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Posted By: Kenny Member Level: Gold Posted Date: 22 May 2008
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2005 ICFAI University M.B.A Suggested Answers Economics (MB141): October 2005 Question paper
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Suggested Answers Economics (MB141): October 2005 1. Answer : (a) Reason : The proportionate change in quantity demanded due to the change in price can be expressed as elasticity of demand. < TOP > 2. Answer : (b) Reason : When the demand for life saving drugs is perfectly inelastic, the burden of a tax is borne entirely by the buyers. < TOP > 3. Answer : (e) Reason : At equilibrium, Qs = Qd 400 + 15P = 600 – 10P 25P = 200 Or, P = 8 Since, price ceiling is above the equilibrium price of Rs.8, there would not have any affect on demand and supply of the good. < TOP > 4. Answer : (b) Reason : Marginal product of labor is the addition to the total production by employment of an extra unit of a variable factor. (a) Is not the answer because marginal product of labor is not the cost of employing labor for producing one more unit of output. (b) Is the answer because marginal product of labor is the change in output from using one more unit of labor. (c) Is not the answer because marginal product of labor is not the change in revenue from selling one more unit of output. (d) Is not the answer because marginal product of labor is not the change in revenue from using one more unit of output. (e) Is not the answer because none of the above is not the answer. < TOP > 5. Answer : (d) Reason : Total cost for producing 500 units = 500 x 5 = 2500 Total Variable Cost (TVC) = 2500 – Total Fixed Cost = 2500 - 500 = Rs.2,000 Average variable cost = 2000/500 = Rs.4 Total cost for producing 750 units = 750 x 4 + 500 = Rs.3,500 Total revenue (TR) = 750 x 10 = 7,500 Thus, total profit = 7500 – 3500 = Rs.4,000. < TOP > 6. Answer : (c) Reason : Diseconomies of scale refer to the forces causing the average cost of production to increase as the output increases. Therefore the answer is (c). < TOP > 7. Answer : (d) Reason : A combination of inputs to the right of the cost line indicates that it is a point above the cost function which cannot be reached with the given budget. Hence, the correct answer is (d). (a) Is not the answer because the combination of capital and labor lies to the right of the firm’s cost line is not undesirable. (b) Is not the answer because the combination of capital and labor lies to the right of the firm’s cost line is not concerned whether the combination is efficient or not, given the budget. (c) Is not the answer because the combination of capital and labor lies to the right of the firm’s cost line is not concerned whether the combination is inefficient or not, given the budget (d) Is the answer because the combination of capital and labor lies to the right of the < TOP >
12 firm’s cost line is unattainable, given the budget. The firm’s cannot hire the combination of capital and labor, given the budget. (e) Is not the answer because the combination of capital and labor are not inferior to the points within the constraint in terms of production, but it is not attainable. 8. Answer : (c) Reason : TC = Q3 – 40Q2 + 450Q AC = Q2 – 40Q + 450 ?AC / ?Q = 0 gives 2Q – 40 = 0 Q = 20 When Q = 20, AC = 202 – 40 × 20 + 450 = 400 – 800 + 450 = 50. < TOP > 9. Answer : (c) Reason : Differentiating the equation we get;?Q/?P = -5 But slope =?P/?Q = -1/5 Hence the correct answer is (c) < TOP > 10. Answer : (a) Reason : A perfectly competitive firm is in equilibrium only when P = MR =MC because in perfect competition, MR = P. (a) Is the answer because a perfectly competitive firm is in equilibrium only when P = MR =MC. (b) Is not the answer because a perfectly competitive firm is not in equilibrium when P = MR, but MR > MC. (c) Is not the answer because a perfectly competitive firm is not in equilibrium when P = MC, but MR < MC. (d) Is not the answer because a perfectly competitive firm is not in equilibrium when MR = MC, but P < MR. (e) Is not the answer because a perfectly competitive firm is not in equilibrium when MR= MC, but P > MR. < TOP > 11. Answer : (c) Reason : MR = AR(1-1/e) 15 = AR ( 1-1/2)or AR = 30 < TOP > 12. Answer : (c) Reason : Consumer surplus is the amount of money actually paid by the consumer and the amount of money he is willing to pay rather than go without it. Consumer surplus = (100×10) – (100 × 9) Or Rs.100 < TOP > 13. Answer : (e) Reason : When marginal product (MP) is greater than average product (AP), AP will be increasing. When MP < AP, AP will be decreasing. Therefore, AP is maximum when AP is equal to MP. When MP=0, total product is maximum and AP will be decreasing. Hence option (a) is not the answer. When MP is maximum, AP is less than MP and AP will be increasing. Hence option (b) is not the answer. When MP is minimum, AP will be decreasing. Hence option (c) is not the answer. When MP is negative, AP will be decreasing. Hence option (d) is not the answer. < TOP > 14. Answer : (b) Reason : Profit = TR –TC < TOP >
13 TR = 20Q TC = total fixed cost + total variable cost Or 20,000 + 15Q Total revenue = 20Q Profit = TR – TC or 20Q – (20,000 + 15Q) = 20Q –20000-15Q Given profit = 30,000 20Q- 20,000 – 15Q = 30000 or Q = 10,000 15. Answer : (a) Reason : QS = 8,500 + 100P QD = 14,500 – 300P At equilibrium QS = QD 8,500 + 100P = 14,500 – 300P 400P = 6,000 P = 15 Since the firm is operating in a perfectly competitive industry, the firm is a price taker and the price is constant at 15. TC = 500 + 8Q + 0.035Q2 To maximize profits MC = MR MC = QTC?? = 8 + 0.07 Q MR = P = 15 8 + 0.07Q = 15 Q = 07.07 = 100. Profit maximizing output for the firm is 100 units. < TOP > 16. Answer : (d) Reason : From the equation we have P = 40 – 0.02 Q Revenue is amximum when MR = 0 TR= 40Q – 0.02Q2 MR = 40 – 0.04Q Revenue is maximum when MR =0 or 40 – 0.04Q = 0 or Q = 1000 units. < TOP > 17. Answer : (e) Reason : By the point elasticity formula the price elasticity in this case is given by Change in price/change in quantity ×original price/original quantity Which means (0.5/0.5)(10/20) which gives the value 0.5 However, since in the question, there is a perceptible difference in price and quantity, the arc elasticity formula need to be used. Which gives ?q (P1 +P2)/?P (Q1 + Q2) = 5 × 25 / 5 × 35 = 0.714. < TOP > 18. Answer : (c) Reason : When the demand is unit elastic and the quantity sold of the cars increase from 30 to 60 units, he has to sell the additional cars at Rs.5,000 each. When the elasticity is unity, the total revenue must be the same. < TOP > 19. Answer : (a) Reason : The indifference curve are convex to the origin. It follows from the assumption that the marginal rate of substitution of X for Y (MRSxy) diminishes as more and more of X is < TOP >
14 substituted for Y. Only a convex indifference curve can mean a diminishing marginal rate of substitution of X for Y. 20. Answer : (c) Reason : The law of diminishing returns states that by employing more units of some factors of production to work with one or more fixed factors, the total product will increase at an increasing rate, then at a constant rate and finally at a diminishing rate. (a) Is not the answer because the law of diminishing returns holds good when factors are not perfect substitutes of each other. When factors are perfect substitutes one factor can be substituted for other factor and there will not be a problem of diminishing returns (b) Is not the answer because the law of diminishing returns is relevant only when the time period is short because in long run all factors are variable.
(c) Is the answer because the law of diminishing returns is not applicable when the two inputs are used in same proportion. When all factor inputs are increased by the same proportion, this law is not relevant. (d) Is not the answer because the law of diminishing returns assumes that the state of technology is given and remains constant. (e) Is not the answer because according to the law of diminishing returns, one factor of production must always be kept constant at a given level. So if capital is held constant, with varying labor, this law of diminishing returns holds good. < TOP > 21. Answer : (a) Reason : Break even point by definition is the point where the total revenue equals total cost. < TOP > 22. Answer : (c) Reason : The total revenue = Price × quantity. The it becomes 24Q.Profits = total revenue – total costs At the output level of 5 units, the firm incurs a loss of Rs. 150. Profits = 24Q – 200 – 4Q – 2Q2 = 20Q – 2Q2 – 200 profit at the output of 5 units = 20 (5) – 2 (5)2 – 200 = 100 – 50 – 200 = 50 – 200 = -150 or a loss of Rs.150 Hence the correct answer is (c) < TOP > 23. Answer : (d) Reason : The MRTS is equal to the ratio of the marginal productivities of the two products – MPL/MPK 6K0.3L-0.7/6K-0.7L0.3 K0.3L-0.7/K-0.7L0.3 K/L < TOP > 24. Answer : (d) Reason : When two goods are perfect complements, the indifference curves are L –shaped showing both of them are jointly required for consumption. Two indifference curves cannot intersect each other and when the indifference curves are downward sloping, it is a case of perfect substitutes. Also different points n an indifference curve shows different combinations of goods yielding the same level of satisfaction. < TOP > 25. Answer : (b) Reason : In a monopolistic market, the products are differentiated, but they are close substitutes of each other. It is not the answer as the products are differentiated and are not homogeneous. It is the answer as the products re close substitutes and is differentiated. It is not the answer. Only if close substitutes are available, there is need to take decisions regarding advertising outlays and selling costs. < TOP >
15 It is not the answer as the products are differentiated but are not perfect substitutes. It is not the answer as the products are neither homogeneous nor are they perfect substitutes. 26. Answer : (b) Reason : Isoquant represents all the alternative combinations of two factors that can produce a given level of output. (a) Is not the answer because an indifference curve shows all the various combinations of two goods that give equal amount of satisfaction or utility to a consumer. (b) Is the answer because isoquant shows all combination of inputs that can produce a given output. (c) Is not the answer because production possibility frontier represents all possible combinations of total output that can be produced with a fixed amount of productive resources. (d) Is not the answer because isocost line shows all the combinations of the two factors (e.g. labor and capital) that the firm can buy with a given set of prices of the two factors. (e) Is not the answer because marginal product curve is the curve, which represents the marginal product of a factor i.e. the addition to the total production by the employment of an extra unit of a variable factor. < TOP > 27. Answer : (e) Reason : (a) Normally, marginal cost falls initially, reaches a minimum and then gradually increases after some point with the increase of output. (b) Average variable cost falls initially, reaches a minimum and then gradually increases after some point with the increase of output. (c) As TFC remains constant, AFC falls continuously with the increase in output. (d) Total variable costs increases with increase of output. (e) The correct answer (e) because none of the above remains constant with the increase of quantity of output. < TOP > 28. Answer : (c) Reason : Here the price elasticity of the good implies a perfectly elastic situation. In the case of perfect price elasticity, if a firm increases the price of the good, the quantity demanded of the good may fall to zero. Hence (c) is the answer. < TOP > 29. Answer : (c) Reason : Marginal costs are independent of the fixed costs and depend only on the variable cost. Hence the marginal cost equals the change in total variable cost i e is Rs. 30 (130 – 100) < TOP > 30. Answer : (b) Reason : Solution Tr = Price X quantity 100 x 10 = 1000 80 x 30 = 2,400 50 x 40 = 2,000 30 x 60 = 1,800 20 x 80 = 1,600 TR is maximum when 30 units of tea is produced < TOP > 31. Answer : (d) Reason : A person pursuing any activity would like to maximize the net benefit from that activity. Net benefit is equal to the benefit less the cost. (a) Is not the answer because net benefit is zero when total benefit is equal to total cost of that activity. (b) Is not the answer because net benefit is zero when average benefit is equal to average cost of that activity. (c) Is not the answer because net benefit cannot be maximized if the cost of that activity is positive < TOP >
16 (d) Is the answer. As long as the marginal benefit is greater than the marginal cost, total net benefit can be increased by pursuing that activity. If marginal benefit is less than the marginal cost, total net benefit can be increased by decreasing that activity. And net benefit is maximized when marginal benefit is equal to the marginal cost. (e) Is not the answer because net benefit cannot be maximized. 32. Answer : (b) Reason : Production function = Q = 10L2 – 0.5L3 APL = 10 L -0.5 L2 = 10 x 10 -0.5 x 102 = 50. < TOP > 33. Answer : (d) Reason : Marginal Utility is change in Total Utility when additional unit of the good is consumed. If MU is negative, Total Utility will be decreasing < TOP > 34. Answer : (a) Reason : For a firm in a perfectly competitive market, the average and marginal revenue curves coincide because the firm is a price taker. < TOP > 35. Answer : (c) Reason : AC = 100/Q + 20 + 4Q TC = 100 + 20Q + 4Q2 TVC = 20Q + 4Q2 At output 15, TVC = 20(15) + 4(15)2 = 300 + 900 =Rs. 1200 < TOP > 36. Answer : (c) Reason : In the short run, a profit maximizing firm will stop production when price is less than average variable cost < TOP > 37. Answer : (a) Reason : The value of all the goods and services produced in an economy during a period of time corrected for inflation is called Real GDP.This is the reflection of the actual GDP. < TOP > 38. Answer : (a) Reason : GNP deflator is a price index, which is used to reveal the cost of purchasing the items included in GNP during the period relative to the cost of purchasing those items during a base year. GNP deflator is used to measure real GNP i.e. in rupees of constant purchasing power. If there is a rise in prices, the nominal GNP is deflated during the latter period to account for the effects of inflation. (a) Is the answer because GNP deflator is the ratio of Nominal GNP to Real GNP. (b) Is not the answer because GNP deflator is not the ratio of Real GNP to Nominal GNP (c) Is not the answer because GNP deflator is not the ratio of Nominal GNP to Real GDP (d) Is not the answer because GNP deflator is not the ratio of Real GNP to Nominal GDP. < TOP > 39. Answer : (c) Reason : NFIA = NNPMP – NDPMP NNPMP = NNPFC + Indirect Taxes – Subsidies = 8,400 + 1,900 – 200 = 10,100. ? NFIA = 10,100 – 10,000 = 100. < TOP > 40. Answer : (a) Reason : When the economy is producing to the right of the equilibrium output determined by the Keynesian cross, there will be unsold inventories. or there will be over production. At the equilibrium point, consumption is equal to disposable income < TOP >
17 41. Answer : (b) Reason : Y = C + I + G Or, Y = 100 + 0.75 (Y – 0.20Y ) + 80 + 150 (? Yd = Y – T) Or, Y = 0.75Y – 0.15Y + 330 Or, Y = 0.60Y + 300 Or, 0.40 Y = 330 Or, Y = 825 MUC < TOP > 42. Answer : (d) Reason : When a central bank reduces the reserve requirements and the bank rate, the money supply in the system increases. This is called an expansionary monetary policy. < TOP > 43. Answer : (c) Reason : GNP = GDP + NFIA NFIA = Factor income received from abroad – Factor income paid abroad. = 100 – 200 = – 100 ? GNP = 8000 – 100 = 7900. < TOP > 44. Answer : (b) 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] = [500 + 500 + 2,000 + 15,000 – [2,500 + 500 + 4,000 + 12,000] = 18,000 – 19,000 = –1,000 i.e. 1,000 MUC (Deficit) < TOP > 45. Answer : (c) 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. < TOP > 46. Answer : (b) Reason : The I in the equation represent gross investment and not net investment, The value of replacement investment is included in the GDP. < TOP > 47. Answer : (e) Reason : Personal Income = National Income – Undistributed corporate profit – corporate tax + Transfer payments National Income = GNP at market price – Depreciation – Indirect taxes + Subsidies = 1,700 – 190 – 173 + 20 < TOP >
18 = 1,357 ?Personal Income = 1,357 – 28 – 75 + 242 = Rs.1,496 cr 48. Answer : (a) Reason : Keynes believed the government had a role to play fighting inflation and unemployment, and using monetary and fiscal policy to manage the macro economy. (a) Is the answer because Keynesian economist argue activist government role in the macro economy (b) Is not the answer because monetarism does not advocate activist government role in the macro economy (c) Is not the answer because new classical economist does not advocate activist government role in the macro economy
(d) Is not the answer because classical economics does not advocate activist government role in the macro economy (e) Is not the answer because rational expectations does not advocate activist government role in the macro economy. < TOP > 49. Answer : (b) 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 < TOP > 50. Answer : (a) 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 > 51. Answer : (b) Reason : MPC = 0.6 Multiplier (m) = 5.24.016.011MPC1==-=-1 ?Y = m . ?I ? ?I = 5.2500mY=? = 200 < TOP > 52. Answer : (a) Reason : Trade deficit for the year 2002-03 = Merchandise (credit) – Merchandise (debit) = 53,000 – 65,474 = $12,474 million < TOP > 53. Answer : (e) Reason : Consumption demand Investment demand and net exports are included in the aggregate demand for goods and services. < TOP > 54. Answer : (c) Reason : The business cycle is defined as the variation in the economic activity with a regular pattern < TOP > 55. Answer : (b) Reason : When the consumption and the investment schedules are added, we get the aggregate demand schedule. This is given by Y = c+I < TOP > 56. Answer: (c) MPC = 0.75 Multiplier = 11MPC-= 110.75-= 4. < TOP >
19 57. Answer : (c) Reason : Here, consumption = 20 + 0.70Yd When income equals 600 consumption = 20 + 0.7(600) = 440 Savings = income – consumption 600 – 440 = 160 < TOP > 58. Answer : (c) Reason : 7.5Rs.250Cr.0.03= < TOP > 59. Answer : (c) Reason : Nominal rate of interest = real rate of interest + inflation. Therefore the answer is (c). < TOP > 60. Answer : (b) Reason : High powered money = Monetary Liabilities of RBI + Government Money = 1275 + 25 = 1300 Money Supply = H × m Money multiplier (m) = rCC1uu++ = 1.200.25 = 4.8 ? Money Supply = 1300 × 4.8 = 6,240 MUC. < TOP > 61. Answer : (b) Reason : Money supply = High Powered money × Money multiplier ? 17,200 = 4,300. m or, m = 17,20044,300= 1CumCur+=+ ? 1Cu4Cu0.10+=+ or, 1+ Cu = 4Cu + 0.40 or, – 3Cu = –.06 or, Cu = 0.20 < TOP > 62. Answer : (d) 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. < TOP > 63. Answer : (c) 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 < TOP > 64. Answer : (b) Reason : S = – 60 + 0.25Yd At equilibrium level of income, S = I : – 60 + 0.25 Yd = 100 < TOP >
20 or, 0.25Yd = 160 Yd = 160/0.25 = 640 65. Answer : (c) Reason : The bank rate is the rate at which the central banks discount the commercial bank bills. < TOP > 66. Answer : (a) Reason : Consumption function shows the relationship between consumption and disposable income. < TOP > 67. Answer : (d) Reason : Variable costs are those costs that increase with the level of output. Salaries of temporary staff are an example of variable cost. < TOP > 68. Answer : (a) Reason : High powered money = Monetary Liabilities of RBI + Government Money Monetary liabilities of RBI = Financial Assets + Other Assets – Non-monetary liabilities Non-monetary liabilities = Other non-monetary liabilities + Net worth = 525 + 1,000 = 1,525 MUC ? Monetary liabilities = 24,000 + 100 – 1525 = 22,575 MUC Government money = 25 MUC ? High powered money (H) = 22,575 + 25 = 22,600 MUC < TOP > 69. Answer : (e) Reason : Multiplier = 1/1-MPC = YI?? ? ?Y = 100× (1/0.2) = Rs 500 crores < TOP > 70. Answer : (b) Reason : Open market operations refer to purchase and sale of securities by the central bank. When the central bank purchases securities it increases the reserve base of the commercial banks and hence leads to multiple expansions of credit and deposits. a. The increase in the monetary base leads to more credit creation and hence leads to increase in output that is aggregate supply. b. As the money supply increases due to open market purchases, in short run production cannot adjust to the increased demand which is a result of higher money supply. The prices tend to increase which results in inflation. Hence b is the correct option. c. The increase in money supply leads to a downward pressure on interest rate and the interest rates will in fact decrease. d. Aggregate demand will increase as the increased money supply will lead to decrease in interest rates which will increase the investment demand and consumption demand. e. Output increases as explained in option (a). < TOP > 71. Answer : (d) Reason : Change in forex reserves = Current a/c balance + Capital a/c balance ? Capital a/c balance = ? Forex reserves + Current a/c deficit = 1000 + 5000 = 6000. < TOP > 72. Answer : (a) Reason : The multiplier states that if there is an increase in autonomous government spending, the increase in aggregate demand caused by that spending would cause a larger increase in national income. (a) Is the answer (b) Is not the answer because when the multiplier increases the MPC is high and not low (c) Is not the answer since this is not the expression for multiplier (d) Is not the answer since it is just a observed fact and not an explanation for the multiplier < TOP >
21 (e) It is not the answer since multiplier is given by the ratio of an increment in income to increment in autonomous investment 73. Answer : (b) 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. < TOP > 74. Answer : (c) Reason : GDPFC = NDPMP + Depreciation – Indirect Taxes + Subsidies Depreciation = Gross domestic investment – Net domestic investment = 1,600 – 1,300 = 300. ? GDPFC = 10,000 + 300 – 700 + 200 = 9800. < TOP >
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