Question Paper

Economics – II (122) : April 2004

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

< Answer
1. The term “rational expectations” is most accurately associated with the notion that >

(a) Economic policy is ineffective and should not be used in a discretionary way
(b) It is always possible to reduce inflation without recession by simply letting aggregate demand fall
which it will do automatically
(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
of the future
(e) All of the above.
(1 mark)
< Answer
2. A current account deficit >

(a) Is never possible because the balance of payments must always balance
(b) Can seldom be larger than 50% of a capital account surplus
(c) Can be used to help finance a government deficit indefinitely
(d) Can be used to help finance a government deficit if foreign lenders accumulate government bonds
(e) Does not include investment earnings that are part of the capital account.
(1 mark)
< Answer
3. A logical extension of the Phillips curve relationship between inflation and the difference between >
actual and potential GNP is that
(a) The inflation rate and the unemployment rate should be positively correlated
(b) The inflation rate and the natural rate of unemployment should be positively correlated
(c) The inflation rate and the unemployment rate should be negatively correlated
(d) The inflation rate and the natural rate of unemployment should be negatively correlated
(e) The difference between actual and potential GNP should be negatively correlated with the
difference between actual and full employment.
(1 mark)
< Answer
4. To avoid double counting, when the GNP is estimated, economists >

(a) Price all goods and services bought and sold in all markets
(b) Use the GNP deflator
(c) Price only intermediate goods
(d) Calculate value added at each stage of production
(e) Only price goods for sale at retail shops.
(1 mark)
< Answer
5. The IS curve is based on which of the following assumptions? >

(a) There is only one interest rate and income level at which the product market can be in equilibrium
(b) Investment equals savings at equilibrium, investment increases with income, and saving is related
to interest
(c) Money market equilibrium can occur at many levels of interest and income
(d) Investment and savings decisions vary inversely with income
(e) Stock market prices are generally high when interest rates are low.
(1 mark)
< Answer
6. During inflation >
 (a) Lenders lose, borrowers gain (b) Borrowers lose, lenders gain
(c) The real interest rate rises (d) Borrowers and lenders both lose
(e) Unemployment increases.
(1 mark)
< Answer
7. Crowding-out refers to >

(a) Imports replacing domestic goods

(b) Government spending reducing private spending
(c) The central government expenditure replacing state and local government expenditure
(d) Fiscal policy negative effects on monetary factors
(e) The central government budget deficits’ negative effects on balance of payments.
(1 mark)
< Answer
8. For the economy to have an unambiguously higher level of investment, given that the government is >
running a budget deficit, the proper monetary policy and fiscal policy mix would be
(a) Easy money and a government induced increase in personal income tax
(b) Easy money and a government induced decrease in personal income tax
(c) Tight money and reduced government spending
(d) Tight money and increased government spending
(e) None of the above.
(1 mark)
< Answer
9. From a Keynesian perspective, business investment will decline as a result of >

(a) A fall in the interest rate (b) A decrease in business taxes

(c) A decline in business expectations (d) Acceleration of business depreciation
(e) An increase in consumption expenditure.
(1 mark)
< Answer
10. Which of the following is not a stock variable? >

(a) Foreign exchange reserves (b) Public debt (c) Wealth of a country
(d) Inflation (e) Money supply.
(1 mark)
< Answer
11. Which of the following statements is true with regard to price indices? >

(a) GDP deflator measures the cost of buying a fixed basket of goods and services
(b) Consumer Price Index (CPI) measures the prices of a larger basket of goods than the GDP deflator
does
(c) When automobile production in the economy is relatively large, automobiles receive a relatively
larger weight in the computation of the GDP deflator
(d) If prices of imports increase, the GDP deflator also increases
(e) When automobile production in the economy is relatively large, automobiles receive a relatively
larger weight in the computation of the CPI.
(1 mark)
< Answer
12. Which of the following is not a component of aggregate expenditure in an economy? >

(a) Consumption (b) Investment

(c) Government purchases (d) Net exports
(e) Taxes.
(1 mark)
< Answer
13. Which of the following is true when the consumption function is above the 45° line? >
 (a) Consumption exceeds income and saving is negative
(b) Consumption is less than income and saving is negative
(c) Consumption exceeds income and saving is positive
(d) Consumption is less than income and saving is positive
(e) None of the above.
(1 mark)
< Answer
14. The unemployment in the Keynesian model is caused by >

(a) Demand deficiency (b) Supply deficiency

(c) Excess demand (d) Excess supply
(e) Both (a) and (b) above.
(1 mark)
< Answer
15. Suppose there is a broad increase in the price of stocks, which causes an increase in the wealth of >
individuals. Consumption spending in the economy rises in response to the increase in wealth. This will
cause
(a) The aggregate demand curve to shift to the left
(b) The rate of unemployment to decrease
(c) The general price level to fall
(d) The aggregate supply curve to shift to the right
(e) The aggregate demand curve remains at the present level.
(1 mark)
< Answer
16. Which of the following is a liability for a commercial bank? >

(a) Reserves with the RBI (b) Loans to Public Sector Undertakings
(c) Credit to the Central Government (d) Deposits from the public
(e) Discounted commercial bills.
(1 mark)
< Answer
17. Which of the following is a new classical view of the economy? >

(a) Fiscal policy tools are the most preferred means of stabilization
(b) Monetary policy tools are the preferred means of stabilization
(c) There is no need for government stabilization policies
(d) Intervention is required only when unpredictable shocks affect the economy
(e) None of the above.
(1 mark)
< Answer
18. Which of the following schools of thought believes in an activist government role in the macro >
economy?
(a) Keynesian economics (b) Monetarism
(c) New classical economics (d) Supply-side economics
(e) Rational expectations.
(1 mark)
< Answer
19. Which of the following is true when the price level increases? >

(a) The money supply falls

(b) The quantity of money demanded increases
(c) The quantity of money demanded decreases
 (d) There is no change in the quantity of money demanded
(e) Both (a) and (d) above.
(1 mark)
< Answer
20. Which of the following is true with respect to terms of trade for a country? >

(a) It is the ratio of its currency to other currencies

(b) It is the ratio of export prices to import prices
(c) It is the ratio of its opportunity costs to world opportunity costs
(d) It is the ratio of value of exports to value of imports
(e) None of the above.
(1 mark)
< Answer
21. Automatic stabilizer indicates the >

(a) Stock market mechanisms that automatically cause stock market gains to be cancelled out by
losses
(b) Invisible hand mechanism that automatically brings 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 that keeps inflation automatically under control
(e) None of the above.
(1 mark)
< Answer
22. If the economy is at full employment, the budget deficit is >

(a) A combination of cyclical and structural deficits

(b) Always averted by higher tax revenues
(c) Equal to the cyclical deficit
(d) Equal to the structural deficit
(e) Zero.
(1 mark)
< Answer
23. Which of the following policy instruments has the least ‘outside lag’? >

(a) Cash reserve ratio (b) Bank rate (c) Repo rate
(d) Taxes (e) Open market operations.
(1 mark)
< Answer
24. The quantity theory of money implies that a given percentage change in the money supply will cause >

(a) An equal percentage change in nominal GDP

(b) A smaller percentage change in nominal GDP
(c) A larger percentage change in nominal GDP
(d) An equal percentage change in real GDP
(e) A smaller percentage change in real GDP.
(1 mark)
< Answer
25. Which of the following is most likely to happen during a recession? >

(a) Decrease in inventory (b) Producers will be cautiously optimistic

(c) Capacity under utilization (d) Expansion in bank credit
(e) Increasing income levels.
(1 mark)
< Answer
26. Refer to the figure below: >
 During which of the following periods of the business cycle is the economy in a recovery stage?
(a) The period from A to B (b) The period from C to D
(c) The period from C to E (d) The period from A to C
(e) The period from B to C.
(1 mark)
< Answer
27. The difference between M3 and M1 is >

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

(c) Savings deposits (d) Time deposits (e) M2.
(1 mark)
< Answer
28. Banks can create money >

(a) By printing currency notes

(b) By paying interest to their depositors
(c) By making loans that result in additional deposits
(d) By offering financial services, such as money market accounts
(e) By accepting deposits from the public.
(1 mark)
< Answer
29. Which of the following is not a leakage from national income flow? >

(a) Savings (b) Imports (c) Investment (d) Taxes (e)

Depreciation.
(1 mark)
< Answer
30. In a period of sustained economic recovery the demand for investment goods increase more rapidly >
than the general rise in activity, because of
(a) Inflation (b) The multiplier (c) The accelerator
(d) Deflation (e) Rising marginal efficiency of capital.
(1 mark)
< Answer
31. An expansionary monetary policy includes measure such as >

(a) Increase in Bank rate (b) Increase in cash reserve ratio

(c) Reduction in cash reserve ratio (d) Selling government securities in open market
(e) Devaluation of the currency.
(1 mark)
< Answer
32. Which of the following is not a cause for growing fiscal deficit of the Union Government? >

(a) Subsidies (b) Interest payments

(c) Reduction in revenue expenditure (d) Employee salaries/pensions
(e) Defense expenditure.
(1 mark)
 < Answer
33. When the contribution of services sector to GDP increases in relation to industry and agriculture and >
consequently the pattern of employment changes leading to some job losses, it is called
(a) Frictional unemployment (b) Seasonal unemployment
(c) Structural unemployment (d) Voluntary unemployment
(e) Cyclical unemployment.
(1 mark)
< Answer
34. In an economy operating below full employment, a deficiency in demand will result in >

(a) Full employment (b) Fall in interest rates

(c) Larger level of unemployment (d) Inflation
(e) Rise in real wages.
(1 mark)
< Answer
35. An economy in deep recession requires >

(a) A contractionary fiscal policy (b) An expansionary monetary policy

(c) An expansionary fiscal policy (d) A contractionary monetary policy
(e) Both (b) and (c) above.
(1 mark)
< Answer
36. Which of the following dampens the growth rate of an economy? >

(a) Expansion in money supply (b) Increase in the level of investment

(c) Reduction in the rate of interest (d) Steep rise in the tax rates
(e) Rising prices.
(1 mark)
< Answer
37. In the standard IS-LM model, which of the following is true, if the government raises tax rate and the >
Reserve Bank of India decides to hold the money supply constant?
(a) Disposable income remains constant (b) IS curve shifts to the right
(c) LM curve shifts to the left (d) Interest rate falls
(e) Interest rate increases.
(1 mark)
< Answer
38. An increase in government transfer payments will >

(a) Shift both IS and LM curves to the right

(b) Shift both IS and LM curves to the left
(c) Not affect the position of LM curve but shift the IS curve to left
(d) Not affect the position of IS curve but shift the LM curve to right
(e) Not affect the position of LM curve but shift the IS curve to right.
(1 mark)
< Answer
39. Which of the following is true, if the prices of factor inputs increase in an economy? >

(a) Aggregate supply curve shifts to the left

(b) Aggregate supply curve shifts to the right
(c) Aggregate demand curve shifts to the right
(d) Aggregate demand curve shifts to the left
(e) Both aggregate supply and demand curves remain constant.
(1 mark)
< Answer
40. 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
41. The following data is taken from National Income Accounts of a country. >
Particulars Rs. Cr.
GNP at market prices 3,400
Transfer payments 484
Indirect taxes 346
Consumption of capital 380
Undistributed corporate profits 56
Corporate tax 150
Subsidies 40
Personal disposable income 2,586
Personal tax payments are
(a) Rs.786 cr (b) Rs.712 cr (c) Rs.612 cr (d) Rs.556 cr (e) Rs.406 cr.
(2 marks)
< Answer
42. Production Account of an economy is given below. >

Dr.
Cr.
Rs. Cr. Rs. Cr.
Wages paid to domestic residents 1,200 Sales to Households 1,650
Wages paid to foreigners 720 Gross Fixed Investment 255
Interest payments on loans taken 30 Changes in stock 165
from foreign banks
Retained profits 60 Exports 120
Corporate tax 30
Imports 75
Indirect taxes 45
Depreciation 30
2,190 2,190
For the economy, NDP at market prices is
(a) Rs.1,650 cr (b) Rs.1,870 cr (c) Rs.2,085 cr (d) Rs.2,040 cr (e) Rs.2,130 cr.
(2 marks)
< Answer
43. The following information is extracted from the National Income Accounts of an economy. >

Particulars Million Units of

Currency (MUC)
Depreciation 590
Government expenditure 2,970
Corporate taxes 720
Gross domestic investment 3,195
Transfer payments 695
Personal taxes 2,025
Net income earned from abroad 110
Retained earnings 1,500
Consumption expenditure 20,000 If the national income is 25,000
MUC, the personal savings in the economy are
(a) 1,040 MUC (b) 420 MUC (c) 1,450MUC (d) 3,230 MUC
(e) 4,440 MUC.
(2 marks)
< Answer
44. From the following information, compute subsidies. >

GDP at factor cost = Rs.5,000 cr.

 Net factor income from abroad = Rs.500 cr.
Indirect taxes = Rs.1,355 cr.
GNP at market prices = Rs.5,730 cr.
(a) Rs. 950 cr. (b) Rs.1,030 cr. (c) Rs.1,125 cr. (d) Rs.1,290 cr.
(e) Rs.1,500 cr.
(1 mark)
< Answer
45. The following information is extracted from the National Income Accounts of an economy. >

Particulars MUC
NDP at market prices 20,000
NNP at factor cost 16,800
Gross domestic investment 3,200
Corporate profits (profit before tax) 3,000
Subsidies 400
Net domestic investment 2,600
Corporate profit tax 1,400
Personal tax payments 1,400
Indirect taxes 3,800
Factor income paid abroad 500 What is the factor income received from
abroad?
(a) –300 MUC (b) 300 MUC (c) –700 MUC (d) 700 MUC
(e) 400 MUC.
(2 marks)
46. An economy consists of three sectors: primary, secondary and tertiary sectors. Transactions related to the < Answer
>
three sectors are given below.
(MUC)
Items Primary Sector Secondary Sector Tertiary Sector
Sales 500 750 650
Intermediate Consumption 75 125 75
Indirect taxes 60 65 85
Depreciation 50 60 75
Subsidies 35 40 35
GDP at factor cost for the economy is
(a) 1,465 MUC (b) 1,500 MUC (c) 1,525 MUC (d) 1,835 MUC
(e) 1,710 MUC.
(2 marks)
47. The break-even income of Mr.Rakesh is Rs.10,000. His current income is Rs.5,000, and he borrowed < Answer
>
Rs.1,250 to finance his current consumption expenditure. Marginal propensity to consume of Mr.Rakesh
is
(a) 0.50 (b) 0.40 (c) 0.75 (d) 1.33 (e) 0.80.
(2 marks)
48. The net export function for the economy is estimated as E = 200 – 0.1Y. The marginal propensity to < Answer
>
consume is 0.75 and the tax rate is 20%. Assuming that the investment is autonomous and increases by
700 MUC during the year, the trade balance deteriorates by
(a) 140 MUC (b) 200 MUC (c) 300 MUC (d) 450 MUC
(e) 500 MUC.
(2 marks)
< Answer
49. The following information is extracted from the national income accounts of an economy for the year >
2003-04.
 Particulars Rs. Cr.
Gross domestic product at factor cost 2,570
Indirect taxes 850
Subsidies 125
Net factor income from abroad –5
Savings of non-dept. public enterprises 15
Income from property and entrepreneurship accruing to govt. dept. 100
Consumption of fixed capital 290
Interest on national debt 60
Current transfers from government 245
Current transfers from the rest of the world 310
Corporate taxes 190
Savings of the private corporate sector 85
Direct taxes paid by households 500
Personal disposable income (PDI) is
(a) Rs.2,000 Cr. (b) Rs.2,060 Cr.
(c) Rs.2,115 Cr. (d) Rs.2,510 Cr.
(e) Rs.2,595 Cr.
(2 marks)
< Answer
50. The following relations are derived for an economy. (All macro aggregates are in million units of >
currency and interest in term of percent per annum)

Savings function (S) –30 + 0.3Yd

Disposable Income (Yd) Y–T+R
Transfer payments (R) 40
Tax function (T) 0.2Y
Investment function (I) 400 – 10i
Exogenous Government Expenditure (G) 300
Imports (M) 20 + 0.2Y
Exports (E) 250
Transaction demand for money (Mt/P) 0.3Y
Speculative Demand for money (Ma/P) 125 – 50i
Money supply (Ms/P) 300 Trade balance and budget deficit
at equilibrium are
(a) –63.28 MUC and 47.72 MUC respectively
(b) –62.28 MUC and 47.72 MUC respectively
(c) 62.28 MUC and –47.72 MUC respectively
(d) –64.28 MUC and 47.72 MUC respectively
(e) –62.28 MUC and 57.72 MUC respectively.
(3 marks)
< Answer
51. The following consumption function has been estimated for an economy: >

Ct = 10 + 0.7Ydt + 0.3Ct-1
Where Ct and Ct-1 denote consumption in periods t and t-1 respectively and Ydt is the disposable income
in period t. If Ydt increases from 400 MUC to 600 MUC and remains there indefinitely, what could be
the change in the steady state level of consumption?
(a) 20 MUC (b) 140 MUC (c) 160 MUC (d) 200 MUC (e) 400 MUC.
(1 mark)
< Answer
52. If the marginal propensity to consume (MPC) in an economy is 1.5, marginal propensity to save (MPS) >
in the economy is
(a) – 0.50 (b) – 0.25 (c) 1.00 (d) 1.50
(e) Insufficient data.
(1 mark)
 < Answer
53. In an economy, demand for money is L = 0.4Y – 100i and supply of money is 600 MUC. If the >
government intends to increase the equilibrium interest rate from the current level of 6% to 8%, what will
be the change in the equilibrium level of output?
(a) 250 MUC (increase) (b) 500 MUC (decrease)
(c) 250 MUC (decrease) (d) 500 MUC (increase)
(e) No change in the equilibrium level of output.
(2 marks)
< Answer
54. Savings function of an economy is S = – 600 + 0.25Y d. Break-even disposable income for the economy >
is
(a) 1,750 MUC (b) 1,800 MUC (c) 1,900 MUC (d) 2,200 MUC (e) 2,400
MUC.
(1 mark)
< Answer
55. In an economy, the incremental capital output ratio is 7 and the expected population growth rate is 5% >
per annum. What is the required investment, if the targeted per capita real GDP growth rate is 8%?
(a) 45% of GDP (b) 56% of GDP (c) 84% of GDP (d) 91% of GDP
(e) 100% of GDP.
(2 marks)
< Answer
56. The following information is available of a commercial bank as on March 31, 2004. >

Reserves with the central bank = 5,000 MUC

Volume of demand deposits = 20,000 MUC
Reserve requirements = 25%
If the volume of the reserves is decreased by 700MUC and volume of demand deposits increased by
1,000MUC what is the new reserve ratio?
(a) 0.420 (b) 0.2501 (c) 0.230 (d) 0.205 (e) 0.250.
(1 mark)
< Answer
57. The money supply in an economy is 660 MUC. At equilibrium, the transaction demand for money and >
the interest rate (i) in the economy are 500 MUC and 8 percent respectively. If the precautionary demand
for money is zero, the speculative demand for money in the economy is
(a) 580 MUC (b) 160 MUC (c) 0 (d) 360 MUC
(e) 1,160 MUC.
(1 mark)
< Answer
58. The following information pertaining to an economy is available. >

Commodity market, Y = 3,000 – 30i

Demand for money = 0.3Y – 300i
Current money supply = 300 MUC
Rate of inflation = 5%
If the commercial banks charge nominal rate of interest which is 2% higher than the equilibrium rate of
interest, the cost of borrowings from the commercial banks is
(a) 3.94% (b) 6.94% (c) 9.94% (d) 8.94% (e) 8.54%.
(3 marks)
< Answer
59. 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 700 MUC
Import function 25 + 0.25Y

The current account balance at

 equilibrium in the economy is
(a) 637.5 MUC (deficit) (b) 637.5 MUC (surplus)
(c) 687.5 MUC (deficit) (d) 687.5 MUC (surplus)
(e) 667.5 MUC (surplus).
(2 marks)
< Answer
60. For an economy, goods market equilibrium is >

0.5Y = 1,400 – 70i.

If expansionary monetary polices decrease the rate of interest in the economy by one percentage point,
the equilibrium income will
(a) Decrease by 70 MUC (b) Increase by 70 MUC
(c) Decrease by 140 MUC (d) Increase by 140 MUC
(e) Insufficient data.
(1 mark)
< Answer
61. The transactions demand for money and the speculative demand for money are given as kY and >

1
5
( – k)Y respectively. If the equilibrium level of income (Y) is 200MUC, the equilibrium money
supply (Ms) when k = 1.5 is
(a) 10 MUC (b) 30 MUC (c) 40 MUC (d) 50 MUC (e) 5MUC.
(1 mark)
< Answer
62. The monetary liabilities of the central bank of an economy are 20,000 MUC. The government money in >
the economy is 200MUC. Currency deposit ratio for the economy is estimated to be 0.2 and reserve ratio
imposed by the central bank is 5 percent. If foreign exchange reserves of the country decline by
250MUC, what would happen to the money supply?
(a) Decline by 1,200MUC (b) Increase by 1,200MUC
(c) Decline by 1,820MUC (d) Increase by 1,820 MUC
(e) Decline by 1,480MUC.
(2 marks)
< Answer
63. The following data is taken from balance sheet of a Central Bank. >
Particulars Million units of currency (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.
The Central Bank imposes a reserve ratio of 10 percent and the currency deposit ratio is estimated to be
20 percent. If the exchange rate is 5 units of domestic currency to a dollar ($), net foreign exchange
assets with the Central Bank are
(a) $1,700 million (b) $1,800 million
(c) $1,950 million (d) $2,010 million
(e) $2,000 million.
(2 marks)
< Answer
64. The following are the indicators of financial development of an economy for the year 2002-03. >

Finance Ratio 0.25

Intermediation Ratio 0.70 If the Net Physical Capital Formation and
 the new issues for the year 2002-03 are 42,500MUC and 30,000MUC respectively, the financial
interrelation ratio is
(a) 1.2 (b) 1.4 (c) 2.4 (d) 0.6 (e) 0.1.
(2 marks)
< Answer
65. The following information pertains to an economy. >

(MUC)

Private consumption expenditure 600

Investment in fixed capital 250
Increase inventory 150
Government expenditure 100
Merchandise exports 50
Imports 150
Money supply 250 The velocity of money in the economy is
(a) 4 (b) 5 (c) 3 (d) 2 (e) 8.
(1 mark)
< Answer
66. The government’s tax function is given as T = 80 + 0.6Y. If the marginal propensity to consume is >
constant at 0.8, an increase in GNP of 50 MUC would cause consumption to
(a) Increase by 16 MUC (b) Decrease by 16 MUC
(c) Increase by 40 MUC (d) Decrease by 40 MUC
(e) Increase by 30 MUC.
(2 marks)
< Answer
67. The data pertaining to various components of money supply are as follows. >

Currency with the public Rs. (in crores)

Notes in circulation 1,50,000
Rupee coins 2,000
Small coins 900
Cash in hand 5,000 Deposit money
of the public
Demand deposits with banks 1,00,000
Other deposits with RBI 6,000
Time Deposits with banks 4,50,000 Post office
deposits
Post office savings bank deposits 5,000
Total post office deposits 26,000 The three measures of
money stock as evolved by the RBI are
(a) M1 =Rs.2,63,900cr., M2= Rs 2,68,900cr., M3= Rs 7,13,990cr.
(b) M1= Rs 2,63,900cr., M2= Rs. 2,68,900cr., M3= Rs.7,13,900cr.
(c) M1= Rs 2,63,900cr., M2= Rs 2,68,990cr., M3= Rs 7,13,900cr.
(d) M1= Rs 2,63,990cr., M2= Rs 2,68,990cr., M3= Rs 7,13,990cr.
(e) M1= Rs 2,63,990cr., M2= Rs 2,68,900cr., M3= Rs 7,13,900cr.
(2 marks)
< Answer
68. The fiscal deficit in the Union Budget is given as is Rs.1,40,000 Cr. For the economy, money multiplier >
is estimated to be 3. If government plans to monetize 10% of the fiscal deficit, what would be the change
in money supply?
(a) Rs.42,000 cr. (b) Rs.52,000 cr. (c) Rs.55,500 cr. (d) Rs.58,000 cr. (e) Rs.70,000
cr.
 (1 mark)
< Answer
69. The following information is extracted from the Union budget for the year 2002-2003. >

Rs. in crore
Tax revenue (Net) 3,89,093
Non-tax revenue 2,06,142
Recoveries of loans 45,492
Borrowings and other liabilities 3,48,942
Non-plan expenditure:
On revenue account (which includes 7,51,023
interest payments of Rs.3,36,900 crore)
On capital account 74,346
Plan expenditure:
On revenue account 1,80,675
On capital account 1,04,625 The revenue deficit of the
government is
(a) Rs.66,492 crore (b) Rs.3,36,463 crore
(c) Rs.3,09,029 crore (d) Rs.3,87,397 crore (e) Rs.4,15,434 crore.
(2 marks)
< Answer
70. The balance of payments of a country for the year 2003 is given below. >

Particulars MUC
Merchandise imports 50,000
Merchandise exports 45,000
Software exports 40,000
Software imports 30,000
Earnings on loans and investments abroad 1,000
Earnings on loans and investments in the country by foreigners 2,500
Private remittances to abroad 500
Private remittances from abroad 375
Government loans to abroad 75
Government loans from abroad 50
Direct investments abroad 25
Foreign direct investment in the country 375
Short-term loans and investments abroad 500
Foreign short-term loans and investments in the country 100
What
is the current account balance for the year 2003?
(a) 3,375 MUC (Cr.) (b) 3,375 MUC (Dr.)
(c) 4,125 MUC (Cr.) (d) 4,125 MUC (Dr.) (e) 4,875 MUC (Cr.).
(2 marks)
< Answer
71. The following information pertains to the balance of payments of a country for the year 2003-04. >
 Particulars MUC
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 foreign
exchange reserves increase by 285,856 MUC, capital account balance is
(a) 132,944 MUC (surplus)(b) 132,944 MUC(deficit)
(c) 202,000 MUC (surplus) (d) 202,000 MUC (deficit)
(e) 123,144 MUC(surplus).
(2 marks)
< Answer
72. In a two sector economy the consumption function (C) is equal to 8 + 0.7Y and savings is equal to 52 >
MUC. The equilibrium level of income in the economy is
(a) 52 MUC (b) 60 MUC (c) 43 MUC (d) 100 MUC (e) 200 MUC.
(1 mark)
< Answer
73. GDP for the current year is 2,500 MUC and is expected to increase to 3,000 MUC during the next year. If >
accelerator coefficient is 5, investment during the next year will be
(a) 125 MUC (b) 625 MUC (c) 750 MUC (d) 2,000 MUC (e) 2,500 MUC.
(1 mark)
< Answer
74. Net domestic capital formation in a country is 4,000 MUC. Savings by private and public sectors in the >
economy are 1,800 MUC and –100 MUC respectively. Current account deficit for the economy is
(a) 2,100 MUC (b) 2,200 MUC (c) 1,300 MUC (d) 2,400 MUC (e) 2,300 MUC.
(1 mark)
< Answer
75. Suppose the rate of inflation is 3% and the real interest rate is 5%. The nominal interest rate will be >

(a) 2.5% (b) 3.0% (c) 5.0% (d) 8.0% (e) 4.0%.
(1 mark)
< Answer
76. The following relations describe an economy. >

S = –5+0.2Yd
I = 50–10i
If government spending is 10 MUC and tax collected is 10 MUC, the IS curve for the economy is
(a) Y=285+50i (b) Y=245+60i (c) Y=270–10i (d) Y =210–0.5i (e) Y
=285 –50i.
(2 marks)

END OF QUESTION PAPER

 Suggested Answers
Economics – II (122) : April 2004
1. Answer : (d) < TOP
>
Reason : It is important to distinguish between a concept like “rational expectations” and some of its
implications under certain conditions. The term “rational expectations” means nothing more than people
being rational in the formation of their opinions and decisions. They should, therefore, use, as much
information as possible in the process, particularly as they determine their views about what is most
likely to occur in the future. In so doing, they may render policies ineffective, but that is a result of the
process which can be disputed rather than a definition of a hypothesized mode of behavior which cannot
be disputed.
(a) (a) Is not the answer because rational expectations is not accurately associated with the notion
that Economic policy is ineffective and should not be used in a discretionary way
(b) (b) Is not the answer because rational expectations does not say that it is always possible to
reduce inflation without recession by simply letting aggregate demand fall which it will do
automatically
(c) (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) (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) (e) Is not the answer because all of the above cannot be the answer.
2. Answer : (d) < TOP
>
Reason : A current account deficit indicates a domestic economy’s need for borrowing from abroad to
finance excessive consumption (imports in excess of exports). Part of domestic consumption is a
government component that may or may not indicate a government spending greater than the tax
receipts. If a government is spending more than its receipts, then the government must borrow from
someone by issuing bonds. If those bonds are purchased by foreigners as part of the balancing of a
current account deficit, then foreign lenders are, in fact, helping to finance a domestic government
deficit.
(a) (a) Is not the answer because a current account deficit is possible because the balance of
payments must always balance
(b) (b) Is not the answer because a current account deficit can be larger than 50% of a capital
account surplus
(c) (c) Is not the answer because a current account deficit can not be used to help finance a
government deficit indefinitely
(d) (d) Is the answer because a current account deficit can be used to help finance a government
deficit if foreign lenders accumulate government bonds
(e) (e) Is not the answer because a current account deficit includes investment earnings that are
part of the capital account.
3. Answer : (c) < TOP
>
Reason : The Phillips curve relation asserts that inflation should be positively correlated with the
difference between actual and potential GNP; e.g., should actual GNP climb above (fall below) potential
GNP, then inflation should accelerate (decline). Since the unemployment rate increases (decreases) as
actual GNP falls (increases) relative to potential, a negative correlation between the unemployment and
inflation rates should be expected.
(a) (a) Is not the answer because a logical extension of the Phillips curve relationship between
inflation and the difference between actual and potential GNP is that the inflation rate and the
unemployment rate is not positively related.
(b) (b) Is not the answer because the inflation rate and the natural rate of unemployment is not
positively correlated
(c) (c) Is the answer because the inflation rate and the unemployment rate should be negatively
 correlated
(d) (d) Is not the answer because the inflation rate and the natural rate of unemployment is not
negatively correlated
(e) (e) Is not the answer because the difference between actual and potential GNP is not
negatively correlated with the difference between actual and full employment.
4. Answer : (d) < TOP
>
Reason : Calculating value added at each stage of production eliminates the problem of counting the
product more than once. (a), (c), and (e) would involve double counting. The GNP deflator is
used to remove the effects of inflation and not the potential of double counting.
(a) (a) Is not the answer because, to avoid double counting when the GNP is estimated,
economists do not price all goods and services bought and sold in all markets
(b) (b) Is not the answer because, to avoid double counting when the GNP is estimated,
economists do not use the GNP deflator
(c) (c) Is not the answer because, to avoid double counting when the GNP is estimated,
economists do not price only intermediate goods
(d) (d) Is the answer because, to avoid double counting when the GNP is estimated,
economists calculate value added at each stage of production
(e) (e) Is not the answer because, to avoid double counting when the GNP is estimated,
economists do not only price goods for sale at retail shops.

5. Answer : (b) < TOP

>
Reason : The IS curve is a locus of points showing all possible levels of income and interest for a given
savings (or consumption) schedule, where investment is equal to savings, investment
decreases with the rate of interest, and savings is a positive function of income. There are
many levels of interest and income consistent with product market equilibrium. The IS curve
is for the product market and not the money market. This is contrary to the correct
assumptions. (E) is true but not related to the question
(a) (a) Is not the answer because IS curve is not based on the assumption that there is only
one interest rate and income level at which the product market can be in equilibrium
(b) (b) Is the answer because IS curve is based on the assumption that investment equals savings
at equilibrium, investment increases with income, and saving is related to interest
(c) (c) Is not the answer because IS curve is not based on the assumption that money market
equilibrium can occur at many levels of interest and income
(d) (d) Is not the answer because IS curve is not based on the assumption that investment and
savings decisions vary inversely with income
(e) (e) Is not the answer because IS curve is not based on the assumption that stock market
prices are generally high when interest rates are low.
6. Answer : (a) < TOP
>
Reason : When inflation exists, the purchasing power of money declines. Borrowers will be paying
back loans with dollars that have less purchasing power.
(a) (a) Is the answer because during inflation, lenders lose, borrowers gain.
(b) (b) Is not the answer because during inflation, borrowers do not lose, lenders do not gain.
(c) (c) Is not the answer because during inflation, the real interest rate does not rise
(d) (d) Is not the answer because during inflation, it is not true that borrowers and lenders both
lose
(e) (e) Is not the answer because during inflation, unemployment may not increase.
7. Answer : (b) < TOP
>
Reason : When the Government has large expenditures and especially large deficits, many economists
suggest that private investment must compete with government for limited funds. (A) refers to
 import substitution and (C), (D), and (E) have no relevance or specific terminology.
(a) (a) Is not the answer because crowding-out does not refer to imports replacing domestic
goods
(b) (b) Is the answer because crowding-out refers to government spending reducing private
spending
(c) (c) Is not the answer because crowding-out does not refer to the central government
expenditures replacing state and local government expenditures
(d) (d) Is not the answer because crowding-out does not refer to fiscal policy negative effects
on monetary factors
(e) (e) Is not the answer because crowding-out does not refer to the central government
budget deficits’ negative effects on balance of payments.
8. Answer : (a) < TOP
>
Reason : Easy money would result in a larger supply of money and therefore lower interest rates. An
increase in personal income tax will decrease the need for the government to borrow, again
lowering the interest rates. Since investment is a function of the interest rate, investment will
increase.
(a) (a) Is the answer because the proper monetary policy and fiscal policy mix would be
easy money and a government induced increase in personal income tax
(b) (b) Is not the answer because the proper monetary policy and fiscal policy mix would
not be Easy money and a government induced decrease in personal income tax
(c) (c) Is not the answer because the proper monetary policy and fiscal policy mix would
not be tight money and reduced government spending
(d) (d) Is not the answer because the proper monetary policy and fiscal policy mix would
not be tight money and increased government spending
(e) (e) Is not the answer because none of the above cannot be the answer.

9. Answer : (c) < TOP

>
Reason : A decline in business expectations could be interpreted as a decline in expected business
profits. A fall in the interest rates (A), a decrease in business taxes (B), acceleration of business
depreciation (D) and increases in consumption expenditure could all be expected to lead to an
increase in investment.
(a) (a) Is not the answer because from a Keynesian perspective, business investment will
decline not as a result of a fall in the interest rate
(b) (b) Is not the answer because from a Keynesian perspective, business investment will
decline not as a result of a decrease in business taxes
(c) (c) Is the answer because from a Keynesian perspective, business investment will
decline as a result of decline in business expectations
(d) (d) Is not the answer because from a Keynesian perspective, business investment will
decline not as a result of acceleration of business depreciation
(e) (e) Is not the answer because from a Keynesian perspective, business investment will
decline not as a result of an increase in consumption expenditure.

10. Answer : (d) < TOP

>
Reason : A variable is defined as a stock variable if it is measured at a point of time and as a flow
variable if it is measured over a period of time. Of all the variables listed, only inflation is
measured over a period of time and hence is a flow variable
(a) (a) Is not the answer because foreign exchange reserves are stock variable
(b) (b) Is not the answer because public debt is stock variable
 (c) (c) Is not the answer because wealth of a country stock variable
(d) (d) Is the answer because inflation is a flow variable
(e) (e) Is not the answer because money supply is stock variable.
11. Answer : (c) < TOP
>
Reason : It is Consumer Price Index (CPI) that measures the cost of buying a fixed basket of goods and
services, but not the GDP deflator. GDP deflator considers much wider group of goods, all
final goods and services produced during the year, than WPI and CPI. The basket of goods
included in the GDP deflator varies from year to year, depending on what is produced in the
economy during the year.
a. (a) is not correct. GDP deflator measures changes in the price levels of a basket of goods
that varies from year to year depending on the goods and services produced during the
year.
b. The basket of goods of the GDP deflator includes all final goods and services produced
during the year irrespective of their nature (i.e. consumer or producer goods), and hence
is broader than WPI and CPI.
c. The basket of goods included in the GDP deflator changes every year depending on what
is produced in the economy in that year. Thus, when automobile production is large, it
receives a relatively larger weight in the computation of GDP deflator.
d. GDP deflator includes only prices of goods and services that are produced within the
boundaries of a country. Hence prices of imports do not affect the GDP deflator.
e. CPI measures only the cost of buying a fixed basket of goods and services, hence
increase in automobile production does not affect computation of the CPI.
12. Answer : (e) < TOP
>
Reason : Aggregate expenditure in an economy consists of Consumption, Investment,
Government purchases and Net exports. Hence the answer is (e).
(a) (a) Is not the answer because consumption is a component of aggregate expenditure in an
economy.
(b) (b) Is not the answer because investment is a component of aggregate expenditure in an
economy
(c) (c) Is not the answer because Government purchases is a component of aggregate
expenditure in an economy
(d) (d) Is not the answer because net exports is a component of aggregate expenditure in an
economy
(e) (e) Is the answer because taxes is not a component of aggregate expenditure in an
economy.
13. Answer : (a) < TOP
>
Reason : For any value of income less than Y0, consumption is greater than income; thus, saving is
negative.
(a) (a) Is the answer because when the consumption function is above the 45° line,
consumption exceeds income and saving is negative
(b) (b) Is not the answer because when the consumption function is above the 45° line,
consumption is not less than income and saving is negative
(c) (c) Is not the answer because when the consumption function is above the 45° line,
consumption exceeds income and saving is not positive
(d) (d) Is not the answer because when the consumption function is above the 45° line,
consumption is not less than income and saving is negative
(e) (e) Is not the answer because none of the above cannot be the answer.
14. Answer : (a) < TOP
>
Reason : In the Keynesian model, unemployment could be reduced if the aggregate demand increases.
Therefore, unemployment is caused by demand deficiency. The Keynesian theory of
 unemployment suggests that governments can play an active role in the economy by adjusting
the aggregate demand through its fiscal and monetary instruments.
(a) Is the answer because unemployment in the Keynesian model is caused by demand
deficiency.
(b) Is not the answer because unemployment in the Keynesian model is not caused by supply
deficiency.
(c) Is not the answer because unemployment in the Keynesian model is not caused by excess
demand
(d) Is not the answer because unemployment in the Keynesian model is not caused by excess
supply
(e) Is not the answer because unemployment in the Keynesian model is not caused by both
demand deficiency and supply deficiency
15. Answer : (b) < TOP
>
Reason : Increase in consumption spending encourages producers to increase the production, which
requires employment of resources. It in turn reduces the unemployment rate in the economy.
(a) (a) Is not the answer because when consumption spending in the economy rises in response
to the increase in wealth does not shift the aggregate demand curve to the left
(b) (b) Is the answer because when consumption spending in the economy rises in response
to the increase in wealth results in the rate of unemployment to decrease
(c) (c) Is not the answer because when consumption spending in the economy rises in
response to the increase in wealth does not result in the general price level to fall
(d) (d) Is not the answer because when consumption spending in the economy rises in
response to the increase in wealth does not result in the aggregate supply curve to shift to
the right
(e) (e) Is not the answer because when consumption spending in the economy rises in
response to the increase in wealth does not result in the aggregate demand curve remains at
the present level.
16. Answer : (d) < TOP
>
Reason : a. Reserves with RBI (both surplus reserves and statutory reserves) are assets of a
commercial bank.
b. Loans given to public sector undertakings are assets of the banks.
c. Credit given to any individual, firm or government is an asset to the bank lend.
d. Deposits from the public are liabilities to the bank because it has to repay the amount at a
later time.
e. Discounted commercial bills from the public are assets to the bank because it purchased
(discounted) the bills from the holder of the bill.
17. Answer : (c) < TOP
>
Reason : Neither fiscal nor monetary policy is needed in an economy with full employment and market
clearing in all markets.
(a) (a) Is not the answer because ‘fiscal policy tools are the most preferred means of
stabilization’ is not advocated by classical economist.
(b) (b) Is not the answer because ‘monetary policy tools are the preferred means of
stabilization’ is not advocated by classical economist.
(c) (c) Is the answer because classical economists argue that there is no need for government
stabilization policies
(d) (d) Is not the answer because it is not advocated by the classical economist that
intervention is required only when unpredictable shocks affect the economy
(e) (e) Is not the answer because none of the above cannot be the answer.
18. Answer : (a) < TOP
>
Reason : Keynes believed the government had a role to play fighting inflation and unemployment, and
 using monetary and fiscal policy to manage the macro economy
(a) (a) Is the answer because Keynesian economist argue activist government role in the
macro economy
(b) (b) Is not the answer because monetarism does not advocate activist government role in
the macro economy
(c) (c) Is not the answer because new classical economist does not advocate activist
government role in the macro economy
(d) (d) Is not the answer because supply side economist does not advocate activist
government role in the macro economy
(e) (e) Is not the answer because rational expectations does not advocate activist government
role in the macro economy.
19. Answer : (b) < TOP
>
Reason : When the price level increases, the quantity of money demanded increases, as from the
quantity theory of money equation, MV = PQ. So, when P increases, PQ also increases.
(a) (a) Is not the answer because when the price level increases, money supply does not
fall
(b) (b) Is the answer because when the price level increases, the quantity of money
demanded increases
(c) (c) Is not the answer because when the price level increases, the quantity of money
demanded does not decrease
(d) (d) Is not the answer because when the price level increases, there is changes in the
quantity of money demanded
(e) (e) Is not the answer because options (a) and (d) is not true.
20. Answer : (b) < TOP
>
Reason : Terms of trade is the real terms at which a nation sells its export products and buys its import
products. It involves the ratio of an index of import prices.
(a) (a) Is not the answer because terms of trade is not the ratio of its currency to other
currencies
(b) (b) Is the answer because terms of trade is the ratio of export prices to import prices
(c) (c) Is not the answer because terms of trade is not the ratio of its opportunity costs to
world opportunity costs
(d) (d) Is not the answer because terms of trade is not the ratio of value of exports to value of
imports
(e) (e) Is not the answer because none of the above cannot be the answer.
21. Answer : (c) < TOP
>
Reason : Automatic stabilizers automatically adjust net taxes to stabilize aggregate demand as the
economy expands or contracts. The purpose of such stabilizers is to smooth out business
cycles and diminish the negative effects of recessions and expansions.
(a) (a) Is not the answer because automatic stabilizer does not indicate stock market
mechanisms that automatically cause stock market gains to be cancelled out by losses
(b) (b) Is not the answer because automatic stabilizer does not indicate invisible hand
mechanism that automatically bring the economy out of a recession
(c) (c) Is the answer because automatic stabilizer indicate government revenue and
expenditure items that change automatically in response to changes in economic activity
(d) (d) Is not the answer because automatic stabilizer does not indicate discretionary
monetary policy that keep inflation automatically under control
(e) (e) Is not the answer because none of the above cannot be the answer.
< TOP
22. Answer : (d)
 >

Reason : The structural deficit is the deficit that remains when the economy is at full employment.
(a) (a) Is not the answer because if the economy is at full employment, the budget deficit is
not a combination of cyclical and structural deficits
(b) (b) Is not the answer because if the economy is at full employment, the budget deficit is
not always averted by higher tax revenues
(c) (c) Is not the answer because if the economy is at full employment, the budget deficit is
not equal to the cyclical deficit
(d) (d) Is the answer because if the economy is at full employment, the budget deficit is
equal to the structural deficit
(e) (e) Is not the answer because if the economy is at full employment, the budget deficit is
not zero.
< TOP
23. Answer : (d) >
Reason : Outside lag ’is the duration involved for output and employment to respond to changes of the
implemented of policies.Taxes has 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.
24. Answer : (a) < TOP
>
Reason : Quantity theory of money (QTM) says
MV = PY
Where,
M = money supply
V = velocity of money
P = price level
Y = real GDP
PY = nominal GDP
Assuming V is a constant, a change in M leads to an equal percentage change in PY.
(a) (a) Is the answer because the quantity theory of money implies that a given percentage
change in the money supply will cause an equal percentage change in nominal GDP
(b) (b) Is not the answer because the quantity theory of money implies that a given
percentage change in the money supply will not cause a smaller percentage change in
nominal GDP
(c) (c) Is not the answer because the quantity theory of money implies that a given
percentage change in the money supply will not cause a larger percentage change in
nominal GDP
(d) (d) Is not the answer because the quantity theory of money implies that a given
percentage change in the money supply will not cause an equal percentage change in real
GDP
(e) (e) Is not the answer because the quantity theory of money implies that a given
percentage change in the money supply will not cause a smaller percentage change in real
GDP.

25. Answer : (c) < TOP

>
Reason : In the business cycles theory, after a business peak or boom, the economy enters contraction
stage. The sales of most businesses fall and real GNP of an economy grows at a slow pace.
There is a large number of unemployment in the labor market. This phase is otherwise known
 as recession.
(a) Is not the answer because the inventory stock increases gradually in recession.
(b) Is not the answer because business expectation will be pessimistic with cautious
decision-making.
(c) Is the answer because there is an underutilization of existing capacity in the economy.
(d) Is not the answer because bank credit starts falling in the recession phase of business
cycle.
(e) Is not the answer because there is a decline in the income levels of the people.
26. Answer : (a) < TOP
>
Reason : A business cycle refers to short-run fluctuations in the business activity in an economy. There
are four phases in a business cycle – depression, recession, recovery and boom. Recession
signifies reduced business activity in the economy and depression represents the extreme form
of recession. Recovery refers to picking up of business activity in the economy after facing
depression, while boom refers to greater business activity in the economy.
a) The period from A to B indicates recovery phase.
b) The period from C to D indicates recession phase.
c) The period from C to E indicates both recession and depression phases.
d) The period from A to C indicates both recovery and boom phases.
e) The period from B to C indicates phase of boom.
27. Answer : (d) < TOP
>
Reason : M = Currency with the public + Demand deposits with the banking system
1

+ other deposit with the bank.

M = M + Time deposits with the banking systems.
3 1

(a) Is not the answer because the difference between M and M is not the demand deposits.
3 1

(b) Is not the answer because the difference between M and M is not the post office savings
3 1

deposits.
(c) Is not the answer because the difference between M and M is not the savings deposits.
3 1

(d) Is the answer because the difference between M and M is the time deposits.
3 1

(e) Is not the answer because the difference between M and M is not M
3 1 2.

28. Answer : (c) < TOP

>
Reason : Loans are a form of credit, and as they can be used to purchase goods and services they are the
equivalent of money. Banks through the ‘process of credit creation’ creates the money. The
process of credit creation is done by accepting deposits and lending loans.
(a) (a) Is not the answer because banks cannot create money by printing currency notes
(b) (b) Is not the answer because banks cannot create money by paying interest to their
depositors
(c) (c) Is the answer because banks cannot create money by making loans that result in
additional deposits
(d) (d) Is not the answer because banks cannot create money by offering financial services,
such as money market accounts
(e) (e) Is not the answer because banks cannot create money by accepting deposits from the
public.
29. Answer : (c) < TOP
>
Reason : Leakages from National income stream are those variables which deny incomes to others and
provide incomes outside the country. Savings are not spending; taxes take away personal
disposable income, depreciation is not paid to any factor. Imports provide income to foreign
exporters. The correct answer is C – Investment that provides jobs and incomes. It is an
injection of income into the national income stream.
(a) (a) Is not the answer because savings is a leakage from national income flow
(b) (b) Is not the answer because imports is a leakage from national income flow
(c) (c) Is the answer because investments is not a leakage from national income flow
 (d) (d) Is not the answer because taxes is a leakage from national income flow
(e) (e) Is not the answer because depreciation is a leakage from national income flow.
30. Answer : (c) < TOP
>
Reason : When there is a sustained increase in economic recovery, there is an anticipation that the level
of aggregate demand would go up and so the demand for investments to produce consumer
goods goes up. Hence the correct answer is C. Accelerator in conjunction with multiplier will
take the economy towards a higher trajectory level.
(a) (a) Is not the answer because in a period of sustained economic recovery the demand for
investment goods increase more rapidly than the general rise in activity, not because of
inflation.
(b) (b) Is not the answer because in a period of sustained economic recovery the demand for
investment goods increase more rapidly than the general rise in activity, not because of the
multiplier.
(c) (c) Is the answer because in a period of sustained economic recovery the demand for
investment goods increase more rapidly than the general rise in activity, because of
accelerator.
(d) (d) Is not the answer because in a period of sustained economic recovery the demand for
investment goods increase more rapidly than the general rise in activity, not because of
deflation
(e) (e) Is not the answer because in a period of sustained economic recovery the demand for
investment goods increase more rapidly than the general rise in activity, not because of
rising marginal efficiency of capital.
31. Answer : (c) < TOP
>
Reason : An expansionary monetary policy is undertaken to stimulate an economy moving at a slow
pace. By injecting additional money supply and easing the liquidity in the banking system easy
credit is made available for productive endeavor. A reduction in cash reserves increase lend
able resources of banks. The correct answer is C – along with it, reduction in bank rate and
buying government securities stimulate the economy. Devaluation is undertaken in an extreme
case of a persistent deficit in BOP.
(a) (a) Is not the answer because increase in bank rate is a contractionary monetary policy.
(b) (b) Is not the answer because increase in cash reserve ratio is a contractionary monetary
policy
(c) (c) Is the answer because reduction in cash reserve ratio is an expansionary monetary
policy
(d) (d) Is not the answer because selling government securities in open market is not an
expansionary monetary policy
(e) (e) Is not the answer because devaluation of the currency is not an expansionary
monetary policy.
32. Answer : (c) < TOP
>
Reason : Fiscal deficit is revenue expenditure such as subsidy, interest payments defense expenditure,
salaries and pensions financed by borrowings.
(a) (a) Is not the answer because subsidies does not cause for growing fiscal deficit of the
Union Government
(b) (b) Is not the answer because interest payments does not cause for growing fiscal deficit
of the Union Government
(c) (c) Is the answer because reduction in revenue expenditure is responsible for growing
fiscal deficit of the Union Government
(d) (d) Is not the answer because employee salaries/pensions do not cause for growing fiscal
deficit of the Union Government
(e) (e) Is not the answer because defense expenditure does not cause for growing fiscal
deficit of the Union Government
33. Answer : (c) < TOP
 Reason : The correct answer is C. Structural unemployment is caused by structural changes in the >
economy by the relative changes in the economy by the relative changes in contributions to
GDP by the three sectors.
(a) (a) Is not the answer because frictional unemployment is caused by the constant changes
in the labor market.
(b) (b) Labors find jobs seasonally. In the year, most of the time they are unemployed. This
type of unemployment is mainly prevalent in agriculture sector in India.
(c) (c) Is the answer because unemployment that is caused by the structural changes in the
economy is called structural unemployment.
(d) (d) Some people are not willing to work and they are voluntarily unemployed.
(e) (e) Cyclical unemployment arises when there is general down turn in business activity.
34. Answer : (c) < TOP
>
Reason : An economy with less than full employment level will lead to further unemployment, if the
level of aggregate demand is not equal to aggregate supply. Hence the correct answer is C.
(a) (a) Is not the answer because in an economy operating below full employment, a
deficiency in demand will not result in full employment
(b) (b) Is not the answer because in an economy operating below full employment, a
deficiency in demand will not result in fall in interest rates
(c) (c) Is the answer because in an economy operating below full employment, a deficiency
in demand will result in larger level of unemployment
(d) (d) Is not the answer because in an economy operating below full employment, a
deficiency in demand will not result in inflation
(e) (e) Is not the answer because in an economy operating below full employment, a
deficiency in demand will not result in rise in real wages
< TOP
35. Answer : (e) >
Reason : An economy in deep recession needs to set up the level of aggregate effective demand by an
expansionary fiscal and monetary policy. Hence the answer is (e).
(a) (a) Is not the answer because a contractionary fiscal policy does not help an economy in
deep recession.
(b) (b) Is not the answer because only an expansionary monetary policy does not help an
economy in deep recession
(c) (c) Is not the answer because only an expansionary fiscal policy does not help an
economy in deep recession
(d) (d) Is not the answer because a contractionary monetary policy does not help an economy
in deep recession
(e) (e) Is the answer because both an expansionary monetary policy and an expansionary
fiscal policy help an economy in deep recession.
36. Answer : (d). < TOP
>
Reason : Steep rise in taxes will dampen the economy and so not the right medicine. So the correct
answer is D. All the other measures A, B, C, and E will boost the Economy
(a) (a) Is not the answer because expansion in money supply does not dampen the growth
rate of an economy
(b) (b) Is not the answer because increase in the level of investment does not dampen the
growth rate of an economy
(c) (c) Is not the answer because reduction in the rate of interest does not dampen the growth
rate of an economy
(d) (d) Is the answer because steep rise in the tax rates dampens the growth rate of an
economy
 (e) (e) Is not the answer because rising prices does not dampen the growth rate of an
economy
37. Answer : (d) < TOP
>
Reason : If the government raises tax rate, it has an effect on the IS curve because it is a fiscal policy
and the IS curve shifts to left. And at the same time the Reserve Bank of India keep the money
supply constant. It implies that there is no change in the LM curve. This will result in a fall in
the interest rate.
(a) Is not the answer because when the Government raises tax rate, disposable income falls.
(b) Is not the answer because if the government raises tax rate and the Reserve Bank of India
hold the money supply constant, the IS curve shifts to the left.
(c) Is not the answer because if the government raises tax rate and the Reserve Bank of India
hold the money supply constant, there is no shift in the LM curve.
(d) Is the answer because if the government raises tax rate and the Reserve Bank of India
hold the money supply constant, the IS curve shifts to the left while LM curve unchanged
means that the interest rate falls.
(e) Is not the answer because interest rate doesn’t increase.
38. Answer : (e) < TOP
>
Reason : Expansionary monetary policy will shift the LM curve to the right and contractionary
monetary policy will shift the LM curve to the left. Expansionary fiscal policies will shift the
IS curve towards right but will not affect LM curve. Increase in transfer payments is an
expansionary fiscal policy, hence the answer is (e).
(a) (a) Is not the answer because an increase in government transfer payments will not
shift both IS and LM curves to the right
(b) (b) Is not the answer because an increase in government transfer payments will not shift
both IS and LM curves to the left
(c) (c) Is not the answer because an increase in government transfer payments will not
affect the position of LM curve but does not shift the IS curve to left
(d) (d) Is not the answer because an increase in government transfer payments will affect
the position of IS curve but does not shift the LM curve to right
(e) (e) Is the answer because an increase in government transfer payments will not affect
the position of LM curve but shift the IS curve to right.
39. Answer : (a) < TOP
>
Reason : Aggregate demand (supply) curve is a curve showing relationship between the level of real
domestic output demanded (available) at each possible price level. The aggregate demand
shows the overall demand for goods and services produced in a country. Thus, AD = C + I + G
+ NE. A shift in the aggregate demand curve takes place if the any of the factor other than
price levels affect the aggregate demand.
Aggregate supply, on the other hand, shows the overall supply of goods and services at various
price levels. Any factor other than price level that affect the aggregate supply results in shift in
aggregate supply curve. Increase in the factor input prices reduces the incentive for production
that lead to reduction in aggregate supply. A reduction in supply because of any other factors
other than price level is shown by a leftward shift in the aggregate supply curve. A shift in the
aggregate demand curve is caused by changes in the consumption spending, investment
spending, government spending and net export spending. Changes in the prices of factor inputs
do not affect aggregate demand. Hence, statement (a) is correct.
(a) (a) Is the answer because if the prices of factor inputs increase in an economy, aggregate
supply curve shifts to the left
(b) (b) Is not the answer because if the prices of factor inputs increase in an economy,
aggregate supply curve does not shift to the right
(c) (c) Is not the answer because if the prices of factor inputs increase in an economy,
aggregate demand curve does not shift to the right
(d) (d) Is not the answer because if the prices of factor inputs increase in an economy,
 aggregate demand curve does not shift to the left
(e) (e) Is not the answer because if the prices of factor inputs increase in an economy, both
aggregate supply and demand curves do not remain constant.
40. Answer : (b) < TOP
>
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
41. Answer : (e) < TOP
>
Reason : Personal Income = National Income – Undistributed corporate profit – corporate tax +
Transfer payments
National Income = GNP at market price – Depreciation – Indirect taxes + Subsidies
= 3,400 – 380 – 346 + 40
= 2,714
Personal Income = 2,714 – 56 – 150 + 484
= Rs.2,992 cr
Personal tax payments = Personal Income – Personal disposable income
= 2992 – 2586 = Rs.406cr.
42. Answer : (c) < TOP
>
Reason : NDPat market price = NDP at factor cost + Indirect taxes
NDPat factor cost = wages paid to domestic residents + wages paid to foreigners + Interest
payment on loans taken + Retained profits + Corporate tax
= 1,200 + 720 + 30 + 60 + 30
= 2,040
∴ NDPat market prices = 2,040 + 45
= Rs.2,085 cr.
43. Answer : (c) < TOP
>
Reason : Personal income = National income – (corporate taxes + retained earnings) + Transfer
payments =25000 – (720 + 1500) + 695 = 23475.
Personal disposable income = personal income – personal taxes = 23475 – 2025 = 21450
Personal savings in the economy = Personal disposable income – Consumption expenditure
= 21,450 – 20,000 = 1,450 MUC.
44. Answer : (c) < TOP
>
Reason : GNPMP = GDPFC + NFIA + Indirect taxes – Subsidies
5730 = 5000 + 500+ 1355 – X
X = – 5730 +5500 + 1355
= Rs.1125 cr.
45. Answer : (d). < TOP
>
Reason : NFIA = NNPMP – NDPMP
NNPMP = NNPFC + Indirect Taxes – Subsidies = 16800 + 3800 – 400 = 20200
Thus, NFIA = 20200 – 20000 = 200MUC.
Factor income received from abroad = Factor income paid abroad + net factor income earned
 abroad
= 500 + 200 = 700MUC.
46. Answer : (e) < TOP
>
Reason : Value added by factor of production = Sales – Intermediate consumption – Indirect taxes +
Subsidies
∴ Value added by Primary sector = 500 – 75 – 60 + 35 = 400
Value added by Secondary sector = 750 – 125 – 65 + 40 =600
Value added by Tertiary sector = 650 – 75 – 85 + 35= 525
∴ NDP at factor cost = Sum of value added by Primary sector, Secondary sector and tertiary
sector
= 400 + 600 + 525
= 1525
Depreciation = 50+ 60 + 75 = 185
∴ GDP factor cost = 1525 + 185 = 1710 MUC.
47. Answer : (c) < TOP
>
Reason :
Y = 5000
Borrowed amount = Rs.1250
Y = 5000 + 1250 = 6250
6250= a + b 5000
a = 6250 – 5000 b……………(i)
Y* = Rs.10,000
10000 = a + 10000 b
a = 10000 – 10000 b…………..(ii)
By solving (i) and (ii) we get, 3750–5000b = 0
b = 3750 / 5000 = 0.75.
48. Answer : (a) < TOP
>
Reason : Multiplier = 1/(1 – MPC + MPC × t + MPI) = 1/(1 – 0.75+ 0.75 × 0.2+0.10) = 1/ 0.50= 2
Thus if investment increases by 700, income increases by 1400. Thus, change in trade balance
= – 0.1 x 1400 = (140).
49. Answer : (a) < TOP
>
Reason : NNPFC = GDPFC – Depreciation + NFIA
= 2570 – 290 + (-5)
= 2275 crores.
Private Income (Pl) = NNPFC + Current transfer from abroad + Current
Transfer from government + Interest on National
Debt – Savings of Public enterprises – Income from property
= 2275 + 310 + 245 + 60 – 15 – 100
= Rs.2775 crores.
Personal Disposable income (PDI) = Private income – Direct Tax –
Corporation Tax – Savings of private sector
= 2775 – 500 – 190 – 85
= Rs.2,000 crores
50. Answer : (a) Answer : < TOP
>
(b)
Reason : Goods market will be in equilibrium when:
 Y = C+I+G+E–M
Given savings function (S) = 30 + 0.3Yd

Consumption function (C) = 30 + 0.Yd

Y = 30 + 0.7Yd + 400 – 10i + 300 + 250 – (20+0.2Y)
= 30 + 0.7(0.8Y + 40) + 400 – 10i + 300 + 250 – 20 –0.2Y
= 988 + 0.36Y – 10i
0.64Y = 988 – 10i
Y = 1543.75 – 15.63i

Money market will be in equilibrium when supply of money = demand of money

300 = 0.3Y + 125 – 50i
0.3Y = 175 – 50i
Y = 583.33 + 166.67i

Equating IS and LM curve:

1543.75 – 15.63i = 583.33 + 166.67i
On solving the equation we get i = 5.27

Substituting in IS curve
Y = 1543.75 – (15.63*5.27)
= 1461.38

Trade balance at Equilibrium = E – M

= 250 – 20 – 0.2Y
= 230 – 292.28
= – 62.28

Budget Deficit = Government Expenditure – taxes + transfer payments

= 300 – 292.28 + 40
= 47.72
51. Answer : (d) < TOP
>
Reason : At the steady state level of consumption, Ct = Ct-1
Given the equation, Ct = 10 + 0.7Ydt + 0.3Ct-1
Ct = 10 + 0.7Ydt + 0.3Ct since Ct = Ct-1
Or, 0.7Ct = 10 + 0.7Ydt
Or, ∆ Ct/ ∆ Ydt = 0.7/0.7 = 1
Thus, if Ydt increases by 200 MUC, then the steady state level of consumption also increases
by 200 MUC.
52. Answer : (a) < TOP
>
Reason : MPC + MPS = 1
Thus, MPS = 1 – MPC = 1 – 1.50 = – 0.50.
53. Answer : (d) < TOP
>
Reason : L = 0.4Y – 100i
At equilibrium, demand for money = Supply of money
i.e. 0.4Y – 100i = 600
When, i = 6, 0.4Y – 100(6) = 600
 Or, 0.4Y = 1200
Or, Y = 3000
When i = 8 , 0.4Y–100 (8) = 600
Or, 0.4Y = 1400
Or, Y = 3500
∴ Change in the equilibrium level of output = 3500 – 3000= 500 MUC (increase).
54. Answer : (e) < TOP
>
Reason : At break-even level of disposable income, savings are zero.
∴ S = –600 + 0.25Yd = 0
0.25 Yd = 600
600
0.25
Yd = = 2400 MUC
55. Answer : (d) < TOP
>
Reason : Required nominal growth rate = Real GDP growth rate + Population growth rate
= 5% + 8% = 13%
Thus, investment requirement = Required nominal growth rate × Incremental capital
output ratio
= 13 x 7 = 91% of GDP
56. Answer : (d) < TOP
>
Reason : Reserves are decreased by 700 = 5000 – 700
= 4300
Volume of demand deposits increased by 1000 = 20000 + 1000
= 21000
Reserve requirement = 4300/21000 = 0.205.
57. Answer : (b) < TOP
>
Reason : At equilibrium, Supply of money = Demand for money
Demand for money = Transaction demand for money + Speculative demand for money +
Precautionary demand for money
Or, speculative demand for money = 660 – 500 – 0 = 160MUC.
58. Answer : (d) < TOP
>
Reason : LM Equation
Money supply = Money Demand
300 = 0.3Y –300i
0.3Y = 300 +300i
Y = 1000 + 1000i

IS Equation is = 3000 – 30i

Equating IS = LM
1000 + 1000i = 3000 – 30i
On solving I = 1.94%
Thus Y = 3000 – 30(1.94)
= 2941.8MUC

(i) (i) The growth rate in the nominal stock of money will be (1.2*3.5) + 5 which is
equal to 9.2%. Hence expected nominal stock of money = 300*1.092 = 327.6MUC
(ii) (ii) The cost of borrowing from the commercial banks will be = Real rate of
 interest + rate of inflation + Higher charge by commercial banks

= 1.94 + 5 + 2 = 8.94%
59. Answer : (a) < TOP
>
Reason : Goods market equilibrium:
0.5Y = 2,925 – 37.5i
or, Y = 5,850 –75i (IS Function)
Money market equilibrium:
0.25Y = 312.5 + 125;
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
= 700 – (25 + 0.25Y)
= 700 – 25 – .25 (5,250)
= 700 – 25 – 1,312.50
= – 637.50 MUC (deficit)
60. Answer : (d) < TOP
>
Reason : 0.5Y = 1400 – 70i
Y = 2800 – 140i
If i decrease by one percentage point, equilibrium income would increase by 140.
61. Answer : (c) < TOP
>
Reason : Ms = m1+ m2
1
5
= kY + ( – k)Y.
1
5
= .15 (200 ) + ( – .15) 200.
= 30 + 10 = 40 MUC.
62. Answer : (a) < TOP
>
Reason : Ms = High-powered money x {(1 + Cu)/(Cu + r)}; where High powered money = monetary
liabilities of the central bank + government money.
∆Ms = ∆H. m
m= (1+Cu) /( Cu + r)
= (1+0.2)/ (0.2+0.05)
= 4.8
When foreign exchange reserves of the country decline by Rs.250 MUC, the monetary
liabilities also fall by 250 MUC. Thus, money supply decline by 4.8 x 250 = 1200MUC.
63. Answer : (b) < TOP
>
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 = 9,000MUC.
The exchange rate is 5 units of domestic currency to a dollar ($).
Net foreign exchange assets = 9,000 /5 =$1,800 million.
64. Answer : (a) < TOP
>
Reason : Intermediation Ratio = Secondary issues/New issues
Or, secondary issues = Intermediation ratio x New issues = 0.7 x 30,000 = 21,000 MUC
Total issues = New issues + Secondary issues = 30,000 + 21000 = 51,000 MUC
Financial Interrelations Ratio = Total issues/Net Physical Capital Formation (NPCF)
= 51000 /42500 = 1.2.
65. Answer : (a) < TOP
>
Y
Ms
Reason : Velocity of money =
Y = 600 + 250 + 150 + 100 + 50 – 150 = 1,000
1, 000
=4
250
∴ Velocity of money = .
66. Answer : (a) < TOP
>
Reason : Since the tax rate is .6, an increase of 50 MUC income will result in additional disposable
income of 50 – .6(50) = 20 MUC .
With a MPC of .8, disposable income consists of.8 (20) = 16 MUC of consumption
expenditure.
67. Answer : (b) < TOP
>
Reason : M1 = Currency with public + Demand deposits with banks + Demand portion of savings
deposits with banks + other deposits with RBI
= 157900 + 100000 + 6000
= Rs. 263900 Crore.
M2 = M1 + Post office savings deposits
= 263900 + 5000
= Rs.268900 Crore.
M3 = M1 + Time deposits (i.e., Fixed deposits) with banks
= 263900 + 450000
= Rs.713900 Crore
68. Answer : (a) < TOP
>
Reason : Fiscal Deficit = Rs.1,40,000 Cr.
10% of fiscal deficit = Rs.14000 Cr.
Monetization of deficit directly increase the high powered money in the economy
∴∆H = Rs.14,000 Cr.
∆Ms = m. ∆H = 3× 14,000 = Rs.42,000.
∴ Monetization of 10% of the fiscal deficit would increase the money supply by
Rs.42,000 Cr.
69. Answer : (b) < TOP
>
Reason : Revenue deficit = Revenue expenditure – Revenue receipts
Revenue expenditure = Non-plan revenue expenditure + Plan revenue expenditure
= 7,51,023 + 1,80,675 = 9,31,698
Revenue receipts = Tax revenue + Non-tax revenue
 = 3,89,093 + 2,06,142 = 5,95,235
∴ Revenue deficit = 9,31,698 – 5,95,235 = Rs.3,36,463 crore
70. Answer : (a) < TOP
>
Reason : Current account balance = Merchandise exports – Merchandise imports + Software exports –
Software imports + Earnings on loans and investments abroad – Earnings on loans and
investments by foreigners + Private remittances from abroad – Private remittances to abroad
= 45,000 – 50,000+40,000 – 30,000 +1,000 – 2,500 +375 –500 = 3375MUC(cr).
71. Answer : (c) < TOP
>
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 – 267474 = 83856 i.e. current account surplus (Credit)
Thus, Capital account balance = 285856 – 83856 = 202,000MUC (surplus).
72. Answer : (e) < TOP
>
Reason : C = 8 + 0.7Y
S = 52.
At equilibrium, Y =C + S.
Y = 8 + 0.7Y + 52.
0.3Y = 60
∴ Y = 200MUC.
73. Answer : (e) < TOP
>
Investment
Change in Income
Reason : Acceleration Coefficient =
Investment
500
5 =
∴ Investment for the next year = 5´ 500
= 2,500 MUC.
74. Answer : (e) < TOP
>
Reason : S – I = CAB
S = 1800 – 100 = 1700
I = 4000
∴ CAB = 1700 – 4000 = –2300
∴ Current Account Deficit = 2300MUC
75. Answer : (d) < TOP
>
Reason : Nominal rate of interest = Real rate of interest + Inflation = 5 + 3 = 8%

76. Answer : (e) < TOP

>
Reason : At equilibrium, S=I
If government spending of 10MUC and a lump-sum tax of 10MUC is added, the IS equation is
determined by
S + T = I+G
S = –5+0.2(Y–10)
T=10.
I=50–10i
G=10.
–5+0.2(Y–10)+10=50–10i+10
–5+0.2Y–2+10=50–10i+10.2y=50–10i+10=5=2–10
0.2Y=57–10i
Y=285–50i.

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