Question Paper

Economics - II (MB142): April 2006

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

< Answer >

1. GDP at factor cost exceeds GDP at market price
(a) When the net factor income from abroad is negative
(b) When the net factor income from abroad is positive
(c) When depreciation of fixed capital exceeds gross investment
(d) When direct taxes exceed indirect taxes
(e) When subsidies exceed indirect taxes.
(1 mark)
2. When the addition to capital goods in an economy is less than the depreciation allowance, the economy < Answer >
experiences
(a) Negative net investment (b) Zero net investment
(c) Positive net investment (d) Negative gross investment
(e) Zero gross investment.
(1 mark)
< Answer >
3. Net factor income from abroad is
(a) NNP at market prices – NDP at market prices
(b) NDP at market prices – indirect taxes + subsidies
(c) NDP at factor cost + depreciation
(d) NDP at factor cost – depreciation
(e) NNP at market prices + depreciation.
(1 mark)
< Answer >
4. The circular flow of income in a two sector model implies
(a) Payments from households to firms and back again
(b) Payment from firms to firms
(c) Payments from households to households
(d) Payment from households to firms
(e) Payments from government to firms.
(1 mark)
5. In a two-sector economy, the savings function is estimated to be S = – 20 + 0.30Yd. < Answer >
If the equilibrium output is 600 MUC, the level of investment in the economy is
(a) 140 MUC (b) 150 MUC (c) 160 MUC (d) 130 MUC (e) 170 MUC.
(2 marks)
< Answer >
6. The following balances are taken from the National Accounts of an economy.

Particulars Million Units of Currency (MUC)

NDP at market prices 5,000
NNP at factor cost (National income) 4,200

Subsidies 100

Indirect taxes 950

The Net Factor Income from Abroad (NFIA) for the economy will be
(a) 8,150 MUC (b) 250 MUC (c) 80 MUC (d) 100 MUC (e) 50 MUC.
(2 marks)

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 < Answer >
7. The following information is extracted from National Income Accounts of a country:

Particulars MUC
NNP at factor cost 8,400
Corporate profits 1,500
Transfer payments by the government 150
Dividends 300

The personal income of the country will be

(a) 6,750 MUC (b) 9,450 MUC
(c) 10,050 MUC (d) 7,350 MUC (e) 7,000 MUC.
(2 marks)
8. In a two-sector economy, the marginal propensity to consume (MPC) is estimated to be 0.6. To bring < Answer >
about a Rs.1,000 billion change in equilibrium national income (Y), the required increase in corporate
investment (I) is
(a) Rs.125 billion (b) Rs.400 billion
(c) Rs.240 billion (d) Rs.300 billion (e) Rs.360 billion.
(2 marks)
< Answer >
9. The multiplier effect occurs because
(a) An increase in government purchases will increase income which will result in further increments
in spending
(b) An increase in government purchases will increase interest rates which will reduce further rounds
of spending
(c) An increase in government purchases will increase the government deficit which will decrease
further rounds of spending
(d) An increase in government purchases will stimulate monetary policy which will increase further
rounds of spending
(e) An increase in government purchases will increase the surplus in the balance of payments.
(1 mark)
< Answer >
10. Which of the following correctly illustrates investment?
(a) Addition to the existing stock of capital
(b) The difference between gross investment and net investment
(c) The ratio of increment in income to increment in expenditure
(d) The difference between consumption and investment
(e) The ratio of savings to income.
(1 mark)
< Answer >
11. Consumption demand does not depend upon the level of
(a) Income (b) Propensity to consume
(c) Propensity to save (d) Wealth
(e) Marginal efficiency of investment.
(1 mark)
< Answer >
12. In a two-sector economy the consumption function (C) is equal to 5 + 0.6Y and autonomous investment
is equal to 25 MUC. The equilibrium level of income in the economy is
(a) 21 MUC (b) 30 MUC (c) 43 MUC (d) 75 MUC (e) 150
MUC.
(2 marks)
< Answer >
13. In an economy, the autonomous savings amount to –100 MUC and the marginal propensity to save is
0.25. If savings in the economy is 100 MUC, the equilibrium income in the economy is
(a) 750 MUC (b) 700 MUC (c) 800 MUC (d) 950 MUC (e) 1,050 MUC.
(2 marks)
< Answer >
14. The following data pertains to national income aggregates of a hypothetical economy:

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 Consumption function (C) = 200 + 0.80Yd, where Yd is disposable income
Investment (I) = 500 MUC
Government spending (G) = 200 MUC
The equilibrium level of income is
(a) 1,640 MUC (b) 4,500 MUC (c) 4,200 MUC
(d) 4,300 MUC (e) 4,400 MUC.
(2 marks)
< Answer >
15. The real rate of interest
(a) Equals the nominal rate of interest plus the rate of inflation
(b) Equals the rate of inflation minus the nominal rate of interest
(c) Equals the nominal rate of interest minus the rate of inflation
(d) Tends to increase when inflation increases
(e) Is more relevant to investors than consumers.
(1 mark)
16. In a macro economic model, without foreign trade or government spending, aggregate demand is the
< Answer >
sum of
(a) Saving and investment (b) Saving and consumption
(c) Consumption and income (d) Consumption and investment
(e) Personal saving and private saving.
(1 mark)
< Answer >
17. If the money supply grows faster than the rate of growth of real GDP, the quantity theory predicts
(a) A steady increase in the real GDP to match the grow of the money supply
(b) A steady increase in the real wages to match the growth of money supply
(c) An increase in the prices in the long run
(d) A decrease in the velocity of money in the long run
(e) An increase in the velocity of money in the long run.
(1 mark)
18. The consumption equation of an economy is in the form C = 120 + 0.8 YD. If an initial investment of
< Answer >
Rs.5 billion is made in this economy, the income generated will be
(a) Rs.1 billion (b) Rs.10 billion (c) Rs.25 billion
(d) Rs.4 billion (e) Rs.5 billion.
(2 marks)
< Answer >
19. Inflation is best defined as
(a) A sustained and persistent increase in the general money supply
(b) A sustained and persistent increase in the general level of income
(c) A sustained and persistent increase in the general price level
(d) A continuous increase in the nominal interest rates
(e) A persistent increase in the general level of output.
(1 mark)
< Answer >
20. According to the classical theory, at a level of output corresponding to the full employment level of
output
(a) The aggregate supply curve will be horizontal
(b) Aggregate supply curve will be vertical
(c) Aggregate supply curve will be upward sloping
(d) The aggregate supply curve will be downward sloping
(e) The aggregate supply curve is absent.
(1 mark)
< Answer >
21. As per the Keynesian theory, unemployment is caused by
I. The deficiency of aggregate demand.
II. Excess of aggregate demand.
III. Deficiency of aggregate supply.
(a) Only (I) above (b) Only (II) above

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 (c) Only (III) above (d) Both (II) and (III) above
(e) Both (I) and (III) above.
(1 mark)
< Answer >
22. Which of the following conditions represent the equilibrium in the classical labor market?
(a) Marginal productivity of labor equals price
(b) Marginal productivity of labor equals nominal wage
(c) Marginal productivity of labor equals real wage
(d) Marginal productivity of labor equals cost of raw materials
(e) Marginal productivity of labor equals demand for goods.
(1 mark)
< Answer >
23. Which of the following statements is true regarding an increase in the real wage?
(a) The quantity of labor supplied is increased but the quantity of goods supplied is reduced
(b) The quantity of labor supplied is increased but the quantity of labor demanded is reduced
(c) Quantity of labor supplied is increased but the quantity of goods demanded is reduced
(d) Both the quantity of labor supplied and the quantity of labor demanded is reduced
(e) Quantity of labor supplied and demanded remains the same.
(1 mark)
< Answer >
24. According to the Keynesian analysis, the key variable influencing the relation between the quantity of
money and the price level is
(a) The rate of interest (b) The rate of inflation
(c) The level of output (d) The supply of goods
(e) The demand for goods.
(1 mark)
< Answer >
25. 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 >
26. Which of the following sequences correctly shows the impact of the reduction in CRR?
I. Change in money supply.
II. Change in nominal interest rates.
III. Change in consumption and investment.
IV. Change in aggregate demand.
V. Change in real GDP and price level.
(a) (I), (II), (III), (IV) and (V) above (b) (I), (II), (III), (V) and (IV) above
(c) (I), (II), (IV), (V) and (III) above (d) (I), (V), (II), (III) and (IV) above
(e) (I), (III), (II), (IV) and (V) above.
(1 mark)
< Answer >
27. Which of the following is not an instrument of monetary policy?
(a) Bank rate (b) Reserve requirement
(c) Open market operations (d) Tax rate
(e) Selective credit controls.
(1 mark)
< Answer >
28. A contractionary fiscal policy combined with a tight monetary policy results in
I. A lower level of output.
II. A higher level of output.
III. A lower interest rate.
IV. A higher interest rate.
V. A lower or higher interest rate depending on the relative magnitude of fiscal and monetary

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 policies.
(a) Both (I) and (III) above (b) Both (I) and (IV) above
(c) Both (II) and (V) above (d) Both (II) and (IV) above
(e) Both (I) and (V) above.
(1 mark)
< Answer >
29. 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 >
30. The monetary liabilities of the central bank of a country are 47,250 MUC and government money in the
economy is 750 MUC. Currency deposit ratio for the economy is estimated to be 0.30. Cash reserve
ratio (CRR) imposed by the RBI is 7.5 percent. The money supply in the economy will be
(a) 48,000 MUC (b) 58,000 MUC (c) 1,55,500 MUC
(d) 1,66,560 MUC (e) 1,58,000 MUC.
(2 marks)
< Answer >
31. The monetary liabilities of the central bank for an economy are 990 MUC. The amount of Government
money is 10 MUC. Total money supply in the economy is 4,000 MUC and the currency deposit ratio is
0.2. What would be the reserve ratio imposed by the central bank?
(a) 10% (b) 11% (c) 12% (d) 13% (e) 14%.
(2 marks)
< Answer >
32. Assume that reserve requirement for X Bank is 5%. X Bank has cash of 50 MUC, loans of 200 MUC
and demand deposits of 250 MUC. The amount of money X Bank will be allowed to lend will be
(a) 40.0 MUC (b) 37.5 MUC (c) 27.5 MUC (d) 27.0 MUC (e) 30.0 MUC.
(2 marks)
< Answer >
33. Consider the following information:
High powered money Rs. 8,000 Cr.
Currency deposit ratio in the economy 12%
Cash reserve requirement of the central bank 5%

The money multiplier is

(a) 6.59 (b) 5.25 (c) 7.75 (d) 8.25 (e) 9.50.
(1 mark)
< Answer >
34. In an economy, the high-powered money and money supply are 4,500 MUC and 17,500 MUC
respectively. If the reserve ratio is 10%, currency deposit ratio for the economy is
(a) 0.170 (b) 0.190 (c) 0.240 (d) 0.270 (e) 0.211.
(2 marks)
< Answer >
35. 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 >
36. The term ‘narrow money’ is
(a) Currency with the public
(b) Currency with the public + currency with the Government of India
(c) Currency with the public + demand deposits of the banking system + other deposits with the RBI
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 (d) Currency with the public + demand deposits of the banking system + post office savings bank
deposits
(e) Currency with the public + total post office deposits.
(1 mark)
< Answer >
37. If a scheduled bank meets its cash reserve requirement of 4% by depositing Rs. 9 crore with the RBI,
then
(a) Total deposit liabilities of the bank are Rs.22.50 crore
(b) Total deposit liabilities of the bank are Rs.225.00 crore
(c) Total deposit liabilities of the bank are Rs.250.00 crore
(d) Total deposit liabilities of the bank are Rs.150.00 crore
(e) Total deposit liabilities of the bank are Rs.175.00 crore.
(1 mark)
< Answer >
38. In a deflationary period, the appropriate policy for the RBI would be to
(a) Buy government securities in the open market
(b) Discourage commercial banks to increase their loans
(c) Increase Cash Reserve Ratio
(d) Increase bank rate
(e) Reduce the credit to government.
(1 mark)
< Answer >
39. The following information is available with respect to an economy:
Particulars MUC
Monetary liabilities or central bank 3,600
Government money 400

High-powered money in the economy is

(a) 3,000 MUC (b) 3,100 MUC (c) 3,200 MUC (d) 3,300 MUC (e) 4,000 MUC.
(1 mark)
< Answer >
40. In an economy the high-powered money is 400 MUC. The currency deposit ratio is estimated to be 0.40
and the reserve ratio is 10%. If foreign exchange assets with the central bank increase by 50 MUC what
is the new reserve ratio so that the money supply remains at the previous level?
(a) 9.25% (b) 10.50% (c) 16.25% (d) 18.25% (e) 18.50%.
(2 marks)
< Answer >
41. The following information relates to an economy:
Particulars Rs. in crore
Consumption 1,500
Investment 300
Government expenditure 200
If the velocity of money is 4, money supply in the economy is
(a) Rs.162.50 crore (b) Rs.245.00 crore (c) Rs.262.50 crore
(d) Rs.500.00 crore (e) Rs.487.50 crore.
(2 marks)
< Answer >
42. In a two-sector economy the multiplier value is 4 and the increment in income is 4,000 MUC, the
required amount of savings when the economy is at equilibrium will be
(a) 6,000 MUC (b) 1,000 MUC (c) 5,000 MUC
(d) 7,000 MUC (e) 2,000 MUC.
(2 marks)
< Answer >
43. Domestic savings for a year is 1,500 MUC. If the budget deficit is 500 MUC, private savings for the
year is
(a) 400 MUC (b) 1,000 MUC (c) 2,000 MUC
(d) 2,000 MUC (e) 2,500 MUC.
(1 mark)

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 < Answer >
44. The following information is extracted from the National Income Accounts of an economy.
Particulars MUC
GNP at market prices 1,000
Depreciation 40
Indirect taxes 400
Subsidies 50
National Income (NI) of the economy is
(a) 610 MUC (b) 1,390 MUC (c) 510 MUC
(d) 5,900 MUC (e) 1,490 MUC.
(2 marks)
< Answer >
45. The following is the information from national accounts of an economy:
Particulars MUC
Indirect taxes 34,200
Net factor income from abroad –9,000
Depreciation 36,000
Subsidies 18,000
National income 1,44,000
The GDP at market prices is
(a) 74,400 MUC (b) 90,600 MUC (c) 2,05,200 MUC
(d) 1,57,050 MUC (e) 1,36,80 MUC.
(2 marks)
< Answer >
46. The position of the short run Philips curve depends on
(a) Expected rate of output growth (b) Expected rate of money supply growth
(c) Expected rate of inflation (d) Expected rate of unemployment
(e) Expected rate of growth of nominal income.
(1 mark)
< Answer >
47. Which of the following statements is true?
(a) Real interest rate equals nominal interest rate plus rate of inflation
(b) Inflation equals real interest rate plus nominal interest rate
(c) Expected real interest rate equals expected nominal interest rate plus inflation
(d) Expected real interest rate equals expected nominal interest rate minus rate of inflation
(e) Inflation rate is the product of real interest rate and nominal interest rate.
(1 mark)
< Answer >
48. During hyperinflation, the velocity of money
(a) Increases (b) Remains constant
(c) Decreases (d) Increases at the rate of money supply growth
(e) Decreases with the rate of money supply growth.
(1 mark)
< Answer >
49. During a period of sustained inflation
(a) Interest rate tends to decrease because the value of money decreases
(b) Interest rate tends to decrease because the unemployment rate tends to decrease
(c) Interest rate tends to increase because the value of money decreases
(d) Interest rate tends to increase the unemployment rate decreases
(e) Interest rate remains constant.
(1 mark)
< Answer >
50. If an economy reaches full employment, the increase in the quantity of money leads to
(a) Increase in the price level
(b) Increase in the employment level
(c) An increase in the consumption level
(d) Decrease in the price level
(e) A decrease in the consumption level.

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 (1 mark)
< Answer >
51. Gross fiscal deficit implies
(a) Excess of total government expenditures over revenue receipts and grants
(b) Total of governments non-plan expenditure
(c) Difference between governments non-plan and plan expenditure
(d) Difference between non-developmental expenditure and capital gains
(e) It is the same as revenue deficit.
(1 mark)
< Answer >
52. When there is an expansionary monetary and fiscal policy, it will shift
(a) Aggregate demand to the right (b) Aggregate demand to the left
(c) Aggregate supply to the right (d) Aggregate supply to the left
(e) No change in the aggregate demand and aggregate supply.
(1 mark)
< Answer >
53. When an economy is experiencing a recessionary GDP gap, the prudent course of action would be to
(a) Decrease transfer payments to individuals and organizations
(b) Increase the overall tax levels
(c) Decrease aggregate spending
(d) Undertake expansionary fiscal policies
(e) Reduce government purchases of goods and services.
(1 mark)
< Answer >
54. Which of the following statements is true?
(a) Discretionary fiscal policy refers to automatic changes in tax and expenditure policies in response
to the economic situations
(b) Changes in tax revenues and unemployment compensation are examples of discretionary fiscal
policy
(c) Deliberate changes in tax rates and government expenditures is referred to as discretionary fiscal
policy
(d) Government can resort to an expansionary fiscal policy by a reduction in the bank rate or cash
reserve ratio
(e) When an economy is experiencing a recessionary GDP gap, the government must decrease its
aggregate spending.
(1 mark)
< Answer >
55. Given the following data, compute the current account balance for the country.
Particulars MUC
Earnings on loans and investments from abroad 3,500
Earnings on loans and investments to abroad 1,7500
Import of services 28,000
Private remittances to abroad (transfers) 3,500
Private remittances from abroad (transfers) 3,500
Exports of services 14,000
Merchandize exports 1,05,000
Merchandize imports 84,000
(a) 7,000 MUC (Surplus) (b) 7,000 MUC (Deficit)
(c) 500 MUC (Surplus) (d) 500 MUC (Deficit) (e) Zero.
(2 marks)
< Answer >
56. Which of the following is a stock variable?
(a) Gross Domestic Product (b) Inventory of a firm (c) Inflation
(d) Exports (e) Investment.
(1 mark)
< Answer >
57. The following information is available from the balance of payment statements of an economy:

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 Item MUC
Trade balance –5,000
Current account balance –2,000
Capital account balance 6,000

The foreign exchange reserves of the country will

(a) Decrease by 7,000 MUC (b) Increase by 7,000 MUC
(c) Decrease by 4,000 MUC (d) Increase by 4,000 MUC
(e) Decrease by 6,000 MUC.
(1 mark)
< Answer >
58. The capital inflows and outflows in an economy during the year 2004-05 are 6,300 MUC and 4,300
MUC respectively. Suppose there is no change in the official foreign reserve assets held by the central
bank, what could be the current account balance for the economy?
(a) 1,500 MUC (Deficit) (b) 1,500 MUC (Surplus)
(c) 2,000 MUC (Deficit) (d) 2,000 MUC (Surplus) (e) Zero.
(1 mark)
< Answer >
59. If the country X enjoys a comparative advantage in the production of coffee over the country Y, then
(a) The opportunity cost of producing coffee in X is higher than in Y
(b) The opportunity cost of producing coffee in X is lower than in Y
(c) Neither X nor Y should specialize in the production of coffee
(d) Both the countries enjoy absolute advantage in the production of coffee
(e) The opportunity cost of producing coffee is same in Y and X.
(1 mark)
< Answer >
60. Which of the following is a consequence of a reduction in the required reserve ratio?
(a) Decrease in the credit creation and decrease in the money supply
(b) An increase in the credit creation and decrease in the money supply
(c) Increase in the credit creation and increase in the money supply
(d) Decrease in credit creation and increase in the money supply
(e) The money supply remains unaffected.
(1 mark)
< Answer >
61. The consumption function shows the relationship between consumption and
(a) Disposable income (b) Expectations (c) Price level
(d) Money supply (e) Rate of interest.
(1 mark)
< Answer >
62. Which of the following best describes the bank rate?
(a) The rate at which the central bank discounts foreign bills
(b) The rate at which the central bank discounts the government’s bills.
(c) The rate at which the central bank discounts the commercial bank’s bills
(d) The rates at which loans are given to costumers by commercial banks.
(e) The rate at which deposits are mobilized by commercial banks.
(1 mark)
< Answer >
63. The term balance of trade implies
(a) The difference between the balance on capital and current account
(b) The difference between merchandise exports and imports
(c) The ratio of exports to imports
(d) Same as the balance of capital account
(e) The ratio of imports to exports.
(1 mark)
< Answer >
64. The change in foreign exchange reserves and reserves of monetary gold held by the monetary
authorities will be recorded in

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 (a) Current account of the BoP statement
(b) Capital account of the BoP statement
(c) Errors and omissions account
(d) Official reserves account
(e) Invisible accounts.
(1 mark)
< Answer >
65. In general, when unemployment is decreasing rapidly
(a) The economy is experiencing slow growth (b) The economy is in a recession
(c) The economy is in a depression (d) The economy is in boom
(e) The economy is stagnant.
(1 mark)
< Answer >
66. Which of the following variables will be at low levels during boom phase of a business cycle?
(a) Bank reserves (b) Wage rates (c) Bank credit
(d) Inventory (e) Cost of production.
(1 mark)
< Answer >
67. Robert begins his job search soon after his Post-graduation in Computer Science. After two months of
search, he is hired by a software company as a system administrator. The nature of unemployment
encountered by Robert is
(a) Structural (b) Frictional (c) Cyclical
(d) Seasonal (e) Disguised.
(1 mark)
< Answer >
68. Suppose a drop in consumer confidence results in an economic contraction. In order to move the
economy out of recession,
I. Government spending could be increased.
II. Taxes could be lowered.
III. The money supply could be increased.
IV. Interest rate could be reduced.
(a) Only (I) above (b) Both (I) and (II) above
(c) Both (II) and (III) above (d) (II), (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
(1 mark)
< Answer >
69. If planned consumption equals 70 + 0.80 Yd and planned investment is 90 MUC, the equilibrium level
of income is
(a) 100 MUC (b) 200 MUC (c) 400 MUC (d) 800 MUC (e) 1,000 MUC.
(1 mark)
< Answer >
70. If the multiplier is 2.5, the marginal propensity to consume is
(a) 0.20 (b) 0.60 (c) 0.75 (d) 1.00 (e) 4.00.
(1 mark)
< Answer >
71. GDP of a country is 8,000 MUC. Value of output produced in domestic country by foreign factors of
production is 200 MUC and value of the output produced by domestic factors of production in foreign
countries is 100 MUC. GNP of the country is
(a) 7,700 MUC (b) 7,800 MUC (c) 7,900 MUC
(d) 8,100 MUC (e) 8,200 MUC.
(2 marks)
< Answer >
72. The following information is extracted from the National Income Accounts of an economy for the year
2005:
Particulars MUC
GNP at market prices 700
Factor income received by domestic residents from foreigners 20
Net indirect taxes 60
Subsidies 25
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 Subsidies 25
Depreciation 10
NNP at factor cost for the year 2005 is
(a) 560 MUC (b) 620 MUC (c) 655 MUC (d) 665 MUC (e) 810 MUC.
(2 marks)
< Answer >
73. An economy produces only two commodities – bread and butter. During the year 2005, it doubled its
production to 1500 units of bread and 2500 units of butter, as compared to last year. The commodity
prices in the economy during the two years are given below: (Consider 2004 as the base year)

Price of Bread Price of Butter

Year
(Rs. per unit) (Rs. per unit)
2004 20 15
2005 25 20
GDP deflator for the year 2005 is
(a) 125 (b) 142 (c) 140 (d) 130 (e) 121.
(2 marks)
< Answer >
74. The following information is given from the national income accounts for a country in the year 2005-
06:

Particulars Rs. crore

Subsidies 12,000
NDP at market prices 2,34,000
Indirect taxes 36,000
What is the NDP at factor cost for the year 2005-06?
(a) Rs.2,10,000 crore (b) Rs.2,00,000 crore
(c) Rs.1,90,000 crore (d) Rs.1,80,000 crore
(e) Rs.2,58,000 crore.
(2 marks)
< Answer >
75. The following balances are taken from the balance sheet of the Central Bank:

Particulars MUC
Financial assets 3,520
Other assets 60
Non-monetary liabilities 280
The monetary liabilities would amount to
(a) 3,000 MUC (b) 3,050 MUC (c) 3,100 MUC (d) 3,300 MUC (e) 3,400 MUC.
(2 marks)
< Answer >
76. Balance of payments statements of a country for the year 2005 is given below:

Particulars MUC
Merchandise imports 20,000
Merchandise exports 18,000
The trade balance for the year 2005 is
(a) 2,000 MUC (deficit) (b) 2,000 MUC (surplus)
(c) 1,000 MUC (surplus) (d) 1,350 MUC (surplus)
(e) 1,950 MUC (surplus).
(2 marks)

Suggested Answers
Economics - II (MB142): April 2006
11
1. Answer : (e) < TOP >

Reason : GDPFC = GDPMP – Indirect taxes + Subsidies

∴ If GDPFC > GDPMP, Subsidies > Indirect taxes.
2. Answer : (a) < TOP >

Reason : When investment < Depreciation, capital stock decreases and net investment will be
negative. Note that capital consumption is nothing but depreciation.
3. Answer : (a) < TOP >

Reason: NNP at market prices = NDP at market prices + net factor income from abroad
Thus net factor income from abroad = NNP at market prices – NDP at market prices.

4. Answer : (a) < TOP >

Reason : The circular flow diagram shows the payments from the households to the firms for the
goods and services and firms paying the households for the factor services rendered by the
firms.
5. Answer : (c) < TOP >
Reason : Savings function S = –20 + 0.30Yd
∴C = 20 + 0.70Yd
At Y=600, S = –20 + 0.30(600) = – 20 + 180 = 160 MUC. = Investment as S = I.
6. Answer : (e) < TOP >

Reason : NFIA = NNPMP – NDPMP

NNPMP = NNPFC + Indirect Taxes – Subsidies = 4200 + 950 – 100 = 5050
Thus, NFIA = 5050 – 5000 = 50.
7. Answer : (d) < TOP >

Reason : Personal Income (PI) = NI – Corporate profit + Dividends + Transfer Payments

= 8,400 – 1,500 + 300 + 150
= 7,350.
8. Answer : (b) < TOP >

Reason : MPC = 0.6

Multiplier (m) =
∆Y = m . ∆I

∴ ∆I = = 400
9. Answer : (a) < TOP >

Reason : When autonomous expenditure, like government expenditure (G), increase in the economy,
further rounds of increase in AD and output is triggered in future periods. This is defined as
multiplier effect.
10. Answer : (a) < TOP >

Reason: Investment means addition to the existing stock of capital. It can be positive or negative

11. Answer : (e) < TOP >

Reason : (a) Consumption depends on the income and as income increase consumption also
increase.
(b) Propensity to consume refers to the changes in consumption as a result of change in
income. Hence propensity to consume effects consumption.
(c) Propensity to save refers to changes in savings as a result of changes in income. The
level of savings affects the level of consumption. Hence changes in savings does
affect consumption
(d) Consumption demand depend upon the level of wealth
(e) Consumption demand does not depend upon the level of marginal efficiency of
12
 investment.
12. Answer : (d) < TOP >
Reason : Y = C + I
Y = 5 + 0.6Y + 25
Y = 30 + 0.6Y
0.4Y = 30
Y = 75 MUC
13. Answer : (c) < TOP >

Reason : S = – 100 + 0.25Yd

When S = 100, 100 = –100 + 0.25Yd
or, 200 = 0.25Yd
or, Yd = 800
Since the economy is a two sector economy, Y = Yd (disposable income).
14. Answer : (b) < TOP >

Reason: Y = 200 + 0.80Y+500+200

Y = 900 + 0.8Y
0.2Y = 900
Y = 4,500
15. Answer : (c) < TOP >

Reason : Nominal rate of interest = real rate of interest + inflation. Therefore the answer is (c).
16. Answer : (d) < TOP >

Reason : By definition national income is the sum of consumption and investment

The only option that contains consumption and investment as the variables is option (d).
Hence (d) is the answer. Also, by definition, national income is the sum of personal
consumption and private investme
17. Answer : (c) < TOP >

Reason : If the money supply grows faster than the rate of growth of real GDP, then it will be a case
of too much money chasing too few goods and leads to inflation.
18. Answer : (c) < TOP >

Reason : C = 120 + 0.8Yd

Multiplier = 1/ (1-0.8) = 5
If an initial investment of Rs.5 billion is made, the income will be
5×5 = 25 billion

19. Answer : (c) < TOP >

Reason : Inflation is a sustained and persistent increase in the general price level
20. Answer : (b) < TOP >

Reason : According to the classical theory, at the full employment level of output, all the labor has
been fully employed and hence, the aggregate supply curve will be perfectly inelastic or
vertical
21. Answer : (a) < TOP >

Reason : As per the Keynesian theory, unemployment is caused by the deficiency of aggregate
demand. He advocates government spending to boost aggregate demand.
< TOP >
22. Answer : (c)
Reason : In the classical theory, the equilibrium in the labor market is achieved when the marginal
productivity equals the real wage.
< TOP >
23. Answer : (b)

13
 Reason : At a high real wage, the quantity of labor supplied is increased, but due to higher real
wage, the quantity of labor demanded is reduced. When the real wages are high, there will
be more incentive on the part of the laborers to supply labor but the labor demanded will
not increase since more wages have to be paid
(a) Is not the answer. The quantity of labor aupplied can increase however no prediction
can be made regarding the quantity of goods supplied
(c) Is not the answer since no prediction is possible regarding the quantity of goods
demanded
(d) Is not the answer since again nothing can be said regarding the goods manufactured
(e) Is not the answer since the quantity of labor supplied has to increase in response to an
increase in the real wage.
24. Answer : (a) < TOP >

Reason : According to the Keynesian theory, the relation between the quantity of money and the
price level is an indirect one via the rate of interest. When the quantity of money increases
the rate of interest falls and if the demand for liquidity is high, and assuming there are
unemployed resources, the aggregate demand will increase. This will push up costs and
wages and increase the price level.
25. Answer : (b) < TOP >

Reason : Sterilization means neutralization of changes in the money supply caused by changes in the
foreign exchange reserves of a country.
26. Answer : (a) < TOP >

Reason : When the CRR is reduced to 4.5% from 4.75%, the money supply in the economy
increases with the increase in the value of money multiplier. Higher money supply lowers
the interest rates in the economy. Lower interest rate in turn encourages investment and
consumption in the economy. As consumption and investment are part of aggregate
demand, aggregate demand increases with the reduction of CRR. When aggregate demand
increases, the real GDP and price levels increase in the economy.
Therefore, change in the CRR → change in money supply → change in nominal interest
rate → change in consumption and investment → change in aggregate demand → change
in real GDP and price level.

27. Answer : (d) < TOP >

Reason : Taxation is not an instrument of monetary policy, rather it is a fiscal policy instruments. So
the answer is (d).
28. Answer : (e) < TOP >

Reason : Contractionary (tight) fiscal policy involves increasing tax rate and/or decreasing the
government spending to bring down the aggregate demand and price level in the economy.
Reduced government spending reduces the public borrowings, and thereby interest rate and
output in the economy. The tight monetary policy, conversely, reduces the money supply
and thereby increases the interest rate in the economy. Increased interest rate reduces both
consumption and investment and thereby reduces output in the economy. Thus, we can say
that the combined effect of tight fiscal policy and tight monetary policy lowers the output.
But, the direction of change in interest rate is not known unless we know the magnitude of
influence of fiscal and monetary policies on interest rate.
I. A contractionary fiscal policy combined with a tight monetary policy result in a lower
level of output.
II. A contractionary fiscal policy combined with a tight monetary policy do not result in
a higher level of output.
III. A contractionary fiscal policy combined with a tight monetary policy do not result in
a lower interest rate
IV. A contractionary fiscal policy combined with a tight monetary policy result in a
higher interest rate
V. A contractionary fiscal policy combined with a tight monetary policy result in a lower
or higher interest rate depending on the relative magnitude of fiscal and monetary
policies. So, the answer is (e).
29. Answer : (b) < TOP >

14
 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.
(c) Monetary policy will not be more effective when the private investment is less
sensitive to interest rate.
(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.
30. Answer : (d) < TOP >

Reason : High powered money = Monetary Liabilities of RBI + Government Money

∴High powered money (H) = 47,250 + 750 = 48,000
Money supply (Ms) = H×m

Money multiplier (m) =

= = = 3.47
∴Money Supply
in the economy = 48,000 × 3.47
= 166,560 MUC
31. Answer : (a) < TOP >

Reason : High powered money = Monetary Liabilities of RBI + Government Money

Monetary liabilities of RBI = 990
Government money = 10
High powered money = 990 + 10 = 1000
Money Supply = H×m

m = money multiplier =
4000 = 1000 × m

m= = 4.

=4

=4
1.2 = 0.8 + 4r

r= = 0.10 = 10%.
32. Answer : (b) < TOP >
Reason : When the reserve requirement is 5%, the money multiplier is 20 (1/0.05) = The reserve
ratio is 0.05. So the bank has to keep 12.5 million (0.05 ×250) as reserves. Hence the
excess reserves with the bank is 50 – 12.5 =37.5 which it can afford to lend out.
33. Answer : (a) < TOP >

15
 Reason : Money multiplier = = = 6.59
34. Answer : (e) < TOP >

Reason : Money supply = High Powered money × Money multiplier

∴ 17,500 = 4,500. m

or, m =

∴
or, 1+ Cu = 3.89Cu + 0.389
or, – 2.89Cu = –0.611
or, Cu = 0.211
< TOP >
35. Answer : (c)
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.
36. Answer : (c) < TOP >

Reason : The term ‘narrow money’ is Currency with the public + Demand deposits of the Banking
system + other deposits with the RBI.
37. Answer : (b) < TOP >

Reason :
38. Answer : (a) < TOP >
Reason : It would be appropriate for the RBI to pursue a expansionary monetary policy during a
period of deflation. Through expansionary monetary policy RBI would like to increase the
aggregate demand in the economy thereby causing the prices to increase. Of all the options,
only open market purchase of government securities is an expansionary monetary policy.
All other options are contractionary monetary policies.

39. Answer : (e) < TOP >

Reason : High – Powered money (H) = monetary liabilities or central bank + Government money.
M = 3,600 + 400 = 4000 MUC
40. Answer : (c) < TOP >

Reason : Money supply, M =

=
= 2.8 × 400
= 1120 MUC
If there is an additional inflow of 50 MUC of foreign exchange assets, H = 400 + 50 = 450
If money supply is to be maintained at 1,400 MUC,

1120 =

or, 0.40 + r =
or, 0.40 + r = 0.5625
16
 or, r = 0.1625 = 16.25%
41. Answer : (d) < TOP >

Reason : Velocity of money =

Total expenditure = C + I + G = 1500+300+200 = 2000
Money supply = 2000/4 = Rs.500cr.
42. Answer : (b) < TOP >

Reason : Multiplier = = 4.
Increment in income = 16,000 – 12,000 = 4,000
Required saving in the economy = 4,000/4 = 1, 000 MUC.
43. Answer : (c) < TOP >

Reason : Domestic savings = Private savings + Public savings

Private savings = 1500 – (–500) = 2000
∴ The answer is (c)
44. Answer : (a) < TOP >

Reason : National Income = NNP at factor cost

= GNP at market prices – depreciation – indirect taxes + subsidies.
= 1000 – 40 – 400 + 50
= 610.

45. Answer : (c) < TOP >

Reason : National income = NNP at factor cost

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
= 144000 + 34200 – 18000 – (– 9000) + 36000 = 205200 MUC.
46. Answer : (c) < TOP >

Reason : Philips curve shows the trade off between inflation and unemployment. The position of the
short run Philips curve depends on the expected rate of inflation.
Hence, (c) Is the answer
47. Answer : (d) < TOP >

Reason : The expected real interest rate is given by expected nominal interest rate minus the rate
of inflation.
48. Answer : (a) < TOP >

Reason : During hyperinflations, money loses its value very fast. Thus there is an incentive to spend
money as rapidly as possible, and velocity tends to increase
49. Answer : (c ) < TOP >

Reason : When there is accelerating inflation, the general price level increases and the value of
money decreases. When the general price level increases, the interest rate will increasse.
There is a positive relation between inflation and the rate of interest.
50. Answer : (a) < TOP >

Reason : If an economy reaches full employment, the increase in the quantity of money leads to a
proportionate increase in the price level. Therefore the Fisher’s quantity theory of P =
MV/T applies only in case of full employment situation.
51. Answer : (a) < TOP >

Reason : The term ‘gross’ fiscal deficit implies the excess of total government expenditures over
revenue receipts and grants.

17
52. Answer : (a) < TOP >

Reason : An expansionary monetary policy makes the supply of money easier. This will mean more
money in the hands of the public and hence an increase of aggregate demand. An
expansionary fiscal policy will cause more government spending, which will also shift the
aggregate demand to the right.
53. Answer : (d) < TOP >

Reason : When an economy suffers from a recessioanry GDP gap, it is experiencing a downturn in
its economic variables. Hence , it would be prudent to undertake an expansioanry fiscal
policy which includes increase in government spendig and decrease in the level of taxation
to stimulate aggregate demand.
54. Answer : (c) < TOP >

Reason : A discretionary fiscal policy refers to deliberate changes in tax rate and expenditure
policies by the government in times of contraction or expansion.
55. Answer : (b) < TOP >

Reason : Current account balance = Credit (Current account )– debit (Current account)
= [Earnings on loans and investments from abroad + Private remittances from abroad
(transfers) + Exports of services + Merchandize exports] – [Earnings on loans and
investments to abroad + Private remittances to abroad (transfers) + Import of services +
Merchandize imports] = [3500 + 3500 + 14,000 + 105,000] – [17,500 + 3500 + 28,000 +
84,000]
= 126,000 – 133,000 = –7,000 i.e. 7,000 MUC (Deficit)
56. Answer : (b) < TOP >

Reason : Stock is a variable which is measured at a point of time.

a. GDP is the money value of goods and services produced within the domestic territory
of a country (which includes depreciation) in a year and hence not a stock because it
is measured over a period of time, usually a year.
b. Inventories refer to the unsold stock or the raw materials maintained by a firm to be
use in the production process. Hence it is measured at a point of time, i.e., number of
unsold goods as on 31 March, 2003 are 100. Hence, it is a stock variable
c. Inflation refers to persistent increase in prices over a period of time. It is measured
over a period of time hence it is a flow and not a stock variable.
d. Exports is an example of flow variables.
e. Investment is an example of flow variables.
57. Answer : (d) < TOP >

Reason : Change in foreign exchange reserves = Current account balance + Capital account balance
= –2000 + 6000 = 4000 MUC
58. Answer : (c) < TOP >

Reason : Capital inflows – capital outflows = 6,300 – 4,300 = 2,000 MUC (Deficit).
59. Answer : (b) < TOP >

Reason : If the country called X enjoys a comparative advantage in the production of coffee over the
country called Y, then the opportunity cost of production in X is lower than in Y
60. Answer : (c) < TOP >

Reason : When the reserve ratio is reduced, the money supply increases by the money multiplier
given by M = 1 + Cu / Cu + r
A reduction in the reserve ratio will thus tend to increase the money supply, which will
enable the banks to increase the loans
61. Answer : (a) < TOP >

Reason : Consumption function shows the relationship between consumption and disposable
income.
62. Answer : (c) < TOP >

Reason : The bank rate is the rate at which the central banks discount the commercial bank bills.
18
 This is treated as the benchmark for other interest rates.
63. Answer : (b) < TOP >

Reason : The term balance of trade is the differences between merchandise exports and imports.
(a) The difference between the balance on the current and capital account is the overall
balance
(b ) The ratio of exports to imports is called the terms of trade and not balance of trade
(c) Balance on the capital account is simply called the capital account balance and not
balance of trade
(d) There is no definition for the ratio of imports to exports.
64. Answer : (d) < TOP >

Reason : Inventories of foreign countries and gold that could be sold for dollars are held under the
official reserves account with the central bank that they would sell in the market when
there is an excess demand for dollars. Conversely, when there is an excess supply of
dollars, they would buy up the dollars.
65. Answer : (d) < TOP >

Reason : In general, when the unemployment is falling, it means that more people are able to find
jobs and the resources are more fully utilized. This increases the income ands the aggregate
demand thereby expanding the economic growth.
66. Answer : (d) < TOP >

Reason : (a) During a boom bank reserves will be high as the bank credit is high to support the
increased economic activity
(b) Wage rate will be high as demand for labor increase during the boom phase
(c) As the economic activity increase during the boom bank credit also increases
(d) During a boom demand increased at a faster rate and inventories tend to be low. All
other variables tend to increase during a boom.
(e) Cost of production will be high as demand for factors of production will be
relatively high during the boom phase.
67. Answer : (b) < TOP >

Reason : (a) Structural unemployment arises when the regional or occupational pattern of the job
vacancies does not match the pattern of workers availability and suitability. The
above situation does not represent structural unemployment.
(b) Unemployment that is caused by constant changes in the labor market is called
frictional unemployment. It occurs on account of two reasons: (a) employers not fully
aware of all available workers and their job qualifications; and (b) available workers
are not fully aware of the jobs being offered by employers. Even though the suitable
job is available for Mr.Robert it took him 2 months to find the job. Thus, the
unemployment encountered by Robert is in the nature of frictional (natural)
unemployment.
(c) Unemployment that arises when there is general downturn in business activity is
called cyclical unemployment.
(d) Unemployment that arises because of seasonal variations is called seasonal
unemployment. For example, agricultural labors normally face unemployment during
summer.
(e) When marginal productivity becomes negative because of excess employment we call
it as disguised unemployment. In less developed countries like India there is
widespread disguised unemployment in agricultural sector.
68. Answer : (e) < TOP >

Reason : If an economy is in recession, expansionary fiscal and monetary policies can help increase
the AD and revive economic activity. Options (a) and (b) are expansionary fiscal policy
tools and options (c) and (d) are expansionary monetary policy tools. Therefore, any of the
options would be appropriate to help an economy in recession.
69. Answer : (d) < TOP >

19
 Reason : Y = c + 1
Y = 70 + 0.80Y + 90
0.20Y = 160
Y = 800.
70. Answer : (b) < TOP >

Reason : Multiplier =
1
2.5 = 1 − MPC
2.5 – 2.5 MPC = 1
= 2.5 MPC
MPC = 0.60
71. Answer : (c) < TOP >

Reason : GNP = GDP + NFIA

NFIA = Factor income received from abroad – Factor income paid abroad.
= 100 – 200
= – 100
∴ GNP = 8000 – 100
= 7900.

72. Answer : (c) < TOP >

Reason : GNP at factor cost = GNP at market prices +subsidies–indirect taxes

Or 700 +25 – 60 = 665
NNP at factor cost = GNP at factor cost – depreciation
Or 665 – 10 = 655 MUC
73. Answer : (d) < TOP >

Reason : Real GDP for 2005 = (Quantity of bread in 2005 x Price of bread in 2004) + (Quantity of
butter in 2005 x Price of butter in 2004) = (1500 x 20) + (2500 x 15) = Rs.67500.
Nominal GDP for 2005 = (Quantity of bread in 2005 x Price of bread in 2004) + (Quantity
of butter in 2005 x Price of butter in 2005) = (1500 x 25) + (2500 x 20) = 37500 + 50000 =
87,500.
Nominal GDP
×100
GDP deflator = Real GDP = (87500/67500) x 100 = 1.296 x 100 = 129.6 or 130
approximately.
74. Answer : (a) < TOP >

Reason : NDP at factor cost = NDP at market prices – Indirect taxes + subsidies
= 234000 – 36000 + 12000
= Rs.210000 Cr.
75. Answer : (d) < TOP >

Reason : Monetary liabilities = Financial assets + other assets – Non monetary liabilities
= 3,520 + 60 – 280
= 3,300
76. Answer : (a) < TOP >

Reason : Balance of trade(BoP) = Merchandise exports – Merchandise imports +

= 18,000 –2,0000 = 2000 MUC (deficit).

< TOP OF THE DOCUMENT >

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