opened to trade in goods and services with rest of the world, the multiplier in the economy will be where, β→ < TOP > 47. < TOP > 1 1 − β + βt + µ marginal propersity to consumer tax marginal propensity to import 1 1 − 0.75 + ( 0.75 ×0.20 ) + 0.10 1 =2 0.5 t→ µ→ multiplier = = 48. Answer : (b) Reason : S = – 250 + 0.30Yd ∴ C = 250 + 0.70Yd T = 0.25Yd M = 0.3Y ∴ The value of multiplier = m = 1 1 − 0.75 + 0.15 + 0.10 = < TOP > 1 1−β(1− t) + µ 1 1 − 0.70 ( 1 − 0.25 ) + 0.3 1 1 − 0.70 ( 0.75 ) + 0.3 1 = 1.29 0.775 = = = Y = mI Or, 100 = 1.29I Or, I = 100 = 77.5 1.29 MUC 49. Answer : (c) Reason : S = – 300 + 0.20Y At Y = 2,250, S = – 300 + 0.20 (2,250) = –300 + 450 = 150 At equilibrium, S = I ∴200 – 5i = 150 or, – 5i = – 50 or, I = 10% < TOP > 50. Answer : (b) Reason : L = 0.4Y – 10i At equilibrium, demand for money = Supply of money i.e. 0.4Y – 100i = 300 When, i = 8, 0.4Y – 100(8) = 300 Or, 0.4Y = 380 Or, Y = 950 When I = 6 , 0.4Y–100 (6) = 300 Or, 0.4Y = 360 Or, Y = 900 ∴ change in the equilibrium level of output = 900 – 950= 50 MUC Answer : (e) Reason : High – Powered money (H) = monetary liabilities or central bank + Government money. Non monetary liabilities = 200 + 80 = 280 Financial assets = Loans given to Government + Credit to banks + Loans given to commercial section + foreign exchange assets = 1,200 + 800 + 20 + 1,500 = 3,520 Monetary liabilities = Financial assets + other assets – Non monetary liabilities = 3,520 + 60 – 280 = 3,300 ∴ M = 3,300 + 100 = 3,400 MUC Answer : (e) Reason : Personal Income = National Income – Undistributed corporate profit – corporate tax + Transfer payments National Income = GNP at market price – Depreciation – Indirect taxes + Subsidies = 1,700 – 190 – 173 + 20 = 1,357 ∴Personal Income = 1,357 – 28 – 75 + 242 = Rs.1,496 cr < TOP > 51. < TOP > 52. < TOP > 53. Answer : (b) Reason : Net factor Income from Abroad (NFIA) = NNPat factor cost – NDPat factor cost NDPat factor cost = 50,000 MUC NDPat factor cost = NDP market price – Depreciation – Indirect taxes + Subsidies = 60,000 – 3,000 – 2,00 + 500 < TOP > = 55,500 ∴NFIA = 55,500 – 50,000 = 5,500 MUC 54. Answer : (c) Reason : NDPat market price = NDP at factor cost + Indirect taxes NDPat factor cost = wages paid to domestic residents + wages paid to foreigners + Interest payment on loans taken + Retained profits + Corporate tax = 400 + 240 + 10 + 20 + 10 = 680 ∴ NDPat market prices 55. = 680 + 15 = Rs.695 cr Answer : (c) Reason : Current account balance = Factor income received from abroad + Exports – Wages paid to foreigners – Imports – Interest payment on loans taken = 200 + 40 – 240 – 25 –10 = Rs. –35 cr ( deficit) Answer : (b) Reason : Real GDP (current year ) = GDP at Market Pr ice (Current year) ×100 GDP deflator (current year) 1, 500 × 100 120 < TOP > < TOP > 56. < TOP > = = 1,250 MUC 57. Answer : (e) Reason : Value added by factor of production = Sales – Intermediate consumption – Indirect taxes + Subsidies ∴ Value added by Primary sector = 100 – 15 – 12 + 7 = 80 Value added by Secondary sector = 150 – 25 – 13 + 8 =120 Value added by Tertiary sector = 130 – 15 – 17 + 7 = 105 ∴ NDP at factor cost = Sum of value added by Primary sector, Secondary sector and tertiary sector = 80 + 120 + 105 = 305 Depreciation = 10 + 12 + 15 = 37 ∴ GDP factor cost = 305 + 37 = 342 MUC 58. Answer : (a) Reason : Trade deficit for the year 2002-03 = Merchandise (credit) – Merchandise (debit) = 53,000 – 65,474 = $12,474 million Answer : (a) Reason : Total Current account ( Credit) = Merchandise + Services + Transfer + Income = 53,000 + 24,986 + 15,225 + 2,826 = 96,037 Total Current account (Debit) = 65,474 + 18,780 + 367 + 7,708 = 92,329 ∴ Current account balance = 96,037 – 92,329 = $ 3,708 million (surplus) < TOP > < TOP > 59. < TOP > 60. Answer : (d) Reason : Net foreign investment in India = Foreign direct investment (credit) + Portfolio investment (credit) – foreign direct investment (debit) – Portfolio investment (debit) = 4,790 + 7,535 – 1,179 – 6,591 = $ 4,555 Million Answer : (e) Reason : Overall balance of payment = Total Credit of the Bop – Total debit of the Bop = 1,46,559 – 1,29,579 = $ 16,980 million (surplus) < TOP > 61. < TOP > 62. Answer : (c) Reason : Revenue deficit Revenue Expenditure Revenue receipts = Revenue expenditure – Revenue receipt = Non plan revenue expenditure + Plan revenue expenditure = 2,89,384 + 76,843 = 3,66,227 = Tax revenue + Non. Tax revenue = 1,84,169 + 69,766 = 2,53,935 = 3,66,227 – 2,53,935 = Rs.1,12,292 cr < TOP > ∴ Revenue Deficit 63. Answer : (d) Reason : Primary deficit = Fiscal deficit – Interest payment Fiscal deficit = Borrowings and other Liabilities ∴ Primary deficit = 1,53,637 – 1,23,223 = Rs.30,414 cr < TOP > 64. Answer : (b) Reason : Velocity of money = Y = 750 + 250 + 150 + 100 + 50 – 150 = 1,150 ∴ Velocity of money = 1,150 =5 230 Y Ms < TOP > 65. Answer : (c) Reason : When i = 10, Investment , I = 200 – 10(10) = 100 Because of expansionary fiscal policy, i = 12, Then investment I = 200– 10(12) = 80 ∴ crowding out = 100 – 80 = 20 MUC Answer : (b) Reason : There will not be any crowding out if i = 10% This can happen only when LM curve shifts to the right. Substituting i = 10%, LM function become Y = 500 + 200(10) = 2,500 Total demand for money function = = 0.50Y + 250 – 100 Substituting Y = 2,500 and i = 10 in the total demand for money function, we get, M t + Ma p p < TOP > 66. < TOP > 0.50 (2,500) + 250 – 100(10) = 1,250 + 350 – 1,000 = 600 MUC Since money supply is equal to demand for money, the new money supply will be 600 MUC. 67. Answer : (e) Reason : Saving function = – 50 + 0.50 Yd Hence, consumption function = 50 + 0.50 Yd Y=C+I+G+E–M Or, Y = 50 + 0.50 (Y– 0.40Y + 80) + 1,000 – 30i + 800 + 450 – (20 + 0.20Y) Or, Y = 50 + 0.50Y – 0.2Y + 40 +1,000 – 30i + 800 + 450 – 20 – 0.20Y Or, Y = 2,320 + 0.1Y – 30i Or, 0.90Y = 2,320 – 30i Or, Y = 2,577.78 – 33.33i………………..IS Curve Ms < TOP > = or, 500 = 0.5Y + 250 – 100i or, 0.50Y = 250 + 100i or, Y = 500 + 200i …………………….LM Curve By equating the IS and LM function, we can get the equilibrium rate of interest. ∴500 + 200i = 2,577.78 – 33.33 or, 233.33i = 2,077.78 or, i = 8.9% ∴ Y = 2,577.78 – 33.33 (8.9) = 2,577.78 – 296.64 = 2,281.14 = 2,281MUC (approximately) 68. Answer : (c) Reason : Goods market equilibrium: 0.5Y = 2,925 – 37.5; or, Y = 5,850 –75i (IS Function) Money market equilibrium: 0.25Y = 312.5 + 125; or, Y = 1,250 + 500i (LM function) At simultaneous equilibrium of goods market and money market, IS = LM ∴ 5,850 –75i = 1,250 + 500i or, 575i = 4,600 or, i = 8% ∴ Y = 5,850 – 75(8) = 5,850 – 600 = 5,250 ∴ Trade balance at equilibrium =E–M = 650 – (25 + 0.25Y) = 650 – 25 – .25 (5,250) = 650 – 25 – 1,312.50 = – 687.50 MUC (deficit) 69. Answer : (e) Reason : If Government expenditure increase by 475 MUC, IS function becomes 0.5Y = 2,925 + 475 – 37.5i < TOP > < TOP > p Mt + Ma p p or, 0.5Y = 3,400 – 37.5i or, Y = 6,800 – 75i At simultaneous equilibrium, IS = LM Or, 6,800 – 75i = 1,250 + 500i Or, 575i = 5,500 Or, i = 9.65% 70. Answer : (c) Reason : Stock of high powered money ( H) = monetary liabilities of the central bank + government money = 1,250 MUC Current deposit ratio (Cu) = 0.20 Reserve ratio (r) = 0.05 ∴ Money supply Ms = = = = 71. Answer : (c) Reason : Money supply, M = = 1 + Cu ×H Cu + r 1 + 0.40 × 500 0.40 + 0.10 1 + Cu ×H Cu + r 1 + 0.20 ×1, 250 0.20 + 0.05 < TOP > 4.8 × 1,250 6,000 MUC < TOP > = 2.8 × 500 = 1,400 MUC If there is an additional inflow of 10 MUC of foreign exchange assets, H = 500 + 10 = 510 If money supply is to be maintained at 1,400 MUC, 510 × 1,400 = ( 0.40 + r ) 510 × 1.40 1, 400 1.40 or, 0.40 + r = or, 0.40 + r = 0.51 or, r = 0.11 = 11% 72. Answer : (e) Reason : Finance Ratio = Total issue National Income < TOP > ∴ Total Issue = Finance Ratio × National Income = 0.50 × 19,200 = 9,600 MUC 73. Answer : (b) Reason : Money supply = High Powered money × Money multiplier ∴ 17,200 = 4,300. m < TOP > or, m = m= 1 + Cu Cu + r 17, 200 =4 4, 300 ∴ 1 + Cu =4 Cu + 0.10 or, 1+ Cu = 4Cu + 0.40 or, – 3Cu = –.06 or, Cu = 0.20 74. Answer : (c) Reason : Wages and salaries paid by the government = Factor income received by households – (wages and salaries paid by the business sector + Dividends paid to house holds + Factors income receive abroad) = 160 – 100 – 10– 20 = 30 MUC. Answer : (a) Reason : Demand for money = Rs.5,000 ∴ Currency held in money form = Rs.2,500 Reserve ratio = 10% ∴ Amount required by banks to meet the reserve requirement = < TOP OF THE DOCUMENT > 2, 500 × 10 100 < TOP > 75. < TOP > = Rs.250.