All India Management Association (AIMA) 2009 M.B.A Marketing Management Business Economics II 09 - Question Paper

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⁷³*In an economy, the exogenous investment is 50 MUC, Government spending is 100 MUC and autonomous consumption is 50 MUC. The net export function is 100 - 0.1Y. If an increase in autonomous investment by 40 MUC leads to an increase in equilibrium income and consumption by 100 MUC and 80 MUC respectively, what would be the new equilibrium income for the economy?

(a)    320 MUC

(b)    500 MUC

(c)    800 MUC

(d)    850 MUC

(e)    900 MUC.

⁷⁴*In an economy the high-powered money is 500 MUC. The currency deposit ratio is estimated to be 0.40 and the reserve ratio is 10%. If foreign exchange assets with the central bank increase by 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%.

⁷⁵*Consider the following information:

High powered money	Rs.5,100 cr.
Currency deposit ratio in the economy	10%
Cash reserve requirement of the central bank	10%

The money multiplier is

(a)	1.10
(b)	7.33
(c)	5.50
(d)	10.00
(e)	15.00.

END OF QUESTION PAPER

Suggested Answers Business Economics - II (MB1B4): January 2009

ANSWER    REASON

D In a four sector economy, consisting of households, firms, government and foreign sectors, the transfer payments flow from Government to households.

C National product at market price is always higher than national product at factor cost because the amount of indirect taxes which increases the prices is always greater than the subsidies which lower the price.

D Real GDP is a measure of the value of all goods and services produced in a country during a period of time, corrected for inflation. Thus the extent of difference between nominal GDP and real GDP shows the rate of inflation.

E The following may cause double counting problem while calculating GDP.

Transfer incomes.

Stock inflation.

Intermediary products.

According to the Keynesian theory beyond full employment level of output, the aggregate supply will increase with increase in aggregate demand and prices also increase.

C According to Keynes, the consumption function explains the level of aggregate consumption desired at each level of personal disposable income

E Actual investment can be defined as the investment in new plant and equipment. It also includes inventories acquired during the year whether they are desired or undesired inventories.

C In a situation of recession the government of India should increase its spending and decrease the taxes.

9.    B The rate of interest at which the Central bank rediscounts approved bills of <

exchange is called as Bank rate.

10. D Monetarist advocated that nominal GDP in the short run and prices in the long run < are determined by growth of money.

D Bank Rate, Open market operation and Regulation of consumer credit are monetary < policy measures the Central bank can adopt to control inflation in an economy.

12. E Mobilization of resources, Reduction of disparities of income and Price stability are objective(s) of fiscal policy in general.

13. A The ratio of total financial claims issued during the year to national income of that year is called as Finance ratio.

14. E Quotas, Subsidies and Licensing are called as non tariff barriers.

15. A Aggregate demand states the relationships between various quantities of output that all people together will buy at various price levels in a defined period.

E Human resources, Capital resources and Self-sufficiency affect the size of a nations < income.

17. C Tax exemptions to firms making investments in new businesses, new plants and buildings etc. to encourage incentives is suggested by supply side economists.

18. D Open market operations refer to the buying or selling of securities such as < government securities, bankers acceptances or foreign exchanges by the Central Bank.

19. E Credit to the Government is an example of assets of Reserve Bank of India (RBI).

20. C During recession, there is unexpected reduction the general level of demand for < goods and services. This is an important cause of Cyclical unemployment.

21. A Aggregate supply curve is the real value of output producers are willing and able to bring to market at alternative price levels (ceteris paribus).

22. B Due to the multiplier effect, a decrease in investment spending leads to an even < larger decrease in output.

D Steep rise in taxes will dampen the economy and so not the right medicine. So the correct answer is D. All the other measures A, B, C, and E will boost the Economy

(a)    Is not the answer because expansion in money supply does not dampen the growth rate of an economy

(b)    Is not the answer because increase in the level of investment does not dampen the growth rate of an economy

(c)    Is not the answer because reduction in the rate of interest does not dampen the growth rate of an economy

(d)    Is the answer because steep rise in the tax rates dampens the growth rate of an economy

(e)    Is not the answer because rising prices does not dampen the growth rate of an economy

C In the equations, C = 1,400 + 0.2Y_d, the marginal propensity to consume is 0.2; autonomous consumption spending is Rs.1,400.

25. D If the RBI sells bonds in an open market operation the equilibrium level of GDP < decreases

26 A The RBI currency together with the Government money with commercial banks is < considered as vault cash.

27. A Aggregate expenditure is the spending by households, government, and firms on < final goods and services.

28. A In the short-run, in Keynesian model, when aggregate expenditure is less than GDP, < output will decline as firms reduces production to stop the buildup of inventories.

29. A Value of the car will be included in GDP for the year 2007 because the production has taken place during this period. As we already know, GDP is the value of final goods and services produced during the period.

_30. B In the period of recession employment decreases and aggregate production decreases.

31. ^D Excise duty is an indirect tax. An indirect tax is imposed on one person but paid wholly or partly by another person.

33. E Increase in price level, Population growth and Development Basic infrastructures are responsible for the increase in public expenditure.

34. B Under the paper currency system, determination of the exchange rate usually takes into account the purchasing power of a national currency.

35. A The correct sequence of events of a contractionary monetary policy is interest rate increase, causing planned investment to decrease, causing aggregate output to decrease, causing money demand to decrease.

B In the long run, the economy is at full employment. So there is no long run trade-off between inflation and unemployment. As a result, the long run Phillips Curve is a vertical line above full employment. The long run Phillips curve, in contrast to the short run curve, does not hold the expected inflation rate constant (but does hold the natural unemployment rate constant). More specifically, the long run Phillips curve shows the relationship between inflation and unemployment when the actual inflation rate equals the expected inflation rate. This curve is vertical at the natural rate of unemployment: any anticipated (and actual) inflation rate is possible at the natural rate of unemployment. When inflation is accurately anticipated, real GDP equals potential GDP, and unemployment is at the natural rate. Expected inflation has no impact on the long run Phillips curve.

C A countrys balance of payment is a systematic record of all economic transactions between that country and the rest of the world.

38. A Leakages are factors which tend to decrease the level of national income. Imports tend to decrease the national income.

A Stagflation refers to a situation where there is high unemployment and high inflation occur simultaneously.

Statement I is true as stagflation refers to coexistence of stagnant output and high inflation.

Statement II is false because during stagflation, there is no increase in output and hence the output is stagnant. Therefore real GDP is not growing.

Statement III is true because during stagflation, the output is stagnant, new employment opportunities are not created and hence unemployment level is high. Statement IV is false as the price are high and there is unemployment, the aggregate demand tends to be low.

So the answer is (a).

C Velocity of money refers to the speed at which money changes hands. The ratio of nominal GDP to the money stock defines the income velocity of money (that is, V = GDP/M = PQ/M). Thus, the price level in the economy will increase because of rise in velocity of money.

C NDP at market price = NDP at factor cost + Indirect taxes

Wages paid to domestic residents + Wages paid to foreigners + Interest payment on loans taken from foreign banks + Retained profits + Corporate tax 400 + 240 + 10 + 20 + 10 = 680 680 + 15 = Rs.695 cr.

B NDP at factor cost = NDP at market prices - Indirect taxes + Subsidies

= 2,60,000 - 30,000 + 40,000 = Rs.2,70,000 Cr.

D National Income =    NNP at factor cost

=    NNP at market prices - Indirect taxes + Subsidies

=    [1,00,000 - 14,000 + 2,000]

=    88,000 MUC

Personal income =    National Income - Corporate profit taxes - Retained profit

=    88,000 - 6,500 - 30,000 MUC

=    51,500 MUC.

A Net exports = Y -C-I-G = 5,000 - (3,000 + 600 + 200) = 1,200MUC.

B S = -30 + 0.40Y_d

Consumption C = Y - S

= Y - (-30 + 0.40Y_d)

= 30 + 0.60 Y_d

Yd = C + I

= 30 + 0.60 Y_d + 70 = 100 + 0.60 Y_d

0.4 Y_d = 100 Y_d = 250MUC.

C S = - 100 + 0.25 Y_d

When S = 100, 100 = -100 + 0.25 Y_d or, 200 = 0.25 Y_d or, Y_d = 800 MUC.

Since the economy is a two sector economy, Y = Yd (disposable income).

Investment in period t = 0.75 x Designed investment in period t

Designed investment in period t

= Acceleration co-efficient x change in income = 2 x 200 = 400 Investment in period t = 0.75 x 400 = 300 MUC The answer is (b).

MPC = 0.75

1 1 Multiplier = 1 - MPC = 1 - 0.75= 4 Therefore increase in AD = 4 x 10 = Rs.40 billion

As the crowding out effect is Rs. 4 billion, net increase in AD = 40 - 4 = Rs.36 billion.

When Y = 20,000, C = Y = 20,000

C =	Y ca + a
20,000 =	a + (0.7 x 20,000)
a =	20,000 - 14,000 = Rs.6,000.
Y	= C + I + G + NX
C	= a + bY
Or, C	= 100 + 0.75Y
Y	= C + I + G + NX
Or, Y	= 100 + 0.75Y + 50 + 150 + 20
Or, 0.25 Y	= 320
Or, Y	320 -1,280 = 0.25 MUC.

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)

.. Money supply Ms

1 + 0.20 ₁ 250 -x 1,250

= 0.20 + 0.05    = 4.8 x 1,250 = 6,000 MUC.

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.

NFIA = NNP_mp - NDP_mp

NNP_mp = NNP_fc + Indirect Taxes - Subsidies = 16800 + 3800 - 400 = 20200 Thus, NFIA = 20200 - 20000 = 200MUC.

Factor income received from abroad = Factor income paid abroad + net factor income earned abroad = 500 + 200 = 700MUC.

_Y_

Velocity of money = ^Moneysupply

Where Y = C + 1 + G + E - M = 15,000

Money supply = Y/Velocity of money = 15,000/15 = Rs.1,000 cr.

Non-monetary liabilities = Paid-up capital + Reserves + Government deposits = 5 + 150 + 700 = Rs.855 cr.

60 C Goods market will be in equilibrium when Y = AD = C + I + G    <

Y    = 500 + 0.75(Y - T) + 100 - 50i + 1000 = 1600 + 0.75(Y - 1000) - 50i

Y    = 850 + 0.75Y - 50i

0.25Y = 850 - 50i    .....IS curve

Money market will be in equilibrium when:

Money supply (M,) = Money demand (M_d)

500 = 0.25Y + 125 - 50i 375 = 0.25Y - 50i

0.25Y    = 375 + 50i    .....LM curve

Thus, at simultaneous equilibrium,

850 - 50i = 375 + 50i 475 = 100i i = 4.75

When i = 4.75, 0.25Y = 375 + 50 (4.75) = 612.5 or, Y = 612.5/0.25 = 2450.

1.    Private saving = Y - T - C = 2450 - 1000 - [500 + 0.75(2450 - 1000)]

= 1450 - [500 + 1087.5] = (137.5)

ii.    Public saving = T - G = 1000 - 1000 = 0

iii.    Domestic saving = Private saving + Public saving = (137.5) + 0 = (137.5).

61. D Change in foreign exchange reserves = Balance on current account + Balance on < capital account

Current Account

Dr.    Cr.

Particulars Amount Particulars Amount Fighter plane imports Dividends paid to foreigners Surplus on current account 1,200 250 1,150 Primary sector exports Automobile exports Earnings of Indian consultants abroad Aid from abroad 1,500 650 300 150 2,600 2,600

Capital Account Dr.    Cr.

Particulars Amount Particulars Amount Investment in shares abroad 180 FDI 200 Short-term loans 120 Balance on capital account 100 300 300

Change in foreign exchange reserves = 1,150 - 100 = Rs.1050 crore.

Multiplier = ¹ P + P^{t + H}

Where ^P = mpc. t = 0.40

^H = 0.16

1

' ₁₂₅ = 1-P + 0.40P + 0.16

1

Or, 1.25 = ¹ 16 - 060p

Or, 1.45 - 0.75 ^P = 1

Or, 0.75 ^P = 0.45

Or, ^P = 0.60 mpc = 0.60.

Velocity of money = Y/M_S

Y = C + I + G + E - M

10,500 + 3,150 + 700 + 2,240 + 560 - 150 = 17000 Velocity of money = 17000/4250 = 4.

A Ms = High-powered money x {(1 + Cu)/(Cu + r)}; where High powered money = monetary liabilities of the central bank + government money.

AMs = AH. m m = (1+Cu) /( Cu + r)

= (1+0.2)/ (0.2+0.05)

= 4.8

When foreign exchange reserves of the country decline by Rs.250 MUC, the monetary liabilities also fall by 250 MUC. Thus, money supply decline by 4.8 x 250 = 1200MUC.

D High powered money = Monetary liabilities of central bank + Government money

Monetary liabilities of central bank = Financial Assets + Other assets - Nonmonetary liabilities

Financial Assets = Credit to government + claims on commercial banks + credit to

commercial sectors + foreign exchange assets

= 4,480+ 1,400 + 2,200+ 600 = 8680

Non-monetary liabilities = 400 + 1,680 = 2080

Monetary liabilities of central bank = 8680 + 200 - 2080 = 6,800

High powered money = 6800 + 100 = Rs.6,900 crore.

C Intermediation Ratio = Secondary issues/New issues

Or, secondary issues = Intermediation ratio x New issues = 0.5 x 40,000 = 20,000 MUC

Total issues = New issues + Secondary issues = 40,000 + 20000 = 60,000 MUC Financial Interrelations Ratio = Total issues/Net Physical Capital Formation (NPCF) = 60000 /30000 = 2.0.

B Y = C + I

Y = 1600 + 0.5 Y + I

0.5 x 4400 = 1600 + I I = 600 MUC.

68. ^B We have C = a + b (Y - T + J) where C is the aggregate consumption, a is the autonomous consumption, b is the marginal propensity to consume, Y is the income level, T refers to absolute amount of tax and J refers to transfer payments Substituting, we have

C = 20 + 0.6 (10000 - 2,500 + 1,000 ) = 20 + 0.6(8,500) = 5,120 MUC [Total tax collected = 2500 MUC which is 25 % of total income. So total income = 10,000 MUC].

69 D Balance of trade = Merchandise (cr.) - Merchandise (Dr.)

= 5,30,000 - 6,54,740 = -Rs.1,24,740 million = Rs.1,24,740 million (deficit).

70. A Contribution to National income = Contribution to GNP at market prices depreciation - indirect taxes = 40,000 - 3,000 - 1,000 =Rs.36,000.

Money multiplier =

1 + Cu" " 1 + 0.10 " _ Cu + r _ = _ 0.10 + 0.10 _

= 5.50

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