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Question Paper
Economics - II (MSF1A4): January 2008
• Answer all 74 questions.
• Marks are indicated against each question.

Total Marks : 100

<Answer>
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:
Million Units of
Particulars
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

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(b) – 0.25
(c) 1.00
(d) 1.25
(e) Insufficient data.
(1 mark)
<Answer>
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 3,400
Transfer payments 484
Indirect taxes 346
Personal taxes 406
Consumption of capital 380
Undistributed corporate profits 56
Corporate tax 150
Subsidies 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

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(e) Human resources.

(1 mark)
<Answer>
13. The following information is available from the consolidated balance sheet of the banking sector:
Particulars Rs. billion
Net Bank Credit to the Government 14,000
Bank Credit to the Commercial Sector 21,000
Net Foreign Exchange Assets of the Banking Sector 15,400
Net 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 equilibrium 0.5Y = 2,925 – 37.5i
Money market equilibrium 0.25Y = 312.5 + 125i
Exports 550 MUC
Import function 20 + 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 4,500
Wages & Salaries 2,700
Interest income 675
:
Rental income : 450
The 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 9,600
Indirect taxes 45,600
Factor income paid abroad 48,000
Factor income received from abroad 36,000
Depreciation 48,000
Surplus 4,200

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Subsidies 24,000
National 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)
<Answer>
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:
Primary Secondary Tertiary
Items
Sector (MUC) Sector (MUC) Sector (MUC)
Sales 200 300 260
Closing Stock 30 40 50
Intermediate Consumption 30 50 30
Opening Stock 20 20 30
Indirect taxes 24 26 34
Depreciation 20 24 30

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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)
<Answer>
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 MUC
Government spending (G) = 60 MUC
Tax 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 by
Ct = 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

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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)
<Answer>
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

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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: <Answer>

Government spending (G) = 1,000 MUC

Taxes (T) = 1,000 MUC
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) = 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)
40. A price index equal to 90 in a given year <Answer>

(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)
41. As on December 31, 2007, monetary liabilities of the central bank are 1,500 MUC and government money <Answer>
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

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(e) 9,180 MUC.

(2 marks)
42. If government spending increases by the same amount as taxes, the effect is <Answer>

(a) Neutral
(b) Expansionary
(c) Contractionary
(d) First expansionary then contractionary
(e) Indeterminable.
(1 mark)
43. The following balances are taken from the balance sheet of the Central Bank of a country: <Answer>

Particulars MUC
Net worth 1,000
Credit to Central Government 2,500
Credit to commercial banks 1,250
Other non-monetary liabilities 250
Other assets 500
Government deposits 250
Foreign 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 3,000
Investment in fixed capital 1,000
Increase in stock 600
Government expenditure 400
Merchandise exports 200
Imports 600
Money 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:

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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)
<Answer>
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 ratio 0.34

Financial interrelation ratio 0.32

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

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External Assistance 8,319 15,699

Commercial Borrowings (MT & LT) 8,211 13,305
Commercial Borrowings (Short Term) 24,567 21,630
Commercial Banks 60,778 16,919
Others 1,608 738
Rupee Debt Service – 1,422
Other Capital 19,206 8,727
Errors & 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)
<Answer>
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

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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)
<Answer>
57. The following information is extracted from the Union Budget for the year 2006–07:
(Rs. In crore)
Tax Revenue (net to Centre) 7,36,676
Non-tax revenue 3,79,064
Recoveries of Loans 72,092
Other Receipts 52,800
Borrowings and other Liabilities 6,14,548
Non-plan Expenditure
On Revenue Account (of which Interest Payments is 11,57,536
Rs.4,92,892 cr.)
On Capital Account 1,13,748
Plan Expenditure
On Revenue Account 6,07,372
On 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)
60. The following data is available for an economy: <Answer>

Particulars MUC
Export of services 13,000
Import of services 9,000
Government loans to abroad 190
Government loans from abroad 120
Direct investment abroad 130
Foreign direct investment in the country 560
Short-term loans and investment abroad 1,300
Foreign 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.)

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(d) 690 MUC (Dr.)

(e) 1,655 MUC (Cr.)
(2 marks)
<Answer>
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.

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

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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)
<Answer>
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)

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 < TOP
coal. This would cause the short-run aggregate supply curve to shift to the left. >

2. C Net factor Income from Abroad (NFIA) = NNPat factor cost – NDPat factor cost < TOP
>
NDP at factor cost = 1,25,000 MUC
NNP 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
3. E A construction worker who has been laid off during a recession is an example of cyclical < TOP
unemployment. >

4. E At equilibrium, Y = C + I + G = 60 + 0.50Y + 90 + 20 = 170 + 0.5Y < TOP

>
0.5Y = 170
Y = 170/0.5 = 340 MUC.
5. A The long-run aggregate supply is fixed at potential output and cannot shift to the right is a false < TOP
statement. >

6. B APC + APS = 1 < TOP

>
Thus, APS = 1 – APC = 1 – 1.25 = – 0.25
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 < TOP
payments >

National Income = GNP at market price – Depreciation – Indirect taxes + Subsidies

= 3,400– 380– 346 + 40 = 2714
∴Personal Income = 2714 – 56 – 150 + 484 = 2992 MUC
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. < TOP
>
(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 < TOP

>
= S + 0.20Y
At equilibrium
Ms = Md
S + 0.20Y = 250
Y1 = 800 MUC
S1 = 250 – 0.20 x 800 = 90
Y2 = 900 MUC
S2 = 250 – 0.20 x 900
= 250 – 180 = 70
Change in Money available for speculations purposes
= 70 – 90
= – 20 MUC.
12. A Economic growth refers to situation where increased productive capabilities of an economy are < TOP
made possible by either an increasing resource base or technological advance. A country, thus, >
can achieve economic growth through:
(a) Improvement in technology
(b) Natural resources
(c) Capital
(d) Human resources
Change in tastes and preferences of consumers only affect the demand of an individual good or
services, and it does not increase the production capabilities of an economy.
13. B Money Supply = Net bank credit to Government + Bank credit to commercial sector + Net < TOP
foreign exchange assets of the banking sector – Net non-monetary liabilities of the banking >
sector + Government money
Rs.45000billion = 14,000+ 21,000 + 15,400– 8,400 + Government money
Government money = 45000–42000 = Rs.3000 billion.
14. D Monetarists and new classical economists believe that wages and prices are flexible in the short < TOP
run. >

15. C Goods market equilibrium: < TOP

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

>
NNP at factor cost
= GDP at market price – Indirect taxes + subsidies + NFIA – Depreciation
Or, GDP at market price
= NNP at factor cost + Indirect taxes – subsidies - NFIA + Depreciation
= 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
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 < TOP
save. And greater the fraction of any additional disposable income consumer will spend. >

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 = 30,000 < TOP

>
C = 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.
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 + < TOP
Subsidies >

∴ Value added by Primary sector = 200 – 30 – 24 + 14 = 160

Value added by Secondary sector = 300– 50 – 26+ 16 =240
Value 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 = 610
Depreciation = 20 + 24+ 30 = 74
∴ GDP factor cost = 610+ 74 = 684 MUC
24. C Increased government spending in the absence of increased taxes could be a cause of demand- < TOP
pull inflation. >

25. A Y = C + I+ G < TOP

>
Y = 50 + 0.75Yd + 90 + 60
Y = 50 + 0.75 (Y – 0.2 Y)+ 90 + 60
Y = 50 + 0.75 Y – 0.15 Y+ 90 + 60
Y = 200 + 0.6Y
0.4Y = 200
Y = 500
∴ Budget surplus = T – G = 0.2 (500) – 60 = 100 – 60 = 40 MUC.
26. A If one country buys cars from another country, it is recorded in the current account of the balance < TOP
of payments. >

27. C Multiplier = 1/(1 – MPC + MPI) = 1/(1 – 0.70 + 0.2) = =2 < TOP
>
Thus if investment increases by 2,500, income increases by 2500 × 2= 5,000 MUC.
28. A The aggregate supply curve in the classical model is vertical because Factor such as labor import < TOP
costs, capital stock technological progress are not influenced by changes in the average price >
level.
29. B At steady state, < TOP
>
C t = Ct – 1

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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’ < TOP
>
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).
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= 2 < TOP
>
Thus if investment increases by 1250, income increases by 2500. Thus, change in trade balance
= – 0.1 x 2500= (250) MUC.
33. A To increase the money supply, the Reserve Bank of India would decrease the reserve < TOP
requirement and the discount rate, and buy bonds. >

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

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

36. E Goods market will be in equilibrium when Y = AD = C + I + G < TOP

>
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)
700 = 0.25Y + 125 – 50i
575 = 0.25Y – 50i
0.25Y = 575 + 50i ….. LM curve
Thus, at simultaneous equilibrium,
850 – 50i = 575 + 50i
275 = 100i
i = 2.75
When i = 2.75, 0.25Y = 575 + 50 (2.75) = 712.5
Or, Y = 712.5/0.25 = 2,850 MUC
37. C High powered money = monetary liabilities + government money = 13,500 + 1,500 < TOP
>
= 15,000
Ms = H ×
60,000 = 15,000
= (1 + 0.25)/(0.25 + r) = 4
= 1 + 4r = 1 + 0.25
4r = 0.25
r = 0.0625 = 6.25%
38. A GDP as expenditures can be expressed as C + I + G + NX. < TOP
>

39. E At equilibrium, IS = LM < TOP

>
Y = 7700 + 0.5Y – 100i

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0.5Y = 7700 – 100i

Y = 15400 – 200i ………. IS function
Y = 6200 + 800i ………. LM function
Thus at simultaneous equilibrium,
15400 – 200i = 6200 + 800i
Or, 9200 = 1000i
Or, i = 9.2
When government spending increases by 200, the IS function becomes
0.5Y = (7700 + 200) – 100i
0.5Y = 7900 – 100i
Or, Y = 15800 – 200i
Thus, at equilibrium,
6200 + 800i = 15800 – 200i
Or, 1000i = 9600
Or, 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 < TOP
year. >

41. D Stock of high powered money ( H) < TOP

>
= monetary liabilities of the central bank + government money = 1600 MUC
Current deposit ratio (Cu) = 0.20
Reserve ratio (r) = 0.05
∴ Money supply Ms- =
=
= 4.8 × 1600
= 7,680 MUC
42. B If government spending increases by the same amount as taxes, the effect is expansionary. < TOP
Because income increase more than government spending due to the presence of the multiplier >
effect.
43. C High-powered money (H) = Monetary liabilities of Central Bank + Government money = 3250 + < TOP
625= 3,875 >

Total 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+ ML
Or, ML = 3,250
44. D A lender who does not expect any change in the price level is willing to make a mortgage loan at < TOP
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.
45. D Velocity of money = < TOP
>
Y = 3,000+1,000+600+400+200–600=4600
∴ Velocity of money =
46. A An economy is in equilibrium at price level P0 and output level Y0. If the price of oil increases in < TOP
>
the economy, the new equilibrium price will greater than P0 and the new equilibrium level of
output will be less than Y0.

47. C Rate of growth of money stock (gM) = a.gY + gP < TOP

>
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%

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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 = < TOP

>
∴ Total Issue = Finance Ratio × National Income = 0.34 × 28,000
= 9520 MUC
50. B Overall balance of payment < TOP
>
= Total Credit of the Bop – Total debit of the Bop
= 449677 – 378737
= Rs. 70940million (surplus)
51. A The graph that shows the relationship between the aggregate quantity of output supplied by all < TOP
the firms in an economy and the overall price level is the aggregate supply curve. >

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 < TOP
is >

Y=
Hence, equilibrium income depends on the position of IS curve only.
54. C Required nominal growth rate = Real GDP growth rate + Population growth rate < TOP
>
= 10% + 4% = 14%
Thus, investment requirement = Required nominal growth rate × Incremental capital
output ratio
= 14 x 3 = 42% of GDP
55. A If the Reserve bank of India accommodates a fiscal expansion by increasing the money supply so < TOP
that the interest rate does not increase, the crowding-out effect will zero. >

56. A If firms sharply increase the number of investment projects undertaken when interest rates fall < TOP
and sharply reduce the number of investment projects undertaken when interest rates increase, >
then expansionary monetary police will be very effective.
57. B Revenue deficit = Revenue expenditure – Revenue receipt < TOP
>
Revenue Expenditure = Non plan revenue expenditure + Plan revenue expenditure
= 1157536 + 607372
= 1764908
Revenue receipts = Tax revenue + Non. Tax revenue
= 736676+ 379064
= 1115740
∴ Revenue Deficit = 1764908– 1115740
= Rs.649168 cr
58. D It is important to distinguish between a concept like “rational expectations” and some of its < TOP
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 < TOP
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.
60. D Capital account balance: (Government loans from abroad – Government loans to abroad – Direct < TOP
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.)
61. A Leakages are factors which tend to decrease the level of national income. Savings tend to < TOP
decrease the national income and so does imports >

62. B Stocks and flows variables are very essential in studying macroeconomics. < TOP
>
(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.
63. C Bank rate, cash reserve requirements, open market operations and statutory liquidity ratio are the < TOP
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.
64. E Inflation rate = rate of growth of nominal money supply – rate of growth of real money demand < TOP
growth of real money demand= income elasticity of money demand × growth of real income = >

20 – (2/3×3) = 18%
65. B Sterilization means neutralization of changes in the money supply caused by changes in the < TOP
foreign exchange reserves of a country. >

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

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

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

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69. C Supply side economics advocates promoting competition, decreasing role for the state, incentives < TOP
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).
70. B (a) It is not the answer since NNP at factor cost plus depreciation = GNP at factor cost < TOP
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.
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 < TOP
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.
73. B National income (NI) = Factor income received by domestic residents + Factor income received < TOP
by domestic residents from foreigners + corporate profit taxes + retained earnings = 3,300+132 >
+99+165 = 3,696MUC.
74. B If money supply increases by 10% and the price level increases by 8%, then the LM curve shifts < TOP
to the right. >

< TOP OF THE DOCUMENT >

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