122 1004

Question Paper
Economics II (122) : October 2004

• • Answer all questions.
• • Marks are indicated against each question.
1. Which of the following helps in understanding the problem of scarcity better, by showing < Answer>
what can be produced with given resources and technology?
(a) Isoquant curve (b) Production possibility frontier
(c) Giffen paradox (d) Isocost curve (e)
Business cycles.
(1 mark)
< Answer
2. Which of the following variables is a flow variable? >
(a) Capital stock (b) A firm’s assets
(c) Gross fixed investment (d) Price index (e) Public debt.
(1 mark)
3. Suppose the rate of inflation is 2% and the real interest rate is 5%. The nominal interest rate < Answer>
will be
(a) 2.5% (b) 3.0% (c) –3.0% (d) 7.0% (e)
–7.0%.
(1 mark)
< Answer
4. The circular flow diagram shows >
I. Households providing firms with factors of production.
II. Income for factors of production flowing from households to firms.
III. Firms owning factors of production.
(a) Only (I) above (b) Only (III) above

(c) Both (I) and (III) above (d) Both (II) and (III) above (e) (I),
(II) and (III) above.
(1 mark)
5. On 30th September 2004, Rajesh, a stockbroker, collects Rs.20,000 towards his commission. < Answer>
Over the day, the value of his office equipments depreciated by Rs.2,000. Of the remaining
Rs.18,000, he paid Rs.1,000 to the government as service taxes; retains Rs.7,000 in his
business and took home the remaining amount as his wages. From his personal income, he
pays Rs.3,000 as income tax. What is the contribution made by Rajesh to national income?
(a) Rs.18,000 (b) Rs.20,000 (c) Rs. 7,000 (d) Rs.21,000 (e)
Rs.17,000.
(1 mark)
< Answer
6. The net factor income earned within the domestic territory of a country must be equal to >
(a) Net Domestic Product at factor cost
(b) Net Domestic Product at market price
(c) Net National Product at factor cost
(d) Net National Product at market price
(e) Personal income.
(1 mark)
7. In 2003,the world's best and worst performing economies are likely to be in Africa according < Answer>
to forecasts by the Economist Intelligence Unit, a sister organisation of The Economist.
Boosted by oil and gas industries, Equatorial Guinea is likely to see a 12.5% rise in its GDP
this year, while Chad can expect economic growth of almost 10%. Zimbabwe's economy is
forecast to shrink by almost 9%, as the country sinks further into political and economic
chaos. This year, three rich countries–Switzerland, Portugal and Japan–are likely to be among
the ten worst performers. The following information is extracted from the National Income
Accounts of Guinea-Bissaau.
Particulars Million Units of
Currency (MUC)
Factor income received by domestic residents from business 500
sector
Factor income received by domestic residents from foreigners 20
Gross investment 200
Retained earnings 25
Net indirect taxes 60
Corporate profit taxes 15
Personal income taxes 100
Net factor income from abroad –5
Dividends 100
National Income (NI) of Guinea-Bissaau is
(a) 560 MUC (b) 620 MUC (c) 640 MUC (d) 720 MUC (e)
810 MUC.
(2 marks)
8. Which of the following price indices is/are most widely used for determining of inflation in < Answer>
India?
(a) Wholesale price index (WPI) (b) GDP deflator
(c) Consumer price index (CPI) (d) Both (a) and (b) above
(e) Both (b) and (c) above.
(1 mark)
9. The Central Statistical Organisation (CSO), Ministry of Statistics and Programme < Answer>
Implementation, has released the revised estimates of national income for the financial year
2003-04 at constant (1993-94) and current prices. The advance estimates of national income
for the year 2003-04 have now been revised incorporating latest estimates of agricultural
production, index of industrial production and performance of key sectors like, railways,
transport other than railways, communication, banking and insurance and government
expenditure. The following information is extracted from the National Income Accounts of
India for the year 2003-2004.
Particulars Rs. Crore
Compensation to employees 1,942
Exports of goods and services 134
Depreciation 118
Government expenditure 594
Gross domestic investment 639
Transfer payments 139
Imports of goods and services 165
Personal taxes 405
Net income earned from abroad 22
Personal consumption expenditure 2,191 The NDP at market prices for the
year 2003-04 is
(a) Rs.1,472 crore (b) Rs.3,275 crore (c) Rs.2,346 crore (d) Rs.1,782 crore (e)
Rs.3,393 crore.
(2 marks)
10. There are different stages in the production of good ‘Zebra’. The values at each stage are < Answer>
given as under:
Particulars Value
(MUC)
Raw material 30
Manufacturing 50
Packaging 80
Retailing 120 The value added in manufacturing stage and the total
value added in the process of producing Zebra are
(a) 20 MUC and 120 MUC respectively (b) 50 MUC and 120 MUC respectively
(c) 20 MUC and 100 MUC respectively (d) 50 MUC and 100 MUC respectively
(e) 20 MUC and 50 MUC respectively.
(1 mark)
< Answer
11. Consider the following information: >
Particulars Rs. Crores
Income from Employment 25,000
Income from self-employment 15,000
Gross trading profit of companies 45,000
Gross trading surplus of public companies 35,000
Rental Income 15,000
Net Factor income from abroad 35,000 The GNP at factor
cost as per the income method is
(a) Rs 40,000 crores (b) Rs 70,000 crores (c) Rs 1,35,000
crores
(d) Rs 1,60,000 crores (e) Rs 1,70,000 crores.
(1 mark)
12. The main cause of this new confidence is Australia’s recent success in rebuilding its economy. < Answer>
The country may no longer be quite the “working man’s paradise” it was in the late 19th
century, when for a long stretch it was the richest in the world per head of population. But it is
now comfortably ensconced among the 15 most affluent countries and income inequalities,
though widening, are still smaller than in most comparable places. Growth has hovered around
4% or more for the past seven years, productivity has improved beyond all expectations,
inflation is relatively quiescent, and unemployment is heading downwards.
The following macro economic relations are given for Australia.
Savings function (S) – 250 + 0.30Yd
Disposable income (Yd) Y–T
Tax function (T) 0.25Y
Investment (I) A$ 100 billion
Government expenditure (G) A$ 500 billion
Exports (E) A$ 40 billion
Import function (M) 0.3Y If the
equilibrium output of Australia is to be increased by A$ 100, investment should be increased
by
(a) A$ 60.0 billion (b) A$ 77.5 billion (c) A$ 70.0 billion
(d) A$ 95.0 billion (e) A$ 90.5 billion.
(2 marks)
< Answer
13. For a two-sector economy, the consumption function is >
C = 100 + 0.75Y
And the autonomous investment in the economy is 100 MUC.
If the current output is 800 MUC, what will be the involuntary inventory accumulation in the
economy?
(a) 0 (b) 100 MUC (c) 200 MUC (d) 50 MUC (e)
250 MUC.
(1 mark)
< Answer
14. Which of the following is/are considered as an investment? >
(a) Arun deposits Rs.10,000 with a nationalized bank in a term deposit for a period of 5 years
(b) Barucha invests Rs.5,000 in equity shares of a company
(c) Charlie and Co. accumulates unsold inventory worth Rs.1,000
(d) Delta Corp. buys ten used vehicles to strengthen its transportation fleet
(e) Both (a) and (b) above.
(1 mark)
< Answer
15. Consumption function for an economy is estimated to be C = 1,000 + 0.80 Yd. >
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)
< Answer
16. The following figure shows 'Keynesian' equilibrium of income and expenditure. >
If Y3 is full employment production, which of the following situations is likely to occur?
(a) An inflationary gap (b) A recessionary gap
(c) No output gap (d) A full employment situation
(e) A deflationary situation.
(1 mark)
17. Japan has had a sluggish economy for the past decade for reasons almost totally opposite of < Answer>
the United States. It is understandable that two such different cultures would have differing
economic problems as well as solutions to those problems. The normal Japanese citizens'
savings far exceeds their annual income, practically an unheard of practice in the U.S. This
lack of spending for years has plagued an economy in desperate need of a boost, but with
consumer confidence still falling it is unlikely that the Japanese will relinquish their tight fist
hold over savings anytime soon. The following data pertains to national income aggregates of
Japan.
Consumption function (C) = 200 + 0.80Yd, where Yd is disposable income
Investment (I) = ¥ 500
Government spending (G) = ¥ 200
Taxes (T) = ¥ 100
The equilibrium level of savings is of Japan is
(a) ¥ 600 (b) ¥ 700 (c) ¥ 500 (d) ¥ 800 (e)
¥ 900.
(2 marks)
< Answer
18. The following data pertains to an economy: >
Consumption (C) = 100 + 0.8Yd
Autonomous investment ( ) = 140 MUC
I
G
Autonomous Government spending ( ) = 400 MUC
Transfer payments ( ) = 200 MUC
TR
Tax rate (t) = 25%

The budget surplus in the economy is
(a) 100 MUC (b) (100) MUC (c) 200 MUC (d) (200) MUC (e)
(140) MUC.
(2 marks)
19. In an economy, the investment function is given by I = 1000 – 40i. If an increase in < Answer>
government spending by 250 MUC increases the interest rate in the economy by 5%, what
could be the amount of crowding out in the economy?
90 MUC.
(1 mark)
20. Acceleration coefficient in an economy is 2. Investment in a period is equal to 75% of the < Answer>
difference between the desired capital stock and the existing capital stock. If income in period
‘t’ is expected to increase by 200, investment during the period ‘t’ will be
600 MUC.
(1 mark)
21. In an economy, the marginal propensity to consume is estimated to be 0.8. If tax rate is 25%, < Answer
>
an increase in 500 MUC in government spending would result in
(a) No affect on the equilibrium income
(b) Increase in equilibrium income by 200 MUC
(c) Increase in equilibrium income by 400 MUC
(d) Increase in equilibrium income by 1,250 MUC
(e) Increase in equilibrium income by 2,500 MUC.
(1 mark)
22. In an economy the savings function and investment functions are given by S = – 50 + 0.3Y < Answer>
and I = 150 – 5i respectively. If the equilibrium income level, Y = 500, the rate of interest is
(a) 20.0% (b) 15.0% (c) 10.0% (d) 5.0%
(e) 12.5%.
(1 mark)
< Answer
23. The following relationships are given for an economy: >
Goods market equilibrium 0.5Y = 2925 – 37.5i
Money market equilibrium 0.25Y = 312.5 + 125i
Exports 650 MUC
Import function 25 + 0.25Y If the government
expenditure increases by 475 MUC, the new equilibrium rate of interest will be
(a) 7.83% (b) 8.01% (c) 8.83% (d) 9.13% (e)
9.65%.
(1 mark)
24. The transaction demand for money (Mt) in an economy is estimated to be 0.25Y. Money < Answer>
supply (Ms) is 4,000 MUC and the current equilibrium income (Y) is 12,000 MUC.
Expansionary fiscal policies increased the equilibrium income by 2,000 MUC. If the money
supply is maintained at the current level, then speculative demand for money is
(a) 1,000 MUC (b) Decreased by 500 MUC
(c) Increased by 500 MUC (d) Increased by 1,000 MUC
(e) Decreased by 1,000 MUC.
(2 marks)
< Answer
25. The following relationships are derived for an economy. >
Transaction demand for money (Mt) : 0.50Y
Speculative demand for money (Ms) : 350 – 100i
Investment function (I) : 200 – 10i
Supply of money (Ms) : 500 MUC
Current equilibrium rate of interest : 8%
Tax rate : 20%
If the expansionary fiscal policies increase the equilibrium rate of interest to 12% and IS
function to Y = 2,900 – 100i, what should be the money supply in the economy to avoid the
crowding out?
750 MUC.
(2 marks)
26. The latest estimates for saving and capital formation pertain to 2002-03. The CSO’s quick < Answer>
estimates indicate that the rate of Gross Domestic Saving (GDS) rose to 24.2 per cent of GDP
at current market prices in 2002-03, entirely due to reduction in the public sector’s dis-saving.
Households - the mainstay of overall saving in the economy - recorded a decline in terms of
financial saving which, in turn, marginally reduced the rate of household sector saving. There
was also a marginal decline in the rate of private corporate sector saving in 2002-03. The
following sets of macroeconomic relationships have been identified for India.
Government spending (G) = Rs.1,000 crore
Taxes (T) = Rs.1,000 crore
Consumption(C) = 500 + 0.75Yd
Investment demand (I) = 100 – 50i
Transaction demand for money (Mt/P) = 0.25Y
Speculative demand for money (Ma/P) = 125 – 50i
Money supply (Ms/P) = Rs.500 crore
The amount of domestic saving of India is
(a) Rs.125.5 crore (b) Rs.(52.5) crore (c) Rs.(137.5)
crore
(d) Rs.(102.5) crore (e) Rs.102.5 crore.
(2 marks)
< Answer
27. 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)
28. The IS function and LM function of an economy are estimated to be Y = 2,860 + 0.5Y – 60i < Answer>
and Y = 2,600 + 400i respectively. The investment function in the economy is 800 – 50i. If the
government wants to increase the output by 10% by raising the government expenditure, what
is the crowding out in the economy?
(a) 52.5 MUC (b) 55.5 MUC (c)
62.5 MUC
(d) 500.0 MUC (e) 125.0 MUC.
(2 marks)
< Answer
29. If the aggregate supply curve slopes upward before reaching potential real GDP >
(a) Prices will remain constant as government spending increases
(b) Prices will decrease as government spending increases
(c) The government must increase its spending by more than the recessionary gap to reach
potential GDP
(d) The effect of government spending on real GDP is enhanced
(e) Prices will remain constant as government spending decreases.
(1 mark)
< Answer
30. Which of the following is most likely to increase long-run aggregate supply? >
(a) An advancement in technology
(b) An increase in real resource prices
(c) An increase in the minimum wage rate
(d) An increase in the expected rate of inflation
(e) A decrease in population.
(1 mark)
31. Monetary conditions continued to ease during 2003-04. Reserve money expansion was higher < Answer>
than in 2002-03 even though large and persistent capital inflows were substantially sterilised
by outright open market operations (OMOs) and repos under the Liquidity Adjustment
Facility (LAF). Overall monetary expansion was also higher than in the preceding year, albeit
in consonance with higher output growth. Liquidity in the financial system continued to be
ample, even as substitution occurred between time deposits in the banking system and small
savings. The following balances are taken from the balance sheet of the Reserve Bank of
India:

Loans given to the Government 1,200
Reserves maintained by the banks 300
Net worth 80
Loans to the commercial banks 800
Government deposits 200
Other assets 60
Other deposits with the central bank 10
Net foreign exchange assets 1,500
Loans to the commercial sector 20
If the government money is Rs.100 crore, high-powered money in the economy is
(a) Rs.3,000 crore (b) Rs.3,050 crore (c)
Rs.3,100 crore
(d) Rs.3,300 crore (e) Rs.3,400 crore.
(2 marks)
32. With the robust macroeconomic performance of 2003-04, the Indian economy broke free of < Answer>
adversities that had beset it in 2002-03. The over all real GDP growth in 2003-04 was the
highest since 1991-92 and turned out to be one of the fastest growing economies of the world.
The buoyant, all round revitalization of growth places the economy with in striking range of
the Tenth plan projections of 8 percent to be achieved over the period 2002-07. The following
information is available for India.
Income elasticity of demand for real balances 2.0
Acceptable inflation rate 4%
Money multiplier 4 If the real GDP is desired
to grow at 8%, what is the rate at which reserve money should grow?
(a) 14.0% (b) 5.0% (c) 32.0% (d) 8.0% (e)
5.5%.
(2 marks)
33. In a hypothetical economy, the high-powered money is 2,000 MUC and the money supply is < Answer>
6,000 MUC. Currency deposit ratio is estimated to be 0.2. The central bank sells government
securities worth 500 MUC in the open market. Even after the open market sale, if the central
bank wants to maintain the money supply at the same level, the reserve ratio should be
(a) 0.1% (b) 1.0% (c) 3.0% (d) 10.0% (e)
30.0%.
(1 mark)
< Answer
34. The interest rate charged on a loan transaction by a bank is >
(a) The real rate of interest
(b) The nominal rate of interest minus the rate of inflation
(c) The real rate of interest plus the rate of inflation
(d) The nominal rate of interest plus the rate of inflation
(e) The same as the rate of inflation.
(1 mark)
35. A government employee received a cheque for Rs.1,200 drawn on the RBI. When the cheque < Answer>
is credited to the employee’s account, high-powered money in the economy increases by
(a) Rs.1,100 (b) Rs.1,200 (c) Rs. 800 (d) Rs.1,000 (e)
Rs.2,400.
(1 mark)
36. The currency deposit ratio in an economy is estimated to be 0.4. The central bank of the < Answer>
country imposed a reserve ratio of 10%. Monetary liabilities of the central bank stood at
50,000 million units of currency (MUC). Due to an exogenous boost to the economy, the
foreign exchange reserves of the country are expected to increase by 500 million dollars
during the next period. If the central bank would like to neutralize the impact of change in
foreign exchange reserves on the money supply by adjusting the reserve ratio, what should be
the new reserve ratio? (Assume that the exchange rate is 12 units of local currency to a dollar)
(a) 10.04% (b) 10.50% (c) 11.25% (d) 15.00% (e)
16.00%.
(2 marks)
< Answer
37. The following data is taken from balance sheet of a Central Bank. >
Particulars MUC
Net worth 6,000
Credit to government 10,000
Credit to commercial sector 5,000
Government deposits 150
Credit to banks 4,000
Other non-monetary liabilities 3,000
Other deposits with the central bank 50
Other assets 100 The Government money in
the economy is 1,050 MUC and Money supply in the economy is 80,000 MUC. If Central
Bank imposes a reserve ratio of 10 percent and the currency deposit ratio is estimated to be 20
percent, Net foreign exchange assets with the Central Bank are
(a) 8,500 MUC (b) 9,000 MUC (c) 9,750 MUC (d) 10,050 MUC (e)
10,000 MUC.
(2 marks)
< Answer
38. The term ‘narrow money’ is >
(a) Currency with the public
(b) Currency with the public + currency with the Government of India
(c) Currency with the public + Demand deposits of the Banking system + other deposits
with the RBI
(d) Currency with the public + Demand deposits of the banking system + Post office savings
bank deposits
(e) Currency with the public + Total post office deposits.
(1 mark)
< Answer
39. In the short run, if the price level falls, the real wage rate will be >
(a) Less than the equilibrium real wage rate and employment will fall
(b) Less than the equilibrium real wage rate and employment will rise
(c) Higher than the equilibrium real wage and employment will fall
(d) Higher than the equilibrium real wage rate and employment will rise
(e) Equal to the equilibrium real wage rate and employment will stay constant.
(1 mark)
< Answer
40. Which of the following is true with respect to aggregate supply (AS) curve? >
(a) AS curve is positively sloped in the short run and it is vertical in the long run
(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 rectangular hyperbola in the long-run.
(1
mark)
< Answer
41. Disguised unemployment arises when >
(a) There is downturn in business activities
(b) There are structural changes in the economy
(c) Marginal productivity of labor is zero
(d) Marginal productivity of labor is increasing
(e) Marginal productivity of labor is decreasing.
(1 mark)
• • Which of the following is not one of the basic postulates of the Keynesian model? < Answer
>
42. (a) Full employment occurs only by coincidence is 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)
< Answer
43. Which of the following emphasize rational expectations? >
(a) Keynesian economists (b) Monetarists
(c) New classical economists (d) Monetarists and Keynesians
(e) Classical economists.
(1 mark)
44. Which of the following theory (ies) developed as a response to the problem of unemployment < Answer>
and inflation at the same time?
(a) Keynesian theory (b) Monetarist theory
(c) New classical economics theory (d) Classical theory
(e) Both (b) and (c) above.
(1 mark)
< Answer
45. 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
46. Immediately following a depression, >
(a) Unemployment rate increases moderately
(b) Aggregate demand decreases further because of recession
(c) There will be rapid increase in wages but less than the increase in prices of goods and
services
(d) The cost of production will gradually increase because of gradual increase in wages
(e) Output will decrease rapidly.
(1 mark)
< Answer
47. Phases of business cycles in an economy are designated primarily based on the >
(a) Unemployment rate (b) Price levels (c)
Real GDP
(d) Inventory levels (e) Gross investment.
(1 mark)
< Answer
48. Recession is defined as >
(a) Two or more quarters of increasing inflation
(b) The period after the trough of a business cycle
(c) The period before the peak of the business cycle
(d) Two or more quarters of declining output
(e) Two or more quarters of declining inflation.
(1 mark)
< Answer
49. The slope of the IS curve is not affected by >
(a) Changes in tax rate
(b) Changes in Marginal Propensity to Import (MPI)
(c) Changes in Marginal Propensity to Consume (MPC)
(d) Changes in the interest rate
(e) Changes in the sensitivity of investment spending to interest rate.
(1 mark)
< Answer
50. The long run Phillips curve is >
(a) An upward sloping curve (b) A downward sloping curve
(c) A horizontal straight line (d) A vertical straight line
(e) Indeterminable.
(1 mark)
< Answer
51. Which of the following would cause stagflation? >
(a) Aggregate demand shifts right (b) Aggregate demand shifts left
(c) Aggregate supply shifts right (d) Aggregate supply shifts left
(e) Aggregate supply remains constant.
(1 mark)
< Answer
52. Cost push inflation occurs when >
(a) Wages are decreased (b) Productivity of labor increases
(c) Cost of raw material increases (d) Aggregate supply curve shifts to the right
(e) New raw material reserves are found.
(1 mark)
< Answer
53. A country may be able to correct its persistent balance of payments deficit by >
(a) Lowering the import barriers (b) Reducing its official reserves
(c) Increasing the national income (d) Reducing the international value of its
currency
(e) Reducing the money supply.
(1 mark)
54. Which of the following items represents a credit entry in India’s Balance of Payments < Answer>
statement?
(a) Purchase of gold by Minerals and Metals Trading Corporation (MMTC) from a Swiss
Bank
(b) Repatriation of dividends by an MNC
(c) Investment by an Indian Mutual Fund in the UK
(d) Foreign exchange earned by Minerals and Metals Trading Corporation (MMTC)
(e) Remittance to USA by an American executive based at New Delhi.
(1 mark)
55. Mr. Rajesh, a software engineer, has remitted $1,000 to his parents in India from the $20,000 < Answer>
he earned in USA. This transaction is recorded under which of the following heads in the
Balance of Payments statement?
(a) Capital account (b) Errors and omissions
(c) Merchandize (d) Invisibles (e) External
assistance.
(1 mark)
56. The capital account has also contributed to strengthen the size of the capital account surplus < Answer>
during April-December 2003-04 was far more than that for the full year 2002-03.Earlier, the
capital account surplus in India’s balance of payments used to be partially offset by current
account deficits, leading to lower overall surplus. However, since 2001-02, surpluses in both
the current and capital account have resulted in larger overall surpluses, which have led to
accumulation in the foreign exchange reserves of the country. The following information pertains
to the balance of payments for the year 2003-04:
Merchandize imports 140,240
Merchandize exports 116,320
Services rendered to foreigners 230,010
Services rendered by foreigners to residents 125,234
Gifts sent to non-residents by the residents 2,000
Cash remitted by non-residents for their family maintenance 4,000
Income earned by residents on ownership of financial assets 1,000
Foreign direct investment 100,000 If
the capital account balance (credit) is Rs.202,000 crore, what is the change in foreign exchange
reserves?
(a) Rs.69,056 crore (b) Rs.179,056 crore (c)
Rs.285,856 crore
(d) Rs.23,920 crore (e) Rs.123,144 crore.
(2 marks)
57. Which of the following statements is correct for resources mobilization in a non-inflationary < Answer>
manner?
(a) Indirect taxes should be increased
(b) Non-plan spending should be increased
(c) Fiscal concessions should be increased
(d) Efforts should be made to substantially raise the tax-GDP ratio
(e) Direct taxes should be increased.
(1 mark)
< Answer
58. The Laffer curve explains the relationship between >
(a) Consumption and investment (b) Investment and interest rate
(c) Total tax revenue and tax rates (d) Interest rates and borrowing
(e) Disposal income and saving.
(1 mark)
< Answer
59. Automatic stabilizers refer to >
(a) Inherent mechanisms in the stock market that automatically cause stock market gains to
be cancelled out by losses, which make expected long-run returns equal to zero
(b) The invisible hand mechanisms which automatically bring the economy out of a recession
(c) Government revenue and expenditure items that change automatically in response to
changes in economic activity
(d) Discretionary monetary policy maneuvers designed to keep inflation under control
automatically
(e) Policy instrument of the Government to stabilize the exchange rate of home currency.
(1 mark)
< Answer
60. The value-added tax (VAT) is a good example of >
(a) Income tax (b) Gift tax (c) Wealth tax (d) Sales tax (e)
Sur-tax.
(1 mark)
< Answer
61. Which of the following policy instruments has the least ‘outside lag’? >
(a) Cash reserve ratio (CRR) (b) Bank rate (c)
Repo rate
(d) Taxes (e) Open market operations (OMO).
(1 mark)
< Answer
62. An expansionary fiscal policy combined with a liberal monetary policy results in >
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 (III) above
(d) (II) and (V) above (e) (I) and (V) above.
(1 mark)
< Answer
63. In a deflationary period, the appropriate policy for the RBI would be to >
(a) Buy government securities in the open market
(b) Discourage commercial banks to increase their loans
(c) Increase Cash Reserve Ratio
(d) Increase bank rate
(e) Reduce the credit to government.
(1 mark)
< Answer
64. Monetary policy will be more effective when >
(a) The economy is facing recession
(b) The private investment is more sensitive to interest rate
(c) The private investment is less sensitive to interest rate
(d) The economy is suffering from liquidity trap
(e) The economy is in boom.
(1 mark)
< Answer
65. Which of the following is not a quantitative instrument of RBI’s monetary policy? >
(a) Bank rate (b) Cash reserve requirements
(c) Selective credit control (d) Open market operations
(e) Statutory liquidity ratio.
(1 mark)
66. For an economy consumption income ratio is given to be 0.72. The incremental capital output < Answer>
ratio is 4. Given that the population is growing at 3% p.a. what will be the growth rate of Per
Capita Income?
(a) 9% (b) 1% (c) 7% (d) 4% (e)
8%.
(2 marks)
67. An economy appears to be in a resilient mode in terms of growth, inflation and balance of < Answer>
payments, a combination that offers large scope for consolidation of the growth momentum
with continued macroeconomic stability. Apart from agriculture, the industry and service sector
also maintained the momentum with GDP growth. In the economy, population is expected to
grow at 1.5% p.a. Planners fix a target of per capita GDP growth of 4.5% p.a. If the capital
output ratio is 5:1 assuming no depreciation, what should be the rate of investment as a
percentage of GDP?
(a) 7.5% (b) 15.0% (c) 22.5% (d) 30.0% (e)
36.0%.
(2 marks)
< Answer
68. The depreciation in the value of rupee is aimed at >
(a) Increasing imports (b) Increasing exports (c) Decreasing
exports
(d) Decreasing national income (e) Decreasing the rate of inflation.
(1 mark)
69. Which of the following committees appointed by government of India, in July 1967, submitted < Answer>
a report on the working of the licensing system?
(a) Dutt committee (b) Narasimham committee (c)
Tandon committee
(d) Nayak committee (e) Tarapore committee.
(1 mark)
< Answer
70. The following information pertains to national income aggregates of a hypothetical economy: >
Particulars Rs. crore
Compensation to employees paid by the Government 50
Profit distributed as dividends by the firms 70
Old age pension, scholarships etc. distributed by Government 21
Purchases made by the government sector 246
Indirect taxes paid by the firms 75
Value of exports 22
Factor income paid as dividends abroad 25
Corporate tax 62
Personal Savings 22
Undistributed profits of the firms 42
Income tax 94
Factor incomes received by the household sector 632 The
Personal Disposable Income in the economy is
(a) Rs.509 crore (b) Rs.539 crore (c) Rs.529 crore (d) Rs.559 crore (e)
Rs.549 crore.
(2 marks)
71. Inflation remains low and stable worldwide. Deflation risks have receded with the < Answer>
strengthening of global recovery and a number of commodity prices have risen in recent
months. Indeed, the outlook is now fraught with the upward risk emanating from commodity
markets, although there are also prospects of commodity prices levelling off in the medium
term. In India, as domestic economic activity strengthens, inflation is likely to respond, with
specific demand-supply conditions in key movers – iron and steel, cotton and fuel – dominating
intra-year movements. An increase in inflation ahead would be triggered by the timing of
adjustments in the prices of administered items, as also the possibility of a further spurt in
global commodity prices. The following table gives information about price and units of
aggregate output for the years 2003 and 2004.
2003 2004
Goods Quantity Price Quantity Price
(Units) (Rs.) (Units) (Rs.)
Cotton 30 2.00 35 2.50
Steel 55 6.00 65 8.00
Iron 45 5.00 60 6.00
Fuel 35 4.00 40 5.00
Cement 40 3.00 50 4.50 What is the value of
GDP deflator for the year 2004?
(a) 122 (b) 104 (c) 151 (d) 142 (e)
130.
(2 marks)
< Answer
72. The following information is extracted from National Income accounts of an economy: >
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
185 MUC.
(1 mark)
73. In an economy the demand for money is estimated to be L = 0.25Y – 10i. If the interest rate is < Answer
>
6% and money supply is 200 MUC, the equilibrium level of output is
1,120 MUC.
(1 mark)
74. The following information is available from the consolidated balance sheet of the banking < Answer>
sector:
Item Rs. billion
Net Bank Credit to the Government 2,000
Bank Credit to the Commercial Sector 3,000
Net Foreign Exchange Assets of the banking sector 2,200
Net Non-Monetary Liabilities of the banking sector 1,200
Money supply in the economy 6,200
Government Currency Liabilities to the Public is
(a) Rs. 200 billion (b) Rs.6,000 billion (c)
Rs.6,200 billion
(d) Rs.7,400 billion (e) Rs.4,800 billion.
(1 mark)
75. In recent years India’s balance of payment (BOP) has been characterized by surpluses in both < Answer>
the current and capital accounts. After recording current account surpluses for the past two
years, the BOP estimates for the first nine-months (April-December) also indicate the current
account surplus. India’s overall Balance of Payments for the year 2003-04 is given below.
(Rs. Crore)
Items Credit Debit
Merchandise 53,000 65,474
Services 24,986 18,780
Transfers 15,225 367
Income 2,826 7,708
Foreign Direct Investment 4,790 1,179
Portfolio Investment 7,535 6,591
External Assistance 2,773 5,233
Commercial Borrowings (MT & LT) 2,737 4,435
Commercial Borrowings (Short Term) 8,189 7,210
Commercial Banks 16,926 8,973
Others 536 246
Rupee Debt Service — 474
Other Capital 6,402 2,909
Errors & Omissions 634 —During the
year 2003-04, over all Balance of Payments position for India is
(a) Rs.18,280 crore (surplus) (b) Rs.16,980 crore (deficit)
(c) Rs.17,280 crore (deficit) (d) Rs.17,280 crore (surplus)
(e) Rs.16,980 crore (surplus).
(2 marks)
76. Current account deficit for an economy is 5,000 MUC. If foreign exchange reserves increase by < Answer
1,000 MUC for the same period, capital account balance is >
10,000 MUC.
(1 mark)
77. A strong balance of payment (BOP) position in recent years has resulted in a steady < Answer>
accumulation of foreign exchange reserves. This accretion to reserves is attributed not only to
capital inflows and current account surplus, but also to valuation gains arising from a steady
appreciation of the major currencies such as the euro and pound sterling against the US dollar.
Given the following data, compute the current account balance for India.

Earnings on loans and investments from abroad 500
Earnings on loans and investments to abroad 2,500
Import of services 4,000
Private remittances to abroad (transfers) 500
Private remittances from abroad (transfers) 500
Exports of services 2,000
Merchandize exports 15,000
Merchandize imports 12,000 (a)
Rs.1,000 crore (Surplus) (b) Rs.1,000 crore (Deficit)
(c) Rs.500 crore (Deficit) (d) Rs.500 crore (Surplus) (e)
Zero.
(2 marks)
78. The Government of India is expecting tax collections (net) to the tune of Rs.1,84,169 crore during < Answer>
the year 2004-05. The borrowings and other liabilities are expected to be Rs.1,53,637 crore. If
the non-plan revenue expenditure of the government is Rs.2,89,384 crore (inclusive of interest
payments of Rs.1,23,223 crore), the primary deficit for the year 2004-05 is
(a) Rs.1,53,637 crore (b) Rs.1,35,747 crore (c)
Rs.1,05,215 crore
(d) Rs.30,414 crore (e) Rs. 130414 crore.
(1 mark)
79. As per the provisional accounts released by the Controller General of Accounts, fiscal deficit in < Answer>
2003-04 declined to 4.6 percent of GDP as compared with the budgeted fiscal deficit of 5.6
percent of GDP. The deterioration in the other fiscal indicator, namely, revenue deficit, which
was even greater in the recent past, also seems to have been reversed in 2003-04. High revenue
deficits indicate a problem in the quality of the fiscal deficit. Budget Estimate for the year 2004-05
is given below.
(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 (of which Interest Payments is Rs.1,23,223 cr.) 2,89,384
On Capital Account 28,437
Plan Expenditure
On Revenue Account 76,843
On Capital Account 44,131The
estimated revenue deficit for the year 2004-05 is
(a) Rs.1,13,292 cr (b) Rs.1,12,392 cr (c) Rs.1,12,292 cr (d) Rs.1,19,292 cr (e)
Rs.1,19,922. cr.
(2 marks)
END OF SECTION B
Suggested Answers
Economics II (122) : October 2004
1. Answer : (b) < TOP >
Reason : 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.
2. Answer : (c) < TOP >
Reason : A variable is a stock if it is measured at a particular point of time. It is a flow variable if it is

measured over a period of time.
a. Capital stock is measured at a particular point of time, hence is a stock variable
b. A firm’s assets are measured at a particular point of time, hence is a stock variable
c. Investment is measured over a period of time hence is a flow variable.
d. Price index is measured at a particular point of time, hence is a stock variable
e. Public debt is measured at a particular point of time, hence is a stock variable
3. Answer : (d) < TOP >
Reason : Nominal rate of interest = Real rate of interest + Inflation = 5 + 2 = 7%

4. Answer : (a) < TOP >
Reason : In the Circular flow model all the factors of production are owned by Housholds and all the
production activity is undertaken by firms in the Business sector. Households provide factor of
production to firms in return for factor payments. Business sector (firms) produce and sell goods
and services to the Households.
5. Answer : (e) < TOP >
Reason : Contribution to National income = Contribution to GNP at market prices – depreciation – indirect
taxes = 20,000 – 2,000 – 1,000 = 17,000.
Reason : Since the value added within the domestic territory will belong to the domestic factor inputs, NDP
at factor cost must be equal to domestic factor income.
Hence answer is (a).
(b) Is not the answer because the net factor income earned within the domestic territory of a
country is not equal to Net Domestic Product at market price.
(c) Is not the answer because the net factor income earned within the domestic territory of a
country is not equal to Net National product at factor cost
(d) Is not the answer because the net factor income earned within the domestic territory of a
country is not equal to Net National Product at market price
(b) Is not the answer because the net factor income earned within the domestic territory of a
country is not equal to Personal income.
Reason : National income (NI) = Factor income received by domestic residents + Factor income received by
domestic residents from foreigners + corporate profit taxes + retained earnings = 500 + 20 + 15 + 25
= 560.
Reason : In India, Whole Sale Price index (WPI) is widely used for determinime of inflation. Because the
Office of the Economic Advisor to the Government of India publishes wholesale price indices for
individual commodities, commodity groups and the overall WPI monthly. They are reported in a
number of other publications also.
(a) Is the answer because Whole Sale Price index (WPI) is widely used for determinime of
inflation in India.
(b) Is not the answer because GDP deflator is not used for determining inflation in India. GDP
deflator is used to reveal the cost of purchasing the items included in GNP during the period
relative to the cost of purchasing those items during a base year. And it is difficult to bet the
data for the two years for comparisons.
(c) Is not the answer because in practice it is difficult to include each and every item for
construction of Consumer Price Index. (CPI)
(d) Is not the answer because both Whole Sale Price index (WPI) and GDP deflator are not used in
measuring inflation.
(e) Is not the answer because both GDP deflator and Consumer Price Index. (CPI) are not used in
measuring inflation.
Reason : GDP at market price = C + I + G + NX = 2191 + 639 + 594 + (134 – 165) = 3393
Thus, NDP at market price = GDP at market price – depreciation = 3393 – 118 =
Rs.3275 crore.
Reason : Total value added in the process = Market value of the final product = 120
Value added in the manufacturing stage = Total value of the good after manufacturing stage – Total
cost for procuring raw-material = 50 – 30 = 20.
Reason : According to the Income Method

GNP at factor cost = Income from employment + Income from self-employment + Gross trading
profit of companies + gross trading surplus of public corporations + Rental income + Net factor
income from abroad
GNP at factor cost = 25000+15000+45000+35000+15000+35000 = Rs 1,70,000 crores
S = – 250 + 0.30Yd
∴ C = 250 + 0.70Yd
T = 0.25Yd
M = 0.3Y
∴ The value of multiplier = m
1
1−β(1− t) + µ
=
1
1 − 0.70 ( 1 − 0.25 ) + 0.3
=
1
1 − 0.70 ( 0.75) + 0.3
=
1
= 1.29
0.775
=
Y = mI
Or, 100 = 1.29I
100
=
1.29
Or, I = A$ 77.5.
Reason : When output (income) = 800, aggregate demand = C + I = 100 + 0.75(800) + 100 = 800. When AD
= Y, there will be no involuntary inventory accumulation in the economy.
Reason : Investment includes expenditure on the plant and machinery produced during the year, expenditure
incurred on construction activities (both residential and non-residential) during the year and change
in inventories.
(a) And (b) are not the answer as both are financial transactions, which do not form part of
investment.
(c) Is the answer as change inventories is considered to be an investment.
(d) Is not the answer as purchase of used vehicles amounts only to transfer of ownership and not
an investment
Reason : If Yd is zero, consumption is 1000, which is autonomous consumption. This consumption is

financed by dissavings or borrowing. Hence dissavings are 1000
Reason : If the point Y3 indicates full employment situation, the diagram shows recessionary gap, since
equilibrium income is less than the full employment income.
< TOP >
17. Answer : (a)
Reason : C = 200 + 0.80Yd = 200 + 0.80 (Y– 100) = 200 + 0.80Y – 80 = 0.80Y + 120.
Y = C+I+G
Or, Y = 0.80Y + 120 + 500 + 200
Or, 0.20Y = 820
Y = 4,100.
S = – 200 + 0.20Yd = – 200 + 0.20 (Y – 100) = – 200 + 0.20 (4100– 100)
= – 200 + 800
= 600.
< TOP >
18. Answer : (b)
Reason : At equilibrium, Y = C + I + G
Y = 100 + 0.8(Y – 0.25Y + 200) + 140 + 400
Y = 100 + 0.8Y – 0.2Y + 160 + 140 + 400
Y = 800 + 0.6Y
0.4Y = 800
Y = 2000
Budget surplus = Tax receipts – Transfer payments – Government spending
= 0.25(2000) – 200 – 400 = 500 – 600 = (100).
Reason : crowding-out refers to decrease in private investment because of increase in interest rate caused by
the increase government spending . crowding out = 40 × 5 = 200.
Reason : Investment in period ‘t’ = 0.75 × Designed investment in period ‘t’

Designed investment in period ‘t’ = Acceleration co-efficient × change in income
= 2 × 200
= 400
∴ Investment in period ‘t’ = 0.75 × 400 = 300
∴ The answer is (b).
1 1 1
= =
1 −MPC(1 − t) 1 −0.80(1 −0.25) 0.40
Reason : Multiplier = = 2.5
∆Y = 2.5 × 500 = 1250
∴ The answer is (d).
Reason : At equilibrium, S = I
– 50 + 0.3Y = 150 – 5i
Or, – 50 + 0.3(500) = 150 – 5i
Or, – 50 + 150 = 150 – 5i
Or, 5i = 50
Or, i = 10%.
Reason : If Government expenditure increase by 475 MUC,

IS function becomes
0.5Y = 2,925 + 475 – 37.5i
or, 0.5Y = 3,400 – 37.5i
or, Y = 6,800 – 75i
At simultaneous equilibrium,
IS = LM
Or, 6,800 – 75i = 1,250 + 500i
Or, 575i = 5,500
Or, i = 9.65%
Reason : Mt = 0.25Y = 0.25 (12000) = 3,000

Ms = 4000
At equilibrium Mt + Ma = Ms
Therefore Ma = 4000 – 3000 = 1000
New equilibrium income = Y = 12000+2000=14000
Therefore Mt = 0.25 Y = 3500
As the money supply is constant at 4000,
Speculative demand for money = 4000 – 3500 = 500
That is a reduction of 500 (1000 – 500) in the speculative demand for money.
Reason : There will not be any crowding out if i = 8%

This can happen only when IS function shifts to the left
Substituting i = 8%, IS function becomes Y = 2,900 – 100 (8) = 2,100
Total demand for money function = (Mt /p) + (Ms /p) = 0.50Y + 350 – 100i
Substituting Y = 2,100 and I = 8% in the total demand for money function,
0.50(2,100) + 350 – 100(8) = 1,050 + 350 – 800 = 600 MUC.
Reason :
Goods market will be in equilibrium when Y = AD = C + I + G
Y = 500 + 0.75(Y – T) + 100 – 50i + 1000
= 1600 + 0.75(Y – 1000) – 50i
Y = 850 + 0.75Y – 50i
0.25Y = 850 – 50i ….. IS curve
Money market will be in equilibrium when:
Money supply (Ms) = Money demand (Md)
500 = 0.25Y + 125 – 50i
375 = 0.25Y – 50i
0.25Y = 375 + 50i ….. LM curve
Thus, at simultaneous equilibrium,
850 – 50i = 375 + 50i
475 = 100i
i = 4.75
When i = 4.75, 0.25Y = 375 + 50 (4.75) = 612.5
Or, Y = 612.5/0.25 = 2450.
i. Private saving = Y – T – C = 2450 – 1000 – [500 + 0.75(2450 – 1000)]
= 1450 – [500 + 1087.5] = (137.5)
ii. Public saving = T – G = 1000 – 1000 = 0
iii. Domestic saving = Private saving + Public saving = (137.5) + 0 =
Rs .(137.5) crore
Reason :
If interest elasticity of demand for investment and consumption is zero, IS curve is
I LM A
S LM1 Y = 1 − b(1 − t )
i
Hence, equilibrium income depends on the position of IS curve only.
Y
Reason : At simultaneous equilibrium,

0.5Y = 2860 – 60i (or) Y = 5720 – 120i is equal to Y = 2600 + 400i
Or, 5720 – 120i = 2600 + 400i
Or, 3120 = 520i
Or, i = 6
Thus, Y = 2600 + 400(6) = 5000
When government spending is raised to meet the objective, Y = 5000 + 10% = 5500. If Y = 5500,
then using LM function, 400i = 5500 – 2600 (or) i = 7.25%
Initial investment = 800 – 50(6) = 500
New investment = 800 – 50(7.25) = 437.5
Change in investment = 500 – 437.5 = 62.5.
Reason : If the aggregate supply curve slopes up before reading potential real GDP the government must
increase its spending by more than the recessionary gap to reach potential GDP.
< TOP >
30. Answer : (a)
Reason : Advancement in technology increase the productivity of existing factor inputs and shifts the long
run aggregate supply curve towards right. All other factors lead to decrease in the supply.
Reason : High – Powered money (H) = monetary liabilities or central bank + Government money.
Non monetary liabilities = 200 + 80 = 280
Financial assets = Loans given to Government + Credit to banks + Loans given to commercial
section + foreign exchange assets
= 1,200 + 800 + 20 + 1,500
= 3,520
Monetary liabilities = Financial assets + other assets – Non monetary liabilities
= 3,520 + 60 – 280
= 3,300
∴ M = 3,300 + 100 = Rs.3,400 crore.
Reason : 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’ = (2 x 8) + 4 = 20%
Given money multiplier is 4,
Rate of growth of reserve money = 20/4 = 5%.
Reason : Money supply (Ms) = High-powered money (H) x {(1 + Cu)/(Cu + r)}
6000 = (2000 - 500) {(1 + 0.2)/(0.2 + r)
Or, r = 10%.
Reason : Stated differently the real rate of interest is the difference between the interest rate on a loan (or
nominal rate of interest) and the inflation rate.
Reason : When a cheque is drawn on the Central bank, the money in circulation with public increases that in
turn increases the monetary liabilities of the central bank. Since monetary liabilities of the central
bank and government money form part of high-powered money, it also increases by the same
amount for a given increase in monetary liabilities of the central bank. Hence the answer is (b).
Reason : Money multiplier = {(1 + 0.4)/(0.4 + 0.10)} = 2.8

Money supply (before increase of foreign exchange reserves) = 2.8 x H = 2.8 x (50000) = 140,000.
Computation of new CRR:
140,000 = {(1 + 0.4)/(0.4 + r)} (50000 + 500 × 12)
140,000 = {1.4/(0.4 + r)} × 56000
0.4 + r = (1.4 x 56000/140,000)
Or, r = 0.56 – 0.4 = 0.16 = 16%.
Reason : Money supply = High-powered money (H) x Money multiplier

80000 = H x {(1 + 0.2)/(0.2 + 0.1)}
Or, H = 20,000 MUC
H = Monetary Liabilities of the Central Bank + Government money = ML + 1050
Or, ML = 20000 – 1050 = 18950.
Total assets = Total liabilities (= Non-ML + ML)
Total liabilities = Net worth (6000) + Government deposits (150) + Other non-monetary liabilities
(3000) + Monetary liabilities (18950) = 28100.
Thus, total assets = 28100 = (10000 + 4000 + 5000 + 100 + Net foreign exchange assets)
Or, Net foreign exchange assets = 28100 – 19100 = 9,000.
Reason : The term ‘narrow money’ is Currency with the public + Demand deposits of the Banking system +
other deposits with the RBI.
Reason : In the short run, if the price level falls, the real wage rate will be higher than the equilibrium real
wage rate and employment will fall.
Reason : The aggregate supply explains the production behavior of an economy. If the actual price achieved
is more than the expected price, firms will experience a higher than anticipated level of profits. This
will lead to increase in production. That’s why the short run aggregate supply curve slopes upward.
But in the long run, the difference between expected and actual price levels is negligible. In the long
run, the output of an economy doesn’t depend on the price level, but on factors such as labor import
costs, capital stock, technological progress, etc. So aggregate supply curve of an economy in long
run is vertical.
(a) Is the answer because aggregate supply curve is positively sloped in the short run and vertical
in the long run.
(b) Is not the answer because aggregate supply curve is not positively sloped in the short run as
well as in the long run.
(c) Is not the answer because aggregate supply curve is not positively sloped in the short run as
well as in the long run.
(d) Is not the answer because aggregate supply curve is not positively sloped in the short run and
negatively sloped in the long run.
(e) Is not the answer because in the long run, output of an economy doesn’t depend on the price level, but on
factors such as labor import costs, capital stock, technological progress, etc.
Reason : Disguised unemployment arises marginal productivity of labor is zero.
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.
Reason : New classical economist emphasize rational expectations.

Reason : Monetarist and new classical economist theories developed as a response to the problem of
unemployment and inflation at the same time.
Reason : Supply side economics advocates to reduce government controls, to promote competition, to restrict
the power of trade unions and to remove institutional barriers. Supply side economics doesn’t
recommend to increasing corporate tax rate.
(a) Is not the answer because supply side economics recommend reducing government controls to
improve market efficiency
(b) Is not the answer because supply side economics recommend promoting competition to
(c) Is not the answer because supply side economics recommend restricting the power of trade
unions to improve market efficiency
(d) Is not the answer because supply side economics recommend removing institutional barriers to
(e) Is the answer because supply side economics doesn’t recommend increasing corporate tax rate
to improve market efficiency.
Reason : A depression is immediate followed by recovery

(a) During recovery unemployment rate decreases because of picking up of economy activity
(b) Depression is immediately followed by recovery and not recession
(c) Only during boom there will be rapid increase in wages because of high business activity
(d) It is true that during recovery the cost of production will gradually increase because of gradual
increase in wages
(e) Production will increase moderately during recovery.
Reason : The periodic upswings and down swings in the level of economic activity which forms a regular
pattern with an expansion of activity followed by a contraction ,succeeded by further expansion are
referred to as business cycles. Certain features characterize each of the phases.
(a) Mere existence of unemployment cannot be taken, as an indicator of recession or depression,
as in a country like India, even though the economy is growing these is unemployment. Hence
not true.
(b) Price levels are only an indicator of purchasing power, which in turn is dependent on income
levels of the people also. Hence cannot be taken as primarily indicator of the different phases
of business cycles.
(c) By definition, a business cycle is a swing in total national output; income and employment
market by contraction or expansion in many sectors of the economy changes in real GNP
brings changes in prices, employment. Hence only the basis of changes in real GDP different
phases is classified. Hence real GDP is the correct option.
(d) Changes in inventory level do give an indication about the different phases, but the changes
inventory levels are as a result of changes in real GDP.
(e) Gross investment is dependent on future growth rate, which again based on estimation of real
GDP in future. Hence gross investment cannot be primarily indicator.
Reason : Recession is, technically, defined as decline in output for two or more consecutive quarters.
Reason : The slope of the IS curve depends on the (i) sensitivity of investment spending to interest rate and
(ii) multiplier. If the sensitivity of investment spending to interest rate is high, a small change in
interest rate leads to greater change in investment spending and hence aggregate demand. This is
shown by a flatter IS curve. Similarly, the higher the value of multiplier, the higher will be the
change in income for a given change in autonomous factor. Thus, the value of multiplier also affects
the slope of the IS curve. As tax rates, MPI and MPC are determinants of multiplier, any change in
these factors would affect the slope of the IS curve. Mere changes in interest rates do not affect the
slope of the IS curve.
Reason : Phillips curve shows the relationship between the unemployment and inflation. In short-run there
exist inverse relationship between inflation rate and unemployment rate because actual rate of
inflation is not always the same as the expected rate. But in the long run, the actual rate of inflation
equals expected rate and hence the economy automatically reach its natural rate of unemployment.
As there is no trade off between inflation and unemployment in the long run, the long run Phillips
curve is vertical.
Reason : Aggregate supply which shifts left would cause stagflation.

Reason : Cost-push inflation refers to increase in price as a result of the causes originating from the supply
side. The left ward shift of the supply curve occurs as a result of increase in the wage level
unmatched by the increase in the labour productivity, increase in the profit margins by those who
can exercise the market power and supply shocks.
a. Decrease in wages leads to decrease in cost of production and hence prices will reduce if the
producer passes on to the consumer
b. When the productivity of labour increase it leads to lowering the cost of production per unit
and hence the prices will decrease
c. As the cost of raw material increases it leads to increase in cost of production which results in
increases in prices. Hence this option is correct
d. Right ward shift in the supply curve occurs when there is a decrease in prices and hence not
the correct option
e. Finding of new raw material would lead to lower cost of raw material as the supply of raw
material has increased and hence lowers the prices.
Reason : A country may be able to correct its persistent balance of payments deficit by reducing the
international value of its currency
Reason : Foreign exchange by MMTC represents a credit entry in India’s Balance of Payments Statement.
Options in a, b, c and e are debit entries in India’s Balance of Payments Statement.
Reason : Rajesh, who remitted $1000 to his parents staying in India forms private transfers. Private transfers
are part of invisibles.
a. Capital account includes those transactions that include all international purchases or sales of
assets such as real estate or government securities. It also includes banking capital.
b. The data collection process that underlies the published balance of payments figures is far
from perfect. Because total debits must equal total credits in principle, statisticians insert a
residual to make them equal. This correcting entry is known as statistical discrepancy or errors
and omissions (statistical discrepancy).
c. Merchandize imports and exports record transactions relating to goods purchased and sold by
the domestic country. It does not include transfers.
d. Invisibles have been sub-divided into services, transfers and investment income. Hence (d)
is the answer
e. External assistance includes concessional loans given to government or public sector bodies
and hence is a capital account item.
Reason : Change in foreign exchange reserves = Current account balance + Capital account balance
Current account balance = (116,320 + 230,010 + 4000 + 1000) - (140,240 + 125,234 + 2000) =
351330 – 67474 = 83856 i.e. current account surplus (Credit)
Thus, change in foreign exchange reserves = 83856 + 202,000 = Rs.285856 crore.
Reason : Efforts should be made to substantially raise the tax – GDP ratio for resources mobilization in a
non-inflationary manner.
Reason : The laffer curve explains the relationship between total tax revenue and tax rates.
Reason : Every economy goes through cyclical fluctuations in output, employment and prices. This will have
an automatic impact on certain government expenditures and revenues. The changes in the
government spending and revenues that results automatically as the economy fluctuates are called
non-discretionary fiscal policy. Automatic stabilizers are features of the government budget that
automatically adjust net taxes to stabilize aggregate demand as the economy expands or contracts.
(a) Is not the answer because an automatic stabilizer is not a mechanism in the stock market
that automatically cause stock market gains to be cancelled out by losses.
(b) Is not the answer because automatic stabilizer is not the invisible hand mechanisms,
which automatically bring the economy out of a recession.
(c) Is the answer because automatic stabilizer refers to Government revenues and expenditures
that change automatically in response to changes in economic activity. When the economy is
in a contraction phase, these stabilizers increase transfer payments and reduce tax collections
in order to stimulate aggregate demand. On the other hand, when the economy begins to
expand, the automatic stabilizers increase tax collections and reduce transfer payments in order
to restrain growth in the aggregate demand.
(d) Is not the answer because automatic stabilizer is a discretionary fiscal policy.
(e) Is not the answer because Policy instrument of the Government to stabilize the exchange rate
of home currency does not refer to the automatic stabilizers.
Reason : Value-added tax (VAT) is a good example of which kind of tax sales tax.
Reason : Outside lag ’is the duration involved for output and employment to respond to changes of the
implemented of policies. Taxes have the least outside lag.
(a) Is not the answer because cash reserve ratio has not the least outside lag
(b) Is not the answer because bank rate has not the least outside lag
(c) Is not the answer because repo rate has not the least outside lag
(d) Is the answer because tax has the least outside lag
(e) Is not the answer because open market operation has not the least outside lag.
Reason : An expansionary fiscal policy shifts the IS curve to the right. And a liberal monetary plicy shifts the
LM curve to the right. It will result in a higher level of output, but the level of interest rate is
dependent on the relative magnitude of fiscal and monetary policies
(a) Is not the answer, because an expansionary fiscal policy combined with a liberal monetary
policy does not result in a lower level of output and a lower interest rate.
(b) Is not the answer because an expansionary fiscal policy combined with a liberal monetary
policy does not result in a lower level of output and a higher interest rate.
(c) Is not the answer because an expansionary fiscal policy combined with a liberal monetary
policy results in a higher level of output but not a lower interest rate.
(d) Is not the answer because an expansionary fiscal policy combined with a liberal monetary
policy results in a higher level of output but we can’t say that it results in a higher interest rate.
(e) Is the answer because an expansionary fiscal policy combined with a liberal monetary policy
result in higher level of output, but the level of output, but the level of interest rate is
dependent on the relative magnitude of fiscal and monetary policies.
Reason : It would be appropriate for the RBI to pursue a expansionary monetary policy during a period of
deflation. Through expansionary monetary policy RBI would like to increase the aggregate demand
in the economy thereby causing the prices to increase. Of all the options, only open market purchase
of government securities is an expansionary monetary policy. All other options are contractionary
monetary policies.
Reason : Monetary policy mainly controls the economy by regulating the interest rates through changes in
money supply. If the private investment is more sensitive to interest rate, then monetary policy can
more effectively regulate the economy.
(a) A recessionary condition cannot make a monetary policy more effective.
(b) When private investment is more sensitive to interest rate monetary policy will be more effective as a small
change in the interest rate would lead to a greater change in the output.
(d) During liquidity trap, the effectiveness of monetary policy decreases because during such policy, changes in
interest rate cannot have any effect on investments.
(e) Effectiveness of the monetary policy is not determined by the phases of business cycle.
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.
Reason : Consumption income ratio = 0.72

Saving – income ratio = 1 – Consumption Income ratio = 0.280
ICOR = 4
Savings - Income ratio 0.28
= ×100
1COR 4
Rate of growth of NI = = 7%.
Rate of growth of PCI = Rate of growth of NI – Population growth rate = 7% – 3% = 4%.
Reason : Growth = 1.5 + 4.5 = 6%

Rate of investment = 5 × 6
= 30%.
Reason : The depreciation in the value of rupee is aimed at increasing exports

Reason : Dutt committee is appointed by government of India, in July 1967, submitted a report on the
working of the licensing system during the past ten years.
Reason : Personal Disposable Income = Personal income – personal taxes

= Factor incomes received by the household sector + Transfer payments – personal Taxes
= 632 + 21 – 94 = Rs.559 crore.
Note: Compensation to employees paid by the Government and profit distributed as dividends by
the firms are included in the factor income received by the household sector.
Reason : GDP deflator = Nominal GNP/Real GNP

Nominal GNP =
35 × 2 = 70
65 × 6 = 390
60 × 5 = 300
40 × 4 = 160
50 × 3 = 150.
Real GNP = 70 +390 + 300+160 + 150 = 1,070
35 × 2.5 = 87.5
65 × 8 = 520
60 × 6 = 360
40 × 5 = 200
50 × 4.50 = 225
Nominal GNP = 87.5 + 520 + 300 + 160 + 150 = 1,392.5
GDP deflator = 1,392.5/ 1,070 = 130.14 = 130.
Reason : Corporate profits = Corporate profit tax + Dividends + Retained earnings

= 50 + 15 + 20 = 85
Reason : Demand for money is estimated to be L = 0.25Y – 10i.

At i= 6 %, L = 0.25Y – 60.
At equilibrium demand for money = Supply of money
∴ 0.25Y – 60 = 200
0.25Y= 260
Y = 1,040 MUC.
Reason : 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 +
Rs.6200billion = 2000+3000+2200-1200+ Government money
Government money = Rs.200billion
Reason : Overall balance of payment = Total Credit of the Bop – Total debit of the Bop
= 1,46,559 – 1,29,579
= Rs.16,980 crore (surplus)
Reason : Change in forex reserves = Current a/c balance + Capital a/c balance
∴ Capital a/c balance = ∆ Forex reserves + Current a/c deficit
= 1000 + 5000
= 6000.
Reason : Current account balance = Credit (Current account )– debit (Current account)
= [Earnings on loans and investments from abroad + Private remittances from abroad (transfers) +
Exports of services + Merchandize exports] – [Earnings on loans and investments to abroad +
Private remittances to abroad (transfers) + Import of services + Merchandize imports] = [500 + 500
+ 2,000 + 15,00] – [2,500 + 500 + 4,000 + 12,000]
= 18,000 – 19,000 = –1,000 i.e. Rs.1,000 crore (Deficit)
Reason : Primary deficit = Fiscal deficit – interest payment

= Rs.153,637 Cr. – 123,223 Cr. = Rs.30,414 Cr.
Where Fiscal deficit = Borrowings and other liabilities of the government
= Rs.153,637 Cr.
Reason : Revenue deficit = Revenue expenditure – Revenue receipt

Revenue Expenditure = Non plan revenue expenditure + Plan revenue expenditure
= 2,89,384 + 76,843
= 3,66,227
Revenue receipts = Tax revenue + Non. Tax revenue
= 1,84,169 + 69,766
= 2,53,935
∴ Revenue Deficit = 3,66,227 – 2,53,935
= Rs.1,12,292 cr
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Question Paper

Economics II (122) : October 2004

(a) Only (I) above (b) Only (III) above

Tax rate (t) = 25%

Particulars Rs. Crore

Particulars Rs. Crore

Reason : A variable is a stock if it is measured at a particular point of time. It is a flow variable if it is

Reason : Nominal rate of interest = Real rate of interest + Inflation = 5 + 2 = 7%

Reason : According to the Income Method

Reason : If Yd is zero, consumption is 1000, which is autonomous consumption. This consumption is

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

Reason : If Government expenditure increase by 475 MUC,

Reason : Mt = 0.25Y = 0.25 (12000) = 3,000

Reason : There will not be any crowding out if i = 8%

Reason : At simultaneous equilibrium,

Reason : Rate of growth of money stock (gM) = a.gY + gP

Reason : Money multiplier = {(1 + 0.4)/(0.4 + 0.10)} = 2.8

Reason : Money supply = High-powered money (H) x Money multiplier

Reason : New classical economist emphasize rational expectations.

Reason : A depression is immediate followed by recovery

Reason : Aggregate supply which shifts left would cause stagflation.

Reason : Consumption income ratio = 0.72

Reason : Growth = 1.5 + 4.5 = 6%

Reason : The depreciation in the value of rupee is aimed at increasing exports

Reason : Personal Disposable Income = Personal income – personal taxes

Reason : GDP deflator = Nominal GNP/Real GNP

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

Reason : Demand for money is estimated to be L = 0.25Y – 10i.

Reason : Primary deficit = Fiscal deficit – interest payment

Reason : Revenue deficit = Revenue expenditure – Revenue receipt

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