Question Paper

Economics-II (122) : January 2005

• Answer all questions.
• Marks are indicated against each question.

1. Which of the following is a stock variable? < Answer >

(a) Gross Domestic Product (b) Inventory of a firm

(c) Inflation (d) National Income (e) Exports.
(1 mark)
2. The following data is taken from National Income Accounts of a country: < Answer >

Million Units of
Particulars
Currency (MUC)
GNP at market prices 1,700
Transfer payments 242
Indirect taxes 173
Personal taxes 203
Consumption of capital 190
Undistributed corporate profits 28
Corporate tax 75
Subsidies 20

Personal income in the country is

(a) 1,363 MUC (b) 1,121 MUC (c) 1,230 MUC (d) 1,296 MUC (e) 1,496 MUC.
(2 marks)
3. The term “rational expectations” is most accurately associated with the notion that < Answer >

(a) Econometric models are very useful in evaluating alternative economic policies
(b) Inflation is primarily a monetary phenomenon
(c) Tax adjustments will have no effect, but changes in the money supply can stimulate growth in an
economy
(d) People always use as much information as possible in forming and acting upon their expectations
about the future
(e) There exists a trade-off between inflation and unemployment.
(1 mark)
4. Which of the following is true if, for a given period, there is no change in the foreign exchange reserves < Answer >
of a country?
(a) Balance in the current account is equal to the balance in capital account
(b) Surplus (deficit) in the current account is equal to deficit (surplus) in the capital account
(c) Current account balance is zero
(d) Trade balance is zero
(e) Capital account balance is zero.
(1 mark)
5. Denmark has experienced a slowdown in economic activity beginning in 2001, but economic < Answer >
fundamentals remain sound. The Government expects that growth will pick up in 2004 to a rate of just
under 2 percent (taking account of the recent fiscal measures), but there are downside risks. Private
consumption spending should lead the recovery, as tax cuts increase disposable income, and there should
also be positive wealth effects from improving equity markets and still-strong housing prices. The
rebound in consumption in the fourth quarter of last year was a positive sign. However, a delay in the
turnaround of unemployment could dampen consumer confidence. The consumption schedule for
Denmark is given below:
Consumption Disposable income
(MUC) (MUC)
475.0 500
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 400.0 400
287.5 250
250.0 200
If savings in Denmark is 100 MUC, the equilibrium income in the economy is
(a) 750 MUC (b) 700 MUC (c) 800 MUC (d) 950 MUC (e) 1,050 MUC.
(2 marks)
6. Gabon enjoys a per capita income four times that of most nations of sub-Saharan Africa. This has < Answer >
supported a sharp decline in extreme poverty; yet because of high income inequality a large proportion of
the population remains poor. Gabon depended on timber and manganese until oil was discovered offshore
in the early 1970s. The oil sector now accounts for 50% of GDP. Gabon continues to face fluctuating
prices for its oil, timber, and manganese exports. Despite the abundance of natural wealth, poor fiscal
management hobbles the economy.(Currency of Gabon : Communaute Financiere Africaine franc, XAF)
The following data pertains to Gabon.
Consumption function (C)= 70 + 0.75Yd
Investment (I) = XAF 80
Government spending (G) = XAF 70
Tax function (T) = 0.2Y
At equilibrium, the budget surplus (deficit) of Gabon is
(a) XAF (30) (b) XAF 30 (c) XAF 40 (d) XAF 180 (e) XAF (40).
(2 marks)
7. Which of the following does not affect the balance sheet of Reserve Bank of India? < Answer >

(a) Central government’s borrowings from RBI

(b) Loan taken by one commercial bank from the other
(c) Refinancing of NABARD loans
(d) Increase in reserves of commercial banks
(e) Increase in net foreign exchange assets.
(1 mark)
8. Which of the following is true if the Government monetizes part of its deficit? < Answer >

(a) Money supply in the economy will increase

(b) Interest rate will increase
(c) Primary deficit will increase
(d) Public debt will increase
(e) Revenue deficit will decrease.
(1 mark)
9. Value added by a firm is equal to < Answer >

(a) Firm’s revenue – Costs of intermediate goods

(b) Cost of producing a good – Costs of raw materials
(c) Wages + Interest payments + Indirect taxes – Profits
(d) Wages + Interest payments + Indirect taxes + Costs of intermediate goods + Profits
(e) Price of the goods sold – Profits.
(1 mark)
10. In a hypothetical economy, the marginal propensity to consume is 0.75. If marginal propensity to import < Answer >
is 0.10 and the tax rate is 20%, then the value of multiplier will be
(a) 2.00 (b) 3.33 (c) 0.50 (d) 1.00 (e) 6.00.
(1 mark)
11. Which of the following occurs during the phase of depression in the economy? < Answer >

(a) Output increases, employment decreases

(b) Output decreases, employment increases
(c) Output decreases, employment decreases
(d) Output increases, employment increases
(e) Output decreases, employment remain the constant.
(1 mark)
12. Acceleration coefficient in an economy is 2. Investment in a period is equal to 75% of the difference < Answer >
between the desired capital stock and the existing capital stock. If income in period ‘t’ is expected to
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 increase by 200 MUC, investment during the period ‘t’ will be
(a) 200 MUC (b) 300 MUC (c) 400 MUC (d) 500 MUC (e) 600 MUC.
(2 marks)
13. Which of the following transactions is included in the current account balance of the Balance of Payments < Answer >
statement?
(a) Foreign direct investments (b) Portfolio investments
(c) External commercial borrowings (d) Dividends earned on portfolio investments
(e) External assistance.
(1 mark)
14. Which of the following is not true if the central bank imposes a reserve ratio of 100%? < Answer >

(a) The banking system can no longer affect the supply of money in the economy
(b) Change in the foreign exchange reserves will result in an equal change in the money supply
(c) The lending capacity of banks would narrow down to zero
(d) A rupee deposited in a bank reduces the money supply in the economy by one rupee
(e) Money supply in the economy will be equivalent to the high powered money.
(1 mark)
15. Which of the following is true if prices of all the goods and services in an economy increase in a year? < Answer >

(a) Real GDP will increase

(b) Nominal GDP will increase
(c) Real GDP will increase more than nominal GDP
(d) Real GDP will fall in proportion to the increase in prices
(e) Nominal GDP will not capture the effects of the increase in prices.
(1 mark)
16. GDP of a country is 8,000 MUC. Value of output produced in domestic country by foreign factors of < Answer >
production is 200 MUC and value of the output produced by domestic factors of production in foreign
countries is 100 MUC. GNP of the country is
(a) 7,700 MUC (b) 7,800 MUC (c) 7,900 MUC (d) 8,100 MUC (e) 8,200 MUC.
(1 mark)
17. The difference between M3 and M1 is < Answer >

(a) Demand deposits (b) Post office savings deposits

(c) Savings deposits (d) Time deposits (e) M2.
(1 mark)
18. In the last few years the forex reserves in India have been increasing. Which of the following sterilization < Answer >
policies the Reserve Bank of India would adopt?
(a) Increase cash reserve ratio (b) Decrease cash reserve ratio
(c) Decrease discount rate (d) Buy government securities
(e) Qualitative restrictions.
(1 mark)
19. The Chinese economy has run smoothly and continues to develop towards the expected targets of macro < Answer >
control. In accordance with the decisions and arrangement of the CPC Central Committee and the State
Council, the Peoples Bank of China has adopted various monetary policy instruments to strengthen
aggregate control and encourage commercial banks to optimize credit structure. In general, policy
measures have been proved effective in that the monetary and credit performance was broadly kept in line
with the policy stance of steady growth of money and credit. The following are the excerpts from the
balance sheet of Peoples Bank of China. (Currency of China: Chinese Yuan Renminbi, CNY)
Particulars CNY
Notes in circulation 100
Other deposits 50
Other non-monetary liabilities 100
Statutory and contingency reserves 420
Credit to Central Government 1,120
Shares & loans to financial institutions 550
Central bank claims on Commercial banks 350
Net foreign exchange assets 150
Other assets 50
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 Other assets 50
If the government money is CNY 25, the high powered money in the economy is
(a) CNY 1,650 (b) CNY 1,750 (c) CNY 1,725 (d) CNY 1,825 (e) CNY 1,850.
(2 marks)
20. Savings function of an economy is S = – 150 + 0.25Yd. Break-even disposable income for the economy is < Answer >

(a) Rs. 37.50 (b) Rs. 150.00 (c) Rs. 450.00 (d) Rs. 600.00 (e) Rs. 750.00
(1 mark)
21. The phrase “business cycle” refers to < Answer >

(a) The pattern of fluctuations in the general level of prices as measured by the consumer price index
(b) The pattern of fluctuations in interest rate as measured by the prime lending rate
(c) The pattern of fluctuations in economic activity
(d) The pattern of fluctuations in budget surplus or deficit
(e) The pattern of fluctuations in stock market index.
(1 mark)
22. The following is the information from national accounts of an economy: < Answer >

Particulars MUC
Direct taxes 2,400
Indirect taxes 11,400
Factor income paid abroad 12,000
Factor income received from abroad 9,000
Depreciation 12,000
Surplus 1,050
Subsidies 6,000
National income 48,000
The GDP at market prices is
(a) 24,800 MUC (b) 30,200 MUC (c) 68,400 MUC (d) 52,350 MUC (e) 45,600 MUC.
(2 marks)
23. Consumption function for an economy is estimated to be < Answer >
d
C = 1,000 + 0.80 Y
Which of the following is true if Yd is zero?
(a) Consumption is zero (b) Savings are Rs.1,000
(c) Income must be greater than taxes (d) Dissavings are Rs.1,000
(e) Savings are zero.
(1 mark)
24. Which of the following is not a quantitative instrument of RBI’s monetary policy? < Answer >

(a) Bank rate (b) Cash reserve requirements

(c) Selective credit control (d) Open market operations
(e) Statutory liquidity ratio.
(1 mark)
25. GDP at factor cost exceeds GDP at market price when < Answer >

(a) The net factor income from abroad is negative

(b) The net factor income from abroad is positive
(c) Depreciation of fixed capital exceeds gross investment
(d) Direct taxes exceed indirect taxes
(e) Subsidies exceed indirect taxes.
(1 mark)
26. In an economy the marginal propensity to consume is 0.70 and marginal propensity to import is 10%. < Answer >
Assuming that the investment is autonomous and increases by 1,000 MUC during the year, the income in
the economy increases by
(a) 625 MUC (b) 2,500 MUC (c) 3,000 MUC (d) 4,000 MUC (e) 5,000 MUC.
(2 marks)

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27. Monetarists prefer monetary policy over the fiscal policy because they feel that < Answer >

(a) Statistically, money demand function can be better determined than consumption or investment
demand
(b) Money is a substitute for financial assets
(c) Demand for money is determined by rate of interest
(d) Fiscal policy is ineffective because of ‘crowding out’ effect
(e) Both (a) and (d) above.
(1 mark)
28. As on December 31, 2004, monetary liabilities of the central bank are 1,200 MUC and government < Answer >
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) 5,000 MUC (b) 5,500 MUC (c) 6,000 MUC (d) 6,550 MUC (e) 6,600 MUC.
(2 marks)
29. Which of the following is true if the prices of factor inputs increase in an economy? < Answer >

(a) Aggregate supply curve shifts to the left

(b) Aggregate supply curve shifts to the right
(c) Aggregate demand curve shifts to the right
(d) Aggregate demand curve shifts to the left
(e) Both aggregate supply and demand curves remain constant.
(1 mark)
30. The IS equation is Y = 500 – 20i. Which of the following combinations of interest and income does not < Answer >
represent a point on the IS curve?
(a) i = 0.02% and Y = 450 MUC (b) i = 0.05% and Y = 400 MUC
(c) i = 0.07% and Y = 360 MUC (d) i = 0.10% and Y = 300 MUC
(e) i = 0.04% and Y = 420 MUC.
(1 mark)
31. In the classical model, the money supply determines < Answer >

(a) Interest rates (b) Saving rate

(c) Aggregate supply (d) Price level (e) Aggregate demand.
(1 mark)
32. The central bank’s monetary liabilities as on December 31, 2004 stood at 10,500 MUC and Government < Answer >
money at 1,500 MUC. The currency deposit ratio is estimated to be 0.25. If the Central bank intends to
maintain the money supply at 48,000 MUC, what should be the reserve ratio specified by the Central
bank?
(a) 6.25% (b) 8.10% (c) 9.10% (d) 5.00% (e) 4.25%.
(2 marks)
33. The LM function of an economy is estimated to be Y = 750 –50i. The transaction demand for money and < Answer >
speculative demand for money are 0.25Y and 150 – 20i respectively. If output in the economy is 600
MUC, the velocity of money in the economy is
(a) 0.40 (b) 4.00 (c) 5.00 (d) 2.50 (e) 25.00.
(2 marks)
34. An important difference between the approaches of the Classical economists and Keynesian economists to < Answer >
achieve a macroeconomic equilibrium is that
(a) Keynesian economists actively promote the use of fiscal policy while the classical economists do not
(b) Keynesian economists actively promote the use of monetary policy to improve aggregate economic
performance while classical economists do not
(c) Classical economists believe that monetary policy will certainly affect the level of output while
Keynesians believe that money growth affects only prices
(d) Classical economists believe that fiscal policy is an effective tool for achieving economic stability
while Keynesians do not
(e) Keynesian economists actively promote the use of rational expectations while the classical
economists do not.
(1 mark)

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35. The following information pertains to the balance of payments of Ethionia for the year 2004-05. < Answer >

Particulars MUC
Merchandise imports 20,000
Merchandise exports 18,000
Software exports 16,000
Software imports 12,000
Earnings on loans and investments abroad 400
Earnings on loans and investments in the country by foreigners 1,000
Private remittances to abroad 200
Private remittances from abroad 150
Government loans to abroad 30
Government loans from abroad 20
Direct investments abroad 10
Foreign direct investment in the country 150
Short-term loans and investments abroad 200
Foreign short-term loans and investments in the country 40
The balance of trade (BoT) for the year 2004-05 is
(a) 2,000 MUC (deficit) (b) 2,000 MUC (surplus)
(c) 1,000 MUC (deficit) (d) 1,000 MUC (surplus) (e) 1,850 MUC (surplus).
(2 marks)
36. Given that the marginal propensity to consume is larger, which of the following statements are true? < Answer >

I. Marginal propensity to save will be larger.

II. Multiplier value will be higher.
III. Average propensity to consume will be larger.
IV. Autonomous consumption will be higher.
(a) Both (I) and (II) above (b) Both (II) and (III) above
(c) (II), (III) and (IV) above (d) (I), (II) and (III) above
(e) Both (III) and (IV) above.
(1 mark)
37. Which of the following is true if the RBI lends Rs.1,000 crore to Andhra Pradesh government? < Answer >

(a) High powered money increases by Rs.1,000 crore

(b) Foreign exchange reserves increases by Rs.1,000 crore
(c) Money supply increases by Rs.1,000 crore
(d) CRR increases by 10%
(e) Government money increases by Rs.1,000 crore.
(1 mark)
38. Inflation accompanied by a slowing of economic activity is < Answer >

(a) Known as deflation (b) A result of a stagnant aggregate supply

(c) A result of fiscal stimulus (d) Known as stagflation
(e) Known as a recession.
(1 mark)
39. From the following information, compute subsidies: < Answer >

GDP at factor cost = Rs.2,000 cr.

Net factor income from abroad = Rs.200 cr.
Indirect taxes = Rs.542 cr.
GNP at market prices = Rs.2,292 cr.

(a) Rs. 50 cr (b) Rs.342 cr (c) Rs.450 cr (d) Rs.292 cr (e) Rs.742 cr.
(2 marks)
40. Which of the following is not a leakage from national income flow? < Answer >

(a) Savings (b) Imports (c) Investment (d) Taxes (e) Depreciation.
(1 mark)
41. Amar has just completed his graduation in commerce. He is looking for a suitable job, but the only job < Answer >
that he can find is that of a cook in a restaurant This situation can be described as
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 that he can find is that of a cook in a restaurant. This situation can be described as
(a) Frictional unemployment (b) Structural unemployment
(c) Cyclical unemployment (d) Natural unemployment
(e) Disguised unemployment.
(1 mark)
42. The Ukrainian Government liberalized most prices and established a legal framework for privatization, < Answer >
but widespread resistance to reform within the government and the legislature soon stalled reform efforts
and led to some backtracking. Ukraine's dependence on Russia for energy supplies and the lack of
significant structural reform have made the Ukrainian economy vulnerable to external shocks. Reforms in
the more politically sensitive areas of structural reform and land privatization are still lagging. For
Ukrainian, the following is the estimated steady state level of consumption function. (Currency in
Ukraine: hryvnia, UAH)
Ct = 10 + 0.5Yd t + 0.4C t–1
Where Ct and Ct-1 denote consumption in periods t and t-1. If the Ydt increased from UAH 400 to UAH
500 , what is the amount of change in steady state level of consumption?
(a) UAH 25.00 (b) UAH 65.33 (c) UAH 83.33 (d) UAH 75.33 (e) UAH 61.33.
(2 marks)
43. A contractionary fiscal policy combined with a tight monetary policy results in < Answer >

I. A lower level of output.

II. A higher level of output.
III. A lower interest rate.
IV. A higher interest rate.
V. A lower or higher interest rate depending on the relative magnitude of fiscal and monetary policies.

(a) (I) and (III) above (b) (I) and (IV) above
(c) (II) and (V) above (d) (II) and (IV) above (e) (I) and (V) above.
(1 mark)
44. Which of the following is not a major determinant of economic growth? < Answer >

(a) Tastes and preferences of consumers (b) Technological advancement

(c) Natural resources (d) Physical capital
(e) Human resources.
(1 mark)
45. In the standard IS-LM model, which of the following is true if the government raises tax rate and the < Answer >
Reserve Bank of India decides to hold the money supply constant?
(a) Disposable income remains constant (b) IS curve shifts to the right
(c) LM curve shifts to the left (d) Interest rate falls
(e) Interest rate increases.
(1 mark)
46. The following information is extracted from the Union Budget for the year 2004-05: < Answer >

2004-05
Budget Estimates
(in Rs. crore)
Tax revenue (net to centre) 1,84,169
Non-tax revenue 69,766
Recoveries of loans 18,023
Other receipts 13,200
Borrowings and other liabilities 1,53,637
Non-plan expenditure
On revenue account 2,89,384
On capital account 28,437
Plan Expenditure
On revenue account 76,843
On capital account 44,131
Primary deficit 30,414
The expected interest payment to be made by the Central Government for the year 2004-05 is

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 (a) Rs.289,384 cr. (b) Rs.123,223 cr. (c) Rs. 35,514 cr.
(d) Rs. 42,324 cr. (e) Rs.144,442 cr.
(2 marks)
47. Which of the following is not one of the basic postulates of the Keynesian model? < Answer >

(a) Full employment occurs only by coincidence in an economy

(b) Effective demand determines the level of employment and output
(c) Since full employment is not always possible, Government intervention is essential
(d) Budget deficit is a tool to fight recession
(e) Monetary policy is more effective than fiscal policy.
(1 mark)
48. The quantity theory of money implies that a given percentage change in the money supply will cause < Answer >

(a) An equal percentage change in nominal GDP

(b) A smaller percentage change in nominal GDP
(c) A larger percentage change in nominal GDP
(d) An equal percentage change in real GDP
(e) A smaller percentage change in real GDP.
(1 mark)
49. In an economy, demand for money is < Answer >

Md = 500 + 0.2Y – 20i

If money supply in the economy is 2,340 MUC and equilibrium rate of interest is 8 percent, national
income is
(a) 340 MUC (b) 500 MUC (c) 1,000 MUC (d) 2,000 MUC (e) 10,000 MUC.
(2 marks)
50. The Phillips curve shows the short run trade off between < Answer >

(a) Inflation and unemployment

(b) Unemployment and output
(c) Inflation and the nominal interest rate
(d) The nominal interest rate and investment
(e) Inflation and output.
(1 mark)
51. According to the Laffer curve, as the tax rate increases, tax revenues < Answer >

(a) Rise continuously (b) Decrease continuously

(c) Initially decrease and then increase (d) Initially increase and then decrease
(e) Remain constant.
(1 mark)
52. The economy of Benin remains underdeveloped and dependent on subsistence agriculture, cotton < Answer >
production, and regional trade. Growth in real output has been stable for the past five years, but
population rise offset much of this increase. Inflation has subsided over the past several years. In order to
raise growth still further, Benin plans to attract more foreign investment, place more emphasis on tourism,
facilitate the development of new food processing systems and agricultural products, and encourage new
information and communication technology. For Benin, the growth rate of population is likely to be 2%
per annum. Given that capital output ratio is 5 and possible level of investment is 25 percent of GDP,
what is the possible per capita real GDP growth rate?
(a) 2.0% (b) 3.0% (c) 4.0% (d) 3.5% (e) 4.5%.
(2 marks)
53. Three countries – A, B and C have same Production Possibility Frontier (PPF), but have different < Answer >
investment behavior. Country A made a gross investment equal to its depreciation. Country B spent most
of its income on consumption. Country C invested heavily by sacrificing its current consumption. After 10
years which country will have a higher PPF?
(a) Country A (b) Country B (c) Country C
(d) Both Country B and country C (e) Cannot be determined.
(1 mark)

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54. The capital inflows and outflows in an economy during the year 2003-04 are 6,300 MUC and 4,500 MUC < Answer >
respectively. Suppose there is no change in the official foreign reserve assets held by the central bank,
what could be the current account balance for the economy?
(a) 1,500 MUC (Deficit) (b) 1,800 MUC (Surplus)
(c) 1,800 MUC (Deficit) (d) 1,500 MUC (Surplus) (e) Zero.
(1 mark)
55. The IS curve slopes downward because < Answer >

(a) A higher rate of interest creates a higher level of investment and aggregate expenditure
(b) A lower rate of interest creates a lower level of investment and aggregate expenditure
(c) A lower rate of interest creates a lower level of imports and a higher level of aggregate expenditure
(d) A lower rate of interest creates a higher level of investment and a higher level of aggregate
expenditure
(e) A lower rate of interest creates a higher level of investment and a lower level of aggregate
expenditure.
(1 mark)
56. In an economy, there are three industries X, Y and Z. X sells goods worth of Rs.900 to Y and goods < Answer >
worth Rs.700 to Z. Consumers divide their expenditures equally between Y’s goods and Z’s goods. If the
national product is Rs.2000, and if there are no other transactions than mentioned above, the value added
by industries Y and Z respectively are
(a) Rs.200, Rs.700 (b) Rs.100, Rs.300 (c) Rs.900, Rs.700
(d) Rs.1,000, Rs.1,000 (e) Rs.1,600, Rs.2,000.
(2 marks)
57. According to monetarism, other things remaining the same, if the velocity of money increases, then < Answer >

(a) The stock of money would increase (b) The nominal GDP would decrease
(c) Price level would rise (d) The real GDP would increase
(e) Both (a) and (b) above.
(1 mark)
58. In balance of payments statement, short term inflows and outflows of capital are recorded in < Answer >

(a) Current account (b) Capital account

(c) Official reserves account (d) Errors and omissions account
(e) Transfer payments account.
(1 mark)
59. Estonia, as a new member of the World Trade Organization, is steadily moving towards a modern market < Answer >
economy with increasing ties to the West, including the pegging of its currency to the euro. A major goal
is accession to the EU. The state of the economy is greatly influenced by developments in Finland,
Sweden, and Germany, three major trading partners. Following data in available for Estonia. (Currency in
Estonia: Estonian Kroon ,EEK)
Particulars EEK
Export of services 6,500
Import of services 4,500
Government loans to abroad 95
Government loans from abroad 60
Direct investment abroad 65
Foreign direct investment in the country 280
Short-term loans and investment abroad 650
Foreign short-term loans investments in the country 125

The capital account balance for Estonia is

(a) EEK 425 (Cr.) (b) EEK 425 (Dr.) (c) EEK 345 (Dr.)
(d) EEK 345 (Cr.) (e) EEK 1,655 (Cr.)
(2 marks)

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60. The time between the interest rate changes and the corresponding changes in the spending decisions of the < Answer >
public forms a part of
(a) Recognition lag (b) Administrative lag
(c) Outside lag (d) Inside lag (e) Intermediate lag.
(1 mark)
61. Which of the following is true with respect to Aggregate Supply (AS)? < Answer >

(a) AS curve in the short run is positively sloped and in the long run it is vertical
(b) AS curve is positively sloped both in the short run and in the long run
(c) AS curve is positively sloped in the short run and negatively sloped in the long run
(d) AS curve is vertical both in the short run and in the long run
(e) AS curve is horizontal both in the short run and in the long run .
(1 mark)
62. You are required to compute broad money (M3) from the following information: < Answer >

Particulars Rs. crore

Currency with the public 10,000
Demand deposits with the banking system 20,000
Post office savings bank deposits 15,000
Time deposits with the bank 25,000
Total post office deposits (excluding NSCs) 30,000
(a) Rs. 30,000 Cr (b) Rs. 35,000 Cr (c) Rs. 55,000 Cr (d) Rs. 60,000 Cr (e) Rs. 70,000 Cr.
(1 mark)
63. Who among the following will be benefited most from unanticipated inflation? < Answer >

(a) Creditors
(b) Debtors
(c) Retirees earning fixed income
(d) Employees whose salaries are linked to the consumer price index
(e) All of the above.
(1 mark)
64. The following information is extracted from National Income Accounts of an economy: < Answer >

Investment by business sector = 100 MUC

Corporate profit tax = 50 MUC
Dividends paid by the business sector = 15 MUC
Retained earnings = 20 MUC
Corporate profits for the economy is
(a) 70 MUC (b) 35 MUC (c) 85 MUC (d) 150 MUC (e) 185 MUC.
(1 mark)
65. Which of the following best describes an expansionary fiscal policy? < Answer >

(a) Increase in government spending and increase in money supply

(b) Increase in government spending and decrease in taxes by the same amount
(c) Decrease in government spending and decrease in money supply
(d) Decrease in government spending and increase in taxes
(e) Increase in government spending and increase in taxes.
(1 mark)
66. The following are the indicators of financial development of an economy for the year 2003-04. < Answer >

Finance Ratio 0.25

Intermediation Ratio 0.70
If the Net Physical Capital Formation and the new issues for the year 2003-04 are 42,500 MUC
and 30,000 MUC respectively, the financial interrelation ratio is
(a) 1.2 (b) 1.4 (c) 2.4 (d) 0.6 (e) 0.1.
(2 marks)
67. Which of the following believes that monetary and fiscal policies are effective only if people cannot < Answer >
anticipate the changes?
(a) Monetarists (b) New classical economists
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 (c) Classical economists (d) Keynesian economists
(e) New Keynesian economists.
(1 mark)
68. Latvia's transitional economy recovered from the 1998 Russian financial crisis, largely due to the < Answer >
government's budget stringency and a gradual reorientation of exports toward EU countries, lessening
Latvia's trade dependency on Russia. The majority of companies, banks, and real estates have been
privatized. Latvia officially joined the World Trade Organization. Preparing for EU membership over the
next few years continues as a top foreign policy goal. The following relations are derived for Latvia.
(Currency in Latvia: Latvian lat, LVL)
Savings Function (S) – 50 + 0.50Yd
Disposable income ( Yd) Y–T+R
Transfer Payments (R) LVL 80
Tax function (T) 0. 40Y
Investment function (I) 1000 – 30i
Exogenous government expenditure (G) LVL 800
Import function (M) 20 + 0.20 Y
Exports (E) LVL 450
Transaction demand for money (Mt / P) 0.50Y
Speculative demand for money (Ma / P) 250 – 100i
Money supply (Ms / P) LVL 500
The equilibrium level of income in the economy is
(a) LVL 1,875 (b) LVL 1,985 (c) LVL 2,062 (d) LVL 2,162 (e) LVL 2,281.
(3 marks)
69. Which is the best indicator of economic development of a developing country like India? < Answer >

(a) National income deflator (b) GNP at current prices

(c) Real national income (d) Per capita real national income
(e) GDP deflator.
(1 mark)
70. In an economy, the investment function is given by I = 2,500 – 100i. If an increase in government < Answer >
spending by 625MUC increases the interest rate in the economy by 5%, what could be the amount of
crowding out in the economy?
(a) 250 MUC (b) 375 MUC (c) 190 MUC (d) 500 MUC (e) 225 MUC.
(2 marks)
71. At independence in November 1991, Macedonia was the least developed of the Yugoslav republics. An < Answer >
absence of infrastructure, UN sanctions on Yugoslavia, one of its largest markets, and a Greek economic
embargo over a dispute about the country's constitutional name and flag hindered economic growth until
1996. GDP subsequently rose each year through 2000. However, the leadership's commitment to
economic reform, free trade, and regional integration was undermined by the ethnic Albanian insurgency
of 2001. The economy shrank because of decreased trade, intermittent border closures, increased deficit
spending on security needs, and investor uncertainty. Growth recovered moderately in 2002 but
unemployment at one-third of the workforce remained a critical problem. The following equations are
given with respect to Macedonia. (Currency in Macedonia: Macedonian denar, MKD)

Goods market equilibrium : 1,641.67 – 20i

Money market equilibrium : 775 + 300i
The equilibrium interest rate in Macedonia is
(a) 2.7 % (b) 3.1 % (c) 5.1 % (d) 5.8 % (e) 4.5 %.
(2 marks)

72. The following data is taken from National Income Accounts of a country: < Answer >

Particulars Rs. Cr.

National income 6,785
Transfer payments 1,210
11
 Transfer payments 1,210
Personal taxes 1,015
Undistributed corporate profits 140
Corporate tax 375

Personal disposable income in the country is

(a) Rs.6,815 cr. (b) Rs.5,605 cr. (c) Rs.6,150 cr. (d) Rs.6,465 cr. (e) Rs.7,480 cr.
(2 marks)

73. The Bahams is a stable, developing nation with an economy heavily dependent on tourism and offshore < Answer >
banking. Tourism alone accounts for more than 60% of GDP and directly or indirectly employs almost
half of the archipelago's labor force. Steady growth in tourism receipts and a boom in construction of new
hotels, resorts, and residences have led to solid GDP growth in recent years. Manufacturing and
agriculture together contribute approximately a tenth of GDP and show little growth, despite government
incentives aimed at those sectors. Overall growth prospects in the short run rest heavily on the fortunes of
the tourism sector, which depends on growth in the US, the source of the majority of tourist visitors. The
following information pertains to The Bahams for the year 2004.
Particulars MUC
GNP at factor cost 2,40,000
Depreciation 20,000
Subsidies 12,000
Net factor income from abroad 10,000
Indirect taxes 36,000
NDP at market prices for the year 2004-05 is
(a) 2,10,000 MUC (b) 2,00,000 MUC (c) 1,90,000 MUC
(d) 1,80,000 MUC (e) Rs.2,34,000 MUC.
(2 marks)

74. The following data pertains to a hypothetical economy. < Answer >

Year Nominal GNP GNP deflator

2003-04 1,250 62.5
2004-05 1,650 75.0
What is the rate of inflation in the economy for the year 2004-05?
(a) 10.0% (b) 12.5% (c) 20.0% (d) 5.5% (e) 16.67%.
(2 marks)

12
 Suggested Answers
Economics-II (122) : January 2005
1. Answer : (b) < TOP >

Reason : Stock is a variable which is measured at a point of time.

a. GDP is the money value of goods and services produced within the domestic
territory of a country (which includes depreciation) in a year and hence not a stock
because it is measured over a period of time, usually a year.
b. Inventories refer to the unsold stock or the raw materials maintained by a firm to be
use in the production process. Hence it is measured at a point of time, i.e., number of
unsold goods as on 31 March, 2004 are 100. Hence, it is a stock variable
c. Inflation refers to persistent increase in prices over a period of time. It is measured
over a period of time hence it is a flow and not a stock variable.
d. National Income is the sum of factor income and labour income earned by the
residents of a country earned usually over a period of one year. Hence it is also a
flow concept.
e. Exports are measured as the quantity of goods exported over a period of a time and
hence it is a flow variable.
2. Answer : (e) < TOP >

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
= 1,496 MUC
3. Answer : (d) < TOP >

Reason : It is important to distinguish between a concept like “rational expectations” and some of
its implications under certain conditions. The term “rational expectations” means nothing
more than people being rational in the formation of their opinions and decisions. They
should, therefore, use as much information as possible in the process, particularly as they
determine their views about what is most likely to occur in the future. In so doing, they
may render policies ineffective, but that is a result of the process, which can be disputed
rather than a definition of a hypothesized mode of behavior, which cannot be disputed.
(a) Is not the answer because according to rational expectations econometrics models
are not very useful in evaluating alternative economic policies.
(b) Is not the answer because inflation is primarily a monetary phenomenon is
advocated by monetarists
(c) Is not the answer because rational expectations is not accurately associated with the
notion that tax adjustments will have no effect, but changes in the money supply can
stimulate growth in an economy
(d) Is the answer because rational expectations advocates that people always use as
much information as possible in forming and acting upon their expectations of the
future
(e) Is not the answer because according to rational expectations, no trade-off exists
between inflation and unemployment.
4. Answer : (b) < TOP >

Reason : Because of the double entry concept underlying the recording of transactions, BoP
account must always be in balance. Thus, ‘Balance in current account + Balance in
capital account + Change in reserves = Zero’. When there is no change in the foreign
exchange reserves, then ‘balance in current account + balance in capital account = zero’
(or) balance in current account = - (balance in capital account).
a. Balance in current account + Balance in capital account = Change in reserves. When
balance in current account ‘plus’ balance in capital account is zero, then balance in

13
 the current account = - balance in capital account. Hence, statement (a) is not
correct.
b. There will be no change in the foreign exchange reserves of a country only when
surplus (deficit) in current account is equal to deficit (surplus) in capital account.
c. Current account balance may or may not be zero when the change in foreign
exchange reserves of a country is zero.
d. Trade balance (exports – imports) may or may not be zero when the change in
foreign exchange reserves of a country is zero.
e. Capital account balance may or may not be zero when the change in foreign
exchange reserves of a country is zero.
5. Answer : (c) < TOP >

Reason : C = α + βYd
Where, α = autonomous consumption and β = marginal propensity to consume (MPC)
β = ∆C/∆Yd = (475 – 400)/100 = 0.75
If MPC = 0.75, autonomous consumption:
475 = α + 0.75(500)
Or, α = 100.
Thus, C = 100 + 0.75Yd
Or, S = – 100 + 0.25Yd
When S = 100, 100 = –100 + 0.25Yd
or, 200 = 0.25Yd
or, Yd = 800
Since the economy is a two sector economy, Y = Yd (disposable income).
6. Answer : (c) < TOP >

Reason : Y = C + I+ G
Y = 70 + 0.75Yd + 80 + 70
Y = 70 + 0.75 (Y – 0.2 Y)+ 80 + 70
Y = 70 + 0.75 Y – 0.15 Y+ 80 + 70
Y = 220 + 0.6Y
Y = 550
∴ Budget deficit = T – G = 0.2 (550) – 70 = 110 – 70 = XAF 40.
7. Answer : (b) < TOP >

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.
8. Answer : (a) < 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.

14
 (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.
9. Answer : (a) < TOP >

Reason : The difference between what the producer pays for the intermediate goods and what he
receives from the finished goods is called the firm’s value added. In other words, value
added by the firm = Price of the Good – Cost of Intermediate Goods used.
10. Answer : (a) < TOP >

Reason : Multiplier = 1/(1 – MPC + MPC × tax rate + MPI) = 1/(1 – 0.75 + 0.75 × 0.2 + 0.10) = 2.
11. Answer : (c) < TOP >

Reason : During the period of depression in the economy, output decreases and employment
decreases.
12. Answer : (b) < TOP >

Reason : Investment in period ‘t’ = 0.75 × Desired investment in period ‘t’

Desired investment in period ‘t’
∴ Investment in period ‘t’
∴ The answer is (b).
13. Answer : (d)
= Acceleration coefficient × Change in income
= 2 × 200 = 400
= 0.75 × 400 = 300
< TOP >

Reason : All the transactions which effect the asset or liability position of a country are put under
Capital account of the Balance of Payments statement. Other transactions are put under
the Current account.
(a) Is not the answer. Foreign Direct Investment increase the liability of a country,
hence falls under Capital account.
(b) Is not the answer. Portfolio Investments increase the liability of a country, hence
falls under Capital account.
(c) Is not the answer. External Commercial Borrowings increase the liability of a
country, hence falls under Capital account.
(d) Is the answer. Dividends on portfolio investments are an income earned by a factor
of production (capital). This is included in Income under Invisibles in Current
Account.
(e) Is not the answer. External Assistance increases the liability of a country, hence falls
under Capital account.
14. Answer : (d) < TOP >

Reason : Money supply = Currency in the hands of the public + Demand Deposits with banks. A
rupee deposited in a bank reduces currency by Rs.1 but raises deposits by Rs.1, and hence
does not affect the money supply in the system. As banks are holding entire deposits in
reserves, it cannot affect money multiplier and hence supply of money.
a. If banks maintains 100% of their deposits as reserves, there could be no lending and
hence no deposit creation. Thus, when the reserve ratio is 100%, the banking system
can no longer affect the money stock in the country.
b. Money supply = Money multiplier x High-powered money (H). When the banks
maintain 100% reserves, the value of money multiplier will be 1. Hence, change in
the foreign exchange reserves leads to an equal change in the money supply.
c. If banks have to maintain 100% of their deposits with RBI, then naturally the
15
 lending capacity of banks would be narrowed down to zero.
d. A rupee deposited in a bank reduces the currency with the public, but at the same
time increases the deposits of the banks. Hence, there will be no affect on the money
supply in the economy. Hence, the statement is not correct.
e. Money supply = Money multiplier x High-powered money (H). When banks
maintain 100% reserves, then the value of money multiplier will come down to 1. If
the value of money multiplier is 1, then naturally the money supply must be equal to
high-powered money.
15. Answer : (b) < TOP >

Reason : Real GDP ignores the impact of inflation where as the nominal GDP includes the impact
of inflation. When price of all goods and services increase in a year, nominal GDP will
surely increase.
(a) Is not the answer as increase in prices of all the goods and services only increase the
inflation and real GDP may not increase
(b) Is the answer as increase in prices will increase the nominal GDP even if the real
output remains the same.
(c) Is false. This can happen only if price level decreases and real output increases.
(d) Is false. Real GDP falls only if real output falls.
(e) Is false. Nominal GDP captures the impact of both the real output and price level.
16. Answer : (c) < TOP >

Reason : GNP = GDP + NFIA

NFIA = Factor income received from abroad – Factor income paid abroad.
= 100 – 200
= – 100
∴ GNP = 8000 – 100
= 7,900 MUC.
17. Answer : (d) < TOP >

Reason : M1 = Currency with the public + Demand deposits with the banking system + other
deposit with the bank.
M3 = M1+ Time deposits with the banking systems.
(a) Is not the answer because the difference between M3 and M1 is not the demand deposits.
(b) Is not the answer because the difference between M3 and M1 is not the post office
savings deposits.
(c) Is not the answer because the difference between M3 and M1 is not the savings deposits.
(d) Is the answer because the difference between M3 and M1 is the time deposits.
(e) Is not the answer because the difference between M3 and M1 is not M2.
18. Answer : (a) < TOP >

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
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.

16
 (e) Is not the answer because RBI would not adopt qualitative restrictions.
19. Answer : (c) < TOP >

Reason : High powered money = Monetary liabilities of central bank + Government money
Monetary liabilities of central bank = Financial Assets + Other assets – Non-monetary
liabilities
Financial Assets = Credit to government + claims on commercial banks + credit to
commercial sectors + foreign exchange assets
= 1,120 + 350 + 550 + 150 + = 2,170
Non-monetary liabilities = 100 + 420 = 520
Monetary liabilities of central bank = 2,170 + 50 – 520 = 1,700
High powered money = 1,700 + 25 = CNY 1,725.
20. Answer : (d) < TOP >

Reason : At break-even level of disposable income, savings are zero.

∴ S = –150 + 0.25Yd = 0
d
0.25 Y = 150
150
d
0.25
Y = = Rs. 600.
21. Answer : (c) < TOP >

Reason : Business cycle is the fluctuation in the level of economic activity which forms a regular
pattern.
< TOP >
22. Answer : (c)
Reason : National income = NNP at factor cost
NNP at factor cost = GDP at market price – Indirect taxes + subsidies + NFIA –
Depreciation
Or, GDP at market price = NNP at factor cost + Indirect taxes – subsidies - NFIA +
Depreciation
= 48000 + 11400 – 6000 – (– 3000) + 12000 = 68,400 MUC.
Where NFIA = (Factor income received from abroad – Factor income paid abroad) =
(9000 – 12000) = -3000 MUC
< TOP >
23. Answer : (d)
Reason : If Yd is zero, consumption is Rs. 1000, which is autonomous consumption. This
consumption is financed by dissavings or borrowing. Hence dissavings are Rs.1000
24. Answer : (c) < TOP >

Reason : Bank rate, cash reserve requirements, open market operations and statutory liquidity ratio
are the quantitative instruments of RBI’s monetary policy. Selective credit control is not a
quantitative instrument of RBI’s monetary policy. It is a qualitative instrument of
monetary policy.
25. Answer : (e) < TOP >

Reason : GDPFC = GDPMP – Indirect taxes + Subsidies

∴ If GDPFC > GDPMP, Subsidies > Indirect taxes.
26. Answer : (b) < TOP >

1
Reason : Multiplier = 1/(1 – MPC + MPI) = 1/(1 – 0.70 + 0.1) = 0.40 = 2.5
Thus if investment increases by 1,000, income increases by 1000 × 2.5 = 2,500 MUC.
27. Answer : (e) < TOP >

Reason : Monetarist opines that demand function for money is better determined than consumption
or investment function and hence they prefer monetary policy over fiscal policy. Fiscal
policy is ineffective because increase in public expenditure leads to decrease private
expenditure. (Crowding out)
a. Above reasons shows that option a is true
17
 b. Not true, as this is also a Keynesian proposition
c. Not true, as it is Keynesian economics which says so and hence demand for money
is determined by interest rate.
d. ‘Crowding out’ is one of the importance reasons for ineffectiveness of fiscal policy
and hence true.
e. Since, (a) and (d) are true, this is the correct option.
28. Answer : (c) < TOP >

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
1 + Cu
×H
∴ Money supply Ms = Cu + r
1 + 0.20
× 1, 250
= 0.20 + 0.05
= 4.8 × 1,250
= 6,000 MUC
29. Answer : (a) < TOP >

Reason : Aggregate demand (supply) curve is a curve showing relationship between the level of
real domestic output demanded (available) at each possible price level. The aggregate
demand shows the overall demand for goods and services produced in a country. Thus,
AD = C + I + G + NE. A shift in the aggregate demand curve takes place if the any of the
factor other than price levels affect the aggregate demand. Aggregate supply, on the
other hand, shows the overall supply of goods and services at various price levels. Any
factor other than price level that affect the aggregate supply results in shift in aggregate
supply curve. Increase in the factor input prices reduces the incentive for production that
lead to reduction in aggregate supply. A reduction in supply because of any other factors
other than price level is shown by a leftward shift in the aggregate supply curve. A shift
in the aggregate demand curve is caused by changes in the consumption spending,
investment spending, government spending and net export spending. Changes in the
prices of factor inputs do not affect aggregate demand. Hence, statement (a) is correct.
30. Answer : (a) < TOP >

Reason : IS function Y = 500 – 20i

If, i = 10%, Y = 500 – (20 × 10) = 300
i = 7%, Y = 500 – (20 × 7) = 360
i = 5%, Y = 500 – (20 × 5) = 400
i = 4%, Y = 500 – (20 × 4) = 420
i = 2%, Y = 500 – (20 × 2) = 460
Hence, (a) does not fall on the IS curve.
31. Answer : (d) < TOP >

Reason : In the Classical view, the money supply determines the price level. The more the money
supply, the higher the price level and vice versa.
32. Answer : (a) < TOP >

Reason : High powered money = monetary liabilities + government money = 10,500 + 1,500
= 12,000

Ms = H × {(
1 + C u ) / ( C u + r )}

12,000 {(
1 + 0.25 ) / ( 0.25 + r )}
48,000 =
= (1 + 0.25)/(0.25 + r) = 4
= 1 + 4r = 1 + 0.25
4r = 0.25
18
 r = 0.0625 = 6.25%.
33. Answer : (d) < TOP >

Reason :
Velocity of money = Y/Ms
Money supply (Ms) = Money demand (Md) = 0.25(600) + 150 – 20(3) = 240
Ms = 240
Thus, velocity of money = 600/240 = 2.5
(Working notes: Y = 600 = 750 – 50i
Or, i = 150/50 = 3).
34. Answer : (a) < TOP >

Reason : An important difference between the approaches of the classical and Keynesian
economists use to achieve a macroeconomic equilibrium is that Keynesian economists
actively promote the use of fiscal policy; the classical economists do not. Classical
economists believe intervention can be de-stabilizing and advocate laissez- faire
economy. Therefore the answer is (a).
< TOP >
35. Answer : (a)
Reason : Balance of Trade (BoT) = Merchandise imports – Merchandise exports
= 20,000 –18,000 = 2,000 MUC (deficit)
36. Answer : (b) < TOP >

Reason : Marginal propensity to consume refers to the change in consumption as a result of

increase in income. Part of the changed income is saved.
Hence MPC is equal to 1-MPS. Multiplier is the reciprocal of 1-MPC or MPS. Hence
larger MPC means smaller MPS and hence larger will be the value of the multiplier.
Statement (I) is false because as MPC is larger, MPS will be smaller as it is nothing but 1-
MPC.
Statement (II) is true because multiplier is reciprocal of MPS and MPS is smaller as said
above.
Statement (III) is true. Average propensity to consume will depend on level of
consumption and income. Since the MPC is larger, consumption will also be larger and
hence average propensity to consume will also be larger.
Statement (IV) is false, as autonomous consumption is independent of MPC and hence it
is not possible to say anything about autonomous consumption on the basis of MPC.
Since both (II) and (III) are true, the option (b) is the answer.
37. Answer : (a) < TOP >

Reason : If the RBI lends Rs.1000 crore to Andhra Pradesh, high-powered money increases by
Rs.1000 crore.
38. Answer : (d) < TOP >

Reason : Slowing of economic activity accompanied by inflation is defined as stagflation.

39. Answer : (c) < TOP >

Reason : GNPMP = GDPFC + NFIA + Indirect taxes – Subsidies

2292 = 2000 + 200 + 542 – X
X = – 2292 +2200 + 542
= Rs.450 cr.
40. Answer : (c) < TOP >

Reason : Leakages from National income stream are those variables which deny incomes to others
and provide incomes outside the country. Savings are not spending; taxes take away
personal disposable income, depreciation is not paid to any factor. Imports provide
income to foreign exporters. The correct answer is C – Investment that provides jobs and
incomes. It is an injection of income into the national income stream.
(a) Is not the answer because savings is a leakage from national income flow
(b) Is not the answer because imports is a leakage from national income flow
(c) Is the answer because investments is not a leakage from national income flow

19
 (d) Is not the answer because taxes is a leakage from national income flow
(e) Is not the answer because depreciation is a leakage from national income flow.
41. Answer : (b) < TOP >

Reason : Structural unemployment arises when the regional or occupational pattern of the job
vacancies does not match the pattern of workers availability and suitability.
Unemployment that arises when there is general downturn in business activity is called
cyclical unemployment. Unemployment that is caused by constant changes in the labor
market is called frictional (natural) unemployment. Amar is facing unemployment in the
form of unavailability of decent job that meets his qualifications and hence is considered
as structural unemployment.
42. Answer : (c) < TOP >

Reason : Ct = 10 + 0.5Yd t + 0.4C t–1

In steady state Ct = C t–1
∴Ct = 10 + 0.5Yd t + 0.4C t
Ct – 0.4C t = 10 + 0.5Yd t
0.6 Ct = 10 + 0.5Yd t
d
Ct = [10 + 0.5Y t]/0.6
When Yd increases from 400 to 500,
Ct = [10 + 0.5 (400)]/0.6 – [10 + 0.5 (500)]/0.6 = (210)/0.6 – (260)/0.6
= 350 – 433.33 = – 83.33
∴ Change in steady state consumption = UAH 83.33.
43. Answer : (e) < TOP >

Reason : Contractionary (tight) fiscal policy involves increasing tax rate and/or decreasing the
government spending to bring down the aggregate demand and price level in the
economy. Reduced government spending reduces the public borrowings, and thereby
interest rate and output in the economy. The tight monetary policy, conversely, reduces
the money supply and thereby increases the interest rate in the economy. Increased
interest rate reduces both consumption and investment and thereby reduces output in the
economy. Thus, we can say that the combined effect of tight fiscal policy and tight
monetary policy lowers the output. But, the direction of change in interest rate is not
known unless we know the magnitude of influence of fiscal and monetary policies on
interest rate.
44. Answer : (a) < TOP >

Reason : Economic growth refers to situation where increased productive capabilities of an

economy are made possible by either an increasing resource base or technological
advance. A country, thus, can achieve economic growth through:
(a) Improvement in technology
(b) Natural resources
(c) Capital
(d) Human resources
Change in tastes and preferences of consumers only affect the demand of an individual
good or services, and it does not increase the production capabilities of an economy.
45. Answer : (d) < TOP >

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

20
 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.
46. Answer : (b) < TOP >

Reason : Primary deficit = Fiscal deficit – interest payments

Or, Interest payments = fiscal deficit – primary deficit = 153637 – 30414 = Rs.123,223
Cr.
47. Answer : (e) < TOP >

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
48. Answer : (a) < TOP >

Reason : Quantity theory of money (QTM) says

MV = PY
Where,
M = money supply
V = velocity of money
P = price level
Y = real GDP
PY = nominal GDP
Assuming V is a constant, a change in M leads to an equal percentage change in PY.
(a) Is the answer because the quantity theory of money implies that a given percentage
change in the money supply will cause an equal percentage change in nominal GDP
(b) Is not the answer because the quantity theory of money implies that a given
percentage change in the money supply will not cause a smaller percentage change
in nominal GDP
(c) Is not the answer because the quantity theory of money implies that a given
percentage change in the money supply will not cause a larger percentage change in
nominal GDP
(d) Is not the answer because the quantity theory of money implies that a given
percentage change in the money supply will not cause an equal percentage change in
real GDP
(e) Is not the answer because the quantity theory of money implies that a given
percentage change in the money supply will not cause a smaller percentage change
in real GDP.
49. Answer : (e) < TOP >

Reason : Md = 500 + 0.2Y – 20i

At equilibrium Ms = Md.
∴ 2,340 = 500 + 0.2Y – (20 u 8)
0.2Y = 2,340 – 500 + 160

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 = 2,000
Y = 10,000. Therefore the answer is (e).
50. Answer : (a) < TOP >

Reason : Phillips curve in the short-run shows an inverse relation between inflation and
unemployment. But in the long run there is no trade-off because Phillips curve is vertical
in the long-run.
51. Answer : (d) < TOP >

Reason : The Laffer curve is a backward bending curve indicating that tax revenues initially
increase and then decrease as the tax rate increases.
52. Answer : (b) < TOP >

Reason : Possible GDP growth = Possible level of investment/(capital – output ratio) = 25/5 = 5 %
Possible per capita GDP growth = 5 – 2 =3%
53. Answer : (c) < TOP >

Reason : A production possibility curve indicates the various combinations of two classes of goods
that an economy can produce when its resources are fully employed. An upward shift in
the PPF takes place when the ability of the countries to produce the goods increases.
Country A has only made a gross investment equal to its depreciation. That means, there
is no net investment in the country. Hence, the productive capacity of country A remains
same even after 10 years. Country B has spent most of its income for consumption. As
there is no investment its capital stock erodes and PPF shifts towards left as time
progresses. And hence, countries that invest heavily will have higher investment and
consumption in the future. Thus, country C would have a higher PPF.
54. Answer : (c) < TOP >

Reason : Capital inflows – capital outflows = 6,300 – 4,500 = 1,800 MUC (Deficit).
55. Answer : (d) < TOP >

Reason : Decrease in rate of interest makes investment more profitable. So firms buy more capital
goods, which raises aggregate expenditure.
56. Answer : (b) < TOP >

Reason : Value added by the industry Y = (2000 / 2) – 900 = 1000 – 900 = Rs.100
Value added by the industry Z = (2000 / 2) – 700 = 1000 – 700 = Rs.300.
57. Answer : (c) < TOP >

Reason : ‘Velocity of money’ refers to the speed at which money changes hands. The ratio of
nominal GDP to the money stock defines the income velocity of money (that is, V =
GDP/M = PQ/M). Thus, the price level in the economy will increase because of rise in
velocity of money, given the money supply.
58. Answer : (b) < TOP >

Reason : Though the outflows or inflows of capital are short term, they are still recorded in the
capital account.
59. Answer : (c) < TOP >

Reason : Capital account balance: (Government loans from abroad – Government loans to abroad –
Direct investment abroad + FDI in the country – Short term loans and investment abroad
+ Short term loans investments in the country = 60 – 95 – 65 + 280 – 650 + 125 = 345
(Dr.)
60. Answer : (c) < TOP >

Reason : The lags that are given below basically refers to lags in the monetary policy
(a) Recognition lag refers to the time gap between the requirement of an action and its
actual initiation. Hence not the correct option.
(b) Administrative lag refers to the time gap between recognition lag and the
implementation of monetary policy. Hence not the correct option.
(c) As the monetary makes some changes, it takes some time for the firms and to
respond with changes in output and employment. Such time gap is refered to as
outside lag. Hence (c) is the correct option.

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 (d) Inside lag refers to the time gap between necessity of an action to be taken by
central bank and the action actually undertake. Hence not correct option.
(e) The difference between inside and outside lag is referred to a s intermediate lag.
Whereas the response of the public due to changes in interest rate is part of outside
lag. Hence this option is not correct.
61. Answer : (a) < TOP >

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 the aggregate supply curve is positively sloped in the short
run and vertical in the long run.
62. Answer : (c) < TOP >

Reason : M3 = Currency with the public + demand deposits

with the banking system + Time deposits of the bank
= 10,000+20,000+25,000
= Rs.55,000 Cr.
63. Answer : (b) < TOP >

Reason : The real value of repayments in the future will fall with an increase in the inflation
causing an increase in the wealth of the debtors. With the same reasoning the wealth of
the creditors, retirees on fixed income, employees whose salaries are linked to the CPI
will decrease for an increase in the rate of inflation.
64. Answer : (c) < TOP >

Reason : Corporate profits = Corporate profit tax + Dividends + Retained earnings

= 50 + 15 + 20 = 85
65. Answer : (b) < TOP >

Reason : Expansionary fiscal policy refers to increase in government spending and decrease in
taxes.
66. Answer : (a) < TOP >

Reason : Intermediation Ratio = Secondary issues/New issues

Or, secondary issues = Intermediation ratio x New issues = 0.7 x 30,000 = 21,000 MUC
Total issues = New issues + Secondary issues = 30,000 + 21000 = 51,000 MUC
Financial Interrelations Ratio = Total issues/Net Physical Capital Formation (NPCF)
= 51000 /42500 = 1.2.
67. Answer : (b) < TOP >

Reason : New classical economists believe that monetary and fiscal policies are effective only if
people cannot anticipate the changes.
68. Answer : (e) < TOP >

Reason : Saving function = – 50 + 0.50 Yd

Hence, consumption function = 50 + 0.50 Yd

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 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  M t  +  Ma 
p =  p   p 
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)
69. Answer : (d) < TOP >

Reason : Economic developed is defined as a process of economic transition involving the

Structural transformation of an economy through industrialization. Economic
development leads to improvement in Standard of living of the people.
a. National Income deflator is the ratio of Current price of National Income to
Constant price of National Income. It is only a price index, Cannot be used to
measure economic development.
b. GNP at Current prices measures the money value of final value of goods and
services produced by the residents of a country. The value of goods are measured by
taking the price goods existing in the current year. A increase in GDP at current
prices need not necessarily lead to economic development.
c. Real National Income measures the final value of Goods and Services produced by
the residents of a country. The value of goods are measured by taking the prices
existing in the base year. An increase in real national income need not lead to
economic development if the population is increasing at a faster rate than that of real
national income. Hence, cannot be used as an indicator of economic development.
d. Per Capital real national income is the best indicator, because an increase in per
capita real national income would mean that more goods are available per head,
which would mean the Standard of living has increased.
e. GDP deflator is an indicator of price index, on the basis of reason (a), it is not an
indicator of economic development.
70. Answer : (d) < TOP >

Reason : Crowding-out refers to decrease in private investment because of increase in interest rate
caused by the increase government spending. Crowding out = 100 × 5 = 500.
71. Answer : (a) < TOP >

Reason : Goods market equilibrium

Y = 1641.67 – 20i (IS curve)
Money market equilibrium
Y = 775 + 300i (LM curve)
Equilibrium rate of interest is determined where IS = LM
∴1,641.67 – 20i = 775 + 300i
320i = 866.67
i = 2.7% .
72. Answer : (d) < TOP >

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 Reason : Personal disposable income = National Income – Undistributed corporate profit –
corporate tax + Transfer payments – personal taxes
∴Personal Income = 6785–140–375+1210–1015
= Rs.6,465cr.
73. Answer : (e) < TOP >

Reason : GNP at market prices = GNP at factor cost + Indirect taxes – Subsidies
= 240000 + 36000 – 12000
= 264000 Cr.
NNP at market prices = GNP at market prices – depreciation
= 264000 – 20000
= 244000 Cr.
NDP at market prices = NNP at market prices – Net factor income from abroad.
= 244000 – 10000
= Rs.234000 Cr.
74. Answer : (c) < TOP >

Reason : Inflation rate = (GNP deflator of current period – GNP deflator of previous year) ‘divided
by’ GNP deflator of previous year x 100 = (75/62.5 – 1) x 100 = 20%.
< TOP OF THE DOCUMENT >

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