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Indian Institute of Management Bangalore


Section C
(Chiranjib Sen)

Date: February 16, 2005

Time: 2.5 hours
Max marks=100

Part 1 Multiple Choice ProblemsEach carries 2 points (44 marks total)

1. The difference between microeconomics and macroeconomics is that

a. microeconomics looks at supply and demand for goods, macroeconomics looks at
supply and demand for services.
b. microeconomics looks at prices, macroeconomics looks at inflation.
c. microeconomics looks at individual consumers, macroeconomics looks at national
d. microeconomics looks at national issues, macroeconomics looks at global issues.

2. The classical approach to macroeconomics assumes that

a. wages, but not prices, adjust quickly to balance quantities supplied and demanded
in markets.
b. wages and prices adjust quickly to balance quantities supplied and demanded in
c. prices, but not wages, adjust quickly to balance quantities supplied and demanded
in markets.
d. neither wages nor prices adjust quickly to balance quantities supplied and
demanded in markets.

3. Keynes was motivated to create a macroeconomic theory different from classical theory
a. he believed in government intervention in the economy.
b. he believed in the idea of the invisible hand.
c. monetary policy was more important than the classicals acknowledged.
d. classical theory was inconsistent with the data in the Great Depression.

4. Assume the government changed welfare to workfare, that is, everyone receiving
government transfer payments now had to work for the government and now would
receive a salary. How would GDP be affected?

a. GDP would increase

b. GDP would decrease

c. The change in GDP would depend on whether the salary is greater or less than
the transfer
d. GDP would not change if the payment is the same in both cases

5. What is the difference between GDP and GNP?

a. GNP does not account for depreciation (capital consumption allowances)

b. GNP includes payments to domestically owned factors of production abroad
c. GNP includes indirect taxes but GDP does not
d. GNP does not include government transfer payments but GDP does

6. Assume a model with no government and no foreign sector. If we had savings function
that is defined as S = - 200 + (0.1)Y and autonomous investment decreases by 50, by how
much will consumption change?

a. 100
b. 150
c. 250
d. 450

7. Equilibrium in the economy means

a. unemployment is zero
b. quantities demanded and supplied are equal in all markets
c. tax revenues equal government spending, so the government has no budget deficit.
d. aggregate consumption is exactly as predicted by the consumption function

8. The Keynesian approach to macroeconomics assumes that

a. prices, but not wages, adjust quickly to balance quantities supplied and demanded in
b. wages, but not prices, adjust quickly to balance quantities supplied and demanded in
c. neither wages nor prices adjust quickly to balance quantities supplied and demanded
in markets.
d. wages and prices adjust quickly to balance quantities supplied and demanded in

9. According to the life-cycle theory of consumption, an individual's

a. mpc out of transitory income is fairly large

b. mpc out of transitory income is fairly small
c. level of consumption sharply decreases after retirement
d. level of consumption is not affected by changes in wealth

10. The 23% drop in stock values in the crash of 1987 (in the USA) roughly constituted a
$500 billion decline in wealth. According to the life-cycle theory of consumption, what
should we have seen as a result?

a. no change in current consumption since financial investors lost only what they
previously gained
b. an increase in consumption since people sold their stocks
c. a decrease in current consumption of almost $500 billion
d. only a fairly small drop in current consumption due to the wealth effect

11. Assume a worker at age 30 with annual earnings of Rs. 50,000, who wants to retire at age
65 and expects to live until age 80. How much would that person's annual consumption

a. Rs.45,000
b. Rs.40,000
c. Rs.35,000
d. Rs.30,000

12. In a model with no government and no foreign sector, if autonomous consumption is C*

= 200, autonomous investment is Io = 100, and the level of equilibrium income 1,200,
then the marginal is propensity to save is

a. 0.10
b. 0.25
c. 0.50
d. 0.75

13. According to the permanent-income theory of consumption

a. the short-run multiplier is identical to the long-run multiplier

b. the short-run multiplier is larger than the long-run multiplier
c. the short-run mpc is larger than the long-run mpc
d. the short-run mpc is smaller than the long-run mpc

14. Assume a model with no government or foreign sector. If an increase in autonomous
investment of 200 leads to an increase in consumption of 600, then the size of the
expenditure multiplier is

a. 4.0
b. 3.0
c. 2.0
d. 0.75

15. Because government services are not sold in markets,

a. they are excluded from measurements of GDP.
b. the government tries to estimate their market value and uses this to measure the
government's contribution to GDP.
c. they are valued at their cost of production.
d. taxes are used to value their contribution.

16. Beautiful Boating purchases five new boats at $200 thousand each to rent to vacationing
fishermen. The firm sells its old boats to the public for $500 thousand. The net increase in
GDP of these transactions was
a. $ 500,000.
b. $1,000,000.
c. $1,250,000.
d. $1,500,000

17. Consumer spending is spending by _____ households on final goods and services produced
a. domestic; domestically and abroad
b. domestic; domestically
c. domestic and foreign; domestically and abroad
d. domestic and foreign; domestically

18. Nominal GDP in 1970 was $1,035.6 billion, and in 1980 it was $2,784.2 billion. The GDP
price index is 30.6 for 1970 and 60.4 for 1980, where 1992 is the base year. Calculate
the percent change in real GDP in the decade from 1970 to 1980. Round off to the
nearest percentage point.
a. 36%
b. 97%
c. 136%
e. 169%

19. The A company collects bushels of wild berries, which it sells for $2 million to the B
company to be made into jam. The B company's wild berry jam is sold for a total of $6
million. What is the total contribution to the country's GDP from companies A and B?
a. $2 million
b. $4 million
c. $6 million
d. $8 million

20. To what extent are homemaking and child-rearing accounted for in the government's GDP
a. not at all
b. only to the extent that they are provided for pay
c. only to the extent that taxes are paid on them
d. all homemaking and childrearing are accounted for

21. If an American construction company built a road in Kuwait, this activity would be
a. excluded from U.S. GNP.
b. fully included in U.S. GDP.
c. included in U.S. GNP only for that portion that was attributable to American
capital and labor.
f. included in U.S. GDP but not U.S. GNP.

22. Assume the savings function is of the form S = - 200 + (1/4)YD and the income tax rate
is t = 20%. If the level of government spending increases by 100, by how much will the
level of equilibrium income change?

a. 250
b. 300
c. 400
d. 800

Part 2: True, False Questions. Decide whether each statement is true or false and justify
your answer with a short argument (5-6 lines please). (4 marks for each question, total for
part 2 is 20 marks)

23. The real output per capita is one of the best measures of the standard of living.

24. An increase in the personal savings rate reduces aggregate demand, so it is

unambiguously bad for short and long-term growth.

25. Inflation rates calculated using the consumer price index and the GDP deflator are

26. In order to stimulate the economy, it would be a good policy to introduce a Rs. 2000
crores tax cut, along with a Rs. 2000 crore cut in government expenditure.

27. Expansionary fiscal policy will pay for itself, as it raises income and hence tax revenues.

Part 3: Each question in this part carries 18 marks. Total marks for part 3 is 36.

28. Assume a macro-economic model with income taxes. You have only limited
information about the model. You know that the marginal propensity to consume
out of personal disposable income c =0.75. Total autonomous spending, Ao = 900.
Thus: Aggregate demand AD = Ao + c/ * Y = 900 + c/ * Y, where Y is national income
and output. You also know that the full employment level of income Y* = 3150 can be
reached by increasing government transfer payments by a lump sum increase of 200, i.e.,
TR =200.

(a) What is the current equilibrium level of income?

(b) Can you determine the value of the multiplier on the basis of the above
(c) Suppose you wishes to reach the full-employment level of output by changing the
income tax rate t. What would be the new value of the multiplier after the income
tax rate has been changed appropriately?

29. There are an orange farm and an orange juice company in a country called
Orangeland. Orangelanders live only on orange juice. In 1992, the orange farm
produced 10 oranges,and sold them to the orange juice company at $1 each. The
orange juice company produced 3 bottles of orange juice, and sold them all at a
unit price of $10 plus 10% indirect tax collected by government (so the price
paid was actually $11). The orange farm paid total wages of $6. The orange

juice company paid total wages of $10. The orange juice company also had to
pay $4 to replace the orange juice extractor that was not working properly due
to its use during 1992 (depreciation). Both companies retained 50% of their
profits and paid the rest of it as dividends to the households. After receiving
their wage income and their dividends, the households paid a 10% direct tax on
their total income to the government. The government bought one orange juice
bottle. (Notice that the firms are not paying any direct taxes on their retained

(a) Compute the GNP of Orangeland using the value added approach or the
final goods approach.
(b) What is NNP? What is National Income?
(c) What is government budget deficit (or surplus)?