Question Paper

Economics – II (122) : October 2003

Section A : Basic Concepts (40 Points)
• • This section consists of questions with serial number 1 - 40.
• • Answer all questions.
• • Each question carries one point.
< Answer >
1. Japanese economy is facing the prospects of liquidity trap. Which of the following statements is not
true about liquidity trap?

a. Public is willing to hold whatever money is supplied at the current interest rate
b. LM curve is horizontal
c. Fiscal policy is more effective in increasing income
d. Monetary policy is ineffective in affecting interest rate
e. LM curve is vertical.
< Answer >
2. With respect to Aggregate Supply (AS), which of the following is true?

a. AS in the short run is positively sloped and in the long run it is vertical
b. AS is positively sloped both in the short run and in the long run
c. AS is positively sloped in the short run and negatively sloped in the long run
d. AS is vertical both in the short run and in the long run
e. Costs have greater impact on AS in short run than in the long run.
< Answer >
3. If Mr. X buys a National Small Savings Certificate, which of the following is likely to happen?

a. Increase in Government market borrowings

b. Increase in the other liabilities of the Government
c. Increase in forex reserves
d. Increase in Government revenue
e. Decrease in Government liability.
< Answer >
4. Which of the following statements is not true with respect to stock and flow variables?

a. Both variables have time dimension

b. Flow variables are always determined by stock variables
c. Stock variables are usually affected by flow variables
d. All flow variables need not have stock variable counterparts
e. Flow variables are partly determined by stock variables.
< Answer >
5. 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.
< Answer >
6. 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.
< Answer >
7. Which of the following statements is not true?
 a. GDP deflator is also known as implicit price deflator
b. GDP deflator reflects the change in overall price level of the economy
c. GDP deflator is the most comprehensive index of prices
d. GDP deflator reflects on the purchasing power of the people
e. GDP deflator measures economic growth.
< Answer >
8. 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.
< Answer >
9. 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.
< Answer >
10. Which of the following better explains the inverse relationship between the interest rate and the
demand for money?
a. The transaction demand for money
b. The speculative demand for money
c. The precautionary demand for money
d. The inflationary expectations
e. None of the above. The relationship between the interest rate and the demand for money is
direct, not inverse.
< Answer >
11. 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.
< Answer >
12. In the standard IS-LM model, which of the following is true if the government raises tax rate and the
Reserve Bank of India decides to hold the money supply constant?
a. Disposable income remains constant
b. IS curve shifts to the right
c. LM curve shifts to the left
d. Interest rate falls
e. Interest rate increases.
< 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.
< Answer >
14. In the last few months the forex reserves in India have been increasing. Which of the following
sterilization policies would the Reserve Bank of India should adopt?
a. Increase CRR
 b. Decrease CRR
c. Decrease discount rate
d. Buy government securities
e. None of the above.
< Answer >
15. 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.
< Answer >
16. 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.
< Answer >
17. 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.
< Answer >
18. Which of the following is true if the Government monetizes part of its deficit?
a. Money supply in the economy will increase
b. Interest rate will increase
c. Primary deficit will increase
d. Public debt will increase
e. Revenue deficit will decrease.
< Answer >
19. Which of the following does not affect the balance sheet of Reserve Bank of India?
a. Central government’s borrowings from RBI
b. Loan taken by one commercial bank from the other
c. Refinancing of NABARD loans
d. Increase in reserves of commercial banks
e. Increase in net foreign exchange assets.
< Answer >
20. Which of the following ratios is not an indicator of financial development of a country?
a. Finance Ratio
b. Financial Interrelations Ratio
c. New Issue Ratio
d. Intermediation Ratio
e. Cost Benefit Ratio.
< Answer >
21. The difference between personal disposable income and personal income is
a. Residential investment
b. Indirect taxes
c. Subsidies
d. Transfer payments
e. Personal taxes.
< Answer >
22. Which of the following is true if the RBI increases Cash Reserve Ratio (CRR)?
a. Monetary liabilities of the RBI increases
b. High-powered money in the economy decreases
 c. The value of money multiplier decreases
d. Aggregate demand in the economy increases
e. Price level in the economy increases.
< Answer >
23. Precautionary 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.
< Answer >
24. When the addition to capital goods in an economy is more than the capital consumption allowance,
the economy experiences
a. Negative net investment
b. Zero net investment
c. Positive net investment
d. Negative gross investment
e. Zero gross investment.
< Answer >
25. An expansionary fiscal policy combined with a liberal monetary policy results in
I. A lower level of output.
II. A higher level of output.
III. A lower interest rate.
IV. A higher interest rate.
V. A lower or higher interest rate depending on the relative magnitude of fiscal and monetary
policies.
a. (I) and (III) above
b. (I) and (IV) above
c. (II) and (III) above
d. (II) and (V) above
e. (I) and (V) above.
< Answer >
26. Which of the following is true if the central bank does not impose any reserve ratio?
a. The banking system can no longer affect the supply of money in the economy
b. The banking sector can create unlimited money supply
c. The lending capacity of banks would narrow down to zero
d. A rupee deposited in a bank reduces the money supply in the economy by one rupee
e. Money supply in the economy will be equivalent to the high-powered money.
< Answer >
27. Which of the following ratios best describes the GNP deflator?
a. Nominal GNP to real GNP
b. Real GNP to nominal GNP
c. Nominal GNP to real GDP
d. Real GNP to nominal GDP
e. None of the above.
< Answer >
28. The LM curve shows
a. A positive relationship between rate of interest and level of income
b. A negative relationship between rate of interest and level of income
c. A negative relationship between rate of interest and level of investment
d. A positive relationship between rate of interest and level of investment
e. A positive relationship between level of investment and level of income.
< Answer >
29. Suppose an economy is experiencing inflation. And at the same time, there is a slowing down of
economic activities. This is a case of
a. Deflation
b. Hyper inflation
c. Recession
d. Depression
e. Stagflation.
 < Answer >
30. The unemployment in the Keynesian model is caused by
a. Demand deficiency
b. Supply deficiency
c. Demand sufficiency
d. Supply sufficiency
e Both (a) and (b) above.
< Answer >
31. To improve market efficiency, which of the following is not recommended by Supply side
economics?
a. Reduce government controls
b. Promote competition
c. Restrict the power of trade unions
d. Remove institutional barriers
e. Increase corporate tax rate.
< Answer >
32. If a Government is running surplus in its budget, we can expect that public debt will be
a. Rising
b. Falling
c. Constant
d. Falling if there are tax cuts
e. Falling if the government uses the surplus to repay its past debts.
< Answer >
33. According to the Laffer curve, as the tax rate increases, tax revenues
a. Rise continuously
b. Decrease continuously
c. Initially decrease and then increase
d. Initially increase and then decrease
e. Remain constant.
< Answer >
34. The difference between M3 and M1 is
a. Demand deposits
b. Post office savings deposits
c. Savings deposits
d. Time deposits
e. M2.
< Answer >
35. The Chief Economist to the Government told the Cabinet that the government can no longer fool the
people by increasing its spending during election years, as people will anticipate this kind of behavior
as previous governments used to do so. The economist is an advocate of
a. Classical economics
b. Rational expectations
c. Keynesian economics
d. Supply-side economics
e. Monetarism.
< Answer >
36. 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.
< Answer >
37. Which of the following is an example of a government transfer payment?
a. Salary paid to a soldier
b. Purchase of a new car for the Ministry of Finance
c. Funding of a clinic to provide free vaccinations
d. Free food coupons issued to persons in an anti-poverty program
e. Funding of a new bridge in an urban area.
 < Answer >
38. Which of the following price indices is/are most widely used for determining of inflation in India?
a. Wholesale price index (WPI)
b. GDP deflator
c. Consumer price index (CPI)
d. Both (a) and (b) above
e. Both (b) and (c) above.
< Answer >
39. Personal taxes in India best illustrates a
a. Proportional tax system
b. Progressive tax system
c. Indirect tax system
d. Value added tax system
e. Regressive tax system.
< Answer >
40. Which of the following policy instruments has the least ‘outside lag’?
a. Cash reserve ratio (CRR)
b. Bank rate
c. Repo rate
d. Taxes
e. Open market operations (OMO).

END OF SECTION A
 Section B : Problems (60 Points)
• • This section consists of questions with serial number 41 - 75.
• • Answer all questions.
• • Points are indicated against each question.
< Answer
41. The Planning Commission is targeting a growth rate of 6% p.a. in per capita income for the next 10 >
years. To achieve the target, the required domestic savings to income ratio is 32%. If the population is
expected to grow at the rate of 2% p.a., capital output ratio for the economy is
a. 3.0
b. 4.5
c. 5.0
d. 4.0
e. 5.5.
(2 points)
< Answer
42. Consumption function for an economy is estimated to be C = 400+0.75Yd, where C and Yd are >
measured in Rs. cr. The level of consumption at which the savings will be zero is
a. Rs.1,400 cr
b. Rs.1,500 cr
c. Rs.1,600 cr
d. Rs.1,700 cr
e. Rs.1,300 cr.
(1 point)
< Answer
43. The break-even income of Mr. Ravi is Rs.5,000 and his Marginal Propensity to Consume is 3/4. If his >
current income is Rs.2,500, how much would Mr. Ravi borrow?
a. Rs.125
b. Rs.525
c. Rs.625
d. Rs.425
e. Rs.325.
(2 points)
< Answer
44. In a two sector economy the savings function is S = –60 + 0.25 Yd. If the investment in the economy is >
100 Million Units of Currency (MUC), equilibrium income will be
a. 620 MUC
b. 640 MUC
c. 660 MUC
d. 650 MUC
e. 630 MUC.
(1 point)
Questions 45 to 47 are based on the following information:
Consumption (C) 100+0.75Yd
Investment (I) 80 MUC
Taxes (T) 0.20Y
Government Expenditure (G) 150 MUC
< Answer
45. The equilibrium income for the economy is >

a. 900 MUC
b. 825 MUC
c. 950 MUC
d. 930 MUC
e. 910 MUC.
 (1 point)
< Answer
46. Budget deficit/surplus for the economy is >

a. 10 MUC (deficit)
b. 15 MUC (deficit)
c. 15 MUC (surplus)
d. 20 MUC (deficit)
e. 20 MUC (surplus).
(1 point)
< Answer
47. The economy is opened to trade in goods and services with the rest of the world, and imports and >
exports are as given below:
Imports (M) = 0.10Y
Exports (X) = 420 MUC

The multiplier for the economy is

a. 2.0
b. 3.0
c. 3.5
d. 4.0
e. 4.5.
(1 point)
< Answer
48. The following relations are given for an economy: >

Savings function (S) – 250 + 0.30Yd

Disposable income (Yd) Y–T
Tax function (T) 0.25Y
Investment function (I) 100 – 11i
Government expenditure (G) 500 MUC
Exports (E) 40 MUC
Imports (M) 0.3Y If the equilibrium
output for the economy is to be increased by 100 MUC, investment should be increased by
a. 60.0 MUC
b. 77.5 MUC
c. 70.0 MUC
d. 95.0 MUC
e. 90.5 MUC.
(2 points)
< Answer
49. For an economy, the Savings function is S = – 300 + 0.2Y and the investment function is >
I = 200 – 5i. If the equilibrium level of output is 2,250 MUC, interest rate in the economy is
a. 6%
b. 8%
c. 10%
d. 12%
e. 14%.
(1 point)
< Answer
50. In an economy, demand for money is L = 0.4Y – 10i and supply of money is 300 MUC. If the >
government intends to decrease the equilibrium interest rate from the current level of 8% to 6%, what
will be the change in the equilibrium level of output?
a. 25 MUC Increase
b. 50 MUC Decrease
c. 75 MUC Decrease
d. 50 MUC Increase
e. No change in the equilibrium level of output.
(2 points)
 < Answer
51. The following balances are taken from the balance sheet of the Central Bank: >

MUC
Loans given to the Government 1,200
Reserves maintained by the banks 300
Net worth 80
Loans to the commercial banks 800
Government deposits 200
Other assets 60
Other deposits with the central bank 10
Net foreign exchange assets 1,500
Loans to the commercial sector 20
If the government money is 100 MUC, high-powered money in the economy is

a. 3,000 MUC
b. 3,050 MUC
c. 3,100 MUC
d. 3,300 MUC
e. 3,400 MUC.
(2 points)
< Answer
52. The following data is taken from National Income Accounts of a country: >

Rs. Cr.
GNP at market prices 1,700
Transfer payments 242
Indirect taxes 173
Personal taxes 203
Consumption of capital 190
Undistributed corporate profits 28
Corporate tax 75
Subsidies 20
Personal income in the country is
a. Rs.1,363 cr
b. Rs.1,121 cr
c. Rs.1,230 cr
d. Rs.1,296 cr
e. Rs.1,496 cr.
(2 points)
< Answer
53. In an economy the factor income earned within domestic territory for the year 2002-03 is 50,000 MUC. >
For the year, consumption of capital is 3,000 MUC and the GNP at market prices is 60,000 MUC. If
indirect taxes are 2,000MUC and subsidies are 500 MUC, net factor income from abroad is
a. 5,000 MUC
b. 5,500 MUC
c. 6,000 MUC
d. 6,500 MUC
e. 6,800 MUC.
(2 points)
Questions 54 and 55 are based on the following information:
Production Account
Dr.
Cr.
 Rs. Cr. Rs. Cr.
Wages paid to domestic residents 400 Sales to Households 550
Wages paid to foreigners 240 Gross Fixed Investment 85
Interest payments on loans taken 10 Changes in stock 55
from foreign banks
Retained profits 20 Exports 40
Corporate tax 10
Imports 25
Indirect taxes 15
Depreciation 10
730 730
Assume that there is no government sector in the economy.
< Answer
54. For the economy, NDP at market prices is >
a. Rs.650 cr
b. Rs.670 cr
c. Rs.695 cr
d. Rs.640 cr
e. Rs.630 cr.
(2 points)
< Answer
55. If the Factor Income received from abroad is Rs.200 cr., current account balance for the economy is >

a. Rs.45 cr. (surplus)

b. Rs.35 cr. (surplus)
c. Rs.35 cr. (deficit)
d. Rs.45 cr. (deficit)
e. Rs.55 cr. (deficit).
(2 points)
< Answer
56. For an economy, GDP at market prices for the current year is 1500 MUC. If GDP deflator for the >
current year is 120, real GDP for the current year would be
a. 7,500 MUC
b. 1,250 MUC
c. 300 MUC
d. 1,800 MUC
e. 1,100 MUC.
(1 point)
< Answer
57. An economy consists of three sectors: primary, secondary and tertiary sectors. Transactions related to >
the three sectors are given below:
(MUC)
Items Primary Sector Secondary Sector Tertiary Sector
Sales 100 150 130
Closing Stock 15 20 25
Intermediate Consumption 15 25 15
Opening Stock 10 10 15
Indirect taxes 12 13 17
Depreciation 10 12 15
Subsidies 7 8 7
GDP at factor cost for the economy is
a. 293 MUC
b. 300 MUC
c. 271 MUC
d. 258 MUC
e. 342 MUC.
(2 points)
 Questions 58 to 61 are based on the following information:
India’s overall Balance of Payments for the year 2002 – 03
(US $ million)
Items Credit Debit
Merchandise 53000 65474
Services 24986 18780
Transfers 15225 367
Income 2826 7708
Foreign Direct Investment 4790 1179
Portfolio Investment 7535 6591
External Assistance 2773 5233
Commercial Borrowings (MT & LT) 2737 4435
Commercial Borrowings (Short Term) 8189 7210
Commercial Banks 16926 8973
Others 536 246
Rupee Debt Service — 474
Other Capital 6402 2909
Errors & Omissions 634 —
< Answer
58. During the year 2002-03, trade deficit for India is >

a. $ 12,474 million
b. $ 12,574 million
c. $ 12,974 million
d. $ 13,821 million
e. $ 13,980 million.
(1 point)
< Answer
59. During the year 2002-03, current account balance for India is >

a. $ 3,708 million (surplus)

b. $3,708 million (deficit)
c. $3,998 million (deficit)
d. $3,798 million (surplus)
e. $3,888 million (deficit).
(2 points)
< Answer
60. During the year 2002-03, net foreign investment in India is >

a. $ 4,755 million
b. $ 4,595 million
c. $ 4,625 million
d. $ 4,555 million
e. $ 4,825 million.
(1 point)
< Answer
61. During the year 2002-03, over all Balance of Payments position for India is >

a. $18,280 million (surplus)

b. $16,980 million (deficit)
c. $17,280 million (deficit)
d. $17,580 million (surplus)
e. $ 16,980 million (surplus).
(3 points)
Questions 62 and 63 are based on the following information:
Budget Estimate for the year 2003-04
 Rs.
crore
Tax Revenue (net to Centre) 1,84,169
Non-tax revenue 69,766
Recoveries of Loans 18,023
Other Receipts 13,200
Borrowings and other Liabilities 1,53,637
Non-plan Expenditure
On Revenue Account (of which Interest Payments is Rs.1,23,223 cr.) 2,89,384
On Capital Account 28,437
Plan Expenditure
On Revenue Account 76,843
On Capital Account 44,131
< Answer
62. The estimated revenue deficit for the year 2003-04 is >

a. Rs.1,13,292 cr
b. Rs.1,12,392 cr
c. Rs.1,12,292 cr
d. Rs.1,19,292 cr
e. Rs.1,19,922 cr.
(2 points)
< Answer
63. The estimated primary deficit for the year 2003-04 is >

a. Rs.31,814 cr
b. Rs.30,814 cr
c. Rs.31,414 cr
d. Rs.30,414 cr
e. Rs.32,414 cr.
(1 point)
< Answer
64. The following information pertains to an economy: >
(MUC)
Private consumption expenditure 750
Investment in fixed capital 250
Increase in stock 150
Government expenditure 100
Merchandise exports 50
Imports 150
Money supply 230 The velocity of money in the economy is

a. 4
b. 5
c. 3
d. 2
e. 1.
(2 points)
Questions 65 and 66 are based on the following information:
LM function Y = 500 + 200i
Investment function (I) 200 – 10i
Transaction demand for money (Mt) 0.50Y
Speculative demand for money (Ma) 350 – 100i
Supply of money (Ms) 500 MUC
Current equilibrium rate of interest (i) 10%
< Answer
65. If expansionary fiscal policies increase the equilibrium rate of interest to 12%, the crowding out in the >
 economy is
a. 10 MUC
b. 15 MUC
c. 20 MUC
d. 25 MUC
e. 30 MUC.
(1 point)
< Answer
66. If the government would like to avoid the crowding out as in the above question, what should be the >
new money supply in the economy?
a. 100 MUC
b. 600 MUC
c. 650 MUC
d. 700 MUC
e. 750 MUC.
(2 points)
< Answer
67. The following relations are derived for an economy: >
(All macro aggregates are in million units of currency and interest in terms of percent per annum)
Savings Function (S) – 50 + .50Yd
Disposable income ( Yd) Y–T+R
Transfer Payments (R) 80 MUC
Tax function (T) 0. 40Y
Investment function (I) 1000 – 30i
Exogenous government expenditure (G) 800 MUC
Import function (M) 20 + 0.20 Y
Export (E) 450 MUC
Transaction demand for money (Mt / P) 0.50Y
Speculative demand for money (Ma / P) 250 – 100i
Money supply (Ms / P) 500 MUC The
equilibrium level of income in the economy is
a. 1,875 MUC
b. 1,985 MUC
c. 2,062 MUC
d. 2,162 MUC
e. 2,281 MUC.
(3 points)
Questions 68 to 69 are based on the following information:

The following relationship are given for an economy:

Goods market equilibrium 0.5Y = 2925 – 37.5i

Money market equilibrium 0.25Y = 312.5 + 125i
Exports 650 MUC
Import function 25 + 0.25Y
< Answer
68. The trade balance at equilibrium in the economy is >

a. 637.5 MUC (surplus)

b. 667.5 MUC (surplus)
c. 687.5 MUC (deficit)
d. 687.5 MUC (surplus)
e. 768.5 MUC (deficit).
(2 points)
< Answer
69. If the government expenditure increases by 475 MUC, the new equilibrium rate of interest will be >

a. 7.83%
 b. 8.01%
c. 8.83%
d. 9.13%
e. 9.65%.
(2 points)
< Answer
70. As on September 30, 2003 monetary liabilities of the central bank are 1,200 MUC and government >
money is 50 MUC. If the currency deposit ratio is 0.20 and the central bank specifies a reserve ratio of
5%, money supply in the economy will be
a. 5,000 MUC
b. 5,500 MUC
c. 6,000 MUC
d. 6,550 MUC
e. 6,600 MUC.
(2 points)
< Answer
71. In an economy the high powered money is 500MUC. The currency deposit ratio is estimated to be 0.40 >
and the reserve ratio is 10%. If foreign exchange assets with the central bank increase by 10 MUC what
is the new reserve ratio so that the money supply remains at the previous level?
a. 9%
b. 10%
c. 11%
d. 12%
e. 13%.
(3 points)
< Answer
72. Indicators of financial development of an economy for the year 2002-03 are given below: >

Finance ratio 0.50

Financial interrelation ratio 0.32 If the national income for the year 2002-03 is
19,200MUC, the total issues will be
a. 7,800 MUC
b. 8,200 MUC
c. 8,700 MUC
d. 9,000 MUC
e. 9,600 MUC.
(1 point)
< Answer
73. In an economy, the high-powered money and money supply are 4,300 MUC and 17,200 MUC >
respectively. If the reserve ratio is 10%, currency deposit ratio for the economy is
a. 0.17
b. 0.20
c. 0.24
d. 0.27
e. 0.29.
(2 points)
< Answer
74. Consider the following data: >

Particulars MUC
Factor income paid abroad by the business sector 10
Factor income received by household sector 160
Transfers to household sector 20
Wages and salaries paid by the business sector 100
Dividends paid by the business sector (of which Rs.10 is paid abroad) 20
Household savings 60
Factor income received from abroad by the household sector 20 The
 amount paid by the government to the households towards wages and salaries is
a. 10 MUC
b. 20 MUC
c. 30 MUC
d. 40 MUC
e. 50 MUC.
(2 points)
< Answer
75. Suppose that people hold 50% of their money in currency. If the reserve ratio is 10% and total demand >
for money is Rs.5,000, then the amount required by banks to meet the reserve requirement is equal to
a. Rs.250
b. Rs.2,250
c. Rs.2,500
d. Rs.5,000
e. None of the above.
(1 point)

END OF SECTION B
 Suggested Answers
Economics – II (122) : October 2003
1. Answer : (e) < TOP
>
Reason : Liquidity trap occurs when there is no decrease in the interest rate despite an increase in
the money supply. This results in an addition to idle balances.
(a) Is not the answer because when the economy is facing a situation of liquidity trap,
there is no future expectation of rise in the interest rate. So public hold money rather
than using for investment. The statement is true.
(b) Is not the answer because LM curve gives the combination of income and interest
rates which produce equilibrium in the money market. As the interest rate remains at
the critical rate, the speculative demand for money is nil. As the interest elasticity of
demand is infinity, the LM curve will be horizontal. The statement is true.
(c) Is not the answer because as the interest rate doesn’t increase, a sound fiscal policy
such as tax and expenditure policy will help in increasing the income. The fiscal
policy has a direct bearing on the level of aggregate demand and the level of
economic activity. The is a true statement.
(d) Is not the answer because monetary policy is ineffective in affecting the interest rate
due to the infinite interest elasticity of demand for money. The is a true statement.
(e) Is the answer because LM is not vertical rather than horizontal when there is
liquidity in the economy.
2. Answer : (a) < TOP
>
Reason : The aggregate supply explains the production behavior of an economy. If the actual price
achieved is more than the expected price, firms will experience a higher than anticipated
level of profits. This will lead to increase in production. That’s why the short run
aggregate supply curve slopes upward. But in the long run, the difference between
expected and actual price levels is negligible. In the long run, the output of an economy
doesn’t depend on the price level, but on factors such as labor import costs, capital stock,
technological progress, etc. So aggregate supply curve of an economy in long run is
vertical.
(a) Is the answer because aggregate supply curve is positively sloped in the short run
and vertical in the long run.
(b) Is not the answer because aggregate supply curve is not positively sloped in the
short run as well as in the long run.
(c) Is not the answer because aggregate supply curve is not positively sloped in the
short run as well as in the long run.
(d) Is not the answer because aggregate supply curve is not positively sloped in the
short run and negatively sloped in the long run.
(e) Is not the answer because in the long run, output of an economy doesn’t depend on
the price level, but on factors such as labor import costs, capital stock, technological
progress, etc.

3. Answer : (b) < TOP

>
Reason : If somebody buys National Small Saving Certificate, it increases in the other liabilities of
the government.
(a) Is not the answer because if Mr.X buys a National Small Saving Certificate, it will
not increase Government borrowings.
(b) Is the answer because if Mr.X buys a National Small Saving Certificate, it will
increase in the other liabilities of the Government.
(c) Is not the answer because if Mr.X buys a National Small Saving Certificate, it will
not increase in forex reserves.
(d) Is not the answer because if Mr.X buys a National Small Saving Certificate, it will
 not increase Government revenue.
(e) Is not the answer because if Mr.X buys a National Small Saving Certificate, it will
not decrease Government liability.

4. Answer : (b) < TOP

>
Reason : Stocks and flows variables are very essential in studying macroeconomics.
(a) Is not the answer because a stock variable is measured at a specified point of time
where as a flow variable is measured for a specified period of time. Both the stock
and flow variables have time dimensions. This is a true statement.
(b) Is the answer because flow variables are not always determined by stock variables.
Although a stock can change only as a result of flows, the flows themselves may be
determined in part by changes in stocks.
(c) Is not the answer because, stocks variables are usually affected by flow variables.
(d) Is not the answer because some macroeconomic variables have a direct counter- part
stock macroeconomic variables. Flow variables like, exports, wages, taxes, etc. may
not have direct counterparts, and they could indirectly affect other stocks.
(e) Is not the answer because flow variables are partly determined by stock variables.
5. 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.
6. 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.
7. Answer : (e) < TOP
>
Reason : GDP Deflator is a price index, which is used to measure the average level of the prices of
all goods and services that make up GDP.
(a) Is not the answer because it is a true statement that GDP deflator is otherwise known
as implicit price deflator.
(b) Is not the answer because GDP deflator reflects the change in overall price level in
 the economy.
(c) Is not the answer because GDP deflator is the most comprehensive index of price.
(d) Is not the answer because GDP deflator is used to measure real GNP i.e. GNP in
rupees of constant purchasing power. If prices are rising, the nominal GNP during the
latter period to account for the effects of inflation.
(e) Is the answer because GDP deflator doesn’t measure economic growth.
8. 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.
9. 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.
10. Answer : (b) < TOP
>
Reason : The amount of wealth that household or business hold in the form of money balances is
referred to as demand for money. Individuals and firms may hold part of their wealth in
the form of money to take the advantage of decrease in prices. Speculation can be done
on price of stock and bonds. Securities prices are linked to interest rates and inversely
proportional to a change in interest rates. With a rise in interest rates, prices of securities
fall and the speculative demand for money also comes down. Contrary to this, if the
interest rates fall, securities prices rise and demand for speculation purposes also rises.
Thus speculative demand is inversely proportional to the rate of interest.
(a) Is not the answer because transaction demand for money is largely influenced by
level of income and the frequency with which income is received.
(b) Is the answer because there is an inverse relationship rate of interest and the
speculative demand for money.
(c) Is not the answer because the demand for precautionary balances represents money
that is held as a precaution for some unforeseen events such as medical emergency,
 an accident etc. The precautionary demand for money is highly influenced by level
of income.
(d) Is not the answer because an inflationary expectation doesn’t represent an inverse
relationship between the interest rate and the demand for money.
(e) (e) Is not the answer because the relationship between the interest rate and the
demand for money is inverse, not direct.

11. 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.

12. Answer : (d) < TOP

>
Reason : If the government raises tax rate, it has an effect on the IS curve because it is a fiscal
policy and the IS curve shifts to left. And at the same time the Reserve Bank of India keep
the money supply constant. It implies that there is no change in the LM curve. This will
result in a fall in the interest rate.
(a) Is not the answer because when the Government raises tax rate, disposable income
falls.
(b) Is not the answer because if the government raises tax rate and the Reserve Bank of
India hold the money supply constant, the IS curve shifts to the left.
(c) Is not the answer because if the government raises tax rate and the Reserve Bank of
India hold the money supply constant, there is no shift in the LM curve.
(d) Is the answer because if the government raises tax rate and the Reserve Bank of
India hold the money supply constant, the IS curve shifts to the left while LM curve
unchanged means that the interest rate falls.
(e) Is not the answer because interest rate doesn’t increase.
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 : (a) < TOP
>
Reason : In an economy, the high-powered money is the aggregate of monetary liabilities of the
central bank and government money. The foreign exchange reserves are the asset of the
central bank. When the foreign exchange reserves increases, the monetary liabilities also
increase. This in turn increases the high-powered money in the economy and thereby the
money supply. If the economy is already affected by inflation, the central bank must step
in to curb this expansion of money supply by either contracting its lending its lending to
the banking systems (by increasing the discount rate) or by open market operations (sale
 of government securities) or by increasing the cash reserve ratios of the commercial bank.
(a) Is the answer because the Reserve Bank of India increase CRR to correct the
imbalances created by changes in foreign exchange reserve.
(b) Is not the answer because RBI wouldn’t decrease CRR. It will not help in correcting
the imbalances created by changes in foreign exchange reserve.
(c) Is not the answer because due to increase in foreign exchange reserves, RBI
increases the discount rate.
(d) Is not the answer because RBI checks the expansion of money supply by open
market operations, i.e. sale of government securities.
15. Answer : (a) < TOP
>
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.
16. Answer : (e) < TOP
>
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.
17. 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.
18. Answer : (a) < TOP
 Reason : When the government monetizes part of its deficit, it is an increase in net RBI credit to >
the Government, comprising the net increase in the holdings of Treasury Bills of the RBI
and its contribution to the market borrowings of the Government. To meet the needs of
the Government, the RBI prints more money. This will lead to excess money supply in
the economy.
(a) Is the answer because money supply in the economy increases when the
Government monetizes part of its deficit.
(b) Is not the answer because when there is an excess money supply, interest rate will
decline.
(c) Is not the answer because when the government monetizes part of its deficit,
primary deficit will decrease. Primary deficit is calculated by deducting the interest
payments of the government from the gross fiscal deficit.
(d) Is not the answer because when the government monetizes part of its deficit, public
debt will decrease.
(e) Is not the answer because when the government monetizes part of its deficit,
revenue deficit will increase. Revenue deficit is the difference between
Government’s revenue expenditure and revenue receipts.

19. Answer : (b) < TOP

>
Reason : The balance sheet of Reserve Bank of India contains particulars of Bank’s current assets
and liabilities.
(a) Is not the answer because Central government’s borrowings from RBI constitutes
assets of RBI.It will affect the balance sheet.
(b) Is the answer because loan taken by one commercial bank from the other is a inter
bank loan. It will not affect the balance sheet of the Reserve Bank of India. It is
neither a liability nor an asset to the RBI.
(c) Is not the answer because refinancing of NABARD loans constitutes assets of RBI.
(d) Is not the answer because increase in reserves of commercial banks increases the
liabilities of RBI.
(e) Is not the answer because increase in net foreign exchange assets increases the
assets of RBI.
20. Answer : (e) < TOP
>
Reason : A well-developed financial system is vital for the smooth functioning of an economy. The
financial development ratios such as Finance Ratio, Financial Interrelation Ratio, New
Issues Ratio and Intermediation Ratio are indicators of financial development of a
country.
(a) Is not the answer because Finance Ratio is an indicator of financial development of
a country.
(b) Is not the answer because Financial Interrelation Ratio is an indicator of financial
development of a country.
(c) Is not the answer because New Issues Ratio is an indicator of financial development
of a country.
(d) Is not the answer because Intermediation Ratio is an indicator of financial
development of a country.
(e) Is the answer because Cost Benefit Ratio is not an indicator of financial
development of a country.
21. Answer : (e) < TOP
>
Reason : Personal disposable income = Personal income – Personal taxes.
(a) Is not the answer because the difference between personal disposable income and
personal income is not residential investment.
(b) Is not the answer because the difference between personal disposable income and
personal income is not indirect taxes.
 (c) Is not the answer because the difference between personal disposable income and
personal income is not subsidies.
(d) Is not the answer because the difference between personal disposable income and
personal income is not transfer payments.
(e) Is the answer because the difference between personal disposable income and
personal income is personal taxes
< TOP
22. Answer : (c) >
Reason : Money supply = H × (1+ Cu / Cu + r)
Where, H = Monetary Liabilities of Central Bank + Government Money.
Cu = Currency-deposit ratio
r = Cash reserve ratio.
(a) Is not the answer because When the RBI increases cash reserve ratio (CRR),
monetary liabilities of the RBI decreases.
(b) Is not the answer because When the RBI increases cash reserve ratio (CRR), high
powered money in the economy increases.
(c) Is the answer because When the RBI increases cash reserve ratio (CRR), the value
of money multiplier decreases.
(d) Is not the answer because When the RBI increases cash reserve ratio (CRR),
aggregate demand in the economy decreases.
(e) Is not the answer because When the RBI increases cash reserve ratio (CRR), price
level in the economy decreases.
< TOP
23. Answer : (e) >
Reason : The demand for precautionary balances represents money that is held as a precaution
against some unforeseen events such as medical emergency, accident etc.
This precautionary demand for money is inversely related to rate of interest and
frequency with which income is received. Lower the rate of interest and frequency with
which income is received, higher is the precautionary demand for money and vice versa.
(a) Is not the answer because precautionary demand for money varies directly with the
level of income.
(b) Precautionary demand for money is inversely related to rate of interest.
(c) Is not the answer because precautionary demand for money varies directly with the
wealth a person held.
(d) Precautionary demand for money is inversely related to frequency with which
income is received.
(e) Is the answer because precautionary demand for money is inversely related to rate of
interest and frequency with which income is received.
24. Answer : (c) < TOP
>
Reason : Investment is the flow of expenditures devoted to increasing or maintaining the real
capital stock. When the addition to capital goods is more than the capital consumption
allowance, it will result in a positive net investment.
(a) Is not the answer because when the addition to capital goods is less than the capital
consumption allowance, it will result in negative net investment.
(b) Is not the answer because when the addition to capital goods is more than the capital
consumption allowance, it will not result in zero net investment
(c) Is the answer because when the addition to capital goods is more than the capital
consumption allowance, it will result in positive net investment
(d) Is not the answer because when the addition to capital goods is more than the capital
consumption allowance, it will not result in negative gross investment. Because
gross investment is the total investment that occurs in the economy within any
specific time period.
(e) Is not the answer because when the addition to capital goods is more than the capital
consumption allowance, it will not result in zero gross investment.
25. Answer : (e) < TOP
>
Reason : An expansionary fiscal policy shifts the IS curve to the right. And a liberal monetary plicy
shifts the LM curve to the right. It will result in a higher level of output, but the level of
interest rate is dependent on the relative magnitude of fiscal and monetary policies
a. a. Is not the answer, because an expansionary fiscal policy combined with a liberal
monetry policy does not result in a lower level of output and a lower interest rate.
b. b. Is not the answer because an expansionary fiscal policy combined with a liberal
monetary policy does not result in a lower level of output and a higher interest rate.
c. c. Is not the answer because an expansionary fiscal policy combined with a liberal
monetary policy results in a higher level of output but not a lower interest rate.
d. d. Is not the answer because an expansionary fiscal policy combined with a liberal
monetary policy results in a higher level of output but we can’t say that it results in a
higher interest rate.
e. e. Is the answer because an expansionary fiscal policy combined with a liberal
monetary policy result in higher level of output, but the level of output, but the level
of interest rate is dependent on the relative magnitude of fiscal and monetary
policies.
26. Answer : (b) < TOP
>
Reason : If the central bank doesn’t impose any reserve ratio, the commercial bank need not keep
on deposit with the Reserve bank certain amount of funds equal to a specified percentage
of its own deposit liabilities. Then the banking sector can create unlimited money supply.
(a) Is not the answer because without the imposition of reserve ratio, the banking
system can affect the supply of money through credit creation.
(b) Is the answer because if the central bank doesn’t impose any reserve ratio, the
banking sector can create unlimited money supply.
(c) Is not the answer because without reserve ratio, the lending capacity of banks
wouldn’t narrow down to zero.
(d) Is not the answer because if the central bank doesn’t impose any reserve ratio, a
rupee deposited in a bank doesn’t reduce the money supply in the economy by one
rupee.
(e) Is not the answer because if the central bank doesn’t impose any reserve ratio,
money supply in the economy will not be equivalent to high-powered money.
Money supply = H × (1+ Cu / Cu + r)
Where, H = Monetary Liabilities of Central Bank + Government Money.
Cu = Currency-deposit ratio
r = Cash reserve ratio.
27. Answer : (a) < TOP
>
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.
28. Answer : (a) < TOP
>
Reason : The LM curves gives the combinations of income and interest rates, which produce
 equilibrium in the money market. For all points in the LM curve, the demand for real
balances is equal to supply of real balances. The LM curve shows a positive relationship
between rate of interest and level of income.
(a) Is the answer because the LM curve shows a positive relationship between rate of
interest and level of income.
(b) Is not the answer because the LM curve doesn’t show a negative relationship
between rate of interest and level of income.
(c) Is not the answer because the LM curve doesn’t show a negative relationship
between rate of interest and level of investment.
(d) Is not the answer because the LM curve doesn’t show a positive relationship
between rate of interest and level of investment.
(e) Is not the answer because the LM curve doesn’t show a positive relationship
between level of investment and level of income.
29. Answer : (e) < TOP
>
Reason : In case of stagflation, there is stagnation as well as inflation exists in the economy. There
is a slowing down of economic activities occurs.
(a) Is not the answer because deflation refers to a situation in which there is a decrease
in general level of prices in an economy that is sustained over a period of time
(b) Is not the answer because in the case of hyperinflation, price rise is very large and
accelerating
(c) Is not the answer because recession is characterized by the downturn in economic
activities in an economy
(d) Is not the answer because there is a contraction of economic activities in the
depression period.
(e) Is the answer because there is a stagnation combined with inflation prevails in the
economy in the period of stagflation.

30. Answer : (a) < TOP

>
Reason : In the Keynesian model, unemployment could be reduced if the aggregate demand
increases. Therefore, unemployment is caused by demand deficiency. The Keynesian
theory of unemployment suggests that governments can play an active role in the
economy by adjusting the aggregate demand through its fiscal and monetary instruments.
(a) Is the answer because unemployment in the Keynesian model is caused by demand
deficiency.
(b) Is not the answer because unemployment in the Keynesian model is not caused by
supply deficiency.
(c) Is not the answer because unemployment in the Keynesian model is not caused by
demand sufficiency.
(d) Is not the answer because unemployment in the Keynesian model is not caused by
supply sufficiency.
(e) Is not the answer because unemployment in the Keynesian model is not caused by
both demand deficiency and supply deficiency.
31. Answer : (e) < TOP
>
Reason : Supply side economics advocates to reduce government controls, to promote competition,
to restrict the power of trade unions and to remove institutional barriers. Supply side
economics doesn’t recommend to increasing corporate tax rate.
(a) Is not the answer because supply side economics recommend reducing government
controls to improve market efficiency.
(b) Is not the answer because supply side economics recommend promoting competition
to improve market efficiency.
(c) Is not the answer because supply side economics recommend restricting the power
of trade unions to improve market efficiency.
 (d) Is not the answer because supply side economics recommend removing institutional
barriers to improve market efficiency.
(e) Is the answer because supply side economics doesn’t recommend increasing
corporate tax rate to improve market efficiency.
32. Answer : (e) < TOP
>
Reason : If a government has a surplus budget, and the government repays its past debts using its
surplus budget, public debt will be falling.
(a) Is not the answer because if a Government is running surplus in its budget, public
debt may not be rising.
(b) Is not the answer because if a Government is running surplus in its budget, public
debt may not be falling.
(c) Is not the answer because if a Government is running surplus in its budget, public
debt may not be constant.
(d) Is not the answer because if a Government is running surplus in its budget, public
debt may not be falling if there are tax cuts.
(e) Is the answer because if a Government is running surplus in its budget, public debt
will be falling if the Government uses the surplus to repay its past debts.
33. Answer : (d) < TOP
>
Reason : The Laffer curve depicts the relationship between tax revenues and tax rates. The shape
of the Laffer curve is backward bending indicating that tax revenues initially increase and
then decrease as the tax rate increases.
(a) Is not the answer because according to Laffer curve, tax revenues do not rise
continuously as the tax rate increases.
(b) Is not the answer because tax revenues do not decrease continuously as the tax rate
increases.
(c) Is not the answer because tax revenues do not decrease initially and then increase as
the tax rate increases.
(d) Is the answer because tax revenues increase initially and then decrease as the tax
rate increases.
(e) Is not the answer because tax revenues do not remain constant as the tax rate
increases
34. Answer : (d) < TOP
>
Reason : M = Currency with the public + Demand deposits with the banking system
1

+ other deposit with the bank.

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

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

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

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

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

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

< TOP
35. Answer : (b) >
Reason : According to rational expectations school, discretionary monetary and fiscal policy
cannot be used to stabilize the economy. Proponents of rational expectation argue that
consumers and business firms anticipate the implications of rise in government spending.
Moneywage rate and prices will rise, but output and employment will remain the same.
So government can no longer fool the people by increasing its spending during elections
years. So the answer is (b).
36. 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.
37. Answer : (d) < TOP
>
Reason : Transfer payments are not considered as payment for current services or production.
These items are not entered in national income.
(a) Is the not the answer because salary paid to a soldier is the payment for current
services and hence it is not an examples of government transfer payments.
(b) Is the not the answer because purchasing of a new car for the Ministry of Finance is
not an examples of government transfer payments.
(c) Is the not the answer because funding of a clinic to provide free vaccinations is not
an examples of government transfer payments
(d) Is the answer because free food coupons issued to a persons in an antipoverty
program is not the payment for current services or production and hence it is an
examples of government transfer payments.
(e) Is the not the answer because funding of a new bridge in an urban area is the
payment for current services and hence it is not an examples of government transfer
payments.
38. Answer : (a) < TOP
>
Reason : In India, Whole Sale Price index (WPI) is widely used for determinime of inflation.
Because the Office of the Economic Advisor to the Government of India publishes
wholesale price indices for individual commodities, commodity groups and the overall
WPI monthly. They are reported in a number of other publications also.
(a) Is the answer because Whole Sale Price index (WPI) is widely used for determinime
of inflation in India.
(b) Is not the answer because GDP deflator is not used for determining inflation in
India. GDP deflator 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. And it is difficult to bet the data for the two years for comparisons.
(c) Is not the answer because in practice it is difficult to include each and every item for
construction of Consumer Price Index. (CPI)
(d) Is not the answer because both Whole Sale Price index (WPI) and GDP deflator are
not used in measuring inflation.
(e) Is not the answer because both GDP deflator and Consumer Price Index. (CPI) are
not used in measuring inflation.
39. Answer : (b) < TOP
>
Reason : In India, personal taxes is an example of progressive tax system. Progressive tax system
implies that higher the level of income, higher will be the volume of tax burden,
represented as a percentage of the total income.
(a) Is not the answer because personal tax is not a proportional tax system. In
proportional tax systems, the tax imposed is of a particular percent of income
irrespective of his income level.
(b) Is the answer because personal taxes is an example of progressive tax system.
 (c) Is not the answer because personal tax is not a direct tax system.
(d) Is not the answer because personal tax is not a value added tax system.In value
added tax system, the tax is on the value added at each stage.
(e) Is not the answer because personal tax is not a regressive tax system. In regressive
tax system, people with lower levels of income are imposed with higher taxes as a
proportion of their income.
40. Answer : (d) < TOP
>
Reason : Outside lag ’is the duration involved for output and employment to respond to changes of
the implemented of policies.Taxes has the least outside lag.
(a) Is not the answer because cash reserve ratio has not the least outside lag.
(b) Is not the answer because bank rate has not the least outside lag
(c) Is not the answer because repo rate has not the least outside lag
(d) Is the answer because tax has the least outside lag.
(e) Is not the answer because open market operation has not the least outside lag.
41. Answer : (d) < TOP
>
Reason : Target growth rate = 6% p.a.
Required domestic savings to income = 32%
Expected population growth = 2%
∴ growth rate = 6 + 2 = 8%
32
=4
8
∴ Capital – output ratio =
42. Answer : (c) < TOP
>
Reason : Consumption function for an economy is estimated to be c = 400 + 0.75 Yd
Y=C+S
When S = 0, Y = C
∴ Y = 400 + 0.75 Y
or, 0.25Y = 400
Yd = 1,600
∴ c = 400 + 0.75 ( 1,600) = 400 + 1,200 = Rs.1,600 cr.
43. Answer : (c) < TOP
>
Reason : Y* = Rs.5,000
3
= 0.75
4
MPC =
Y = 2,500
C =a+bY
= 0.75 (2,500)
= 1,875
∴ Borrowed = 2,500 – 1,875 = Rs.625
amount
44. Answer : (b) < TOP
>
Reason : S = – 60 + 0.25Yd
At equilibrium level of income, S = I
: – 60 + 0.25 Yd = 100
or, 0.25Yd = 100
100
Yd = = 640MUC
0.25
or,
45. Answer : (b) < TOP
>
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
46. Answer : (c) < TOP
>
Reason : Budget surplus for the economy = T – G
= 0.20 (825) – 150
= 165 – 150
= 15 MUC
47. Answer : (a) < TOP
>
Reason : M = 0.10Y
X = 420MUC
∴ When the economy is opened to trade in goods and services with rest of the world, the
1
1 − β + βt + µ
multiplier in the economy will be
β→
where, marginal propersity to consumer
tax
t→

marginal propensity to import

µ→

1
1 − 0.75 + ( 0.75 ×0.20 ) + 0.10
multiplier =
1 1
=2
1 − 0.75 + 0.15 + 0.10 0.5
= =
48. Answer : (b) < TOP
>
Reason : S = – 250 + 0.30Yd
∴ C = 250 + 0.70Yd
T = 0.25Yd
M = 0.3Y
∴ The value of multiplier = m
1
1−β(1− t) + µ
=
1
1 − 0.70 ( 1 − 0.25 ) + 0.3
=
1
1 − 0.70 ( 0.75 ) + 0.3
=
1
= 1.29
0.775
=
Y = mI
Or, 100 = 1.29I
100
= 77.5
1.29
Or, I = MUC
49. Answer : (c) < TOP
>
Reason : S = – 300 + 0.20Y
At Y = 2,250, S = – 300 + 0.20 (2,250)
= –300 + 450
= 150
At equilibrium, S = I
∴200 – 5i = 150
or, – 5i = – 50
or, I = 10%
50. Answer : (b) < TOP
>
Reason : L = 0.4Y – 10i
At equilibrium, demand for money = Supply of money
i.e. 0.4Y – 100i = 300
When, i = 8, 0.4Y – 100(8) = 300
Or, 0.4Y = 380
Or, Y = 950
When I = 6 , 0.4Y–100 (6) = 300
Or, 0.4Y = 360
Or, Y = 900
∴ change in the equilibrium level of output = 900 – 950= 50 MUC
51. Answer : (e) < TOP
>
Reason : High – Powered money (H) = monetary liabilities or central bank + Government money.
Non monetary liabilities = 200 + 80 = 280
Financial assets = Loans given to Government + Credit to banks + Loans given to
commercial section + foreign exchange assets
= 1,200 + 800 + 20 + 1,500
= 3,520
Monetary liabilities = Financial assets + other assets – Non monetary liabilities
= 3,520 + 60 – 280
= 3,300
∴ M = 3,300 + 100 = 3,400 MUC
52. 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
= 1,700 – 190 – 173 + 20
= 1,357
∴Personal Income = 1,357 – 28 – 75 + 242
= Rs.1,496 cr

53. Answer : (b) < TOP

>
Reason : Net factor Income from Abroad (NFIA) = NNPat factor cost – NDPat factor cost
NDPat factor cost = 50,000 MUC
NDPat factor cost = NDP market price – Depreciation – Indirect taxes + Subsidies
= 60,000 – 3,000 – 2,00 + 500
 = 55,500
∴NFIA = 55,500 – 50,000
= 5,500 MUC
54. Answer : (c) < TOP
>
Reason : NDPat market price = NDP at factor cost + Indirect taxes
NDPat factor cost = wages paid to domestic residents + wages paid to foreigners +
Interest payment on loans taken + Retained profits + Corporate tax
= 400 + 240 + 10 + 20 + 10
= 680
∴ NDPat market prices = 680 + 15
= Rs.695 cr
55. Answer : (c) < TOP
>
Reason : Current account balance = Factor income received from abroad + Exports – Wages paid
to foreigners – Imports – Interest payment on loans taken
= 200 + 40 – 240 – 25 –10
= Rs. –35 cr ( deficit)
56. Answer : (b) < TOP
>
GDP at Market Pr ice (Current year)
×100
GDP deflator (current year)
Reason : Real GDP (current year ) =
1, 500
× 100
120
=
= 1,250 MUC
57. Answer : (e) < TOP
>
Reason : Value added by factor of production = Sales – Intermediate consumption – Indirect taxes
+ Subsidies
∴ Value added by Primary sector = 100 – 15 – 12 + 7 = 80
Value added by Secondary sector = 150 – 25 – 13 + 8 =120
Value added by Tertiary sector = 130 – 15 – 17 + 7 = 105
∴ NDP at factor cost = Sum of value added by Primary sector, Secondary sector and
tertiary sector
= 80 + 120 + 105
= 305
Depreciation = 10 + 12 + 15 = 37
∴ GDP factor cost = 305 + 37 = 342 MUC
58. Answer : (a) < TOP
>
Reason : Trade deficit for the year 2002-03 = Merchandise (credit) – Merchandise (debit)
= 53,000 – 65,474
= $12,474 million
59. Answer : (a) < TOP
>
Reason : Total Current account ( Credit) = Merchandise + Services + Transfer + Income
= 53,000 + 24,986 + 15,225 + 2,826
= 96,037
Total Current account (Debit) = 65,474 + 18,780 + 367 + 7,708
= 92,329
∴ Current account balance = 96,037 – 92,329
= $ 3,708 million (surplus)
60. Answer : (d) < TOP
>
Reason : Net foreign investment in India = Foreign direct investment (credit) + Portfolio
investment (credit) – foreign direct investment (debit) – Portfolio investment (debit)
= 4,790 + 7,535 – 1,179 – 6,591
= $ 4,555 Million
61. Answer : (e) < TOP
>
Reason : Overall balance of payment = Total Credit of the Bop – Total debit of the Bop
= 1,46,559 – 1,29,579
= $ 16,980 million (surplus)
62. Answer : (c) < TOP
>
Reason : Revenue deficit = Revenue expenditure – Revenue receipt
Revenue Expenditure = Non plan revenue expenditure + Plan revenue
expenditure
= 2,89,384 + 76,843
= 3,66,227
Revenue receipts = Tax revenue + Non. Tax revenue
= 1,84,169 + 69,766
= 2,53,935
∴ Revenue Deficit = 3,66,227 – 2,53,935
= Rs.1,12,292 cr
63. Answer : (d) < TOP
>
Reason : Primary deficit = Fiscal deficit – Interest payment
Fiscal deficit = Borrowings and other Liabilities
∴ Primary deficit = 1,53,637 – 1,23,223
= Rs.30,414 cr
64. Answer : (b) < TOP
>
Y
Ms
Reason : Velocity of money =
Y = 750 + 250 + 150 + 100 + 50 – 150 = 1,150
1,150
=5
230
∴ Velocity of money =
65. Answer : (c) < TOP
>
Reason : When i = 10, Investment , I = 200 – 10(10) = 100
Because of expansionary fiscal policy, i = 12,
Then investment I = 200– 10(12) = 80
∴ crowding out = 100 – 80 = 20 MUC
66. Answer : (b) < TOP
>
Reason : There will not be any crowding out if i = 10%
This can happen only when LM curve shifts to the right.
Substituting i = 10%, LM function become Y = 500 + 200(10)
= 2,500
 M t  +  Ma 
 p  p
   
Total demand for money function =
= 0.50Y + 250 – 100
Substituting Y = 2,500 and i = 10 in the total demand for money function, we get,
 0.50 (2,500) + 250 – 100(10) = 1,250 + 350 – 1,000 = 600 MUC
Since money supply is equal to demand for money, the new money supply will be 600
MUC.
67. Answer : (e) < TOP
>
Reason : Saving function = – 50 + 0.50 Yd
Hence, consumption function = 50 + 0.50 Yd
Y=C+I+G+E–M
Or, Y = 50 + 0.50 (Y– 0.40Y + 80) + 1,000 – 30i + 800 + 450 – (20 + 0.20Y)
Or, Y = 50 + 0.50Y – 0.2Y + 40 +1,000 – 30i + 800 + 450 – 20 – 0.20Y
Or, Y = 2,320 + 0.1Y – 30i
Or, 0.90Y = 2,320 – 30i
Or, Y = 2,577.78 – 33.33i………………..IS Curve
Ms  Mt  + Ma 
 p  p
p    
=
or, 500 = 0.5Y + 250 – 100i
or, 0.50Y = 250 + 100i
or, Y = 500 + 200i …………………….LM Curve
By equating the IS and LM function, we can get the equilibrium rate of interest.
∴500 + 200i = 2,577.78 – 33.33
or, 233.33i = 2,077.78
or, i = 8.9%
∴ Y = 2,577.78 – 33.33 (8.9) = 2,577.78 – 296.64
= 2,281.14
= 2,281MUC (approximately)

68. Answer : (c) < TOP

>
Reason : Goods market equilibrium:
0.5Y = 2,925 – 37.5;
or, Y = 5,850 –75i (IS Function)
Money market equilibrium:
0.25Y = 312.5 + 125;
or, Y = 1,250 + 500i (LM function)
At simultaneous equilibrium of goods market and money market, IS = LM
∴ 5,850 –75i = 1,250 + 500i
or, 575i = 4,600
or, i = 8%
∴ Y = 5,850 – 75(8) = 5,850 – 600 = 5,250
∴ Trade balance at equilibrium =E–M
= 650 – (25 + 0.25Y)
= 650 – 25 – .25 (5,250)
= 650 – 25 – 1,312.50
= – 687.50 MUC (deficit)
69. Answer : (e) < TOP
>
Reason : If Government expenditure increase by 475 MUC,
IS function becomes
0.5Y = 2,925 + 475 – 37.5i
 or, 0.5Y = 3,400 – 37.5i
or, Y = 6,800 – 75i
At simultaneous equilibrium,
IS = LM
Or, 6,800 – 75i = 1,250 + 500i
Or, 575i = 5,500
Or, i = 9.65%
70. Answer : (c) < TOP
>
Reason : Stock of high powered money ( H) = monetary liabilities of the central bank +
government money = 1,250 MUC
Current deposit ratio (Cu) = 0.20
Reserve ratio (r) = 0.05
1 + Cu
×H
Cu + r
∴ Money supply Ms =
1 + 0.20
×1, 250
0.20 + 0.05
=
= 4.8 × 1,250
= 6,000 MUC
71. Answer : (c) < TOP
>
1 + Cu
×H
Cu + r
Reason : Money supply, M =
1 + 0.40
× 500
0.40 + 0.10
=
= 2.8 × 500
= 1,400 MUC
If there is an additional inflow of 10 MUC of foreign exchange assets, H = 500 + 10 =
510
If money supply is to be maintained at 1,400 MUC,
1.40
510 ×
( 0.40 + r )
1,400 =
1.40
510 ×
1, 400
or, 0.40 + r =
or, 0.40 + r = 0.51
or, r = 0.11 = 11%

72. Answer : (e) < TOP

>
Total issue
National Income
Reason : Finance Ratio =
∴ Total Issue = Finance Ratio × National Income
= 0.50 × 19,200
= 9,600 MUC
73. Answer : (b) < TOP
>
Reason : Money supply = High Powered money × Money multiplier
∴ 17,200 = 4,300. m
 17, 200
=4
4, 300
or, m =
1 + Cu
m=
Cu + r

1 + Cu
=4
Cu + 0.10
∴
or, 1+ Cu = 4Cu + 0.40
or, – 3Cu = –.06
or, Cu = 0.20
74. Answer : (c) < TOP
>
Reason : Wages and salaries paid by the government = Factor income received by households –
(wages and salaries paid by the business sector + Dividends paid to house holds +
Factors income receive abroad)
= 160 – 100 – 10– 20
= 30 MUC.
75. Answer : (a) < TOP
>
Reason : Demand for money = Rs.5,000
∴ Currency held in money form = Rs.2,500
Reserve ratio = 10%
2, 500 × 10
100
∴ Amount required by banks to meet the reserve requirement = = Rs.250.
< TOP OF THE DOCUMENT >