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Suggested Answers with Examiner's Feedback Question Paper Economics - II (MSF1A4): January 2008 Answer all 74 questions. Marks are indicated against each question. Total Marks : 100 1. Coal is used as a source of energy in many manufacturing processes. Assume that a long strike by coal miners reduced the supply of coal and increased the price of coal. This would cause (a) The short-run aggregate supply curve to become flatter (b) The short-run aggregate supply curve to shift to the right (c) The short-run aggregate supply curve to shift to the left (d) The short-run aggregate supply curve to become nearly vertical at all levels of output (e) The short-run aggregate supply curve to remain same. (1 mark) <Answer> 2. The following data pertains to a hypothetical economy for 2007: Particulars Million Units of Currency Net Factor income earned within domestic territory 1,25,000 Capital consumption 7,500 GNP at market prices 1,50,000 Indirect taxes 5,000 Subsidies 1,250 The net factor income from abroad for the year 2007 would be (a) 5,000 MUC (b) 12,050 MUC (c) 13,750 MUC (d) 16,250 MUC (e) 17,000 MUC. ( 2 marks) <Answer> 3. A construction worker who has been laid off during a recession is an example of (a) Disguised unemployment (b) Frictional unemployment (c) Structural unemployment (d) Natural unemployment (e) Cyclical unemployment. (1 mark) <Answer> 4. The consumption function in a hypothetical economy is given as C = 60 + 0.50Y. If the investment and government expenditure are 90 MUC and 20 MUC respectively, the equilibrium output of the economy is (a) 80 MUC (b) 110 MUC (c) 160 MUC (d) 320 MUC (e) 340 MUC. (1 mark) <Answer> 5. Which of the following statement is false? (a) The long-run aggregate supply is fixed at potential output and cannot shift to the right (b) The long-run aggregate supply curve can shift to the left if the quality of the factors of production decreases (c) An increase in long-run aggregate supply will decrease the equilibrium price level (d) A decrease in long-run aggregate supply will decrease the equilibrium level of real GDP (e) The long run supply curve is vertical. (1 mark) <Answer> 6. If the Average Propensity to Consume (APC) in an economy is 1.25, Average Propensity to Save (APS) in the economy would be (a) 0.05 <Answer> http://206.223.65.215/suggested/MSF1A4-0108.htm (1 of 21) [27/Jan/08 10:33:02 PM]
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Question Paper Economics - II (MSF1A4): January 2008

• Answer all 74 questions.• Marks are indicated against each question.

Total Marks : 100

1. Coal is used as a source of energy in many manufacturing processes. Assume that a long strike by coal miners reduced the supply of coal and increased the price of coal. This would cause(a) The short-run aggregate supply curve to become flatter(b) The short-run aggregate supply curve to shift to the right(c) The short-run aggregate supply curve to shift to the left(d) The short-run aggregate supply curve to become nearly vertical at all levels of output(e) The short-run aggregate supply curve to remain same. (1 mark)

<Answer>

2. The following data pertains to a hypothetical economy for 2007:

Particulars Million Units of Currency

Net Factor income earned within domestic territory 1,25,000Capital consumption 7,500GNP at market prices 1,50,000Indirect taxes 5,000Subsidies 1,250

The net factor income from abroad for the year 2007 would be

(a) 5,000 MUC(b) 12,050 MUC(c) 13,750 MUC(d) 16,250 MUC(e) 17,000 MUC. (2 marks)

<Answer>

3. A construction worker who has been laid off during a recession is an example of(a) Disguised unemployment(b) Frictional unemployment(c) Structural unemployment(d) Natural unemployment(e) Cyclical unemployment. (1 mark)

<Answer>

4. The consumption function in a hypothetical economy is given as C = 60 + 0.50Y. If the investment and government expenditure are 90 MUC and 20 MUC respectively, the equilibrium output of the economy is (a) 80 MUC(b) 110 MUC(c) 160 MUC(d) 320 MUC(e) 340 MUC. (1 mark)

<Answer>

5. Which of the following statement is false?(a) The long-run aggregate supply is fixed at potential output and cannot shift to the right(b) The long-run aggregate supply curve can shift to the left if the quality of the factors of

production decreases(c) An increase in long-run aggregate supply will decrease the equilibrium price level(d) A decrease in long-run aggregate supply will decrease the equilibrium level of real GDP(e) The long run supply curve is vertical. (1 mark)

<Answer>

6. If the Average Propensity to Consume (APC) in an economy is 1.25, Average Propensity to Save (APS) in the economy would be (a) – 0.05

<Answer>

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(b) – 0.25(c) 1.00(d) 1.25 (e) Insufficient data. (1 mark)

7. An increase in government spending,(a) Decreases aggregate expenditures(b) Has the same effect on aggregate demand as an increase in taxes(c) Will result in a lower level of prices if the aggregate supply curve is horizontal(d) Leads to no change in the aggregate demand(e) Shifts aggregate demand to the right. (1 mark)

<Answer>

8. The following data is taken from National Income Accounts of a country:Particulars MUC

GNP at market prices 3,400Transfer payments 484Indirect taxes 346Personal taxes 406Consumption of capital 380Undistributed corporate profits 56Corporate tax 150Subsidies 40

Personal income in the country is

(a) 1,323 MUC(b) 2,460 MUC(c) 1,714 MUC(d) 2,992 MUC (e) 3,142 MUC. (2 marks)

<Answer>

9. According to the short-run Phillips curve,

(a) Inflation is positively related to unemployment(b) Inflation is not related to unemployment(c) Low inflation and low unemployment can occur simultaneously(d) Inflation is inversely related to unemployment(e) Inflation is positively related to exchange rate. (1 mark)

<Answer>

10. A current account surplus of Rs.20 billion implies that

(a) There is a capital account surplus of Rs.20 billion(b) There are net imports of Rs.20 billion(c) Net foreign borrowings amount to Rs.20 billion(d) Net acquisition of foreign assets amount to Rs.20 billion(e) The country is decreasing its net holding of foreign assets. (1 mark)

<Answer>

11. The speculative demand for money is given by 125 – 400i and the transaction demand is 0.20Y. Given that the money supply in the economy is 250 MUC, what would be the change in money available for speculative demand if income increases from 800 MUC to 900 MUC?

(a) 25 MUC (b) – 20 MUC (c) 20 MUC (d) – 25 MUC (e) Zero. (2 marks)

<Answer>

12. Which of the following is not a major determinant of economic growth?

(a) Tastes and preferences of consumers(b) Technological advancement(c) Natural resources(d) Physical capital

<Answer>

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(e) Human resources. (1 mark)

13. The following information is available from the consolidated balance sheet of the banking sector:

Particulars Rs. billionNet Bank Credit to the Government 14,000Bank Credit to the Commercial Sector 21,000Net Foreign Exchange Assets of the Banking Sector 15,400Net Non-Monetary Liabilities of the Banking Sector 8,400

If the money supply in the economy is Rs.45,000 billion, Government Currency Liabilities to the Public is

(a) Rs. 1,400 billion (b) Rs. 3,000 billion(c) Rs.43,400 billion(d) Rs.25,900 billion (e) Rs.35,900 billion. (1 mark)

<Answer>

14. _____________ believe that wages and prices are flexible in the short run.

(a) Only Monetarists(b) Only Keynesians(c) Monetarists and Keynesians(d) Monetarists and New Classical Economists(e) Rational expectations. (1 mark)

<Answer>

15. The following relationships are given for an economy:

Goods market equilibriumMoney market equilibriumExportsImport function

0.5Y = 2,925 – 37.5i0.25Y = 312.5 + 125i550 MUC20 + 0.25Y

The trade balance at equilibrium in the economy is (a) 1,882.5 MUC (surplus) (b) 1,882.5 MUC (deficit)(c) 782.5 MUC (deficit) (d) 782.5 MUC (surplus)(e) 765.0 MUC (deficit). (2 marks)

<Answer>

16. The following information relates to an economy: Particulars MUC

National income 4,500Wages & Salaries 2,700Interest income :

675

Rental income : 450The profit in the economy is(a) 450 MUC(b) 1,800 MUC(c) 525 MUC(d) 550 MUC (e) 675 MUC. (1 mark)

<Answer>

17. The following is the information from national accounts of an economy:Particulars MUC

Direct taxes 9,600Indirect taxes 45,600Factor income paid abroad 48,000Factor income received from abroad 36,000Depreciation 48,000Surplus 4,200

<Answer>

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Subsidies 24,000National income 1,92,000

The GDP at market prices is (a) 99,200 MUC (b) 2,73,600 MUC(c) 2,49,600 MUC(d) 2,09,400 MUC (e) 1,82,400 MUC. (2 marks)

18. Which of the following is true if, for a given period, there is no change in the foreign exchange reserves 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)

<Answer>

19. The higher the MPC,

(a) The flatter the slope of the consumption function(b) The greater the fraction of any additional disposable income consumers will spend(c) The greater the slope of the saving function(d) The greater the fraction of any additional disposable income consumers will save(e) The slope of the saving function remains the same. (1 mark)

<Answer>

20. Which of the following is responsible for increase in consumption?

(a) An increase in expected profits(b) An increase in disposable income(c) A decrease in population(d) A decrease in disposable income(e) A decrease in government expenditures. (1 mark)

<Answer>

21. At an income level of Rs.30, 000 the saving is zero. If the Marginal Propensity to Save (MPS) is 0.3, the autonomous consumption is

(a) Rs. 4,900(b) Rs. 5,000(c) Rs. 6,000(d) Rs. 9,000(e) Rs.30,000. (1 mark)

<Answer>

22. In the long run, changes in aggregate demand determine only the level of

(a) Income(b) Interest rates(c) Import(d) Prices(e) Aggregate supply. (1 mark)

<Answer>

23. An economy consists of three sectors: primary, secondary and tertiary sectors. Transactions related to the three sectors are given below:

Items PrimarySector (MUC)

SecondarySector (MUC)

TertiarySector (MUC)

Sales 200 300 260Closing Stock 30 40 50Intermediate Consumption 30 50 30Opening Stock 20 20 30Indirect taxes 24 26 34Depreciation 20 24 30

<Answer>

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Subsidies 14 16 14

GDP at factor cost for the economy is

(a) 600 MUC (b) 586 MUC (c) 542 MUC (d) 684 MUC(e) 728 MUC. (2 marks)

24. Which of the following could be a cause of demand-pull inflation?(a) War in the Middle East, which can increase oil prices(b) Drought in the Midwest, which can cause crop failures(c) Increased government spending in the absence of increased taxes(d) Suppliers who increase their profit margins by raising prices faster than their costs increase(e) Increase in wages in the US, which can increase gasoline prices. (1 mark)

<Answer>

25. The following data pertains to a hypothetical economy:Consumption function (C) = 50 + 0.75Yd

Investment (I) = 90 MUCGovernment spending (G) = 60 MUCTax function (T) = 0.2Y

At equilibrium, the budget surplus (deficit) of the economy is

(a) 40 MUC (b) (40) MUC.(c) 540 MUC(d) (540) MUC (e) 550 MUC. (2 marks)

<Answer>

26. Which one of the following transactions is recorded in the current account of the balance of payments?(a) One country buys cars from another country(b) Residents of one country buy property in another country(c) Government purchases of foreign currency(d) Residents of one country buy equity in a foreign company(e) One country allows FDI from another country. (1 mark)

<Answer>

27. In an economy the marginal propensity to consume is 0.70 and marginal propensity to import is 20%. Assuming that the investment is autonomous and increases by 2,500 MUC during the year, the income in the economy increases by(a) 1,750 MUC (b) 2,500 MUC (c) 5,000 MUC (d) 10,000 MUC (e) 20,000 MUC. (2 marks)

<Answer>

28. The aggregate supply curve in the classical model is vertical because

(a) Factor such as labor import costs, capital stock technological progress are not influenced by changes in the average price level

(b) The money market is always in equilibrium(c) The supply of output is not affected by the total stock of money in the economy(d) The goods market is always in equilibrium(e) Labour supply is always fixed in the short run. (1 mark)

<Answer>

29. For a hypothetical economy, the steady state consumption function is given byCt = 15 + 0.6 + 0.4 Ct–1

Where Ct and Ct–1 are consumption in the period t and t–1 respectively. If given that increased from

<Answer>

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500 MUC to 750 MUC, the change in consumption is

(a) 225 MUC (b) 250 MUC (c) 500 MUC (d) 750 MUC (e) 1,250 MUC. (2 marks)

30. Acceleration coefficient in an economy is 3. Investment in a period is equal to 60% of the difference between the desired capital stock and the existing capital stock. If income in period ‘t’ is expected to increase by 250 MUC, investment during the period ‘t’ will be

(a) 200 MUC (b) 300 MUC (c) 450 MUC (d) 500 MUC (e) 600 MUC. (2 marks)

<Answer>

31. If the demand for money is interest rate inelastic, then

(a) The LM curve will be vertical(b) The IS curve will be flatter(c) The LM curve will be horizontal(d) The LM curve will be flatter(e) The IS curve will be vertical. (1 mark)

<Answer>

32. The net export function for the economy is estimated as E = 200 – 0.1Y. The marginal propensity to consume is 0.75 and the tax rate is 20%. Assuming that the investment is autonomous and increases by 1,250MUC during the year, the trade balance deteriorates by(a) 100 MUC (b) 200 MUC (c) 250 MUC (d) 1,250 MUC (e) 2,500 MUC. (2 marks)

<Answer>

33. To increase the money supply, the Reserve Bank of India would (a) Decrease the reserve requirement and the discount rate, and buy bonds(b) Increase the reserve requirement and the discount rate, and sell bonds(c) Increase the reserve requirement and the discount rate, and buy bonds(d) Decrease the reserve requirement and the discount rate, and sell bonds(e) Keep the reserve requirement and the discount rate constant and sell bonds. (1 mark)

<Answer>

34. The following data pertains to a hypothetical economy:

Year Nominal GNP GNP deflator

2005-06 1,250 60

2006-07 1,650 70

What is the rate of inflation in the economy for the year 2006-07?(a) 10.00% (b) 14.28% (c) 20.00% (d) 16.67% (e) 25.00%. (2 marks)

<Answer>

35. Keynesians believe that (a) The government needs to take an active role in managing aggregate demand(b) The price system efficiently allocates resources(c) Monetary policy operates with long and variable lags(d) Supply creates its own demand

<Answer>

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(e) Only unexpected changes in the money supply affect real national income. (1 mark)

36. Consider an economy described by the following equations:Government spending (G) = 1,000 MUCTaxes (T) = 1,000 MUCConsumption (C) = 500 + 0.75Yd

Investment demand (I) = 100 – 50iTransaction demand for money (Mt/P) = 0.25Y

Speculative demand for money (Ma/P) = 125 – 50i

Money supply (Ms/P) = 700 MUC

The equilibrium level of income in the economy is (a) 1,287.5 MUC (b) 2,575.0 MUC (c) 5,000.0 MUC (d) 6,437.5 MUC (e) 2,850.0 MUC. (2 marks)

<Answer>

37. The central bank’s monetary liabilities as on December 31, 2007 stood at 13,500 MUC and Government 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 60,000 MUC, what should be the reserve ratio specified by the Central bank?(a) 4.25% (b) 5.00% (c) 6.25% (d) 7.00% (e) 10.00%. (2 marks)

<Answer>

38. GDP as expenditures can be expressed as (a) Consumption + Investment + Government expenditures + Net exports (b) Wages + Interest + Rent + Profits – Net factor income from abroad + Capital consumption

allowance + Indirect business taxes(c) The sum of the values added at each stage of production(d) National Income + Indirect business taxes(e) National Income + Subsidies. (1 mark)

<Answer>

39. The IS function and LM function in an economy are estimated to be Y = 7,700 + 0.5Y – 100i and Y = 6,200 + 800i respectively. The investment function in the economy is 1600 – 100i. If the government spending increases by 200 MUC, which of the following is true about the interest rate in the economy?(a) Increases from 6.2 % to 6.5%(b) Increases from 9.1% to 10.5%(c) Increases from 9.2% to 10.0%(d) Increases from 6.0 % to 6.4%(e) Increase from 9.2% to 9.6%. (2 marks)

<Answer>

40. A price index equal to 90 in a given year(a) Indicates that prices were lower than prices in the base year(b) Indicates that the year in question was a year previous to the base year(c) Indicates that prices were 10 percent higher than prices in the base year(d) Indicates that prices were 90 percent higher than prices in the base year(e) Is inaccurate because price indexes cannot be lower than 100. (1 mark)

<Answer>

41. As on December 31, 2007, monetary liabilities of the central bank are 1,500 MUC and government money is 100 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) 7,000 MUC (b) 7,200 MUC(c) 7,400 MUC(d) 7,680 MUC

<Answer>

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(e) 9,180 MUC. (2 marks)

42. If government spending increases by the same amount as taxes, the effect is (a) Neutral(b) Expansionary(c) Contractionary(d) First expansionary then contractionary(e) Indeterminable. (1 mark)

<Answer>

43. The following balances are taken from the balance sheet of the Central Bank of a country:Particulars MUCNet worth 1,000Credit to Central Government 2,500Credit to commercial banks 1,250Other non-monetary liabilities 250Other assets 500Government deposits 250Foreign exchange assets 500

If the government money in the economy is 625 MUC, the high-powered money in the economy is(a) 4,125 MUC(b) 3,500 MUC(c) 3,875 MUC(d) 4,000 MUC(e) 4,625 MUC. (2 marks)

<Answer>

44. A lender who does not expect any change in the price level is willing to make a mortgage loan at a 10 percent rate of interest. If that same lender anticipates a future inflation rate of 5 percent, she will charge the borrower (a) 5 percent interest(b) 10 percent interest(c) 20 percent interest(d) 15 percent interest(e) 25 percent interest. (1 mark)

<Answer>

45. The following information pertains to an economy: Particulars MUC

Private consumption expenditure 3,000Investment in fixed capital 1,000Increase in stock 600Government expenditure 400Merchandise exports 200Imports 600Money supply 575

The velocity of money in the economy is(a) 2 (b) 4(c) 6(d) 8 (e) 10. (2 marks)

<Answer>

46. Refer to the diagram below:<Answer>

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An economy is in equilibrium at price level P0 and output level Y0. If the price of oil increases in the

economy, the new equilibrium price will be _______ P0 and the new equilibrium level of output will be

__________ Y0.

(a) Greater than; less than(b) Less than; less than(c) Greater than; greater than(d) Less than; greater than(e) Remain same at; remain same at. (1 mark)

47. The following information is available for an economy:

Income elasticity of demand for real balances 3.0

Acceptable inflation rate 5%

Money multiplier 5

If the real GDP is desired to grow at 6%, what is the rate at which reserve money should grow?

(a) 10.0% (b) 3.0% (c) 4.6% (d) 6.0% (e) 30.0%. (2 marks)

<Answer>

48. Money policy can be effective only if

(a) Money demand reacts to changes in the interest rate(b) Government speaking reacts to changes in the interest rate(c) Planned investment reacts to changes in the interest rate(d) The money supply reacts to changes in the interest rate(e) Planned investment reacts to changes in imports. (1 mark)

<Answer>

49. Indicators of financial development of an economy for the year 2006-07are given below:

Finance ratioFinancial interrelation ratio

0.340.32

If the national income for the year 2006-07 is 28,000 MUC, the total issues will be

(a) 82,352 MUC(b) 9,520 MUC(c) 8,960 MUC(d) 18,480 MUC(e) 36,960 MUC. (2 marks)

<Answer>

50. The overall Balance of Payments of a country for the year 2006-07 is given below:(Rs. million)

Items Credit DebitMerchandise 1,59,000 1,96,422Services 74,958 56,340Transfers 45,675 1,101Income 8,478 23,124Foreign Direct Investment 14,370 3,537Portfolio Investment 22,605 19,773

<Answer>

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External Assistance 8,319 15,699Commercial Borrowings (MT & LT) 8,211 13,305Commercial Borrowings (Short Term) 24,567 21,630Commercial Banks 60,778 16,919Others 1,608 738Rupee Debt Service – 1,422Other Capital 19,206 8,727Errors & Omissions 1,902 –

During the year 2006-07, overall Balance of Payments position for the country is

(a) Rs.70,940 million (deficit) (b) Rs.70,940 million (surplus)(c) Rs.60,940 million (surplus) (d) Rs.60,940 million (deficit)(e) Rs.62,740 million (surplus). (2 marks)

51. The graph that shows the relationship between the aggregate quantity of output supplied by all the firms in an economy and the overall price level is

(a) The aggregate supply curve(b) The production possibility frontier(c) The phillips curve(d) The aggregate demand curve(e) The laffer curve. (1 mark)

<Answer>

52. Radha is in charge of economic policy, and her major concern is that interest rates are too high. She asks you what policy she should pursue to lower interest rates. Which of the following policies would you recommend?

(a) An expansionary export-import policy(b) A contractionary monetary policy(c) An expansionary monetary policy(d) An expansionary fiscal policy(e) An expansionary export policy. (1 mark)

<Answer>

53. If interest elasticity of demand for investment and consumption is zero

(a) Equilibrium income depends solely on the position of LM curve(b) Equilibrium income depends solely on the position of IS curve(c) There is no speculative demand for money(d) Speculative demand for money is infinity(e) Fiscal policy is totally ineffective in changing any of the real variables. (1 mark)

<Answer>

54. In an economy the incremental capital output ratio is 3 and the expected population growth rate is 4% per annum. What is the required investment if the targeted per capita real GDP growth rate is 10%?

(a) 13% of GDP (b) 39% of GDP(c) 42% of GDP(d) 40% of GDP (e) 120% of GDP. (2 marks)

<Answer>

55. If the Reserve bank of India accommodates a fiscal expansion by increasing the money supply so that the interest rate does not increase, the crowding-out effect will

(a) Be zero(b) Increase(c) Decrease, but still positive(d) First increase then decrease(e) Become infinitely large. (1 mark)

<Answer>

56. If firms sharply increase the number of investment projects undertaken when interest rates fall and sharply <Answer>

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reduce the number of investment projects undertaken when interest rates increase, then

(a) Expansionary monetary police will be very effective(b) Contractionary monetary policy will not be effective(c) Contractionary fiscal policy will be very effective(d) Expansionary fiscal policy will be very effective(e) Expansionary trade policy will be very effective. (1 mark)

57. The following information is extracted from the Union Budget for the year 2006–07: (Rs. In crore)

Tax Revenue (net to Centre) 7,36,676Non-tax revenue 3,79,064Recoveries of Loans 72,092Other Receipts 52,800Borrowings and other Liabilities 6,14,548Non-plan Expenditure

On Revenue Account (of which Interest Payments is Rs.4,92,892 cr.)

11,57,536

On Capital Account 1,13,748Plan Expenditure On Revenue Account 6,07,372On Capital Account 1,76,524

The estimated revenue deficit for the year 2006-07 is

(a) Rs. 4,63,168 cr (b) Rs. 6,49,168 cr(c) Rs. 4,49,168 cr(d) Rs. 4,87,168 cr (e) Rs.12,56,540 cr. (2 marks)

<Answer>

58. The term “rational expectations” is most accurately associated with the notion that

(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)

<Answer>

59. Which of the following is true if the Government monetizes part of its deficit?

(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)

<Answer>

60. The following data is available for an economy:Particulars MUCExport of services 13,000Import of services 9,000Government loans to abroad 190Government loans from abroad 120Direct investment abroad 130Foreign direct investment in the country 560Short-term loans and investment abroad 1,300Foreign short-term loans investments in the country 250

The capital account balance for the economy is (a) 850 MUC (Cr.) (b) 850 MUC (Dr.) (c) 690 MUC (Cr.)

<Answer>

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(d) 690 MUC (Dr.) (e) 1,655 MUC (Cr.) (2 marks)

61. Which of the following are leakages from the circular flow?

(a) Saving and imports(b) Consumption and saving(c) Imports and exports(d) Exports and savings(e) Exports and consumption. (1 mark)

<Answer>

62. Which of the following statements is not true with respect to stock and flow variables?

(a) Both variables have time dimension(b) Flow variables are always determined by stock variables(c) Stock variables are usually affected by flow variables(d) All flow variables need not have stock variable counterparts(e) Flow variables are partly determined by stock variables. (1 mark)

<Answer>

63. Which of the following is not a quantitative instrument of RBI’s monetary policy?

(a) Bank rate(b) Cash reserve requirements(c) Moral suasion(d) Open market operations(e) Statutory liquidity ratio. (1 mark)

<Answer>

64. In an economy the nominal money supply growth is 20% and real income is growing by 3% per year. The income elasticity of demand for money is 2/3. The inflation rate in the economy will be

(a) 9%(b) 10%(c) 8%(d) 12%(e) 18%. (1 mark)

<Answer>

65. When the Central Bank of a country resorts to contractionary or expansionary monetary policies to neutralize the change in money supply caused by changes in foreign exchange reserves, it is referred to as

(a) Transmission mechanism(b) Sterilization(c) Stabilization(d) Monetary mechanism(e) Exchange rate mechanism. (1 mark)

<Answer>

66. Which of the following is true if the RBI lends Rs.1,000 crore to Andhra Pradesh government?

(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)

<Answer>

67. In an economy, the investment function is given by I = 2,500 – 100i. If an increase in government spending by 625 MUC increases the interest rate in the economy by 6%, what could be the amount of crowding out in the economy?

(a) 300 MUC (b) 400 MUC (c) 450 MUC (d) 500 MUC (e) 600 MUC.

<Answer>

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(2 marks)

68. The GDP deflator can be used to

(a) Reduce the overstatement of economic activity that would occur if we included intermediate production

(b) Correct nominal GDP for the contribution to domestic GDP made by foreign owned factors of production

(c) Decompose a change in nominal GDP into a change in real GDP and an average change in prices

(d) Obtain the factor income flows that result from the economic activity that has produced the GDP(e) Obtain the factor income flows that result from the non-economic activity that has produced the

GDP. (1 mark)

<Answer>

69. Which of the following is not advocated by supply-side economics?

(a) Promote competition(b) Reduce government controls(c) Increase corporate tax rate(d) Reduce the role of government(e) Remove institutional barriers. (1 mark)

<Answer>

70. Which of the following statements is true?

(a) Net national product at factor cost plus depreciation equals gross national product at market prices

(b) Personal income is equal to national income minus retained earnings minus corporate tax plus transfer payments

(c) Personal disposable income minus personal taxes equals personal consumption(d) Gross domestic product at market prices minus net factor income from abroad equals gross

national product at market prices(e) Per capita income equals national income multiplied by population. (1 mark)

<Answer>

71. In a hypothetical economy, the marginal propensity to consume is 0.70. If marginal propensity to import is 0.20 and the tax rate is 10%, then the value of multiplier will be

(a) 1.00 (b) 1.75(c) 1.50 (d) 2.00 (e) 4.00. (1 mark)

<Answer>

72. Which of the following helps in understanding the problem of scarcity better, by showing what can be produced with the given resources and technology?

(a) Laffer curve(b) Production possibility frontier(c) Business cycle(d) Phillips curve(e) Aggregate demand curve. (1 mark)

<Answer>

73. The following information is extracted from the National Income Accounts of an economy:Particulars MUC

Factor income received by domestic residents from business sector 3,300Factor income received by domestic residents from foreigners 132Gross investment 1,320Retained earnings 165Net indirect taxes 396Corporate profit taxes 99Personal income taxes 660Net factor income from abroad –33Dividends 660National Income (NI) of the economy is

<Answer>

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(a) 3,597 MUC(b) 3,696 MUC(c) 4,224 MUC(d) 4,752 MUC (e) 5,346 MUC. (2 marks)

74. If money supply increases by 10% and the price level increases by 8%, then the LM curve

(a) Shifts to the left(b) Shifts to the right(c) Is not affected(d) Is not affected if money demand is not sensitive to interest rate changes(e) Is not affected if investment demand is not sensitive to interest rate changes. (1 mark)

<Answer>

END OF QUESTION PAPER

Suggested Answers

Economics - II (MSF1A4): January 2008

ANSWER REASON

1. C When there is a long strike by coal miners reduced the supply of coal and increased the price of coal. This would cause the short-run aggregate supply curve to shift to the left.

< TOP >

2. C Net factor Income from Abroad (NFIA) = NNPat factor cost – NDPat factor costNDP at factor cost = 1,25,000 MUCNNP at factor cost = GNP at market price – Depreciation – Indirect taxes + Subsidies= 1,50,000 – 7,500 – 5,000 + 1,250 = 1,38,750∴NFIA = 1,38,750– 1,25,000 = 13,750 MUC

< TOP >

3. E A construction worker who has been laid off during a recession is an example of cyclical unemployment.

< TOP >

4. E At equilibrium, Y = C + I + G = 60 + 0.50Y + 90 + 20 = 170 + 0.5Y0.5Y = 170Y = 170/0.5 = 340 MUC.

< TOP >

5. A The long-run aggregate supply is fixed at potential output and cannot shift to the right is a false statement.

< TOP >

6. B APC + APS = 1Thus, APS = 1 – APC = 1 – 1.25 = – 0.25

< TOP >

7. E An increase in government spending, shifts aggregate demand to the right. < TOP >

8. D Personal Income = National Income – Undistributed corporate profit – corporate tax + Transfer paymentsNational Income = GNP at market price – Depreciation – Indirect taxes + Subsidies= 3,400– 380– 346 + 40 = 2714∴Personal Income = 2714 – 56 – 150 + 484 = 2992 MUC

< TOP >

9. D According to the short-run Phillips curve, inflation is inversely related to unemployment. < TOP >

10. D When there is a current account surplus of Rs.20 billion, the capital account must be in a deficit.(a) is not the answer since the capital account must have a deficit and not a surplus according to the balance of payments identity(b) a current account surplus implies that merchandise exports exceeds imports and hence the net exports and net imports must be Rs.20 billion

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(c) A current account surplus implies net foreign lending and not borrowing(d) Is the answer. The net foreign acquisitions must amount to Rs.20 billion (e) A current account surplus implies the country is increasing its net holding of foreign assets.

11. B Md = Speculative + Transaction = S + 0.20YAt equilibriumMs = MdS + 0.20Y = 250Y1 = 800 MUC

S1 = 250 – 0.20 x 800 = 90

Y2 = 900 MUC

S2 = 250 – 0.20 x 900

= 250 – 180 = 70Change in Money available for speculations purposes = 70 – 90 = – 20 MUC.

< TOP >

12. A 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 resourcesChange 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.

< TOP >

13. B Money Supply = Net bank credit to Government + Bank credit to commercial sector + Net foreign exchange assets of the banking sector – Net non-monetary liabilities of the banking sector + Government moneyRs.45000billion = 14,000+ 21,000 + 15,400– 8,400 + Government money Government money = 45000–42000 = Rs.3000 billion.

< TOP >

14. D Monetarists and new classical economists believe that wages and prices are flexible in the short run.

< TOP >

15. C Goods market equilibrium:0.5Y = 2,925 – 37.5ior, Y = 5,850 –75i (IS Function)Money market equilibrium:0.25Y = 312.5 + 125ior, Y = 1,250 + 500i (LM function)At simultaneous equilibrium of goods market and money market, IS = LM∴ 5,850 –75i = 1,250 + 500ior, 575i = 4,600or, i = 8%\ Y = 5,850 – 75(8) = 5,850 – 600 = 5,250∴ Trade balance at equilibrium = E – M= 550 – (20 + 0.25Y)= 550 – 20 – .25 (5,250)= 550 – 20 – 1,312.50= – 782.5 MUC = 782.5 MUC(deficit)

< TOP >

16. E National income (NNP at FC) = wages & salaries + interest income + rental income + profit. < TOP

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Or, Profit = 4,500 – 2,700– 675 – 450 = 675 MUC >

17. B National income = NNP at factor costNNP 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= 1, 92,000 + 45,600 – 24,000– (–12,000) + 48,000 = 2, 73,600 MUC.Where NFIA = (Factor income received from abroad – Factor income paid abroad)= (36,000 – 48,000) = –12,000 MUC

< TOP >

18. B The net balance in the balance of payments must be zero. < TOP >

19. B The higher the MPC, the smaller the fraction of any additional disposable income consumers will save. And greater the fraction of any additional disposable income consumer will spend.

< TOP >

20. B An increase in disposable income leads to increase in consumption. < TOP >

21. D When saving is zero, Y = C + S = C + I; C = Y = 30,000C = a + bY; where a = autonomous consumption and b = marginal propensity to consume (MPC)If MPS = 0.3, MPC = 1 – 0.3 = 0.7. Thus,30,000 = a + (0.7 x 30,000)a = 30,000 – 21,000 = 9,000.

< TOP >

22. D In the long run, changes in aggregate demand determine only the level of prices. < TOP >

23. D Value added by factor of production = Sales – Intermediate consumption – Indirect taxes + Subsidies∴ Value added by Primary sector = 200 – 30 – 24 + 14 = 160Value added by Secondary sector = 300– 50 – 26+ 16 =240Value added by Tertiary sector = 260– 30 – 34 +14 = 210∴ NDP at factor cost = Sum of value added by Primary sector, Secondary sector and tertiary sector= 160 + 240 + 210 = 610Depreciation = 20 + 24+ 30 = 74∴ GDP factor cost = 610+ 74 = 684 MUC

< TOP >

24. C Increased government spending in the absence of increased taxes could be a cause of demand-pull inflation.

< TOP >

25. A Y = C + I+ G Y = 50 + 0.75Yd + 90 + 60

Y = 50 + 0.75 (Y – 0.2 Y)+ 90 + 60Y = 50 + 0.75 Y – 0.15 Y+ 90 + 60Y = 200 + 0.6Y0.4Y = 200Y = 500∴ Budget surplus = T – G = 0.2 (500) – 60 = 100 – 60 = 40 MUC.

< TOP >

26. A If one country buys cars from another country, it is recorded in the current account of the balance of payments.

< TOP >

27. C Multiplier = 1/(1 – MPC + MPI) = 1/(1 – 0.70 + 0.2) = = 2Thus if investment increases by 2,500, income increases by 2500 × 2= 5,000 MUC.

< TOP >

28. A The aggregate supply curve in the classical model is vertical because Factor such as labor import costs, capital stock technological progress are not influenced by changes in the average price level.

< TOP >

29. B At steady state,Ct = Ct – 1

< TOP >

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Ct = 15 + 0.6 + 0.4 Ct–1

Ct = 15 + 0.6 + 0.4 Ct

0.6 Ct = 15 + 0.6y

= = 1∴ If increases by 250, C also increases by 250 MUC.

30. C Investment in period ‘t’ = 0.60 × Desired investment in period ‘t’Desired investment in period ‘t’ = Acceleration coefficient × Change in income = 3× 250 = 750∴ Investment in period ‘t’ = 0.60 × 750 = 450 MUC.∴The answer is (c).

< TOP >

31. A If the demand for money is interest rate inelastic, then the LM curve will be vertical. < TOP >

32. C Multiplier = 1/(1 – MPC + MPC × t + MPI) = 1/(1 – 0.75+ 0.75 × 0.2+0.10) = 1/ 0.50= 2Thus if investment increases by 1250, income increases by 2500. Thus, change in trade balance = – 0.1 x 2500= (250) MUC.

< TOP >

33. A To increase the money supply, the Reserve Bank of India would decrease the reserve requirement and the discount rate, and buy bonds.

< TOP >

34. D Inflation rate = (GNP deflator of current period – GNP deflator of previous year) ‘divided by’ GNP deflator of previous year x 100 = (70/60 – 1) x 100 = 16.67%

< TOP >

35. A Keynesians believe that the government needs to take an active role in managing aggregate demand.

< TOP >

36. E Goods market will be in equilibrium when Y = AD = C + I + GY = 500 + 0.75(Y – T) + 100 – 50i + 1000 = 1600 + 0.75(Y – 1000) – 50iY = 850 + 0.75Y – 50i 0.25Y = 850 – 50i ….. IS curveMoney market will be in equilibrium when:Money supply (Ms) = Money demand (Md)

700 = 0.25Y + 125 – 50i575 = 0.25Y – 50i0.25Y = 575 + 50i ….. LM curveThus, at simultaneous equilibrium,850 – 50i = 575 + 50i275 = 100ii = 2.75When i = 2.75, 0.25Y = 575 + 50 (2.75) = 712.5Or, Y = 712.5/0.25 = 2,850 MUC

< TOP >

37. C High powered money = monetary liabilities + government money = 13,500 + 1,500 = 15,000Ms = H ×

60,000 = 15,000 = (1 + 0.25)/(0.25 + r) = 4 = 1 + 4r = 1 + 0.254r = 0.25

r = 0.0625 = 6.25%

< TOP >

38. A GDP as expenditures can be expressed as C + I + G + NX. < TOP >

39. E At equilibrium, IS = LMY = 7700 + 0.5Y – 100i

< TOP >

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0.5Y = 7700 – 100i Y = 15400 – 200i ………. IS functionY = 6200 + 800i ………. LM functionThus at simultaneous equilibrium,15400 – 200i = 6200 + 800iOr, 9200 = 1000iOr, i = 9.2 When government spending increases by 200, the IS function becomes0.5Y = (7700 + 200) – 100i0.5Y = 7900 – 100iOr, Y = 15800 – 200iThus, at equilibrium,6200 + 800i = 15800 – 200iOr, 1000i = 9600Or, i = 9.6

40. A A price index equal to 90 in a given year indicates that prices were lower than prices in the base year.

< TOP >

41. D Stock of high powered money ( H) = monetary liabilities of the central bank + government money = 1600 MUCCurrent deposit ratio (Cu) = 0.20Reserve ratio (r) = 0.05∴ Money supply Ms­ =

= = 4.8 × 1600= 7,680 MUC

< TOP >

42. B If government spending increases by the same amount as taxes, the effect is expansionary. Because income increase more than government spending due to the presence of the multiplier effect.

< TOP >

43. C High-powered money (H) = Monetary liabilities of Central Bank + Government money = 3250 + 625= 3,875Total assets = Total liabilities(Credit to Central Government + Credit to commercial banks + Foreign exchange assets + Other assets) = (Net worth + Government deposits + Other non-monetary liabilities + Monetary liabilities)( 2,500+ 1,250 + 500 + 500) = (1,000 + 250+ 250+ ML)4750 = 1500+ MLOr, ML = 3,250

< TOP >

44. D A lender who does not expect any change in the price level is willing to make a mortgage loan at a 10 percent rate of interest. If that same lender anticipates a future inflation rate of 5 percent, she will charge the borrower 15 percent interest.

< TOP >

45. D Velocity of money = Y = 3,000+1,000+600+400+200–600=4600∴ Velocity of money =

< TOP >

46. A An economy is in equilibrium at price level P0 and output level Y0. If the price of oil increases in

the economy, the new equilibrium price will greater than P0 and the new equilibrium level of

output will be less than Y0.

< TOP >

47. C Rate of growth of money stock (gM) = a.gY + gP Where, ‘a’ = income elasticity of demand for real balances ‘gY’ = expected rate of growth in real GDP‘gP’ = acceptable rate of inflation Thus, ‘gM’ = (3 x 6) + 5 = 23%

< TOP >

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Given money multiplier is 5,Rate of growth of reserve money = 23/5 = 4.6%.

48. C Money policy can be effective only if planned investment reacts to changes in the interest rate. < TOP >

49. B Finance Ratio = ∴ Total Issue = Finance Ratio × National Income = 0.34 × 28,000= 9520 MUC

< TOP >

50. B Overall balance of payment = Total Credit of the Bop – Total debit of the Bop = 449677 – 378737= Rs. 70940million (surplus)

< TOP >

51. A The graph that shows the relationship between the aggregate quantity of output supplied by all the firms in an economy and the overall price level is the aggregate supply curve.

< TOP >

52. C An expansionary monetary policy would be recommended to lower the interest rate. < TOP >

53. B If interest elasticity of demand for investment and consumption is zero, IS curve is

Y =

Hence, equilibrium income depends on the position of IS curve only.

< TOP >

54. C Required nominal growth rate = Real GDP growth rate + Population growth rate = 10% + 4% = 14%Thus, investment requirement = Required nominal growth rate × Incremental capital output ratio = 14 x 3 = 42% of GDP

< TOP >

55. A If the Reserve bank of India accommodates a fiscal expansion by increasing the money supply so that the interest rate does not increase, the crowding-out effect will zero.

< TOP >

56. A If firms sharply increase the number of investment projects undertaken when interest rates fall and sharply reduce the number of investment projects undertaken when interest rates increase, then expansionary monetary police will be very effective.

< TOP >

57. B Revenue deficit = Revenue expenditure – Revenue receiptRevenue Expenditure = Non plan revenue expenditure + Plan revenue expenditure = 1157536 + 607372 = 1764908Revenue receipts = Tax revenue + Non. Tax revenue

= 736676+ 379064= 1115740

∴ Revenue Deficit = 1764908– 1115740 = Rs.649168 cr

< TOP >

58. D 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.

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(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.

59. A 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.

< TOP >

60. D 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 = 120 – 190– 130+ 560 – 1,300+ 250 =690 (Dr.)

< TOP >

61. A Leakages are factors which tend to decrease the level of national income. Savings tend to decrease the national income and so does imports

< TOP >

62. B 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.

< TOP >

63. C Bank rate, cash reserve requirements, open market operations and statutory liquidity ratio are the quantitative instruments of RBI’s monetary policy. Moral suasion is not a quantitative instrument of RBI’s monetary policy. It is a qualitative instrument of monetary policy.

< TOP >

64. E Inflation rate = rate of growth of nominal money supply – rate of growth of real money demand growth of real money demand= income elasticity of money demand × growth of real income = 20 – (2/3×3) = 18%

< TOP >

65. B Sterilization means neutralization of changes in the money supply caused by changes in the foreign exchange reserves of a country.

< TOP >

66. A If the RBI lends Rs.1000 crore to Andhra Pradesh, high-powered money increases by Rs.1000 crore.

< TOP >

67. E Crowding-out refers to decrease in private investment because of increase in interest rate caused by the increase government spending. Crowding out = 100 × 6 = 600 MUC.

< TOP >

68. C The GDP deflator is defined as the ratio of nominal GDP which is measured in current prices to GDP measured in constant prices.

< TOP >

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69. C Supply side economics advocates promoting competition, decreasing role for the state, incentives to production sector like decreasing tax rates and reducing government controls and removing institutional barriers to increase efficiency. Supply-side economics do not advocate increase in the tax rate. Hence answer is (c).

< TOP >

70. B (a) It is not the answer since NNP at factor cost plus depreciation = GNP at factor cost and not GNP at market prices(b) It is the answer since the statement is true(c) It is not the answer since disposable income – personal savings = consumption(d) It is not the answer since GDP at market prices + net factor income from abroad = gross national product at market prices(e) It is not the answer since per capita income = national income / population.

< TOP >

71. B Multiplier = 1/(1 – MPC + MPC × tax rate + MPI) = 1/(1 – 0.70 + 0.70× 0.1 + 0.20) = 1.75 < TOP >

72. B The production possibility curve represents the various combinations of two goods that can be produced given the resources and level of technological development. It is nothing but the locus of various combinations of two goods and the production possibility frontier represents the maximum combinations of two goods.

(a) Isoquant represents a locus of various combinations of two inputs to produce a particular level of output. Hence it is a cost curve(b) Beyond the production possibility frontier it is not possible to produce the goods as the resources are not available. Hence PPF represents the problem of scarcity of resources.(c) Giffen paradox is an exception to Law of demand and does not explain scarcity of resources.(d) Isocost curves represent equal cost curves(e) Business cycle refers to fluctuations economic activity which results in cyclical changes in output, employment and prices.

< TOP >

73. B National income (NI) = Factor income received by domestic residents + Factor income received by domestic residents from foreigners + corporate profit taxes + retained earnings = 3,300+132+99+165 = 3,696MUC.

< TOP >

74. B If money supply increases by 10% and the price level increases by 8%, then the LM curve shifts to the right.

< TOP >

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