Question Paper

Economics (CFA520) : July 2007

Answer all questions.
Marks are indicated against each question.


1. At a local supermarket, the price of Simla apples varies every week. Mr. Mishra, who is a regular buyer
of apples, spends exactly Rs.50 on apples every week, irrespective of the price. For Mr. Mishra, the
price elasticity of demand for apples is
(1 mark)
(a) Perfectly elastic
(b) Perfectly inelastic
(c) Unit elastic
(d) Relatively elastic
(e) Relatively inelastic.
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2. Which of the following statements are false?
I. Elasticity of demand is graphically represented by the slope of the demand curve.
II. Elasticity of demand increases, as one goes down along the demand curve.
III. If the demand is inelastic, a decrease in price increases the total revenue of the firm.
IV. Elasticity of demand is measured by dividing change in quantity demanded with the change in the
price of the good.
(1 mark)
(a) Both (I) and (II) above
(b) Both (II) and (III) above
(c) (I), (II) and (III) above
(d) (I), (II) and (IV) above
(e) All (I), (II), (III) and (IV) above.
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3. When the quantity supplied of a commodity exceeds the quantity demanded at a given price, the price
(1 mark)
(a) Remains the same
(b) Increases
(c) Decreases
(d) First increases, then decreases
(e) First decreases, then increase.
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4. The demand curve is usually
(1 mark)
(a) Downward sloping from left to right
(b) Upward sloping from left to right
(c) U-Shaped
(d) Horizontal straight line
(e) Vertical straight line.
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5.
If the demand equation is given as Q
d
= 100 4P and price is Rs.10, the point elasticity of demand is

(2 marks)
(a) 4.00
(b) 0.67
(c) 0.06
(d) 0.10
(e) 0.60.
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6. A product priced at Rs.900 has price elasticity of demand equal to 6. What is the marginal revenue?
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(2 marks)
(a) Rs.700
(b) Rs.750
(c) Rs.800
(d) Rs.850
(e) Rs.900.
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7. Which of the following is/are not true regarding consumer surplus?
I. Consumer surplus is helpful to the government in fixing taxes.
II. Consumer surplus helps the monopolists in fixing price of a commodity.
III. In case of imported products which are cheaper than domestic products the consumer surplus is
less.
IV. A higher consumer surplus indicates that the economy is stable.
(1 mark)
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (III) above
(e) Both (II) and (IV) above.
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8. Which of the following statements is not true?
(1 mark)
(a) The concept of total utility is subjective so it is very difficult to measure it
(b) Beyond the satiety point the marginal utility will be negative
(c) In terms of calculus the marginal utility of a good is the slope of the total utility function
(d) Total utility is the difference between the marginal utilities of current and preceding units of the
product
(e) Marginal utility analysis explains the inverse relationship between the price and quantity
demanded.
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9. At the point of tangency between budget constraint and indifference curve, the consumer
(1 mark)
(a) Minimizes his budget
(b) Maximizes his budget
(c) Is unaffordable to buy the desired goods
(d) Attains maximum satisfaction at a given budget
(e) Consumes only one good.
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10. The locus of points of tangency between budget line and the indifference curves is called as the
(1 mark)
(a) Income consumption curve
(b) Production consumption curve
(c) Isoquant curve
(d) Isocost line
(e) Production possibility curve.
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11. Diamond- water paradox shows the operation of
(1 mark)
(a) Law of demand
(b) Law of supply
(c) Law of diminishing marginal utility
(d) Law of variable proportions
(e) Law of equi-marginal utility.
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12.
The utility function of a consumer is given as U = X
1.5
Y. Prices of good X and Y are Rs.6 and Rs.8
respectively. Consumers weekly budget is Rs.500. What is the optimum allocation of expenditure in
terms of units of both the products for the consumer?
(a) 20 units of X and 35 units of Y
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(2 marks)
(b) 25 units of X and 50 units of Y
(c) 50 units of X and 25 units of Y
(d) 20 units of X and 55 units of Y
(e) 25 units of X and 35 units of Y.
13. For a consumer in equilibrium, Marginal Rate of Substitution of good a for good b (MRS
ab
) is 5. If
price of the good a (P
a
) is Rs.95, price of good b (P
b
) is
(2 marks)
(a) Rs. 17
(b) Rs. 19
(c) Rs. 6
(d) Rs. 14
(e) Rs. 15.
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14. At equilibrium the marginal utilities of product X and product Y are 520 utils and 650 utils respectively.
If the price of product Y at equilibrium is Rs.75, what is the price of product X at equilibrium?
(2 marks)
(a) Rs.55
(b) Rs.50
(c) Rs.60
(d) Rs.65
(e) Rs.70.
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15. The demand function for a good is estimated to be P = 25 0.5Q. What would be the consumer surplus,
if the market price is Rs.5?
(1 mark)
(a) Rs. 480
(b) Rs. 320
(c) Rs. 280
(d) Rs. 512
(e) Rs. 400.
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16. Opportunity costs are also known as
(1 mark)
(a) Spill-over costs
(b) Money costs
(c) Alternative costs
(d) External costs
(e) Sunk costs.
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17. Cost functions are derived from
(1 mark)
(a) Production function
(b) Demand function
(c) Supply function
(d) Revenue function
(e) Profit function.
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18. If the firms total revenue exceeds its economic costs, the residual is called as
(1 mark)
(a) Pure profit
(b) Producer surplus
(c) Accounting profit
(d) Normal profit
(e) Abnormal profit.
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19. The cost that can be easily attributed to a product or a process is called as
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(1 mark)
(a) Fixed cost
(b) Variable cost
(c) Implicit cost
(d) Private cost
(e) Separate cost.
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20. Which of the following statements is not true?
(1 mark)
(a) Fixed cost is incurred even if the production is zero
(b) Total average cost cannot be zero
(c) Average fixed cost decreases with every increase in output
(d) The average total cost curve is flatter than average variable cost curve
(e) The minimum point of average cost will be to the left of the minimum point of the average
variable cost.
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21. Both marginal and average costs are equal to each other when
(1 mark)
(a) Marginal cost is minimum
(b) Average cost is minimum
(c) Fixed cost is minimum
(d) Total cost is maximum
(e) Marginal cost is maximum.
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22.
The total cost function of a firm is given as TC = 500 2Q + 3Q
2
. If the current output is 5 units,
average cost is
(2 marks)
(a) Rs.110
(b) Rs.111
(c) Rs.112
(d) Rs.113
(e) Rs.114.
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23. A firm faces the following average variable cost function:
AVC = 300 9Q + 0.5Q
2

If fixed costs amounts to Rs. 150, what is the minimum possible marginal cost?
(2 marks)
(a) Rs.244
(b) Rs.242
(c) Rs.241
(d) Rs.246
(e) Rs.248.
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24.
Total cost function for a firm is TC = 20Q 0.3Q
2
+ 0.01Q
3
. What is the output at which marginal cost
is minimum?
(2 marks)
(a) 6 units
(b) 7 units
(c) 8 units
(d) 9 units
(e) 10 units.
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25. Consider the following total cost function of a firm:
TC = 5,000 + 800Q 9Q
2
+ 0.25Q
3


Which of the following statement is/are true?
I. The average variable cost function is 800 9Q + 0.25Q
2
.

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II. Fixed cost is Rs. 5,000.
III. Marginal cost function is 800 9Q + 0.25Q
2
.

IV. Average cost function is 800Q 9Q
2
.

(1 mark)
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Only (IV) above
(e) Both (I) and (II) above.
26. The average cost function of a firm is given as follows:
.What is total cost for the firm at an output of 20 units?

(2 marks)
800
AC = + 80 + 4Q
Q
(a) Rs. 3,800
(b) Rs. 3,900
(c) Rs. 3,700
(d) Rs. 3,600
(e) Rs. 4,000.
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27. The demand function of a firm is given as P = 1,000 50Q and the average variable cost function is
estimated as AVC = 250 + 25Q. At the equilibrium level of output if the average fixed cost is Rs.60,
then what is the total cost at that level of output (assume short run)?
(2 marks)
(a) Rs. 2,175
(b) Rs. 2,165
(c) Rs. 2,155
(d) Rs. 2,075
(e) Rs. 2,265.
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28.
The firm in a perfectly competitive market is a price taker. This is because
(1 mark)
(a) The firm has some, but not complete, control over its product price
(b) There are large number of buyers and sellers in the market that any individual firm cannot affect the
market
(c) Each firm produces a homogeneous product
(d) There is easy entry or exit from the market
(e) Of absence of transport cost.
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29. There are 100 firms with identical cost functions operating in a perfectly competitive industry. The
demand function for the industry is estimated to be Q
d
= 6,000 490P. If the cost function of a firm is
TC = 100 100Q + 5Q
2
, equilibrium price of the product is

(2 marks)
(a) Rs. 9.00
(b) Rs. 9.50
(c) Rs. 10.00
(d) Rs. 11.50
(e) Rs. 9.75.
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30. Delta Ltd., is operating in a perfectly competitive industry. The total cost function of Delta Ltd., is
estimated to be TC = 1,200 + 600Q 50Q
2
+ Q
3.
Industry supply function is Qs = 200 + 4P. If profit
maximizing output for Delta Ltd., is 150 units, the total quantity supplied by the industry is
(a) 2,11,600 units
(b) 2,12,000 units
(c) 2,12,600 units
(d) 2,11,000 units
(e) 2,10,000 units.
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(2 marks)
31. In a perfectly competitive market in the long run no firm earns abnormal profit. This is
(1 mark)
(a) Due to homogenous products they produce
(b) Because of constant price
(c) Due to existence of large number of buyers
(d) Due to free entry and exit of firms
(e) Because of absence of transport cost.
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32. Which of the following statements is not true about monopoly?
(1 mark)
(a) There are barriers to entry
(b) A monopolists individual demand curve possesses the same general properties as the industry
demand curve for a perfectly competitive market
(c) A monopolist may maximize profit with respect to variations of either output or price
(d) The monopolist must increase the price of every unit in order to sell additional units
(e) The rate decline in the MR of monopolist is twice the rate of decline in price.
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33. In a monopoly, price is
(1 mark)
(a) Lesser than the marginal revenue
(b) Greater than the average revenue
(c) Greater than the marginal revenue
(d) Equal to the total revenue
(e) Equal to marginal cost.
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34. Which of the following is false in the first degree price discrimination under monopoly?
(1 mark)
(a) The monopolist will be able to extract the entire consumers surplus
(b) The price of each unit will be different
(c) By following the first degree price discrimination, the monopolist earns more than what he could
otherwise earn at a uniform price per unit
(d) The price of the first unit will be less than that of the subsequent units
(e) It is another name for perfect price discrimination.
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35. Alpha Ltd., has a monopoly in producing a product X. The demand function for this product is
estimated as Q = 75 P. The total cost function is TC = 25Q. What is the profit?
(2 marks)
(a) Rs.400
(b) Rs.625
(c) Rs.725
(d) Rs.600
(e) Rs.450.
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36. In a duopoly market there are two firms firm A and firm B having TC
A
= 10Q
A
and

TC
B
= 0.5Q
2
B

. If the demand function for the industry is Q = 200 4P, what is the Cournots
equilibrium output for the industry?
(2 marks)
(a) 89 units
(b) 90 units
(c) 91 units
(d) 92 units
(e) 88 units.
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37. Which of the following represents the possible combinations of two goods that can be produced in a
certain period of time under the condition of given technology and fully employed resources?
(a) Isoquant curve
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(1 mark)
(b) Production possibility frontier
(c) Laffer curve
(d) Phillips curve
(e) Business cycles.
38. Which of the following variables is/are flow variable(s)?
I. Capital stock.
II. A firms assets.
III. Gross fixed investment.
IV. Price index.
(1 mark)
(a) Only (III) above
(b) Both (I) and (II) above
(c) Both (II) and (III) above
(d) Both (II) and (IV) above
(e) (II), (III) and (IV) above.
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39. Which of the following price indices is most widely used for determining inflation in India?
(1 mark)
(a) Wholesale price index
(b) GDP deflator
(c) Consumer price index
(d) Producer price index
(e) GNP deflator.
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40. The following information is extracted from the National Income Accounts of an economy. All figures
are in millions units of currency (MUC).
If the national income is 10,000 MUC, the personal disposable income in the economy would be
(2 marks)
Particulars MUC
Depreciation 236
Government expenditure 1,188
Corporate taxes 288
Gross domestic investment 1,278
Transfer payments 278
Personal taxes 810
Net income earned from abroad 44
Undistributed corporate profits 600
(a) 8,960 MUC
(b) 8,580 MUC
(c) 10,240 MUC
(d) 9,230 MUC
(e) 7,440 MUC.
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41. An economy produces only two commodities bread and butter. During the year 2006, it increased its
production of bread to 1,500 units and of butter to 2,500 units, which is exactly double as compared to
last year. The commodity prices in the economy during the two years are given below: (Consider 2005
as the base year)
Nominal GDP for the year 2005 was
Year
Price of Bread
(Rs. per unit)
Price of Butter
(Rs. per unit)
2005 20 15
2006 25 20
(a) Rs.67,500
(b) Rs.87,500
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(2 marks)
(c) Rs.33,750
(d) Rs.43,750
(e) Rs.23,450.
42. The following is the information from national accounts of an economy:
The GDP at factor cost is
(2 marks)
Particulars MUC
Factor income paid abroad 42,000
Factor income received from abroad 31,500
Depreciation 42,000
Subsidies 21,000
National income 1,68,000
(a) 1,24,800 MUC
(b) 1,30,200 MUC
(c) 1,68,400 MUC
(d) 2,20,500 MUC
(e) 1,25,600 MUC.
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43. In an economy, the investment function is given by I = 1000 40i. If an increase in government
spending by 250 MUC increases the interest rate in the economy by 5%, what could be the amount of
crowding out in the economy?
(2 marks)
(a) 100 MUC
(b) 150 MUC
(c) 75 MUC
(d) 200 MUC
(e) 90 MUC.
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44. Acceleration coefficient in an economy is 2. Investment in a period is equal to 75% of the difference
between the desired capital stock and the existing capital stock. If income in period t is expected to
increase by 200 MUC, investment during the period t will be
(2 marks)
(a) 200 MUC
(b) 300 MUC
(c) 400 MUC
(d) 500 MUC
(e) 600 MUC.
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45. For an economy marginal propensity to consume is estimated to be 0.80 and the proportional tax rate is
25percent. If government expenditure increases by 100 MUC, change in budget deficit is
(2 marks)
(a) 37.50 MUC
(b) 75.00 MUC
(c) 77.00 MUC
(d) 100.00 MUC
(e) 150.00 MUC.
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46. The government decreases both its expenditure and tax receipts by Rs.10 billion. This would
(1 mark)
(a) Reduce the equilibrium level of income
(b) Increase the equilibrium level of income
(c) Reduce the equilibrium level of income only if the government had previously been running a
deficit
(d) Leave the equilibrium level of income unaffected
(e) Increase the equilibrium level of income only if the government had previously been running a
surplus.
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47. 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?
(1 mark)
(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.
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48. For an economy, goods market equilibrium is estimated as
0.5 Y = 1250 75i.
If expansionary monetary polices decrease the rate of interest in the economy by one percentage point,
the equilibrium income will
(2 marks)
(a) Decrease by 75 MUC
(b) Increase by 75 MUC
(c) Decrease by 150 MUC
(d) Increase by 150 MUC
(e) Increase by 200 MUC.
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49. The IS function and LM function of an economy are estimated to be Y = 2,860 + 0.5Y 60i and Y =
2,600 + 400i respectively. The investment function in the economy is 800 50i. If the government
wants to increase the output by 10% by raising the government expenditure, what is the crowding out in
the economy?
(2 marks)
(a) 52.50 MUC
(b) 55.50 MUC
(c) 62.50 MUC
(d) 100.00 MUC
(e) 125.00 MUC.
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50. The following functional relations are derived for an economy.
The equilibrium level of income is
(2 marks)
Consumption function C 100 + 0.75Y
d

Government expenditure G 400
Gross investment function I 200 10i
Tax function T 0.20Y
Net exports NE 100 0.10Y
Transaction Demand for Money (M
t
/P)

0.20Y
Speculative Demand for Money (M
a
/P)

200 4i
Supply of Money (M
s
/P)

500
(a) 1,200 MUC
(b) 1,550 MUC
(c) 1,320 MUC
(d) 1,410 MUC
(e) 2,100 MUC.
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51. Which of the following shifts short-run aggregate supply curve to left?
I. A decrease in the price level.
II. An increase in the expected price level.
III. An increase in the capital stock.
(a) Only (I) above
(b) Only (II) above
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(1 mark)
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
52. In the short run, changes in aggregate demand determine the level of prices and income. In the long run,
changes in aggregate demand determine only the level of
(1 mark)
(a) Income
(b) Prices
(c) Aggregate supply
(d) Interest rates
(e) Employment.
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53. The following balances are taken from the balance sheet of the Central Bank of a country:
If the government money in the economy is 100 MUC, the high-powered money in the economy is
(2 marks)
Particulars MUC
Net worth 400
Credit to Central Government 1,000
Credit to commercial banks 500
Other non-monetary liabilities 100
Other assets 200
Government deposits 100
Foreign exchange assets 200
(a) 1,400 MUC
(b) 1,500 MUC
(c) 1,650 MUC
(d) 1,600 MUC
(e) 1,250 MUC.
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54. Compute the money supply from the following information:

(1 mark)
High powered money Rs. 8,800 Cr.
Currency deposit ratio in the economy 20%
Cash reserve requirement of the central bank 5%
(a) Rs. 440 Cr
(b) Rs. 1,760 Cr
(c) Rs. 2,200 Cr
(d) Rs. 42,240 Cr
(e) Rs. 36,960 Cr.
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55. The following monetary data on financial development of an economy is obtained for the year 2006.
What is the intermediation ratio for the economy?
(2 marks)
New issues ratio 0.77
Net physical capital formation Rs. 1,77,000 Cr
Secondary issues Rs. 1,19,935 Cr
(a) 0.80
(b) 0.70
(c) 0.88
(d) 0.90
(e) 0.92.
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56. Which of the following does not affect the balance sheet of Reserve Bank of India?
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(1 mark)
(a) Central governments borrowings from RBI
(b) Loan taken by one commercial bank from the other commercial bank
(c) Refinancing of NABARD loans
(d) Increase in reserves of commercial banks
(e) Increase in net foreign exchange assets.
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57.
The classical view of the labor market is basically consistent with the assumption of __________
aggregate supply curve.
(1 mark)
(a) A horizontal
(b) A vertical
(c) An upward-sloping
(d) A downward-sloping
(e) Rectangular hyperbola.
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58. In the classical theory, saving and investment determine
(1 mark)
(a) The price level
(b) Unemployment
(c) The supply of money
(d) Interest rates
(e) The demand for money.
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59. Who among the following advocates that, economics focuses on the role government plays in
stabilizing the economy by managing aggregate demand?
(1 mark)
(a) Keynesian
(b) Monetarist
(c) New classical
(d) Classical
(e) Rational expectations.
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60. A continuous decline in prices is referred to as
(1 mark)
(a) Inflation
(b) Deflation
(c) Reflation
(d) Hyper-inflation
(e) Stagflation.
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61. Which of the following statements pertaining to Phillips curve is not correct?
(1 mark)
(a) In the short run, unemployment does not return to its natural rate and there exists a trade-off
between inflation and unemployment
(b) If the expected inflation rises, the Phillips curve shifts upward to the right, indicating higher
inflation at each unemployment level
(c) The position of the short-run Phillips curve depends on the expectations regarding inflation
(d) In the long-run the Phillips curve becomes vertical
(e) In the long run, the policymakers will have enough time to depress aggregate demand to lower
inflation and raise unemployment.
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62. Robert begins his job search soon after his Post-graduation in Computer Science. After two months of
search, he is hired by a software company as a system administrator. The nature of unemployment
encountered by Robert is
(a) Structural
(b) Frictional
(c) Cyclical
(d) Seasonal
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(1 mark)
(e) Disguised.
63. Recession is defined as
(1 mark)
(a) Two or more quarters of increasing inflation
(b) The period after the trough of a business cycle
(c) The period before the peak of the business cycle
(d) Two or more quarters of declining output
(e) Two or more quarters of declining inflation.
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64. Which of the following is not true if the central bank imposes a reserve ratio of 100%?
(1 mark)
(a) The banking system can no longer affect the supply of money in the economy
(b) Change in the foreign exchange reserves will result in an equal change in the 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.
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65. 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.
(1 mark)
(a) Both (I) and (III) above
(b) Both (I) and (IV) above
(c) Both (II) and (III) above
(d) Both (II) and (V) above
(e) Both (I) and (V) above.
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66. Which of the following is not a major determinant of economic growth?
(1 mark)
(a) Tastes and preferences of consumers
(b) Technological advancement
(c) Natural resources
(d) Physical capital
(e) Human resources.
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67. Budget Estimate for the year 2006 is given below.
(Rs. crore)
The estimated revenue deficit for the year 2006 was
Tax Revenue (net to Centre) 7,36,676
Non-tax revenue 2,79,064
Recoveries of Loans 72,092
Other Receipts 52,800
Borrowings and other Liabilities 6,14,548
Non-plan Expenditure
On Revenue Account (of which Interest
Payments is Rs.4,92,892cr.)
11,57,536
On Capital Account 1,13,748
Plan Expenditure
On Revenue Account 3,07,372
On Capital Account 1,76,524
(a) Rs.4,53,168 cr
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(2 marks)
(b) Rs.4,38,328 cr
(c) Rs.4,77,168 cr
(d) Rs.4,49,168 cr
(e) Rs.7,98,504 cr.
68. The record of a country's transactions in goods, services and assets with the rest of the world is known
as
(1 mark)
(a) Current account
(b) Balance of trade
(c) Capital account
(d) Balance of payments
(e) Errors & omissions.
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69. If the US has to forego 3 tons of strawberries in order to produce 10 gallons of wine and Brazil has to
forego 2 tons of strawberries in order to produce 1 gallon of wine then
(1 mark)
(a) Both Brazil and US have a comparative advantage in wine
(b) Both Brazil and US have a comparative advantage in strawberries
(c) Brazil has a comparative advantage in wine and US in strawberries
(d) Brazil has a comparative advantage in strawberries and US in wine
(e) US has absolute advantage in both wine and strawberries.
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70. Indias overall Balance of Payments for the year 2006 is given below.



(US $ million)
During the year 2006, over all Balance of Payments position for India was
(2 marks)
Items Credit Debit
Merchandise 2,65,000 3,27,370
Services 1,24,930 93,900
Transfers 76,125 1,835
Income 14,130 38,540
Foreign Direct Investment 23,950 5,895
Portfolio Investment 37,675 32,955
External Assistance 13,865 26,165
Commercial Borrowings (MT & LT) 13,685 22,175
Commercial Borrowings (Short Term) 40,945 36,050
Commercial Banks 84,630 44,865
Others 2,680 1,230
Rupee Debt Service 2,370
Other Capital 32,010 14,545
Errors & Omissions 3,170
(a) $ 91,400 million (surplus)
(b) $ 84,900 million (deficit)
(c) $ 86,400 million (deficit)
(d) $ 86,400 million (surplus)
(e) $ 84,900 million (surplus).
<
Answer
>
71. Which of the following chain of events results from an expansionary monetary policy?
(a) Aggregate output increases, the demand for money increases, the interest rate increases, planned
investment decreases, and aggregate output decreases
(b) Money supply increases, the interest rate decreases, planned investment increases, aggregate
output increases, and money demand increases
(c) Money demand increases, the interest rate decreases, planned investment increases, aggregate
output increases, and money demand increases
(d) Money supply increases, the interest rate increases, planned investment increases, aggregate
<
Answer
>


(1 mark)
output increases, and money demand increases
(e) Money supply decreases, interest rate decreases, planned investment decreases, aggregate output
decreases, money demand decreases.
72. In the last few years the forex reserves in India have been increasing. Which of the following
sterilization policies the Reserve Bank of India would adopt?
(1 mark)
(a) Increase cash reserve ratio
(b) Decrease cash reserve ratio
(c) Decrease discount rate
(d) Buy government securities
(e) Qualitative restrictions.
<
Answer
>
73. Inflation accompanied by a slowing of economic activity is
(1 mark)
(a) Known as deflation
(b) A result of a stagnant aggregate supply
(c) A result of fiscal stimulus
(d) Known as stagflation
(e) Known as recession.
<
Answer
>
Suggested Answers
Economics (CFA520) : July 2007
1. Answer : (c)
Reason : Total expenditure on a good will not change when the price of a good changes if demand
is unit elastic. When the demand is unit elastic, the upward pressure on expenditure caused
by the price increase would be equally off-set by the downward pressure on expenditure
resulting from the reduction in the quantity demanded. Thus, expenditure of a consumer
on a good with unitary elastic demand remains the same irrespective of the change in the
price of good. (a) If the demand is perfectly elastic, the proportionate change in quantity
demanded would be far higher than the proportionate change in price. Thus, expenditure
of the consumer increases (decreases) with the fall (increase) in the price of the good
because of higher proportionate change in quantity demanded. (b) If the demand is
perfectly inelastic, the proportionate change in quantity demanded would be far lesser than
the proportionate change in price. Thus, expenditure of the consumer decreases (increases)
with the fall (increase) in the price of the good because of lower proportionate change in
quantity demanded. (c)If the demand is unit elastic, the proportionate change in quantity
demanded would be equal to the proportionate change in price. Thus, expenditure of the
consumer remains the same with the decrease or increase in the price of the good because
of proportionate change in quantity demanded. (d) If the demand is relatively elastic, the
proportionate change in quantity demanded would be higher than the proportionate change
in price. Thus, expenditure of the consumer increases (decreases) with the fall (increase)
in the price of the good because of higher proportionate change in quantity demanded. (e)
If the demand is relatively inelastic, the proportionate change in quantity demanded would
be lesser than the proportionate change in price. Thus, expenditure of the consumer
decreases (increases) with the fall (increase) in the price of the good because of lower
proportionate change in quantity demanded.
< TOP >
2. Answer : (e)
Reason : Elasticity of demand is defined as percentage change in the quantity demanded due to the
percentage change in the price; price elasticity of demand = percentage change in the
quantity demanded / percentage change in the price of the commodity.
I. The slope of the demand curve represents the change in the price of the good to the
change in the quantity demanded of the good.
II. As one goes down the demand curve the price elasticity of demand decreases.
III. When the demand for the good is inelastic, a fall in the price of the good does not
result in a greater increase in the quantity demanded. Hence, there would be no
increase in the total revenue of the firm.
IV. Elasticity of demand is measured by dividing the percentage change in the quantity
demanded by percentage change in the price and not by dividing the change in
quantity demanded by change in the price. (Note: E
D
= Percentage change in the
quantity demanded/Percentage change in price).
The correct answer is (e).
< TOP >
3. Answer : (c)
Reason : When the quantity supplied of a commodity exceeds the quantity demanded at a given
price, the price will decrease.
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4. Answer : (a)
Reason : Demand curve is usually drawn as downward sloping as we move from left to right as
demand increases with price fall of a commodity
< TOP >
5. Answer : (b)
Reason : P = Rs.10 Qd = 100 4 (10)
100 40 = 60
= 4(slope)

q
p

< TOP >

E
p
= 4 10 / 60 = - 0.67

6. Answer : (b)
Reason : MR =

MR = since AR = price

= 900 ( 5/6) =Rs. 750.
p
1
AR 1
e

' ;

{ }
1
900 1
6

< TOP >

7. Answer : (c)
Reason : I. Is true. Consumer surplus is useful to the government to fix taxes. It is useful to fix
taxes since the rich or the upper class people have more consumer surplus compared
to the rest. Consumer surplus also reveals the purchasing pattern of the economy. By
observing the nature of the products moving in the market, the government can fix
the taxes through the classification of products.
II. Is true. Consumer surplus helps the monopolists in fixing price of a commodity.
While pricing a commodity, if a monopolist considers consumer surplus, he can
retain the customer for a longer period.
III. Is not true. In case of imported products which are cheaper than domestic
products the consumer surplus is more. This is because he is paying less
for the imported product which is giving him the same level of satisfaction.
IV. Is true. A higher consumer surplus indicates that the economy is stable and vise
versa. A negative consumer surplus indicates that the economy is not functioning
efficiently.
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8. Answer : (d)
Reason : The total utility at any point of time is the summation of marginal utilities of current and
preceding units of consumption.
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9. Answer : (d)
Reason : The point of tangency between the budget constraint and the indifference curve indicates
that the consumer is in equilibrium. That is consumer attains maximum amount of
satisfaction implying that all the other combinations give him the lesser utility or
unassailability given his budget. Hence the correct answer is (d).
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10. Answer : (a)
Reason : The locus of points of tangency between budget line and the indifference curves is called
as the income consumption curve
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11. Answer : (c)
Reason: Diamond water paradox explains that the more of a commodity we have, the marginal
utility starts deminishing. If the availabity of the product is less, marginal utility would be
high.
< TOP >
12. Answer : (c)
Reason :


The consumer can maximize his satisfaction by equating
.5
X
U
MU 1.5X Y
X

1.5
Y
X
Y
U
MU X
Y
P 6
P 8

< TOP >

12Y = 6X
X = 2Y
Given the budget of Rs.500,

hence the optimum allocation is X = 50 units and Y = 25 units
X X
Y Y
.5
1.5
MU P
MU P
1.5X Y 6
X 8
1.5Y 6
X 8

( )
X Y
P .X P .Y 500
6 2Y 8Y 500
20Y 500
Y 25
X 2Y 50
+
+

13. Answer : (b)
Reason : When the consumer is in equilibrium,
=

5 =

P
b
= Rs.19

ab
MRS
a
b
P
P
b
95
P
< TOP >
14. Answer : (c)
Reason : If X and Y are products and MU and P represents marginal utility and price respectively,
consumer reaches an equilibrium where MUx/Px = MUy/Py
So 520/Px = 650/75
Px =

Px = Rs. 60.
75
520 60
650

< TOP >
15. Answer : (e)
Reason : When P = 5; 25 0.5Q = 5, or Q = 40.
When the market price is Rs.5, the consumer surplus = 40 20 = Rs. 400.
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16. Answer : (c)
Reason : The opportunity cost is the benefit of using resources for the next best alternative uses.(a)
Is not the answer because opportunity costs are not spill-over cost.(b)Is not the answer
because opportunity costs are not money cost(c)Is the answer because opportunity costs
are alternative cost(d)Is not the answer because opportunity costs are not external cost.(e)
Is not the answer because sunk costs are those costs which are incurred in the future as
result of a contractual agreement.
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17. Answer : (a)
Reason : Cost functions are derived from production function which describes the available
efficient methods of production at any particular point of time.
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18. Answer : (a)
Reason : If the firms total revenue exceeds its economic costs, the residual accruing to the
entrepreneur is called as economic or pure profit.
< TOP >
19. Answer : (e)
Reason : The cost that can be easily attributed to a product or a process is called as separate cost.
< TOP >
20. Answer : (e)
Reason : Option (e) is not true. The reason for this is that the marginal cost curve cuts the average
cost curve and the average variable cost curve at their minimum points and as the marginal
cost curve is upward rising curve and the average cost curve being flatter than average
variable cost curve. Hence the minimum point of average cost will be to the right of the
minimum point of the average variable cost.
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21. Answer : (b)
Reason : Both marginal and average costs are equal to each other when average cost is minimum.
< TOP >
22. Answer : (d)
Reason : TC = 500 2Q + 3Q
2


AC = 500/Q 2 + 3Q
= 500/5 2 + 15
= Rs.113.
< TOP >
23. Answer : (d)
Reason : AVC = 300 9Q + 0.5 Q
2
VC = Q X AVC = 300 Q 9Q
2
+ 0.5Q
3
Fixed cost = 150
TC = FC + VC = 150 + 300Q 9Q
2
+ 0.5Q
3
MC = = 300 18Q + 1.5Q
2

Minimum possible MC is where
= 0

= -18 + 3Q = 0

3Q = 18
Q = 6
MC = 300 18 (6) + 1.5 (6)
2
= 300 108 + 54
= Rs.246.
dTC
dQ
dMC
dQ
dMC
dQ
< TOP >
24. Answer : (e)
Reason : TC = 20Q 0.3 Q
2
+ 0.01Q
3
MC = = 20 0.6 Q + 0.03Q
2

MC is minimum when = 0

= -0.6 + 0.06 Q = 0

0.06 Q = 0.6
Q = 10 units

dTC
dQ
dMC
dQ
dMC
dQ
< TOP >
25. Answer : (e)
Reason : when TC = 5000 + 800Q -9Q
2 +
0.25Q
3


< TOP >
VC = 800Q -9Q
2
+

0.25Q
3
AVC = 800 9Q + 0.25Q
2

FC = 5000
MC = 800 18Q + 0.75Q
2

AC = 5000/Q + 800 - 9Q + 0.25Q
2


26. Answer : (e)
Reason : AC = 800/Q + 80 + 4Q
TC = 800 + 80Q + 4Q
2
TVC = 80Q + 4Q
2
At output 20,
TC = 800+80(20) + 4(20)
2
= 800+ 1600 + 1600 =Rs.4,000.
< TOP >
27. Answer : (a)
Reason : Since the firm is operating in short run the equilibrium condition of the firm will be
MR = MC
Given
P =1000 50Q
So TR = P x Q
= 1000Q 50Q
2
MR = 1000 100Q
Given
AVC = 250 + 25Q
VC = 250Q +25Q
2
MC = 250 + 50Q
At equilibrium MR = MC
= 1000 100Q = 250 + 50Q
= 750 = 150Q
= Q = 5
At this level of output the AFC = Rs. 60. So FC = 60 x 5 = Rs.300
VC = 250(5) + 25(5)
2
= 1250 + 625 = Rs. 1875

TC = FC + VC
= 300 + 1875 = Rs.2,175
< TOP >
28. Answer : (b)
Reason : A firm is considered a price taker in perfect competition because there are so many
buyers and sellers in the market that any individual firm cannot affect the market.
< TOP >
29. Answer : (c)
Reason : For a firm operating in a perfectly competitive industry, the part of MC curve which is
above the AVC curve is the supply curve of the firm.
MC = TC/Q = - 100 + 10Q = P( because at equilibrium MC = MR and in perfect
competition MR = AR = P = Demand)
Or, 10Q = P + 100
Or, Q = 0.10P + 10
There are 100 firms, hence Qs = 100x Q = 10P + 1000
Equilibrium price is where, Q
s
= Q
d

6000 490P = 10P + 1000
Or, 500P = 5000
Or, P = Rs.10
< TOP >
30. Answer : (c)
Reason : To maximize profits, a perfectly competitive firm produces an output where P = MC
< TOP >
MC = TC/Q = 600 100Q + 3Q
2
P = 600 100Q + 3Q
2
, where Q = 150 units (given)

Hence, P = 600 100(150) + 3(150)
2
= 53,100

Thus, total industrial production is equal to (200 + 4 x 53,100) = 2,12,600 Units.
31. Answer : (d)
Reason : In a perfectly competitive market in the long run no firm earns abnormal profit because of
existence of free entry and free exit into the industry. So when ever there is some extra
profit in the industry some new firms will enter into the market and compete away the
extra profit. Thus in the perfect competition the firms will earn only normal profits.
< TOP >
32. Answer : (d)
Reason : The monopolist must decrease the price of every unit in order to sell additional units, that
is why the marginal revenue curve of the monopolists slopes downwards from left to right.
< TOP >
33. Answer : (c)
Reason : Monopoly is a market structure in which there is one seller of the product implying that
the producer has complete control over market supply of the commodity. The monopolist
must decrease the price he receives for every unit in order to sell an additional unit.
Hence, the marginal revenue of the monopolist would be lesser than price. Hence, the
correct answer is (c).
< TOP >
34. Answer : (d)
Reason : First degree price discrimination involves charging the maximum price possible for each
unit of output. It is also called perfect discrimination. The price of the first unit is greater
than the price of the subsequent units.
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35. Answer : (b)
Reason : Demand function of the firm is given as Q = 75 P
P = 75 Q
TR = P Q

= 75Q Q
2
MR = 75 2Q
TC = 25Q
MC = 25
Profit maximizing output is obtained when MR = MC
= 75 - 2Q = 25
2Q = 50
Q = 25
P = 75 Q
= 75- 25 = 50
Profit = TR TC
TR = P Q

= 50 25 = 1250

TC = 25Q
= 25 25 = 625

profit = 1250 625 =Rs.625.

< TOP >

36. Answer : (c)
Reason : Q = 200 4P
Or 4P = 200 Q
Or P = 50 0.25Q
But, we know that Q = Q
A
+ Q
B

Hence, P = 50 0.25Q
A
0.25Q
B

< TOP >
Thus, TR
A
= P x Q
A
= Q
A
(50 0.25Q
A
0.25Q
B
)

Thus, TR
A
= 50Q
A
0.25Q
A
2
0.25Q
A
Q
B

Thus, MR
A
= 50 0.5 Q
A
0.25Q
B

MR
A
= MC
A


50 0.5Q
A
0.25Q
B
= 10

Or, 40 0.5Q
A
= 0.25Q
B

Or, 160 2Q
A
= Q
B

TR
B
= P x Q
B
= Q
B
(50 0.25Q
A
0.25Q
B
)

TR
B
= 50Q
A
0.25Q
B
2
0.25Q
A
Q
B

MR
B
= 50 0.5Q
B
0.25Q
A

But, MR
B
= MC
B

=
50 0.5Q
B
0.25Q
A
= Q
B

Or, 50 - 0.25Q
A
= 1.5Q
B

Or, 50 0.25Q
A
= 1.5(160 2Q
A
)

Or, 50 0.25Q
A
= 240 3Q
A

Or, 2.75Q
A
= 190

Or, Q
A
= 69 Q
B
= 160 2(69) = 22

Q = Q
A
+ Q
B
= 69 + 22 = 91 units.

37. Answer : (b)
Reason : The production possibility curve represents the various combinations of two goods that
can be produced given the resources and level of technological development. It is nothing
but the locus of various combinations of two goods and the production possibility frontier
represents the maximum combinations of two goods.

< TOP >
38. Answer : (a)
Reason : A variable is a stock if it is measured at a particular point of time. It is a flow variable if it
is measured over a period of time.
Investment is measured over a period of time hence is a flow variable.
Capital stock, a firms assets, price index are stock variable.
< TOP >
39. Answer : (a)
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.
< TOP >
40. Answer : (b)
Reason : Personal income = national income undistributed corporate profits corporate taxes
+transfer payments
= 10000600288+278 = 9390
Personal disposable income = personal income personal taxes
= 9390 810= 8580 MUC.
< TOP >
41. Answer : (c)
Reason : Nominal GDP for 2005 is given by
Price of bread in 2005quantity of bread in 2005 + Price of butter in 2005 quantity of
butter in 2005
75020 + 1250 15 = Rs.33,750
< TOP >
42. Answer : (d)
< TOP >
Reason : National income = NNP at factor cost = 168,000
GDP at factor cost = NNP at factor cost + Depreciation - NFIA = 168,000 + 42,000
(31500 42000) = 220,500 MUC.
43. Answer : (d)
Reason : Crowding-out refers to decrease in private investment because of increase in interest rate
caused by the increase government spending . Crowding out = 40 5 = 200 MUC.
< TOP >
44. Answer : (b)
Reason : Investment in period t = 0.75 Desired investment in period t
Desired investment in period t = Acceleration co-efficient change in income
= 2 200
= 400
Investment in period t = 0.75 400 = 300 MUC
The answer is (b).
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45. Answer : (a)
Reason : MPC = 0.80
T = 25%
Multiplier = =

If G increase by 100, Y = 100 2.5 = 250
T = t . Y = 0.25 250 = 62.50
G = 100,
T = 62.50
Budget deficit (G T) = 37.50.
) t 1 ( MPC 1
1

1
1 0.8(1 0.25)
< TOP >
46. Answer : (a)
Reason : Reduce the equilibrium level of income because decrease in government expenditure
would reduce the AD by Rs.10 billion. Whereas decrease in tax receipts increase the AD
by MPC 10 billion. This results in net decrease in AD thereby reducing equilibrium
level of income.
< TOP >
47. Answer : (d)
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
remain unchanged which means that the interest rate falls.
(e) Is not the answer because interest rate doesnt increase.
< TOP >
48. Answer : (d)
Reason : If expansionary fiscal policies decrease the rate of interest by 1%. The equilibrium
income will increase by (75/0.5) = 150 MUC
< TOP >
49. Answer : (c)
Reason : At simultaneous equilibrium,
0.5Y = 2860 60i (or) Y = 5720 120i is equal to Y = 2600 + 400i
< TOP >
Or, 5720 120i = 2600 + 400i
Or, 3120 = 520i
Or, i = 6
Thus, Y = 2600 + 400(6) = 5000
When government spending is raised to meet the objective,
Y = 5000 + 10% of 5000 = 5500. If Y = 5500,
then using LM function, 400i = 5500 2600 (or) i = 7.25%
Initial investment = 800 50(6) = 500
New investment = 800 50(7.25) = 437.5
Change in investment = 500 437.5 = 62.5.
50. Answer : (b)
Reason : Goods market equilibrium: AD = Y
C + I + G + NE = Y
100 + 0.75(Y 0.2Y) + 200 10i + 400 + 100 0.1Y = Y
800 + 0.6Y 10i 0.1Y = Y
800 + 0.5Y 10i = Y
0.5Y = 800 10i
Y = 1600 20i
Money market equilibrium: M
s
= M
d

0.2Y + 200 4i = 500
0.2Y 4i = 300
0.2Y = 300 + 4i
Y = 1500 + 20i
At simultaneous equilibrium,
1600 20i = 1500 + 20i
100 = 40i
i = 2.5
Y = 1500 + 20i = 1500 + 20(2.5) = 1550 MUC.
< TOP >
51. Answer : (b)
Reason : An increase in the expected price level shifts short-run aggregate supply curve to left.
< TOP >
52. Answer : (b)
Reason : In the short run, changes in aggregate demand determine the level of prices and income.
In the long run, changes in aggregate demand determine only the level of prices.
< TOP >
53. Answer : (a)
Reason :
Total assets = Total liabilities
(Credit to Central Government + Credit to commercial banks + Foreign exchange assets +
Other assets) = (Net worth + Government deposits + Other non-monetary liabilities +
Monetary liabilities)
(1000 + 500 + 200 + 200) = (400 + 100 + 100 + ML)
1900 = 600 + ML
Or, ML = 1300.
High-powered money (H) = Monetary liabilities of Central Bank + Government money =
1300 + 100 = 1400 MUC.
< TOP >
54. Answer : (d)
Reason : Money supply = H

Where H = High powered money
1 Cu
Cu r
+ 1
1
+
]
< TOP >
Cu = Currency deposit ratio
R = reserve ratio = 8800 = Rs.42,240 Cr.

1 0.20
0.20 0.05
+ 1
1
+
]
55. Answer : (c)
Reason : New issues ratio =

Thus 0.77 =

X = 1,36,290
Hence primary issues by non-financial sector are 1,36,290 units
Intermediation ratio = = 0.88

Pr imaryissues by non financial sec tor
Total physical assets formation

x
1, 77, 000
1,19, 935
1, 36, 290
< TOP >
56. Answer : (b)
Reason : The balance sheet of Reserve Bank of India contains particulars of Banks current assets
and liabilities.
(a) Is not the answer because Central governments 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.
< TOP >
57. Answer : (b)
Reason : The classical view of the labour market is basically consistent with the assumption of a
vertical aggregate supply curve
< TOP >
58. Answer : (d)
Reason : In the Classical Theory, saving and investment determine interest rates. Interest rate is
determined at the equilibrium point of saving and investment. As the saving increases
interest rate decreases and vice versa. Similarly, there is direct relationship between
investment and interest rates.
< TOP >
59. Answer : (a)
Reason : Keynesian economics focuses on the role government plays in stabilizing the economy by
managing aggregate demand.
< TOP >
60. Answer : (b)
Reason : A continuous decline in prices is referred to as Deflation.
< TOP >
61. Answer : (e)
Reason : In the long run, the Philips curve is vertical. Hence, there is no inverse relation between
inflation and unemployment. Any policy change effected at this juncture will have no
effect.
< TOP >
62. 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 (natural) unemployment. It occurs on account of two reasons: (a)
employers not fully aware of all available workers and their job qualifications;
< TOP >
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.
63. Answer : (d)
Reason : Recession is, technically, defined as decline in output for two or more consecutive
quarters.
< TOP >
64. Answer : (d)
Reason : If the central bank imposes a reserve ratio of 100%, the entire deposits are kept with the
central bank and the money multiplier is not affected. Hence (d) is the false statement.
< TOP >
65. Answer : (d)
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

< TOP >
66. Answer : (a)
Reason : Economic growth refers to situation where increased productive capabilities of an
economy are made possible by either an increasing resource base or technological
advance. A country, thus, can achieve economic growth through:
Improvement in technology
Natural resources
Capital
Human resources
Change in tastes and preferences of consumers only affect the demand of an individual for
good or services, and it does not increase the production capabilities of an economy.
< TOP >
67. Answer : (d)
Reason : Revenue deficit = Revenue expenditure Revenue receipt
Revenue Expenditure = Non plan revenue expenditure + Plan revenue expenditure
= 1157536+307372 = 1464908
Revenue receipts = Tax revenue + Non. Tax revenue
= 736676+279064 = 1015740
Revenue Deficit = 1464908 1015740 = Rs. 449168 cr.
< TOP >
68. Answer : (d)
Reason : Balance of payments statement is described as a nations record of its goods, services and
assets transactions with the rest of the world. This is recorded in the form of double entry
bookkeeping.
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69. Answer : (d)
Reason : In the example, the opportunity cost of producing 10 gallons of wine for United States is
3 tons of strawberries while for Brazil, it is only 2 tons. This means less opportunity cost
for Brazil and a comparative advantage for brazil in strawberry production.
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70. Answer : (e)
Reason : Overall balance of payment
= Total Credit of the Bop Total debit of the Bop
= 732795647895
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= $ 84900million (surplus)
71. Answer : (b)
Reason : An expansionary monetary policy increases the money supply. This will decrease the
interest rates boosting planned investment and aggregate demanbd. This will further
increase aggregate output and hence money demand.
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72. Answer : (a)
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 wouldnt 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.
(e) Is not the answer because RBI would not adopt qualitative restrictions.
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73. Answer : (d)
Reason : Slowing of economic activity accompanied by inflation is defined as stagflation.
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