Question Paper

Economics - II (122) : July 2004

• • Answer all questions.

• • Marks are indicated against each question.
< Answer
1. Which of the following is a “leakage” from the circular flow of income? >

(a) Mr. Ramesh bought an Indian made color television for Rs.15,000
(b) Mr. Babu bought a second hand refrigerator from his friend Rajesh
(c) Mr. Harsha imported a brand new Ferrari car from Germany for Rs.10 lakh
(d) Mr. Sujit paid Rs.10,000 to his personal secretary towards salary
(e) Both (a) and (c) above.
(1 mark)
< Answer
2. Both dividends and corporate taxes are part of >

I. Corporate profits II. National income

III. Personal income IV. Personal disposable income.
(a) Both (I) and (II) above (b) Both (II) and (III) above
(c) Both (I) and (III) above (d) (I), (II) and (III) above
(e) (I), (II) and (IV) above.
(1 mark)
< Answer
3. Which of the following variables is a flow variable? >

(a) Capital stock (b) A firm’s assets

(c) Gross fixed investment (d) Price index
(e) Public debt.
(1 mark)
< Answer
4. The value-added approach to GDP measurement >

(a) Adds up the difference between the value of output and costs of intermediate goods
(b) Adds up all income received by the household sector in the economy
(c) Removes the effect of inflation from the nominal GDP
(d) Adds up all the expenditures incurred on the goods and services produced by the domestic sector
(e) Adds the total money value of goods and services purchased by their ultimate buyers.
(1 mark)
< Answer
5. Given that the marginal propensity to consume is larger, which of the following statements are true. >

I. Marginal propensity to save will be larger

II. Multiplier value will be larger
III. Average propensity to consume will be larger
IV. Autonomous consumption will be higher.

(a) Both (I) and (II) above (b) Both (II) and (III) above
(c) (II), (III) and (IV) above (d) (I), (II) and (III) above
(e) Both (III) and (IV) above.
(1 mark)
< Answer
6. According to Keynes, the actual expenditure in an economy can differ from the planned expenditure. >
Which of the following is true if the actual expenditure is less than the planned expenditure in the
 economy?
(a) There will be positive fixed investment in the economy
(b) There will be negative fixed investment in the economy
(c) There will be positive inventory investment in the economy
(d) There will be negative inventory investment in the economy
(e) There will be no change in inventory investment in the economy.
(1 mark)
< Answer
7. The demand for money is a demand for real money balances for a given interest rate. If there is an >
increase in the level of income because of increase in real money supply, which of the following
statements holds true?
(a) IS curve shifts to the left (b) LM curve shifts to the left
(c) IS curve shifts to the right (d) LM curve shifts to the right
(e) Both IS and LM curves shifts to the right.
(1 mark)
< Answer
8. Which of the following statements is not true about IS-LM Model? >

(a) IS function represents the goods market equilibrium

(b) LM function represents the money market equilibrium
(c) Interest rate is a variable in both IS and LM functions
(d) Goods and money markets interact to determine the equilibrium national income
(e) IS curve is positively sloped.
(1 mark)
< Answer
9. An increase in government expenditure 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 IS curve to the left
(d) Not affect the position of IS curve but shift LM curve to the right
(e) Not affect the position of LM curve but shift IS curve to the right.
(1 mark)
< Answer
10. Aggregate supply curve becomes vertical even in short run, if >

(a) The economy is facing deficit demand

(b) There are idle resources
(c) All available resources are fully employed
(d) The economy is yet to reach full employment
(e) All firms are earning normal profits.
(1 mark)
< Answer
11. Aggregate demand in an economy increases with the >

(a) Decrease in income of foreigners

(b) Increase in the private transfers from abroad
(c) Decrease in government spending
(d) Increase in interest rates
(e) Increase in tax rates.
(1 mark)
< Answer
12. Bank rate means >

(a) The rate of interest on inter-bank loans

(b) The rate of interest charged by banks on borrowers
 (c) The rate of interest paid by banks to depositors
(d) The rate of interest charged by banks for loans given to the central bank of the country
(e) The rate of interest charged by the central bank of a country on its loans to other commercial
banks.
(1 mark)
< Answer
13. Commercial banks create money through credit creation. Which of the following statements is true >
with regard to credit creation?
(a) Credit creation by commercial banks is limited by CRR
(b) Commercial banks can create as much credit as they want
(c) RBI has no control over the credit created by Commercial banks
(d) CRR has no impact on credit creation
(e) None of the above.
(1 mark)
< Answer
14. Which of the following is true, if Mr. Somesh transfers Rs.1000 from his current account in a bank to >
a fixed deposit scheme in the same bank?
(a) M1 falls, but M2 rises (b) Both M1 and M2 rises
(c) M1 falls, but M3 rises (d) M2 falls, but M3 remains constant
(e) Both M2 and M3 remain constant.
(1 mark)
< Answer
15. In the classical model, the long run effect of an increase in government spending is >

(a) An increase in the price level (b) An upward shift of the aggregate demand curve
(c) An increase in the level of output (d) Both (a) and (b) above
(e) (a), (b) and (c) above.
(1 mark)
< Answer
16. According to monetarism, other things remaining the same, if the velocity of money increases, then >

(a) The stock of money would increase (b) The nominal GDP would decrease
(c) Price level would rise (d) The real GDP would increase
(e) Both (a) and (b) above.
(1 mark)
< Answer
17. Which of the following is not advocated by supply-side economics? >

(a) Promote competition (b) Reduce government controls

(c) Increase corporate tax rate (d) Reduce the role of government
(e) Remove institutional barriers.
(1 mark)
< Answer
18. When a person is employed in a sector where his/her employment does not make any difference to the >
output, it signifies the presence of
(a) Frictional unemployment (b) Cyclical unemployment
(c) Disguised unemployment (d) Structural unemployment
(e) Sectoral unemployment.
(1 mark)
< Answer
19. 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
20. 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
21. Stagflation is a period of >

I. High inflation. II. High growth of real GDP.

III. High unemployment. IV. High aggregate demand.
(a) Both (I) and (III) above (b) Both (III) and (IV) above
(c) (I), (II) and (III) above (d) (II), (III) and (IV) above
(e) All (I), (II), (III) and (IV) above.
(1 mark)
< Answer
22. The Philips curve implies that the goal of price stability is most likely to conflict with the goal of >

(a) Full employment (b) Economic growth

(c) An equitable distribution of income (d) Balance in international trade
(e) Removal of poverty.
(1 mark)
< Answer
23. Which of the following statements is/are true about the impact of inflation in the economy? >

(a) Unanticipated inflation hurts the fixed income earners most

(b) Higher than expected inflation hurts creditors but benefits debtors
(c) Inflation creates inefficiency in the economy because it forces people to search for prices when
they could be doing something else
(d) Inflation can lead to a misallocation of resources because people tend to make mistakes when
there is inflation in the economy
(e) All of the above.
(1 mark)
< Answer
24. If an economy is already under inflation, and there is increasing inflow of foreign exchange, the >
central bank can sterilize the impact by
(a) Decreasing discount rate (b) Buying government securities from banks
(c) Increasing cash reserve ratio (d) Increasing tax rates
(e) Increasing government spending.
(1 mark)
< Answer
25. Which of the following transactions is included in the current account balance of the Balance of >
payments statement?
(a) Foreign direct investments (b) Portfolio investments
(c) External commercial borrowings (d) Dividends earned on portfolio investments
(e) External assistance.
(1 mark)
< Answer
26. Which of the following is true if, for a given period, there is no change in the foreign exchange >
reserves of a country?
(a) Balance in the current account is equal to the balance in capital account
(b) Surplus (deficit) in the current account is equal to Deficit (surplus) in the capital account
(c) Current account balance is zero
 (d) Trade balance is zero
(e) Capital account balance is zero.
(1 mark)
< Answer
27. All entries in the balance of payments statement should collectively sum to >

(a) GDP of the country (b) GNP of the country

(c) Foreign exchange reserves of the country (d) Zero
(e) Exports of the country.
(1 mark)
< Answer
28. Monetized deficit refers to >

(a) Fiscal deficit minus interest payments

(b) Borrowings and other liabilities of the Central Government
(c) Increase in the net RBI credit to the Central Government
(d) Fiscal deficit minus Primary deficit
(e) RBI’s credit to the commercial banks.
(1 mark)
< Answer
29. Recessionary GDP gap signifies >

(a) Higher potential real GDP compared to realized real GDP

(b) Hyper inflationary situation
(c) Deflationary situation with high unemployment
(d) Existence of natural rate of unemployment
(e) Both (b) and (d) above.
(1 mark)
< Answer
30. Automatic stabilizers refer to >

(a) Inherent mechanisms in the stock market that automatically cause stock market gains to be
cancelled out by losses, which make expected long-run returns equal to zero
(b) The invisible hand mechanisms which automatically bring the economy out of a recession
(c) Government revenue and expenditure items that change automatically in response to changes in
economic activity
(d) Discretionary monetary policy maneuvers designed to keep inflation under control automatically
(e) None of the above.
(1 mark)
< Answer
31. Which of the following policy measures is/are fiscal policy measure(s)? >

(a) The government cuts taxes or raises spending to get the economy out of a recession
(b) The central bank changes the money supply to affect the price level, interest rates and exchange
rates
(c) The government restricts imports and stimulates exports
(d) Both (a) and (b) above
(e) Both (a) and (c) above.
(1 mark)
< Answer
32. Which of the following is true if the RBI decreases cash reserve ratio (CRR)? >

(a) Monetary liabilities of the RBI decreases

(b) High-powered money in the economy increases
(c) The value of money multiplier increases
(d) Aggregate demand in the economy decreases
(e) Price level in the economy falls.
(1 mark)
 < Answer
33. Which of the following is a temporary accommodation provided by the RBI to the Central >
Government to meet mismatches in cash flows?
(a) Ad hoc treasury bills (b) Ways and means advances
(c) Gross fiscal deficit (d) Tap T-bills
(e) Government dated securities.
(1 mark)
< Answer
34. 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
35. Which of the following is not a major determinant of economic growth? >

(a) Tastes and preferences of consumers (b) Technological advancement

(c) Natural resources (d) Physical capital (e) Human
resources.
(1 mark)
< Answer
36. Full employment exists when there is >

(a) Zero unemployment (b) Natural rate of unemployment

(c) Least demand for labor (d) Least supply of labor
(e) Both (c) and (d) above.
(1 mark)
< Answer
37. Japan is currently facing a situation similar to ‘liquidity trap’. During such a situation, the most >
appropriate action to revive the economy is
(a) Increase the interest rate (b) Lower the reserve requirements
(c) Carry out open market operations (d) Increase government spending
(e) Both (b) and (d) above.
(1 mark)
< Answer
38. Transaction demand for money varies inversely with >

(a) Income (b) Rate of interest

(c) Wealth (d) Frequency with which income is received
(e) Both (b) and (d) above.
(1 mark)
< Answer
39. Which of the following is not one of the basic Postulates of the Keynesian Model? >

(a) Full employment occurs only by coincidence is an economy

(b) Effective demand determines the level of employment and output
(c) Since full employment is not always possible, Government intervention is essential
(d) Budget deficit is a tool to fight recession
(e) Monetary policy is more effective than fiscal policy.
(1 mark)
< Answer
40. Keynes held that money is used >

(a) To settle transactions (b) To meet unexpected contingencies

(c) To take advantage of fluctuating rates of interest (d) Both (a) and (b) above
 (e) (a), (b) and (c) above.
(1 mark)
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41. The following data is taken from National Income Accounts of a country: Ans
wer
Particulars Rs. Cr. >
GNP at market prices 8,500
Transfer payments 1,210
Indirect taxes 865
Personal taxes 1,015
Consumption of capital 950
Undistributed corporate profits 140
Corporate tax 375
Subsidies 100
Personal income in the country is
(a) Rs.6,815 cr. (b) Rs.5,605 cr. (c) Rs.6,150 cr. (d) Rs.6,480 cr. (e) Rs.7,480 cr.
(2 marks)
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42. The following information is extracted from the National Income Accounts of an economy. Ans
wer
Particulars MUC >
Factor income received by domestic residents from business sector 1,000
Factor income received by domestic residents from foreigners 40
Gross investment 400
Retained earnings 50
Net indirect taxes 120
Corporate profit taxes 30
Personal income taxes 200
Net factor income from abroad –10
Dividends 200
National Income (NI) of the economy is
(a) 1,120MUC (b) 1,240 MUC (c) 1,280 MUC (d) 1,440 MUC (e)1,620 MUC.
(2 marks)
<
43. The following is the information from national accounts of an economy: Ans
wer
Particulars MUC >
Direct taxes 7,200
Indirect taxes 34,200
Factor income paid abroad 36,000
Factor income received from abroad 27,000
Depreciation 36,000
Surplus 3,150
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) 1,36,800 MUC.
(2 marks)
<
44. The following information is given from the national accounts of a country for the year 2002-03. Ans
wer
>
 Particulars MUC
Factor income earned within domestic territory 13,000
Gross domestic fixed capital formation 1,200
Net domestic fixed capital formation 800
GNP at market prices 17,000
Indirect taxes 600
Subsidies 200 The net factor income from
abroad for the year 2002-03 is
(a) 3,000MUC (b) 2,600 MUC (c) 3,200 MUC (d) 3,400 MUC (e)2,200 MUC.
(2 marks)
<
45. The following information relates to an economy: Ans
wer
Particulars MUC >
National income 3,000
Wages & Salaries : 1,800
Interest income : 450
Rental income : 300 The profit in the economy is

(a) 150 MUC (b) 250 MUC (c) 350 MUC (d) 450 MUC (e) 550 MUC.
(1 mark)
<
46. There are different stages in the production of good X. The values at each stage are given as under: Ans
wer
Particulars Value >
(MUC)
Raw material 600
Manufacturing 1,000
Packaging 1,600
Retailing 2,400 The value added in manufacturing stage and the total value added
in the process of producing X are
(a) 400MUC and 2,400 MUC respectively
(b) 1,000 MUC and 2,400 MUC respectively
(c) 400 MUC and 2,000 MUC respectively
(d) 1,000 MUC and 2,000MUC respectively
(e) 400MUC and 1,000 MUC respectively.
(1 mark)
<
47. The following data pertains to a hypothetical economy. Ans
wer
Year Nominal GNP GNP deflator >
2002-03 1,250 62.5
2003-04 1,650 75.0 What is the rate of inflation in the economy for
the year 2003-04?
(a) 10.0% (b) 12.5% (c) 20.0% (d) 5.5% (e) None of the above.
(2 marks)
<
48. From the following information, compute subsidies. Ans
wer
GDP at factor cost = Rs.10,000 cr. >
Net factor income from abroad = Rs.1,000 cr.
Indirect taxes = Rs.2,710 cr.
GNP at market prices = Rs.11,460 cr.
 (a) Rs.250 cr. (b) Rs.1,710 cr. (c) Rs.2,250 cr. (d) Rs.1,460 cr. (e) Rs.3,710 cr.
(1 mark)
<
49. The following data pertains to national income aggregates of a hypothetical economy: Ans
wer
Consumption function (C) = 200 + 0.80Yd, where Yd is disposable income >
Investment (I) = 1,000 MUC
Government spending (G) = 400 MUC
Taxes (T) = 100 MUC

The equilibrium level of savings in the hypothetical economy is

(a) 1,300 MUC (b) 1,400 MUC (c) 1,200 MUC (d) 1,500 MUC (e)1,600 MUC.
(2 marks)
<
50. Acceleration coefficient in an economy is 3. Investment in a period is equal to 75% of the difference Ans
between the desired capital stock and the existing capital stock. If income in period ‘t’ is expected to wer
increase by 400 MUC, investment during the period ‘t’ will be >

(a) 600 MUC (b) 900 MUC (c) 1,200 MUC (d) 1,500 MUC (e)1,800 MUC.
(2 marks)
<
51. In an economy, the investment function is given by I = 2,500 – 100i. If an increase in government Ans
spending by 625MUC increases the interest rate in the economy by 4%, what could be the amount of wer
crowding out in the economy? >

(a) 200 MUC (b) 300 MUC (c) 150 MUC (d) 400 MUC (e) 180 MUC.
(1 mark)
<
52. In a two sector economy the savings function is S = – 40 + 0.25 Yd. If the investment in the economy is Ans
200 million units of currency (MUC), equilibrium income will be wer
>
(a) 640 MUC (b) 960 MUC (c) 800 MUC (d) 160 MUC (e) 1,200 MUC.
(2 marks)
<
53. The consumption schedule for a two sector economy is given below: Ans
wer
Consumption (C) Disposable Income (Yd) >
MUC MUC
475.0 500
400.0 400
287.5 250
250.0 200 If savings in the economy is 200 MUC,
the equilibrium income in the economy is
(a) 1,125 MUC (b) 1,750 MUC (c) 1,200 MUC (d) 1,425 MUC (e) 1,575 MUC.
(2 marks)
<
54. The following equations are given with respect to a hypothetical economy. Ans
wer
>
 Consumption function C 15 + 0.8 Yd
Investment function I 450 – 24i
Exogenous Government expenditure G 300 MUC
Transaction demand for money Mt 0.20Y
Speculative demand for money Ma 145 – 60i
Supply of Money Ms 300 MUC
Exports E 225 MUC
Tax function T 0.25Y
Import function M 5 + 0.2Y

The
equilibrium interest rate in the economy is
(a) 2.55 % (b) 2.70 % (c) 3.33 % (d) 5.10 % (e) 7.10 %.
(3 marks)
<
55. In an economy the high-powered money is 400MUC. The currency deposit ratio is estimated to be 0.40 Ans
and the reserve ratio is 10%. If foreign exchange assets with the central bank increase by 50 MUC what wer
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%.
(3 marks)
<
56. The following relationships are given for an economy: Ans
wer
Goods market equilibrium 0.5Y = 2925 – 37.5i >
Money market equilibrium 0.25Y = 887.5 + 125i
Exports 650 MUC
Import function 25 + 0.25Y If the government expenditure
increases by 575 MUC, the new equilibrium rate of interest will be
(a) 12.17% (b) 10.50% (c) 8.83% (d) 7.30% (e) 6.00%.
(2 marks)
<
57. Indicators of financial development of an economy for the year 2003-04 are given below: Ans
wer
Finance ratio 0.50 >
Financial interrelation ratio 0.32 If the national income for the year 2003-04 is
24,500MUC, the total issues will be
(a) 10,450 MUC (b) 10,800 MUC (c) 11,300 MUC (d) 11,500 MUC (e)12,250MUC.
(1 mark)
<
58. The monetary liabilities of the central bank of an economy are 20,000 MUC. The government money in Ans
the economy is 200 MUC. Currency deposit ratio for the economy is estimated to be 0.2 and reserve wer
ratio imposed by the central bank is 5 percent. If foreign exchange reserves of the country decline by >
100 MUC, what would happen to the money supply?
(a) Decline by 480 MUC (b) Increase by 480 MUC
(c) Decline by 410MUC (d) Increase by 410 MUC (e) Decline by 240 MUC.
(2 marks)
<
59. The following balances are taken from the balance sheet of the Central Bank of a country. Ans
wer
>
 Particulars MUC
Net worth 1,000
Credit to Central Government 2,500
Credit to commercial banks 1,250
Other non-monetary liabilities 250
Other assets 500
Government deposits 250
Foreign exchange assets 500
If the government money in the economy is 250
MUC, the high-powered money in the economy is
(a) 3,500 MUC (b) 3,750 MUC (c) 4,125 MUC (d) 4,000 MUC (e)3,125 MUC.
(2 marks)
<
60. The following information relates to an economy. Ans
wer
Particulars Rs. in crore >
Consumption 1,000
Investment 340
Government expenditure 280 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. 405.00 crore (e) Rs. 487.50 crore.
(2 marks)
<
61. Suppose that people hold 25% of their money in currency. If the reserve ratio is 12% and total demand Ans
for money is Rs.10,000, then the amount required by banks to meet the reserve requirement is equal to wer
>
(a) Rs.900 (b) Rs.2,750 (c) Rs.3,000 (d) Rs.4,500 (e) Rs. 7,500.
(1 mark)
<
62. The following information is available from the consolidated balance sheet of the banking sector: Ans
wer
Particulars Rs. billion >
Net Bank Credit to the Government 7,000
Bank Credit to the Commercial Sector 10,500
Net Foreign Exchange Assets of the Banking Sector 7,700
Net Non-Monetary Liabilities of the Banking Sector 4,200 If the money
supply in the economy is Rs.21,700 billon, Government Currency Liabilities to the Public is
(a) Rs.700 billion (b) Rs.21,000 billion
(c) Rs.21,700 billion (d) Rs25,900 billion (e) None of the above.
(1 mark)
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63. The following information pertains to the balance of payments of a country for the year 2003-04. Ans
wer
Particulars MUC >
Merchandize imports 210,360
Merchandize exports 174,480
Services rendered to foreigners 345,015
Services rendered by foreigners to residents 187,851
Gifts sent to non-residents by the residents 3,000
Cash remitted by non-residents for their family maintenance 6,000
Income earned by residents on ownership of financial assets 1,500
Foreign direct investment 150,000 If the capital
 account balance (credit) is 303,000 MUC, what is the change in foreign exchange reserves?
(a) 103,584 MUC (b) 268,584 MUC
(c) 428,784 MUC (d) 35,880 MUC (e) 184,716 MUC.
(2 marks)
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64. The overall Balance of Payments of a country for the year 2003-04 is given below. Ans
wer
(US $ million) >
Items Credit Debit
Merchandise 159,000 196,422
Services 74,958 56,340
Transfers 45,675 1,101
Income 8,478 23,124
Foreign Direct Investment 14,370 3,537
Portfolio Investment 22,605 19,773
External Assistance 8,319 15,699
Commercial Borrowings (MT & LT) 8,211 13,305
Commercial Borrowings (Short Term) 24,567 21,630
Commercial Banks 50,778 16,919
Others 1,608 738
Rupee Debt Service — 1,422
Other Capital 19,206 8,727
Errors & Omissions 1,902 ––
During the year
2003-04, overall Balance of Payments position for the country is
(a) $60,940 million (surplus) (b) $60,940 million (deficit)
(c) $ 50,940 million (surplus) (d) $50,940 million (deficit)
(e) $52,740 million (surplus).
(3 marks)
<
65. The following information is extracted from the Union Budget for the year 2003–04. Ans
Rs. wer
>
crore
Tax Revenue (net to Centre) 7,36,676
Non-tax revenue 2,79,064
Recoveries of Loans 72,092
Other Receipts 52,800
Borrowings and other Liabilities 6,14,548
Non-plan Expenditure
On Revenue Account (of which Interest Payments is Rs.4,92,892 cr.) 11,57,536
On Capital Account 1,13,748
Plan Expenditure
On Revenue Account 3,07,372
On Capital Account 1,76,524 The
estimated revenue deficit for the year 2003-04 is
(a) Rs.4,53,168 cr (b) Rs.4,49,568 cr (c) Rs.4,49,168 cr
(d) Rs.4,77,168 cr (e) Rs.4,79,688 cr.
(3 marks)
<
66. The annual growth rate of GDP in a country is estimated to be 6%. If the per capita GDP growth rate is Ans
3%, what is the growth rate of population? wer
>
(a) 2.00% (b) 0.291% (c) 2.91%
(d) 3.20% (e) None of the above.
 (2 marks)
<
67. The money supply in an economy is 500 MUC. At equilibrium, the transaction demand for money and Ans
the interest rate (i) in the economy are 350 MUC and 8 percent respectively. If the precautionary wer
demand for money is zero, the speculative demand for money in the economy is >

(a) 0 (b) 150 MUC (c) 350 MUC (d) 425 MUC (e)850 MUC.
(1 mark)
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68. In an economy demand for money is Ans
wer
Md = 500 + 0.2Y – 20i >
If money supply in the economy is 2,500 MUC and equilibrium rate of interest is 5 percent, national
income is
(a) 850 MUC (b) 1,000 MUC (c) 2,500 MUC (d) 5,500 MUC (e)10,500 MUC.
(2 marks)
<
69. If the average propensity to consume (APC) in an economy is 1.25, average propensity to save (APS) in Ans
the economy would be wer
>
(a) – 0.25 (b) – 0.95 (c) 1.00
(d) 1.25 (e) Insufficient data.
(1 mark)
<
70. For a two-sector economy, the consumption function is Ans
wer
C = 50 + 0.75Y >
And the autonomous investment in the economy is 50 MUC.
If the current output is 400, what will be the involuntary inventory accumulation in the economy?
(a) 0 (b) 50 MUC (c) 100 MUC (d) 125 MUC (e)250 MUC.
(1 mark)
<
71. Domestic savings for a year is 2,500 MUC. If the government budget deficit is 1,000 MUC, private Ans
savings for the year is wer
>
(a) 1,500 MUC (b) 2,000 MUC (c) 2,500 MUC (d) 3,500 MUC (e)500 MUC.
(1 mark)
<
72. In a two-sector economy the consumption function (C) is equal to 8 + 0.7Y and autonomous investment Ans
is equal to 28 MUC. The equilibrium level of income in the economy is wer
>
(a) 41 MUC (b) 50 MUC (c) 67 MUC
(d) 120 MUC (e) None of the above.
(1 mark)
<
73. In a closed two-sector economy, there are 100 individuals. All the individuals have identical Ans
consumption functions but have different disposable incomes. One of the individual’s consumption wer
function is C = 100 + 0.7Yd. Aggregate disposable income in the economy is 50,000 MUC. The level of >
investment in the economy is
(a) 5,000 MUC (b) 10,000 MUC (c) 11,000 MUC (d) 15,000 MUC (e)20,000 MUC.
(2 marks)
<
74. The IS function and LM function in an economy are estimated to be Y = 5,700 + 0.5Y - 100i and Y = Ans
5,200 + 800i respectively. The investment function in the economy is 1600 – 100i. If the government wer
spending increases by 200MUC, which of the following is true about the interest rate in the economy? >
(a) Increases from 6.2 to 6.5 (b) Increases from 6.1 to 6.5
(c) Increases from 6.2 to 6.6 (d) Increases from 6.0 to 6.6
(e) None of the above.
(2 marks)

END OF QUESTION PAPER

 Suggested Answers
Economics - II (122) : July 2004
1. Answer : (c) < TOP >

Reason :Circular flow of income refers to money flow from households in return for
goods and services produced by firms and money passes from firms to
households in return for factor services provided by households. If any part of the
income is not spent with in the flow and hence it represents leakages from the
flow.
a. Since Mr. Ramesh is spending his money on consumption of goods, which
would lead to flow of income from households to the firms and hence no
leakage from the system.
b. In the process of buying second hand refrigerator income is transferred from
Mr. Babu to Mr. Rajesh which represents consumption expenditure and hence
income remains in the system.
c. As Mr. Harsha imported a new Ferrari car, part of the income has gone out
the flow in order to pay for commodity which is not produced within the
country. Money spent on Ferrari becomes part of circular flow of exporting
country and a leakage for the importing country. Hence the answer is option
c.
d. Salary paid represents flow of income from Mr. Sujit to his personal
secretary.
e. Since (a) is not true, therefore e cannot be the answer.
2. Answer : (a) < TOP >

Reason :
By definition dividends and corporate taxes are part of corporate profits.
National income refers to the factor income earned by the residents of a country
and it includes profits earned by entrepreneurs. Profit includes dividends and
corporate tax. Hence dividends and corporate tax are part of national income.
Hence dividends and corporate taxes are part of corporate profits and national
income.
a. a. On the basis of the above reason, dividends and corporate taxes are part
of corporate profits (I) and National Income (II). Hence this is true option.
b. b. Dividends and corporate taxes are not part of personal income, hence not
the correct option.
c. c. On the basis of above reason, the option is not correct
d.e. As given in the reason, dividends and corporate taxes are not part of personal
income and personal disposable income. Hence not correct option.
3. Answer : (c) < TOP >

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

variable if it is measured over a period of time.
 a. Capital stock is measured at a particular point of time, hence is a stock
variable
b. A firm’s assets are measured at a particular point of time, hence is a
stock variable
c. Investment is measured over a period of time hence is a flow variable.
d. Price index is measured at a particular point of time, hence is a stock
variable
e. Public debt is measured at a particular point of time, hence is a stock
variable.
4. Answer : (a) < TOP >

Reason : a. Value addition is equal to value of output less value of inputs. By

summing up all the value additions in the economy GDP of the economy
can be computed, which is called value added approach to measuring
GDP. Hence the answer is (a).
b. By adding all the incomes of factors of production in the economy, GDP
can be computed which is called income approach to measuring GDP.
Hence (b) is not the answer.
c. Is not the answer as we get real GDP by removing the effect of inflation
from nominal GDP.
d&e. Is not the answer as we get GDP through expenditure approach by
summing up all the expenditures incurred by the ultimate buyers on the
goods and services produced by the domestic sector.
5. Answer : (c) < TOP >

Reason :Marginal propensity to consume refers to the change in consumption as a result of

increase in income. Part of the changed income is saved. Hence MPC is equal to
1-MPS. Multiplier is the reciprocal of 1-MPC or MPS. Hence larger MPC means
smaller MPS and hence larger will be the value of the multiplier.
Statement (I) is false because as MPC is larger, MPS will be smaller as it is
nothing but 1-MPC.
Statement (II) is true because multiplier is reciprocal of MPS and MPS is smaller
as said above.
Statement (III) is true. Average propensity to consume will depend on level of
consumption and income. Since the MPC is larger, consumption will also be
larger and hence average propensity to consume will also be larger.
Statement (IV) is false, as autonomous consumption is independent of MPC and
hence it is not possible to say anything about autonomous consumption on the
basis of MPC.
Since both (II) and (III) are true, the option (c) is the answer.
6. Answer : (c) < TOP >

Reason :In the Keynesian model, actual expenditure and planned expenditure is same at
the equilibrium level of output. When the actual expenditure is less than the
planned expenditure in the economy, there will be a positive inventory investment
 in the economy.
(a) Is not the answer because there will not be a positive fixed investment in the
economy.
(b) Is not the answer because there will not be a negative fixed investment in the
economy.
(c) Is the answer because there will be positive inventory investment in the
economy.
(d) Is not the answer because there will not be negative inventory investment in
the economy
(e) Is not the answer because there will be change in the inventory investment in the
economy.
7. Answer : (d) < TOP >

Reason :The relationship between demand for money and interest rate is given by the LM
curve. The relationship between interest rate and demand for money is negative.
The LM curve gives the demand schedule for a particular income level.
a. If there is an increase in the level of income because of increase in real
money supply, there is no shift in the IS curve.
b. As at the same interest rate, the demand for money increases with the
increase in income level. The LM curve will shift to the right and hence the
option is not correct.
c. There will be increase in the real balances as income increases, but no shift in
the IS curve.
d. As per the reason given in the option (b), the LM curve shifts to the right and
hence option d is the correct answer.
e. The entire increased income need not be used for consumption as part of it
goes into savings and hence the increased income need not be equal to
changed income. Hence this option is not correct.
8. Answer : (e) < TOP >

Reason :(a) Is not the answer because IS curve shows the combinations of income and
interest rates which reflects the goods market equilibrium.
(b) Is not the answer because LM curve shows the combinations of income and
interest rates, which reflect the money market equilibrium.
(c) Is not the answer because interest rate is a variable in both the IS and LM
model.
(d) Is not the answer because the equilibrium level of national income is
determined when there is a simultaneous equilibrium in the goods market and
money market.
(e) Is the answer because IS curve is not positively sloped rather it is negatively
sloped.
9. Answer : (e) < TOP >

Reason :An increase in government expenditure results in an increase in the level of

 income and an increase in the interest rate. It will shift the IS curve to the right.
But LM curve remain unchanged because an increase in government expenditure,
a fiscal policy measure, has no impact initially in the asset markets.
(a) Is not the answer because an increase in government will not shift both IS
and LM curve to the right.
(b) Is not the answer because an increase in government will not shift both IS
and LM curve to the left.
(c) Is not the answer because an increase in government will not shift IS curve
to the left.
(d) Is not the answer because an increase in government will affect IS curve.
(e) Is the answer because an increase in government will not shift the position of
LM curve but shift IS curve to the right.
10. Answer : (c) < TOP >

Reason :Aggregate supply curve gives the relationship between net national product that
would be supplied at each general price level.
a. a. Deficit demand refers to s situation where aggregate demand is falling
short of aggregate supply, hence price decrease. This results us decrease in
supply. Hence the supply curve will be positive sloped.
b. b. In case there are idle resources, as the prices increase firms can increase
supply by utilization of idle resources. Hence the relationship between supply
and prices is positive
c. c. In a situation where all the resources are fully employed, the firms will
not be in a position to increase the supply even if prices are increased. Hence
the supply curve will be vertical. Hence the correct option.
d. d. Aggregate supply curve is vertical in short run as the resources are fully
employed. Labour is a variable factor in short run, hence the available labour
force is fully employed.
Vertical supply curve only means that all the available resources are fully
employed, it is not necessary that all firms must earn normal profits.
11. Answer : (b) < TOP >

Reason :AD curve gives the relation between quantity of goods and services demanded
and price level. Apart from price, AD is also affected by
i. A change in income
ii. Rate of interest
iii. Government policy
iv. A change in exchange rate and
v. Transfer payments
a. A decrease in income of foreigners will have its impact only on the aggregate
demand of the country to which they belong to and not on the domestic
economy. Hence, there is no impact on the aggregate demand.
b. Transfer payments refer to incomes such as pensions, gifts etc. which are
 unilateral payments. They add to the income of the receiver. Hence private
transfers from abroad will add to the income and leads to increase in
aggregate demand.
c. A decline in government expenditure leads to decrease in aggregate demand
as less money is available for various government activities and hence
demands fewer goods.
d. Increase in interest rates makes loans demanded for investment and
consumption purposes costlier. The people would prefer to wait until the
interest rates come down and hence the aggregate demand will less.
e. An increase in tax rates will lead to decrease in disposable income in case of
direct taxes and investment demand in case of Corporate taxes. The net
impact is that aggregate demand will decrease.
12. Answer : (e) < TOP >

Reason :Bank rate is the minimum rate at which the central bank is prepared to discount or
rediscount the bills of exchange brought to it by the members of the money
market. It is also the interest rate at which the central bank provides loans to the
commercial bank when they borrow money from central bank.
Hence by definition option (e) is correct.
(a) (a) Is not the answer because bank rate doesn’t mean the rate of interest on
inter-bank loans
(b) (b) Is not the answer because bank rate doesn’t mean the rate of interest
charged by banks on borrowers
(c) (c) Is not the answer because bank rate doesn’t mean the rate of interest paid
by banks to depositors
(d) (d) Is not the answer because bank rate does not mean the rate of interest
charged by banks for loans given to the central bank of the country
(e) (e) Is the answer because bank rate means the rate of interest charged by the
central bank of a country on its loans to other commercial banks.
13. Answer : (a) < TOP >

Reason :Creation of credit is a major function of a commercial bank. When a bank creates
credit or advances loans, there tends to be a multiple expansion of credit in the
banking systems.
(a) Is the answer because credit creation by the commercial bank is limited by
the Cash Reserve Ratio(CRR), i.e. every commercial bank must keep on
deposit with the Reserve Bank certain amounts of funds equal to a specified
percentage of it’s own deposit liabilities.
(b) Is not the answer because commercial banks cannot create as much credit as
they want.
(c) (c) Is not the answer because RBI has control over the credit created by commercial banks.
(d) Is not the answer because CRR has an impact on credit creation.
14. Answer : (d) < TOP >
 Reason :Savings account deposits as well as fixed deposits form part of M3 definition of
money supply. M1 = Currency with the public + Demand deposits with the
banking system, while M2 = M1 + Post office savings bank deposits. Thus,
transfer of funds from savings account, reduces both M1 and M2. However, M3
remains constant as decrease in savings account deposits is equally compensated
by the increase in time deposits with the banking system.
15. Answer : (b) < TOP >

Reason : The long run effect of an increase in government spending in the Classical model is to increase the
price level as the long-run aggregate supply curve is considered to be vertical. Therefore any
increase in demand is simply inflationary.
(a) Is not the answer because in the classical model, the long run effect of an increase in
government spending is not an increase in the price level
(b) Is the answer because in the classical model, the long run effect of an increase in government
spending is an upward shift of the aggregate demand curve
(c) Is not the answer because in the classical model, the long run effect of an increase in
government spending is not an increase in the level of output
(d) Is not the answer because both (a) and (b) above cannot be the answer.
(e) Is not the answer because (a), (b) and (c) above cannot be the answer.
16. Answer : (c) < TOP >

Reason :‘Velocity of money’ refers to the speed at which money changes hands. The ratio
of nominal GDP to the money stock defines the income velocity of money (that
is, V = GDP/M = PQ/M). Thus, the price level in the economy will increase
because of rise in velocity of money, given the money supply.
17. Answer : (c) < TOP >

Reason :Supply side economics advocates promoting competition, decreasing role for the
state, incentives to production sector like decreasing tax rates and reducing
government controls and removing institutional barriers to increase
efficiency. Supply-side economics do not advocate increase in the tax rate.
Hence answer is (c).
18. Answer : (c) < TOP >

Reason :
a. a. Frictional unemployment occurs when constant changes in the labour
market lead to unemployment. It occurs on account of imperfect information.
Hence not correct option.
b. b. Unemployment that arises due to general down turn in business activity is
refered to as cyclical unemployment. Hence not related to the output, not the
correct option.
c. c. Disguised unemployment occurs due to excess labour force depending on
agriculture sector. Some labourers are employed, but their contribution to
production is zero. Hence the correct option.
d. d. Structural unemployment occurs due to structural changes in the
economy, and such people are not employed and hence there is no question of
 contribution to production. Not correct option.
e. Sectoral unemployment refers to unemployment that exists in any particular
sector, for example agricultural sector. Hence not correct option.
19. 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.
20. 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.
21. Answer : (a) < TOP >

Reason :Stagflation refers to a situation where there is high unemployment and high
inflation occurs simultaneously.
Statement I is true as stagflation refers to coexistence of stagnant output and high
inflation.
Statement II is false because during stagflation, there is no increase in output and
hence the output is stagnant. Therefore real GDP is not growing.
Statement III is true because during stagflation, the output is stagnant, new
employment opportunities are not created and hence unemployment level is high.
Statement IV is false as the price are high and there is unemployment, the
aggregate demand tends to be low.
So the answer is (a).
< TOP >
22. Answer : (a)
 Reason :Phillips curve indicates the relationship between rate of inflation and
unemployment rate. There exists a trade-off between inflation and
unemployment.
(a) Is the answer because Phillips curve shows that the goal of price stability or
inflation and the goal of full employment can never be achieved
simultaneously. The policy makers can choose a particular combination of
inflation and unemployment.
(b) Is not the answer because Phillips curve doesn’t imply the goal of price
stability is most likely to conflict with the goal of economic growth.
(c) Is not the answer because Phillips curve doesn’t imply the goal of price
stability is most likely to conflict with the goal of equitable distribution of
income.
(d) Is not the answer because Phillips curve doesn’t imply the goal of price
stability is most likely to conflict with the goal of balance in international
trade.
(e) Is not the answer because Phillips curve doesn’t imply the goal of price
stability is most likely to conflict with the goal of removal of poverty.
< TOP >
23. Answer : (e)
Reason :Inflation is a serious problem on the part of the government worldwide. The
effect of inflation is ranging from redistribution of income and wealth of the
society to the worsening the balance of payments position of the country.
(a) It is true statement that unanticipated inflation hurts the fixed income earners
most. Though their monetary income is constant, real income is reduced
because of inflation.
(b) It is true statement that higher than expected inflation hurts creditors but
benefits debtors. Debtors repay the amount, which is fixed in nominal
terms. The real values of repayments in the future will decrease with an
increase in inflation, leads to an increase in the wealth of the debtors. On the
other hand, the wealth of the creditors will decrease with an increase in the
rate of inflation.
(c) It is a true statement that inflation creates inefficiency in the economy
because people spent lot of time to find a reasonable price.
(d) It is a true statement that inflation can lead to a misallocation of resources
because inflation misleads people to invest logically.
(e) Is the answer because all the above statements are correct.
24. Answer : (c) < TOP >

Reason :Since the economy is already under inflation, any increase in money supply has to
be curtailed by the monetary authorities so as to control any further increase in
prices. The increase in foreign exchange reserves leads to increase in monetary
base and hence the money supply in the economy increases.
a. A decrease in discount rate would result in increased borrowings by the
 commercial banks from the central bank. This will increase the money
supply, hence not the correct option.
b. When the government buys securities from the people, the money with the
people will increase, the money supply will increase and prices also will rise.
Hence not the correct option.
c. The central bank by increasing the cash reserve ratio reduces the credit
creation capacity of the banking system. This results in decrease in money
supply which will compensate the increase in the money supply due to
foreign exchange inflow. Hence this option is correct.
d. Not a correct answer it is a fiscal instrument.
e. Increasing government spending is also a fiscal policy instruments.
25. Answer : (d) < TOP >

Reason : All the transactions which effect the asset or liability position of a country are put under Capital
account of the Balance of Payments statement. Other transactions are put under the Current
account.
(a) (a) Is not the answer. Foreign Direct Investment increase the liability of a
country, hence falls under Capital account.
(b) (b) Is not the answer. Portfolio Investments increase the liability of a
country, hence falls under Capital account.
(c) (c) Is not the answer. External Commercial Borrowings increase the
liability of a country, hence falls under Capital account.
(d) (d) Is the answer. Dividends on portfolio investments are an income earned
by a factor of production (capital). This is included in Income under
Invisibles in Current Account.
(e) Is not the answer. External Assistance increases the liability of a country,
hence falls under Capital account.
26. Answer : (b) < TOP >

Reason :Because of the double entry concept underlying the recording of transactions,
BoP account must always be in balance. Thus, ‘Balance in current account +
Balance in capital account + Change in reserves = Zero’. When there is no change
in the foreign exchange reserves, then ‘balance in current account + balance in
capital account = zero’ (or) balance in current account = - (balance in capital
account).
a. Balance in current account + Balance in capital account = Change in
reserves. When balance in current account ‘plus’ balance in capital account is
zero, then balance in the current account = - balance in capital account.
Hence, statement (a) is not correct.
b. There will no change in the foreign exchange reserves of a country only
when surplus (deficit) in current account is equal to deficit (surplus) in
capital account.
c. Current account balance may or may not be zero when the change in foreign
exchange reserves of a country is zero.
 d. Trade balance (exports – imports) may or may not be zero when the change
in foreign exchange reserves of a country is zero.
e. Capital account balance may or may not be zero when the change in foreign
exchange reserves of a country is zero.
27. Answer : (d) < TOP >

Reason : Preparation of BoP statement is based on double-entry system of book keeping. Hence, all debt
items should equal credit items, and the balance is zero.
(a) (a) Is not the answer because all entries in the balance of payments
statement is not collectively sum to GDP of the country.
(b) (b) Is not the answer because all entries in the balance of payments
statement is not collectively sum to GNP of the country
(c) (c) Is not the answer because all entries in the balance of payments
statement is not collectively sum to Foreign exchange reserves of the
country
(d) (d) Is the answer because all entries in the balance of payments statement is
collectively sum to zero.
(e) Is not the answer because all entries in the balance of payments statement is
not collectively sum to Exports of the country.
28. Answer : (c) < TOP >

Reason : Monetized deficit refers to increase in net RBI credit to the Central Government, comprising the
net increase in the holdings of T-bills of the RBI and its contribution to the market borrowings of
the Government. Fiscal deficit = Borrowings and liabilities of the Central Government and
primary deficit = Fiscal deficit – interest payments.
(a) Is not the answer because monetized deficit doesn’t refer fiscal deficit minus
interest payments
(b) Is not the answer because monetized deficit doesn’t refer borrowings and
other liabilities of the Central Government
(c) Is the answer because monetized deficit refers Increase in the net RBI credit
to the Central Government
(d) Is not the answer because monetized deficit doesn’t refer fiscal deficit minus
Primary deficit
(e) Is not the answer because monetized deficit doesn’t refer RBI’s credit to the
commercial banks.
29. Answer : (a) < TOP >

Reason :a. by reason given above this option is true

b. b. Hyper inflationary situation refers to price rise is very large and
accelerating. This occurs when aggregate demand is more than aggregate
supply. In case of recessionary GDP gap, prices are falling. Hence not correct
option.
c. c. When these is necessionary GDP gap, it leads to realized GDP falling
short of potential GDP. Hence during prices will be falling and unemployment
 rate would increase. But there will be high unemployment, which occurs only
during depression.
d. d. National rate of unemployment occurs when potential GDP is equal to
realized GDP. Which is not the case when there is necessionary GDP gap.
Hence not the correct option .
e. Since (b) and (d) are not correct, this is not correct option.
30. Answer : (c) < TOP >

Reason : Every economy goes through cyclical fluctuations in output, employment and prices. This will
have an automatic impact on certain government expenditures and revenues. The changes in the
government spending and revenues that results automatically as the economy fluctuates are called
non-discretionary fiscal policy. Automatic stabilizers are features of the government budget that
automatically adjust net taxes to stabilize aggregate demand as the economy expands or contracts.
(a) Is not the answer because an automatic stabilizer is not a mechanism in the
stock market that automatically cause stock market gains to be cancelled out
by losses.
(b) Is not the answer because automatic stabilizer is not the invisible hand
mechanisms, which automatically bring the economy out of a
recession.
(c) Is the answer because automatic stabilizer refers to Government revenues and
expenditures that change automatically in response to changes in economic
activity. When the economy is in a contraction phase, these stabilizers
increase transfer payments and reduce tax collections in order to stimulate
aggregate demand. On the other hand, when the economy begins to expand,
the automatic stabilizers increase tax collections and reduce transfer
payments in order to restrain growth in the aggregate demand.
(d) Is not the answer because automatic stabilizer is a discretionary fiscal policy.
31. Answer : (a) < TOP >

Reason :Fiscal policy refers to policies dealing with taxes and government expenditure
including transfer payments.
(a) Is the answer because when the government reduces taxes or raises spending
to get the economy out of a recession, is a case of fiscal policy measure.
(b) Is not the answer because when the central bank changes the money supply
to affect the price level, interest rates and exchange rate , it is a monetary
policy.
(c) Is not the answer because when the government restricts imports and
stimulates exports; it is a case of EXIM (Export-Import) policy.
(d) Is not the answer because both (a) and (b) cannot be the answer.
(e) Is not the answer because both (a) and (c) cannot be the answer.
32. Answer : (c) < TOP >

Reason :Money supply (Ms) = High-powered money (H) {(1 + Cu)/(Cu + r)}
Where Cu = currency deposit ratio
R = cash reserve ratio.
 H = Monetary liabilities (ML) + Government money
{(1 + Cu)/(Cu + r)} = Money multiplier
When the cash reserve ratio (CRR) is reduced, the money multiplier increases and
hence the money supply.
a. Monetary liabilities of the Central Bank consist of currency with the
public, reserves of commercial banks and other deposits. Changes in the
CRR do not affect monetary liabilities of the RBI because decrease in
reserves is offset by the increase in currency with the public. Hence,
monetary liabilities remain the same for a given change in CRR.
b. As monetary liabilities are part of high-powered money, hence changes
in the CRR do not affect the high-powered money also.
c. Money multiplier = {(1 + Cu)/(Cu + r)}. Hence decrease in the CRR
increases the value of the money multiplier.
d. Money supply in the economy increases with the cut in the CRR because
of increase in the value of money multiplier. When money supply
increases, the interest rates in the economy falls, leading to increase in
consumption and investment. This results in increase in aggregate
demand in the economy.
e. When money supply increases because of reduction in the CRR, the
aggregate demand in the economy increases. Higher aggregate demand
leads to higher price levels in the country.
33. Answer : (b) < TOP >

Reason :The system of ad hoc treasury bills as a means of financing the budget deficit was
discontinued from 1997. This system is replaced by a system of ways and means
advances (WMA). Under the new arrangement, the temporary mismatches
between expenditure and receipts will be outside the Reserve Bank’s support to
the government’s borrowing program during the year.

34. 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.
< TOP >
35. Answer : (a)
Reason :Economic growth refers to situation where increased productive capabilities of an
economy are made possible by either an increasing resource base or technological
advance. A country, thus, can achieve economic growth through:
a. Improvement in technology
b. Natural resources
c. Capital
 d. Human resources
Change in tastes and preferences of consumers only affect the demand of an
individual good or services, and it does not increase the production capabilities of
an economy.
36. Answer : (b) < TOP >

Reason :
a. a. Zero unemployment refers to situation where there is no unemployment
b. b. Natural rate of unemployment is the long run average of unemployment
caused due to frictional and structural changes in labour market. Full
employment means that there is certain amount of unemployment which is
refered to as natural rate of unemployment.
Hence the correct option.
c. c. During full employment, there still exists certain amount of
unemployment and hence cannot say that demand for labor is at the lowest .
Hence not correct option.
d. d. Supply of labor depends on population and has no relation with full
employment. Hence the option is not correct.
e. Since (c) and (d) are not correct options, this is not true option.
37. Answer : (d) < TOP >

Reason :Liquidity trap refers to a situation where the public are prepared to hold whatever
amount of money is supplied at a given interest rate.
a. a. Increase the interest rate reduces the aggregate demand by reducing
the investment spending and consumption, and hence is not an
appropriate policy to revive economy.
b. b. & (c) During the period of liquidity trap, the tools of monetary
policy become ineffective as they cannot affect the interest rate and hence
the level of income.
Raise in government spending has its full multiplier effect on the equilibrium
output level. As the policy does not depend on the interest rate, it remains
effective even during the period of liquidity trap. Hence, the correct answer is (d).
38. Answer :(e) < TOP >

Reason :Transaction demand for money refers to money used for carrying out daily
transactions.
a. When income of the consumer is high, the demand for money for
transaction purposes also increases.
b. Rate of interest discourages individuals from holding money because it
increases the cost of holding money. Thus, higher the interest rate, the
lower is the transaction demand for money.
c. The greater the wealth of the person, the higher is the transaction
demand for money.
d. If the frequency with which income is received is higher, the consumer
 does not want to hold more money with him for transaction purposes
because he receives the money in short intervals.
e. Since ‘rate of interest’ and ‘frequency of income received’ affect the
transaction demand for money inversely, the correct answer is (e).
39. Answer : (e) < TOP >

Reason :(a) Is not the answer because Keynes considered the existence of full
employment as a special case. The Keynesian underemployment equilibrium
is reflecting real life situations.
(b) Is not the answer because aggregate demand or effective demand indicates
the total quantity of goods and services that people want to buy.
According to Keynes, effective aggregate demand
determines the level of employment and output.
(c) Is not the answer because Keynes argues that State intervention is essential as
full employment is not possible in an economy.
(d) Is not the answer because Keynes argues that an economy facing recession,
budget deficit is an important tool to overcome recession.
(e) Is the answer because in the Keynesian model, monetary policy is not
effective as compared to fiscal policy. Rather it is the fiscal policy, which is
very effective and powerful. Keynes argues that government should maintain
an active stance with a combination of tax and expenditure policies to
maintain the desired levels of output and employment through manipulation
of effective demand
40. Answer : (e) < TOP >

Reason : Keynes held that demand for money consists of

i. Transaction demand for money
ii. Precautionary demand for money and
iii. Speculative demand for money
Hence, the answer is (e).
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
= 8500–950–865+100
= 6785
∴Personal Income = 6785–140–375+1210
= Rs.7,480cr.
42. Answer : (a) < TOP >

Reason :National income (NI) = Factor income received by domestic residents +

Factor income received by domestic residents from foreigners + corporate
 profit taxes + retained earnings = 1000+40+30+50 = 1120MUC.
43. 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.
Where NFIA = (Factor income received from abroad – Factor income paid abroad) =
(27000 – 36000) = –9000 MUC
44. Answer : (c) < TOP >

Reason :NNP at market price = GNP at market prices – Depreciation

= 17,000 – (1,200 – 800) = 16600
NNP at factor cost = NNP at market prices – Indirect taxes + subsidies
= 16600– 600+ 200
= 16200
Net factor income from abroad =NNP at factor cost–NDP at factor cost (Factor
income earned with in domestic territory)
= 16200– 13000 = 3,200MUC.
45. Answer : (d) < TOP >

Reason :National income (NNP at FC) = wages & salaries + interest income + rental
income + profit.
Or, Profit = 3000 – 1800 – 450 – 300 = 450.
46. Answer : (a) < TOP >

Reason :Total value added in the process = Market value of the final product = 2400
Value added in the manufacturing stage
= Total value of the good after manufacturing stage – Total cost for
procuring raw- material
= 1000 – 600= 400.
47. Answer : (c) < TOP >

Reason :Inflation rate = (GNP deflator of current period – GNP deflator of previous year)
‘divided by’ GNP deflator of previous year x 100 = (75/62.5 – 1) x 100 = 20%.
48. Answer : (c) < TOP >

Reason :GNPMP = GDPFC + NFIA + Indirect taxes – Subsidies

11460 = 10000+ 1000 + 2710 – X
X = – 11460 +11000 + 2710
= Rs.2250 cr.
49. Answer : (a) < TOP >
 Reason :C = 200 + 0.80Yd = 200 + 0.80 (Y– 100) = 200 + 0.80Y – 80 = 0.80Y + 120.
Y = C+I+G
Or, Y = 0.80Y + 120 + 1000 + 400
Or, 0.20Y = 1520
Y = 7600
S = – 200 + 0.20Yd = – 200 + 0.20 (Y – 100) = – 200 + 0.20 (7600– 100)
= – 200 + 1500
= 1,300 MUC.
50. Answer : (b) < TOP >

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

Desired investment in period ‘t’ = Acceleration coefficient × Change in
income
= 3 × 400 = 1200
∴ Investment in period ‘t’ = 0.75 × 1200 = 900 MUC.
∴ The answer is (b).
51. Answer : (d) < TOP >

Reason :Crowding-out refers to decrease in private investment because of increase in

interest rate caused by the increase government spending. Crowding out = 100 ×
4 = 400.
52. Answer : (b) < TOP >

Reason :S = – 40 + 0.25Yd
At equilibrium level of income, S = I
: – 40 + 0.25 Yd = 200
or, 0.25Yd = 240
240
Yd = = 960MUC
or, 0.25

53. Answer : (c) < TOP >

Reason :C = α + βYd
Where, α = autonomous consumption and β = marginal propensity to
consume (MPC)
β = ∆C/∆Yd = (475 – 400)/100 = 0.75
If MPC = 0.75, autonomous consumption:
475 = a + 0.75(500)
Or, a = 100.
Thus, C = 100 + 0.75Yd
Or, S = – 100 + 0.25Yd
When S = 200, 200 = –100 + 0.25Yd
or, 300 = 0.25Yd
 or, Yd = 1200 MUC.
Since the economy is a two sector economy, Y = Yd (disposable income).
54. Answer : (a) < TOP >

Reason :Equilibrium rate of interest is determined where IS = LM

Y = C + I +G +E – M
Y = 15 + 0.8 Yd + 450 – 24i + 300 +225 – 5 – 0.20Y
Y = 15 + 0.8 (Y – 0.25Y) + 450 – 24i + 300 + 225 – 5 – 0.20Y
Y = 985 + 0.40Y – 24i
Y = 1641.67 – 40i (IS curve)
Total demand for money = Mt + Ma = 0.20Y + 145 – 60i
Supply of Money = 300 MUC
∴ 0.20Y + 145 – 60i = 300
0.2Y = 155 + 60i
Y = 775 + 300i (LM curve)
Equilibrium rate of interest is determined where IS = LM
∴1,641.67 – 40i = 775 + 300i
340i = 866.67
i = 2.55%.
55. Answer : (c) < TOP >

1 + Cu
×H
Reason :Money supply, M = Cu + r
1 + 0.40
× 400
= 0.40 + 0.10

= 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,
1.40
450 ×
1120 = ( 0.40 + r )
1.40
450 ×
or, 0.40 + r = 1,120

or, 0.40 + r = 0.5625

or, r = 0.1625 = 16.25%
56. Answer : (e) < TOP >

Reason :If Government expenditure increase by 575 MUC,

IS function becomes
 0.5Y = 2,925 + 575 – 37.5i
or, 0.5Y = 3,500 – 37.5i
or, Y = 7,000 – 75i
At simultaneous equilibrium,
IS = LM
Or, 7,000 – 75i = 3,550+ 500i
Or, 575i = 3,450
Or, i = 6.00%.
57. Answer : (e) < TOP >

Total issue
National Income
Reason :Finance Ratio =
∴ Total Issue = Finance Ratio × National Income
= 0.50 × 24500
= 12250 MUC.
58. 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+0.2)/(0.2+0.05) = 4.8
When foreign exchange reserves of the country decline by Rs.100 MUC, the monetary liabilities
also fall by 100 MUC. Thus, money supply decline by 4.8 x 100 = 480 MUC.
59. Answer : (a) < TOP >

Reason :High-powered money (H) = Monetary liabilities of Central Bank + Government

money
Total assets = Total liabilities
(Credit to Central Government + Credit to commercial banks + Foreign exchange
assets + Other assets) = (Net worth + Government deposits + Other non-monetary
liabilities + Monetary liabilities)
(2500+1250+500+500) = (1000+250+250 ML)
4750 = 1500 + ML
Or, ML = 3250
High-powered money (H) = 3250+250 = 3,500 MUC.
60. Answer : (d) < TOP >

Total expenditure(PY)
Money supply (M)
Reason :Velocity of money =
Total expenditure= C + I + G = 1000+340+280 = 1620
Money supply = 1620/4 = Rs.405cr.
61. Answer : (a) < TOP >
 Reason :Total money = Rs.10,000.
25% of total money which is held in the form of currency is Rs.2,500.
Demand deposit component of money supply is Rs.10,000 – Rs.2,500 =Rs.7,500
Given the reserve ratio of 12%, required reserves are 7,500 ´ 0.12 = Rs.900.
62. Answer : (a) < TOP >

Reason :Money Supply = Net bank credit to Government + Bank credit to

commercial sector + Net foreign exchange assets of the
banking sector – Net non-monetary liabilities of the
banking sector + Government money
Rs.21700billion = 7000 + 10500 + 7700 – 4200 + Government money
Government money = 21700–21000 = Rs.700 billion.
63. Answer : (c) < TOP >

Reason :Change in foreign exchange reserves = Current account balance + Capital account
balance
Current account balance = (174480+345015+6000+1500) -
(210360+187851+3000) = 526995–401211 =125784 i.e. current account surplus
(Credit)
Thus, change in foreign exchange reserves =125784 + 303,000 = 428784 MUC
64. Answer : (a) < TOP >

Reason :Overall balance of payment = Total Credit of the Bop – Total debit of the Bop
= 439677 – 378737
= $ 60940million (surplus)
65. Answer : (c) < TOP >

Reason : Revenue deficit = Revenue expenditure – Revenue receipt

Revenue Expenditure = Non plan revenue expenditure + Plan revenue
expenditure
= 1157536 + 307372
= 1464908
Revenue receipts = Tax revenue + Non. Tax revenue
= 736676+ 279064
= 1015740
∴ Revenue Deficit = 1464908– 1015740
= Rs.449168 cr
66. Answer : (c) < TOP >

Reason :Per capita GDP growth rate = (1 + g)/(1 + p) – 1; where g = growth rate of GDP
and p = growth rate of population.
= (1 + 0.06)/(1 + 0.03) – 1 = 0.0291 = 2.91%.
67. 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 = 500 – 350 – 0 = 150.
68. Answer : (e) < TOP >

Reason :Md = 500 + 0.2Y – 20i

At equilibrium Ms = Md.
∴ 2500 = 500 + 0.2Y – (20 ´ 5)
0.2Y = 2500 – 500 + 100
= 2100
Y = 10,500. Therefore the answer is (e).
69. Answer : (a) < TOP >

Reason :APC + APS = 1

Thus, APS = 1 – APC = 1 – 1.25 = – 0.25
70. Answer : (a) < TOP >

Reason : When output (income) = 400, aggregate demand = C + I = 50 + 0.75(400) + 50 = 400. When AD
= Y, there will be no involuntary inventory accumulation in the economy
71. Answer : (d) < TOP >

Reason : Domestic savings = Private savings + Public savings

Private savings = 2500 – (–1000) = 3500.
∴ The answer is (d)
72. Answer : (d) < TOP >

Reason :C = 8 + 0.7Y
S = –8 + 0.3Y
At equilibrium, S = I
–8 + 0.3Y = 28
0.3Y = 36
∴ Y = 120
73. Answer : (a) < TOP >

Reason :At equilibrium, Y = C + I = C + S

Aggregate consumption function = (100 x 100) + 0.7Yd = 10000 + 0.7Yd =
10000 + 0.7(50000) = 45000. Thus, investment (I) = Saving (S) = 50000 – 45000
= 5000.
74. Answer : (c) < TOP >

Reason :At equilibrium, IS = LM

Y = 5700 + 0.5Y – 100i
0.5Y = 5700 – 100i
Y = 11400 – 200i ……….IS function
Y = 5200 + 800i ……….LM function
Thus at simultaneous equilibrium,
11400 – 200i = 5200 + 800i
Or, 6200 = 1000i
Or, i = 6.2
When government spending increases by 100, the IS function becomes
0.5Y = (5700 + 200) – 100i
0.5Y = 5900 – 100i
Or, Y = 11800 – 200i
Thus, at equilibrium,
5200 + 800i = 11800 – 200i
Or, 1000i = 6600
Or, i = 6.6
< TOP OF THE DOCUMENT >