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Posted By: Kenny Member Level: Gold Posted Date: 22 May 2008
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2006 ICFAI University M.B.A Suggested Answers Economics - II (MB142): April 2006 Question paper
Suggested Answers Economics - II (MB142): April 2006
1. Answer : (e)
Reason : GDPFC = GDPMP – Indirect taxes + Subsidies
? If GDPFC > GDPMP, Subsidies > Indirect taxes. < TOP >
2. Answer : (a)
Reason : When investment < Depreciation, capital stock decreases and net investment will be negative. Note that capital consumption is nothing but depreciation. < TOP >
3. Answer : (a)
Reason: NNP at market prices = NDP at market prices + net factor income from abroad
Thus net factor income from abroad = NNP at market prices – NDP at market prices. < TOP >
4. Answer : (a)
Reason : The circular flow diagram shows the payments from the households to the firms for the goods and services and firms paying the households for the factor services rendered by the firms. < TOP >
5. Answer : (c)
Reason : Savings function S = –20 + 0.30Yd
?C = 20 + 0.70Yd
At Y=600, S = –20 + 0.30(600) = – 20 + 180 = 160 MUC. = Investment as S = I. < TOP >
6. Answer : (e)
Reason : NFIA = NNPMP – NDPMP
NNPMP = NNPFC + Indirect Taxes – Subsidies = 4200 + 950 – 100 = 5050
Thus, NFIA = 5050 – 5000 = 50. < TOP >
7. Answer : (d)
Reason : Personal Income (PI) = NI – Corporate profit + Dividends + Transfer Payments
= 8,400 – 1,500 + 300 + 150
= 7,350. < TOP >
8. Answer : (b)
Reason : MPC = 0.6
Multiplier (m) =
?Y = m . ?I
? ?I = = 400 < TOP >
9. Answer : (a)
Reason : When autonomous expenditure, like government expenditure (G), increase in the economy, further rounds of increase in AD and output is triggered in future periods. This is defined as multiplier effect. < TOP >
10. Answer : (a)
Reason: Investment means addition to the existing stock of capital. It can be positive or negative < TOP >
11. Answer : (e)
Reason : (a) Consumption depends on the income and as income increase consumption also increase.
(b) Propensity to consume refers to the changes in consumption as a result of change in income. Hence propensity to consume effects consumption.
(c) Propensity to save refers to changes in savings as a result of changes in income. The level of savings affects the level of consumption. Hence changes in savings does affect consumption
(d) Consumption demand depend upon the level of wealth
(e) Consumption demand does not depend upon the level of marginal efficiency of < TOP >
12
investment.
12. Answer : (d)
Reason : Y = C + I
Y = 5 + 0.6Y + 25
Y = 30 + 0.6Y
0.4Y = 30
Y = 75 MUC < TOP >
13. Answer : (c)
Reason : S = – 100 + 0.25Yd
When S = 100, 100 = –100 + 0.25Yd
or, 200 = 0.25Yd
or, Yd = 800
Since the economy is a two sector economy, Y = Yd (disposable income). < TOP >
14. Answer : (b)
Reason: Y = 200 + 0.80Y+500+200
Y = 900 + 0.8Y
0.2Y = 900
Y = 4,500 < TOP >
15. Answer : (c)
Reason : Nominal rate of interest = real rate of interest + inflation. Therefore the answer is (c). < TOP >
16. Answer : (d)
Reason : By definition national income is the sum of consumption and investment
The only option that contains consumption and investment as the variables is option (d). Hence (d) is the answer. Also, by definition, national income is the sum of personal consumption and private investme < TOP >
17. Answer : (c)
Reason : If the money supply grows faster than the rate of growth of real GDP, then it will be a case of too much money chasing too few goods and leads to inflation. < TOP >
18. Answer : (c)
Reason : C = 120 + 0.8Yd
Multiplier = 1/ (1-0.8) = 5
If an initial investment of Rs.5 billion is made, the income will be
5×5 = 25 billion < TOP >
19. Answer : (c)
Reason : Inflation is a sustained and persistent increase in the general price level < TOP >
20. 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 >
21. Answer : (a)
Reason : As per the Keynesian theory, unemployment is caused by the deficiency of aggregate demand. He advocates government spending to boost aggregate demand. < TOP >
22. Answer : (c)
Reason : In the classical theory, the equilibrium in the labor market is achieved when the marginal productivity equals the real wage. < TOP >
23. Answer : (b) < TOP >
13
Reason : At a high real wage, the quantity of labor supplied is increased, but due to higher real wage, the quantity of labor demanded is reduced. When the real wages are high, there will be more incentive on the part of the laborers to supply labor but the labor demanded will not increase since more wages have to be paid
(a) Is not the answer. The quantity of labor aupplied can increase however no prediction can be made regarding the quantity of goods supplied
(c) Is not the answer since no prediction is possible regarding the quantity of goods demanded
(d) Is not the answer since again nothing can be said regarding the goods manufactured
(e) Is not the answer since the quantity of labor supplied has to increase in response to an increase in the real wage.
24. Answer : (a)
Reason : According to the Keynesian theory, the relation between the quantity of money and the price level is an indirect one via the rate of interest. When the quantity of money increases the rate of interest falls and if the demand for liquidity is high, and assuming there are unemployed resources, the aggregate demand will increase. This will push up costs and wages and increase the price level. < TOP >
25. Answer : (b)
Reason : Sterilization means neutralization of changes in the money supply caused by changes in the foreign exchange reserves of a country. < TOP >
26. Answer : (a)
Reason : When the CRR is reduced to 4.5% from 4.75%, the money supply in the economy increases with the increase in the value of money multiplier. Higher money supply lowers the interest rates in the economy. Lower interest rate in turn encourages investment and consumption in the economy. As consumption and investment are part of aggregate demand, aggregate demand increases with the reduction of CRR. When aggregate demand increases, the real GDP and price levels increase in the economy.
Therefore, change in the CRR ? change in money supply ? change in nominal interest rate ? change in consumption and investment ? change in aggregate demand ? change in real GDP and price level. < TOP >
27. Answer : (d)
Reason : Taxation is not an instrument of monetary policy, rather it is a fiscal policy instruments. So the answer is (d). < TOP >
28. Answer : (e)
Reason : Contractionary (tight) fiscal policy involves increasing tax rate and/or decreasing the government spending to bring down the aggregate demand and price level in the economy. Reduced government spending reduces the public borrowings, and thereby interest rate and output in the economy. The tight monetary policy, conversely, reduces the money supply and thereby increases the interest rate in the economy. Increased interest rate reduces both consumption and investment and thereby reduces output in the economy. Thus, we can say that the combined effect of tight fiscal policy and tight monetary policy lowers the output. But, the direction of change in interest rate is not known unless we know the magnitude of influence of fiscal and monetary policies on interest rate.
I. A contractionary fiscal policy combined with a tight monetary policy result in a lower level of output.
II. A contractionary fiscal policy combined with a tight monetary policy do not result in a higher level of output.
III. A contractionary fiscal policy combined with a tight monetary policy do not result in a lower interest rate
IV. A contractionary fiscal policy combined with a tight monetary policy result in a higher interest rate
V. A contractionary fiscal policy combined with a tight monetary policy result in a lower or higher interest rate depending on the relative magnitude of fiscal and monetary policies. So, the answer is (e). < TOP >
29. Answer : (b) < TOP >
14
Reason : Monetary policy mainly controls the economy by regulating the interest rates through changes in money supply. If the private investment is more sensitive to interest rate, then monetary policy can more effectively regulate the economy.
(a) A recessionary condition cannot make a monetary policy more effective.
(b) When private investment is more sensitive to interest rate monetary policy will be more effective as a small change in the interest rate would lead to a greater change in the output.
(c) Monetary policy will not be more effective when the private investment is less sensitive to interest rate.
(d) During liquidity trap, the effectiveness of monetary policy decreases because during such policy, changes in interest rate cannot have any effect on investments.
(e) Effectiveness of the monetary policy is not determined by the phases of business cycle.
30. Answer : (d)
Reason : High powered money = Monetary Liabilities of RBI + Government Money
?High powered money (H) = 47,250 + 750 = 48,000
Money supply (Ms) = H × m
Money multiplier (m) =
= == 3.47
?Money Supply
in the economy = 48,000 × 3.47
= 166,560 MUC < TOP >
31. Answer : (a)
Reason : High powered money = Monetary Liabilities of RBI + Government Money
Monetary liabilities of RBI = 990
Government money = 10
High powered money = 990 + 10 = 1000
Money Supply = H × m
m = money multiplier =
4000 = 1000 × m
m = = 4.
= 4
= 4
1.2 = 0.8 + 4r
r = = 0.10 = 10%. < TOP >
32. Answer : (b)
Reason : When the reserve requirement is 5%, the money multiplier is 20 (1/0.05) = The reserve ratio is 0.05. So the bank has to keep 12.5 million (0.05 ×250) as reserves. Hence the excess reserves with the bank is 50 – 12.5 =37.5 which it can afford to lend out. < TOP >
33. Answer : (a) < TOP >
15
Reason : Money multiplier = = = 6.59
34. Answer : (e)
Reason : Money supply = High Powered money × Money multiplier
? 17,500 = 4,500. m
or, m =
?
or, 1+ Cu = 3.89Cu + 0.389
or, – 2.89Cu = –0.611
or, Cu = 0.211 < TOP >
35. Answer : (c)
Reason : Loans are a form of credit, and as they can be used to purchase goods and services they are the equivalent of money. Banks through the ‘process of credit creation’ creates the money. The process of credit creation is done by accepting deposits and lending loans. < TOP >
36. Answer : (c)
Reason : The term ‘narrow money’ is Currency with the public + Demand deposits of the Banking system + other deposits with the RBI. < TOP >
37. Answer : (b)
Reason : < TOP >
38. 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 >
39. Answer : (e)
Reason : High – Powered money (H) = monetary liabilities or central bank + Government money.
M = 3,600 + 400 = 4000 MUC < TOP >
40. Answer : (c)
Reason : Money supply, M =
=
= 2.8 × 400
= 1120 MUC
If there is an additional inflow of 50 MUC of foreign exchange assets, H = 400 + 50 = 450
If money supply is to be maintained at 1,400 MUC,
1120 =
or, 0.40 + r =
or, 0.40 + r = 0.5625 < TOP >
16
or, r = 0.1625 = 16.25%
41. Answer : (d)
Reason : Velocity of money =
Total expenditure = C + I + G = 1500+300+200 = 2000
Money supply = 2000/4 = Rs.500cr. < TOP >
42. Answer : (b)
Reason : Multiplier = = 4.
Increment in income = 16,000 – 12,000 = 4,000
Required saving in the economy = 4,000/4 = 1, 000 MUC. < TOP >
43. Answer : (c)
Reason : Domestic savings = Private savings + Public savings
Private savings = 1500 – (–500) = 2000
? The answer is (c) < TOP >
44. Answer : (a)
Reason : National Income = NNP at factor cost
= GNP at market prices – depreciation – indirect taxes + subsidies.
= 1000 – 40 – 400 + 50
= 610. < TOP >
45. Answer : (c)
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. < TOP >
46. Answer : (c)
Reason : Philips curve shows the trade off between inflation and unemployment. The position of the short run Philips curve depends on the expected rate of inflation.
Hence, (c) Is the answer < TOP >
47. Answer : (d)
Reason : The expected real interest rate is given by expected nominal interest rate minus the rate of inflation. < TOP >
48. Answer : (a)
Reason : During hyperinflations, money loses its value very fast. Thus there is an incentive to spend money as rapidly as possible, and velocity tends to increase < TOP >
49. Answer : (c )
Reason : When there is accelerating inflation, the general price level increases and the value of money decreases. When the general price level increases, the interest rate will increasse. There is a positive relation between inflation and the rate of interest. < TOP >
50. Answer : (a)
Reason : If an economy reaches full employment, the increase in the quantity of money leads to a proportionate increase in the price level. Therefore the Fisher’s quantity theory of P = MV/T applies only in case of full employment situation. < TOP >
51. Answer : (a)
Reason : The term ‘gross’ fiscal deficit implies the excess of total government expenditures over revenue receipts and grants. < TOP >
17
52. Answer : (a)
Reason : An expansionary monetary policy makes the supply of money easier. This will mean more money in the hands of the public and hence an increase of aggregate demand. An expansionary fiscal policy will cause more government spending, which will also shift the aggregate demand to the right. < TOP >
53. Answer : (d)
Reason : When an economy suffers from a recessioanry GDP gap, it is experiencing a downturn in its economic variables. Hence , it would be prudent to undertake an expansioanry fiscal policy which includes increase in government spendig and decrease in the level of taxation to stimulate aggregate demand. < TOP >
54. Answer : (c)
Reason : A discretionary fiscal policy refers to deliberate changes in tax rate and expenditure policies by the government in times of contraction or expansion. < TOP >
55. 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] = [3500 + 3500 + 14,000 + 105,000] – [17,500 + 3500 + 28,000 + 84,000]
= 126,000 – 133,000 = –7,000 i.e. 7,000 MUC (Deficit) < TOP >
56. 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 >
57. Answer : (d)
Reason : Change in foreign exchange reserves = Current account balance + Capital account balance
= –2000 + 6000 = 4000 MUC < TOP >
58. Answer : (c)
Reason : Capital inflows – capital outflows = 6,300 – 4,300 = 2,000 MUC (Deficit). < TOP >
59. Answer : (b)
Reason : If the country called X enjoys a comparative advantage in the production of coffee over the country called Y, then the opportunity cost of production in X is lower than in Y < TOP >
60. 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 >
61. Answer : (a)
Reason : Consumption function shows the relationship between consumption and disposable income. < TOP >
62. Answer : (c)
Reason : The bank rate is the rate at which the central banks discount the commercial bank bills. < TOP >
18
This is treated as the benchmark for other interest rates.
63. Answer : (b)
Reason : The term balance of trade is the differences between merchandise exports and imports.
(a) The difference between the balance on the current and capital account is the overall balance
(b ) The ratio of exports to imports is called the terms of trade and not balance of trade
(c) Balance on the capital account is simply called the capital account balance and not balance of trade
(d) There is no definition for the ratio of imports to exports. < TOP >
64. Answer : (d)
Reason : Inventories of foreign countries and gold that could be sold for dollars are held under the official reserves account with the central bank that they would sell in the market when there is an excess demand for dollars. Conversely, when there is an excess supply of dollars, they would buy up the dollars. < TOP >
65. Answer : (d)
Reason : In general, when the unemployment is falling, it means that more people are able to find jobs and the resources are more fully utilized. This increases the income ands the aggregate demand thereby expanding the economic growth. < TOP >
66. 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 >
67. Answer : (b)
Reason : (a) Structural unemployment arises when the regional or occupational pattern of the job vacancies does not match the pattern of workers availability and suitability. The above situation does not represent structural unemployment.
(b) Unemployment that is caused by constant changes in the labor market is called frictional unemployment. It occurs on account of two reasons: (a) employers not fully aware of all available workers and their job qualifications; and (b) available workers are not fully aware of the jobs being offered by employers. Even though the suitable job is available for Mr.Robert it took him 2 months to find the job. Thus, the unemployment encountered by Robert is in the nature of frictional (natural) unemployment.
(c) Unemployment that arises when there is general downturn in business activity is called cyclical unemployment.
(d) Unemployment that arises because of seasonal variations is called seasonal unemployment. For example, agricultural labors normally face unemployment during summer.
(e) When marginal productivity becomes negative because of excess employment we call it as disguised unemployment. In less developed countries like India there is widespread disguised unemployment in agricultural sector. < TOP >
68. Answer : (e)
Reason : If an economy is in recession, expansionary fiscal and monetary policies can help increase the AD and revive economic activity. Options (a) and (b) are expansionary fiscal policy tools and options (c) and (d) are expansionary monetary policy tools. Therefore, any of the options would be appropriate to help an economy in recession. < TOP >
69. Answer : (d) < TOP >
19
Reason : Y = c + 1
Y = 70 + 0.80Y + 90
0.20Y = 160
Y = 800.
70. Answer : (b)
Reason : Multiplier =
2.5 = 11MPC-
2.5 – 2.5 MPC = 1
= 2.5 MPC
MPC = 0.60 < TOP >
71. Answer : (c)
Reason : GNP = GDP + NFIA
NFIA = Factor income received from abroad – Factor income paid abroad.
= 100 – 200
= – 100
? GNP = 8000 – 100
= 7900. < TOP >
72. Answer : (c)
Reason : GNP at factor cost = GNP at market prices +subsidies–indirect taxes
Or 700 +25 – 60 = 665
NNP at factor cost = GNP at factor cost – depreciation
Or 665 – 10 = 655 MUC < TOP >
73. Answer : (d)
Reason : Real GDP for 2005 = (Quantity of bread in 2005 x Price of bread in 2004) + (Quantity of butter in 2005 x Price of butter in 2004) = (1500 x 20) + (2500 x 15) = Rs.67500.
Nominal GDP for 2005 = (Quantity of bread in 2005 x Price of bread in 2004) + (Quantity of butter in 2005 x Price of butter in 2005) = (1500 x 25) + (2500 x 20) = 37500 + 50000 = 87,500.
GDP deflator = NominalGDP×100RealGDP = (87500/67500) x 100 = 1.296 x 100 = 129.6 or 130 approximately. < TOP >
74. Answer : (a)
Reason : NDP at factor cost = NDP at market prices – Indirect taxes + subsidies
= 234000 – 36000 + 12000
= Rs.210000 Cr. < TOP >
75. Answer : (d)
Reason : Monetary liabilities = Financial assets + other assets – Non monetary liabilities
= 3,520 + 60 – 280
= 3,300 < TOP >
76. Answer : (a)
Reason : Balance of trade(BoP) = Merchandise exports – Merchandise imports +
= 18,000 –2,0000 = 2000 MUC (deficit). < TOP >
< TOP OF THE DOCUMENT >
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