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Question Paper
Economics (MB141) : October 2003
Part A : Basic Concepts (30 Points)
• This part consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one point.
• Maximum time for answering Part A is 30 Minutes.
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1. Which of the following is false in first-degree price discrimination?
Answer >
a. The monopolist will be able to extract the entire consumer’s surplus
b. The price of each unit will be different
c. By following first degree price discrimination, the profit of the monopolist will be more
than what he could otherwise earn at a single price
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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2. Which of the following is not an example of an intermediate good?
Answer >
a. Cycle tyres bought by Hero Cycles Ltd.
b. Fertilizer bought by a vegetable cultivator
c. Art paper purchased by a painter
d. A pack of sweets bought by Mr. Rajesh to celebrate his success with friends
e. Aviation fuel sold to Air India.
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3. In the recent monetary policy, the RBI Governor reduced the CRR from 4.75% to 4.50%. Which of
the following sequences correctly shows the impact of the reduction in CRR? Answer >

I. Change in money supply.


II. Change in nominal interest rates.
III. Change in consumption and investment.
IV. Change in aggregate demand.
V. Change in real GDP and price level.

a. (I), (II), (III), (IV) and (V) above


b. (I), (II), (III), (V) and (IV) above
c. (I), (II), (IV), (V) and (III) above
d. (I), (V), (II), (III) and (IV) above
e. None of the above.
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4. Three countries – A, B and C have same Production Possibility Frontier (PPF), but have different
investment behavior. Country A made a gross investment equal to its depreciation. Country B Answer >
spent most of its income on consumption. Country C invested heavily by sacrificing its current
consumption. After 10 years which country will have a higher PPF?
a. Country A
b. Country B
c. Country C
d. Both (b) and (c) above

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e. Cannot be determined.
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5. Immediately following a depression,
Answer >
a. Unemployment rate increases moderately
b. Aggregate demand decreases further because of recession
c. There will be rapid increase in wages but less than the increase in prices of goods and
services
d. The cost of production will gradually increase because of gradual increase in wages
e. Output will decrease rapidly.
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6. An economy is said to be facing inflation with respect to a base year if the price index for the
current year is Answer >

a. Greater than 0 (i.e. positive)


b. Greater than 100
c. 100
d. Between 0 to 100
e. Less than 0 (i.e. negative).
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7. Banks can create money
Answer >
a. By printing currency notes
b. By paying interest to their depositors
c. By making loans that result in additional deposits
d. By offering financial services, such as money market accounts
e. By accepting deposits from the public.
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8. In which of the following markets, the demand curve faced by a firm will be least elastic?
Answer >
a. Perfectly competitive market
b. Monopolistic market
c. Monopoly
d. Pure oligopoly
e. Differentiated oligopoly.
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9. Total market value of all the final goods and services produced in a given period by factors of
production located within a country is Answer >

a. Gross National Product at market prices


b. Gross Domestic Product at market prices
c. Net National Product at market prices
d. Gross National Product at factor cost
e. Gross Domestic Product at factor cost.
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10. “The money payments which are not due to any current productive activity on the part of income
receiver” is called Answer >

a. Plan expenditure
b. Transfer payments
c. Consumption expenditure
d. Past expenditure
e. Both (b) and (d) above.

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11. The difference between M3 and M1 is
Answer >
a. Demand deposits
b. Post office savings deposits
c. Savings deposits
d. Time deposits
e. M2.
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12. The diagram of circular flow of income shows
Answer >
I. Households providing firms with factors of production.
II. Income for factors of production flowing from households to firms.
III. Firms owning factors of production.
a. Only (I) above
b. Only (III) above
c. Both (I) and (III) above
d. Both (II) and (III) above
e. All (I), (II) and (III) above.
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13. Which of the following is not included in personal income?
Answer >
a. Personal savings
b. Personal income taxes
c. Dividends
d. Retained earnings
e. Personal consumption.
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14. In the long-run, a perfectly competitive firm earns only normal profits because of
Answer >
a. Product homogeneity in the industry
b. Large number of sellers and buyers in the industry
c. Free entry and exit of firms in the industry
d. Both (a) and (b) above
e. Both (b) and (c) above.
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15. When the Government increases tax on cigarettes, cigarette manufacturers pass on much of the
Answer >
additional tax to consumers in the form of higher prices. This implies that the demand for
cigarettes is
a. Relatively less elastic than supply
b. Relatively more elastic than supply
c. As elastic as the supply
d. Perfectly inelastic
e. Perfectly elastic.

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<
16. Which of the following is not an example of a firm’s explicit cost?
Answer >
a. Salaries paid to workers
b. An amount of Rs.500 paid to an employee towards the reimbursement of medical
expenses incurred by him
c. Advertisement expenditure incurred by the firm towards promotion of its branded good,
‘Atoka’
d. The firm’s owner has given up a job, where he was earning Rs.10,000 per month to run
the firm
e. Payment of telephone bills by the firm.
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17. A rice miller can sell as much rice as he wants in the market at the prevailing market price. He
knows that even if he increases the price by a small proportion, he will lose the entire market. The Answer >
slope of the demand curve faced by the miller would be
a. Infinity
b. Zero
c. One
d. Between zero and infinity
e. Between one and infinity.
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18. In economics, normal profit means
Answer >
a. Zero accounting profit
b. MR = MC
c. Zero economic profit
d. Zero opportunity cost
e. Both (b) and (c) above.
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19. Which of the following costs is not recorded in the books of a firm?
Answer >
a. Out-of-pocket costs
b. Indirect costs
c. Private costs
d. Implicit costs
e. Fixed costs.
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20. When the available resources in an economy are fully employed, expansionary monetary policy
Answer >
normally result in
I. Demand pull inflation.
II. Supply shock inflation.
III. Wage push inflation.

a. Only (I) above


b. Only (II) above
c. Only (III) above
d. Both (I) and (II) above
e. Both (I) and (III) above.

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21. Which of the following costs remain constant as the output increases?
Answer >
a. Marginal cost
b. Average variable cost
c. Average fixed cost
d. Total variable cost
e. None of the above.
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22. In India which of the following best describes a perfectly competitive market?
Answer >
a. Wheat cultivation
b. Indian railways
c. Soft drinks industry
d. Toilet soap industry
e. Electricity distribution.
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23. Diseconomies of scale refer to
Answer >
a. The forces which reduce the average cost of producing a good as the firm expands the
size of its plant
b. The forces which reduce the marginal cost of producing a good as the firm expands the
size of its plant
c. The forces which increase the average cost of producing a good as the firm expands the
size of its plant
d. The forces which increase the marginal cost of producing a good as the firm expands
the size of its plant
e. The forces which keep the average cost of producing a good constant as the firm
expands the size of its plant.
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24. Which of the following is not true with respect to a perfectly competitive market?
Answer >
a. There are many sellers in the market
b. Individual firms are price makers
c. Products sold by the firms are identical
d. Anyone can enter or exit the industry without any difficulty
e. Buyers and sellers have perfect information about the market.
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25. In a two-sector economy, the consumption function (C) is equal to 8 + 0.7Y and autonomous
investment is equal to 22. The equilibrium level of income in the economy is Answer >

a. 21
b. 30
c. 43
d. 100
e. None of the above.
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26. Savings function of an economy is S = – 300 + 0.25 Yd. Break-even disposable income for the
Answer >
economy is
a. 75
b. 300
c. 900
d. 1200

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e. 1500.
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27. The difference between additional revenue gained by a firm from selling a unit and the additional
cost incurred for producing the unit is Answer >

a. Average profit
b. Average revenue
c. Marginal profit
d. Marginal revenue
e. None of the above.
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28. For a consumer in equilibrium, Marginal Rate of Substitution of good X for good Y (MRSxy) is 3.
If price of the good X (Px) is Rs.75, price of the good Y (Py) is Answer >
a. Zero
b. Rs. 25
c. Rs. 75
d. Rs.150
e. None of the above.
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29. To produce good X, two inputs L and K are used. If Marginal Rate of Technical Substitution
(MRTSLK) remains constant, shape of the Isoquant for the product X is Answer >

a. Concave to origin
b. Convex to origin
c. Straight line with negative slope
d. Straight line with positive slope
e. L-shaped.
<
30. Which of the following price indices is/are most widely used for determining the inflation in India?
Answer >
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.

END OF PART A

Part B : Problems/Caselets (50 Points)


This part consists of questions with serial number 1 – 6.
Answer all questions.
Points are indicated against each question.
Detailed workings should form part of your answer.
Do not spend more than 110 - 120 minutes on Part B.
1. Kiran Lightning Limited (KLL) is currently employing 150 unskilled workers, 100 factory technicians, 50
machinists and 60 electricians. KLL has estimated the marginal product of various categories of labor to be as
follows:

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Category of labor Marginal Product of the last unit of labor


Unskilled workers 800 lights per week
Factory technicians 900 lights per week
Machinists 1100 lights per week
Electricians 1200 lights per week
Unskilled workers are paid Rs.400 as wages per week. Factory technicians are paid Rs.600 per week,
Machinists are paid Rs.700 per week and Electricians are paid Rs.800 per week as wages.
Required:
a. Explain whether KLL is using the optimum combination of labor or not.
b. What would you suggest KLL to minimize the total cost of production for the current level of output.
(4 + 1 = 5 points) < Answer >
2. Alpine Juices Ltd. sells packaged (Tetra pack) juices in New Delhi.The demand function for apple juice is
estimated to be
Q = 7500 – 1500PA + 3.5Y + 150PC + 10AA
Where
Q = Number of packs demanded for Alpine
PA = Price of one packet of apple juice charged by Alpine
PC = Price charged by a competitor for one pack of apple juice
Y = Per capita income of the consumer in New Delhi
AA = Number of advertising messages displayed by Alpine.
Assume that the current price charged by Alpine for each pack is Rs.2.5, the price charged by the competitor
is Rs.3 per pack and the per capita income of the consumer is Rs.3000. At present, Alpine is displaying 30
advertising messages in the local network.
Required:
a. Compute the price, income and promotional elasticities of demand for apple juice sold by Alpine
Juices Ltd. at the current values.
b. For the next period the target sales for Alpine is 17250 packets of apple juice. What are the
options available to Alpine to achieve the target sales? Show all your computations.
(6 + 4 = 10 points) < Answer >

3. The following information is extracted from National Income Accounts of a country:

Million Units of
Currency

GDP at factor cost 50,000

NNP at factor cost 47,000

Personal consumption expenditure 25,000

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Gross domestic investment 12,000

Corporate profits (Profit before tax) 10,000

Transfer payments by the government 500

Subsidies 1,000

Net Domestic investment 8,000

Personal tax payments 5,000

Indirect taxes 6,000

Dividends 400
You are required to compute:
a. NDP at market prices
b. Net Factor Income from Abroad
c. Personal Income
d. Personal Savings
(3 + 2 + 2 + 2 = 9 points) < Answer >

4. The following information is available from the balance sheet of the Reserve Bank of India:

Particulars Rs. Crore

Credit to Banking Sector 10,000

Credit to Government 40,000

Government Deposits 500

Other deposits with the RBI 200

Net worth 12,000

Other non-monetary liabilities 600

Credit to commercial sector 250

Net foreign exchange assets 65,000

Other assets 400


Government money in the economy is Rs.1,450 cr. Currency deposit ratio for the economy is estimated to be
0.30. Cash reserve ratio (CRR) imposed by the RBI is 5 percent. You are required to calculate the money supply
in the economy.
(6 points) < Answer >

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Caselet 1
Read the following caselet carefully and answer the following questions:
5. a. Is branding helping Dabor India in differentiating its products? Apart from branding, what are the
other means available to Dabor India to differentiate its products?
b. Dabur India is planning to promote the key brands by devoting more resources. How does
branding and advertising affect the cost functions of Dabor India? Explain with suitable diagrams.
(4 + 6 =10 points) < Answer >

Dabur India has decided to merge the family products and healthcare products divisions into one besides identifying
five growth drivers in Vatika, Dabur, Hajmola, Anmol and Real brands to maximize shareholder value.
In the new brand architecture, the company decided to deploy far more resources for the growth of the five key brands -
Dabur, Vatika, Hajmola, Anmol and Real - and back these up with much stronger advertising and larger marketing
spends. As part of focused brand building strategy, Dabur will stress on certain key brands already well established in
the consumer's mind, devising a clear positioning for each.
Thus, Vatika will stand for herbal beauty, Hajmola for tasty digestive, Real for fruit-based drinks, Anmol for value for
money hair care and Dabur for natural health. Besides, Dabur has decided to extend the Vatika brand from hair care
products to personal wash category and this year could see the launch of Vatika soap. Vatika will also be the skin care
brand under which two products will be launched this year.
Besides restructuring the FMCG business, the company has also laid out its plans for the new pharma entity, which
include forging alliances and going aggressive overseas. Dabur Pharma plans to be a major player in the global
Oncology generics business, supplementing its own strengths in this area by entering into key alliances with pharma
majors.
Caselet 2
Read the following caselet carefully and answer the following questions:
6. a. Households are driving the economic growth in America but in Japan they are one of the sources
of economic stagnation. Discuss.
b. Explain how the shift in demography and change in inflation affected the savings of households in
Japan
(5 + 5 = 10 points) < Answer >

The profligacy of American households is legendary: their eagerness to spend and spend has been the main motor of the
American economy in recent years. The Japanese, in contrast, are renowned for their thrift. It is often claimed that one
reason for the country's economic stagnation is that consumers, fearful of deflation and unemployment, insist on
keeping their wallets firmly shut. Yet it is a myth. Although in the early 1980s Japanese households were among the
world's champion savers, they are so no longer. Indeed, their saving rate is now roughly the same as that of spendthrift
Americans.
Recently revised figures show that Japanese household saving fell from 23% of personal disposable income in 1975 to
14% in 1990, and then to 6.9% in 2001 (the latest official figure). Osamu Tanaka, an economist at Morgan Stanley,
thinks the ratio fell to 4% last year and to a piffling 2% in the first quarter of 2003. If so, Japan's household saving rate
is now below America's (at present 3.5%) for the first time in 50 years. It is also well below rates in the euro area,
which are typically above 10%.
Thanks to the decline in saving, Japanese consumer spending has outpaced the growth in incomes. Over the past couple
of years it has continued to rise even as incomes have shrunk. Such a sharp fall in saving seems puzzling: a popular

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argument has it that deflation causes people to put off buying things in the expectation that they will be able to get them
more cheaply next year. In addition, Japanese households have suffered from a slump in asset prices, and thus a loss of
wealth. So they should be saving more to rebuild their nesteggs. And there is a third reason why you might have
expected higher, not lower, household saving in Japan: the big increase in government borrowing in the past decade.
According to a theory known as Ricardian equivalence, households should now be anticipating higher future taxes to
repay the extra government debt, by saving more today. Yet ordinary Japanese are saving less.
A study by Peter Morgan, an economist at HSBC, finds that the demographic shift can explain half of the fall in Japan's
saving rate over the 20 years to 2000. The ratio of Japanese aged over 65 to those of working age rose from 15% in
1980 to 28% in 2000. It is forecast to increase to 38% by 2010 and to 50% by 2020. Much of the rest of the decline may
be related to fall in the inflation.

END OF PART B

Part C : Applied Theory (20 Points)


This part consists of questions with serial number 7 - 8.
Answer all questions.
Points are indicated against each question.
Do not spend more than 25 -30 minutes on Part C.

7. In a frenzied bid to cash in on the great Indian retail boom, developers in the two southern cities of
Bangalore and Hyderabad are building huge shopping spaces. Many are crying foul saying that there will be a glut
in the shopping malls and retail space in 12-24 months. Illustrate, with supply and demand curves, how a glut
(excess supply) could happen and what would be the impact on the price and quantity demanded.
(10 points) < Answer >
8. “Inflation is estimated to hover around 4.5-5.0 percent this fiscal. Combined with the encouraging corporate
results, a remarkable buoyancy in the export growth and the appreciating rupee, India’s macroeconomic
fundamentals never looked better”, feels the finance minister. Explain inflation and discuss the sources of inflation.
(10 points) < Answer >

END OF PART C

END OF QUESTION PAPER

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Economics (MB141) : October 2003

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Part A : Basic Concepts


1. Answer : (d) <
TOP >
Reason : (a) True. Under first-degree price discrimination, the monopolist charges the
maximum possible price for each unit of output. That is, the consumer actually pays the price what he
is willing to pay. Hence, the monopolist would extract the entire consumer’s surplus.
(b) True. Since each unit is charged the maximum possible price, price for each unit will be different.
(c) True. As the monopolist is extracting the entire consumer surplus, profit of the discriminating
monopolist would be more than the monopolist charging a single price.
(d) False. Since each unit is charged the maximum possible price, price for each unit will be different
and subsequent units are charged less and less price.
(e) True. Under first-degree price discrimination, the monopolist charges the maximum possible
price for each unit of output. Hence it is also called perfect price discrimination.
2. Answer : (d) <
TOP >
Reason : Intermediate goods are those goods that are meant for resale, further processing, or
manufacturing. The value of the intermediate good is included in the value of final good.
a. The tyres sold to Hero Cycles Ltd. are used as components of Hero cycles and
hence are intermediate goods.
b. Fertilizers bought by a vegetable cultivator are used for production and hence
constitute intermediate goods.
c. Art paper purchased by a painter is for the purpose of painting. The value of the
art paper will be included in the price of painter’s masterpiece. Hence, an art paper purchased by the
painter is an intermediate good.
d. A pack of sweets bought by Mr. Rajesh to celebrate his success with friends is
for his final consumption and hence is a final good.
e. Aviation fuel sold to Air India is an intermediate good since it is an input in
providing air service.
3. Answer : (a) <
TOP >
Reason : When the CRR is reduced to 4.5% from 4.75%, the money supply in the economy
increases with the increase in the value of money multiplier. Higher money supply lowers the interest
rates in the economy. Lower interest rate in turn encourages investment and consumption in the
economy. As consumption and investment are part of aggregate demand, aggregate demand increases
with the reduction of CRR. When aggregate demand increases, the real GDP and price levels increase in
the economy.
Therefore, change in the CRR → change in money supply → change in nominal
interest rate → change in consumption and investment → change in aggregate demand → change in
real GDP and price level.
4. Answer : (c) <
TOP >
Reason : A production possibility curve indicates the various combinations of two classes of
goods that an economy can produce when its resources are fully employed. An upward shift in the PPF

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takes place when the ability of the countries to produce the goods increases. Country A has only made a
gross investment equal to its depreciation. That means, there is no net investment in the country. Hence,
the productive capacity of country A remains same even after 10 years. Country B has spent most of its
income for consumption. As there is no investment its capital stock erodes and PPF shifts towards left
as time progresses. And hence, countries that invest heavily will have higher investment and
consumption in the future. Thus, country C would have a higher PPF.
5. Answer : (d) <
TOP >
Reason : A depression is immediate followed by recovery.
a. During recovery unemployment rate decreases because of picking up of economy activity.
b. Depression is immediately followed by recovery and not recession.
c. Only during boom there will be rapid increase in wages because of high business activity.
d. It is true that during recovery the cost of production will gradually increase because of gradual
increase in wages.
e. Production will increase moderately during recovery.
6. Answer : (b) <
TOP >
Reason : The value of price index in base year is 100. A country is said to be facing inflation
when the price index increases from the base year. Thus, a country having a price index of more than
100 is said to be facing inflation.
7. Answer : (c) <
TOP >
Reason : Loans are a form of credit, and as they can be used to purchase goods and services they
are the equivalent of money. Banks through the ‘process of credit creation’ creates the money. The
process of credit creation is done by accepting deposits and lending loans.
8. Answer : (c) <
TOP >
Reason : a. Price elasticity of demand is infinitely elastic in perfect competition because of
presence of homogenous goods.
b. Because of presence of closely substitutable goods in the monopolistic market, the price
elasticity of demand for a good would be higher when compared to that of monopoly.
c. In monopoly market, there is only one single seller and one good. Hence, the price elasticity of
demand would be least.
d. & e. In oligopoly market, there will be homogenous goods or closely substitutable goods. Hence the
price elasticity of demand would be higher than in monopoly.
9. Answer : (b) <
TOP >
Reason : a. GNPMP is the total market value of the final goods and services produced in a
given period by factors of production owned by the citizens of a country.
b. GDPMP is defined as the total market value of all the final goods and services produced in a
given period by factors of production located within a country
c. NNPMP is GNPMP – depreciation
d. GNPFC is the total value of the final goods and services produced in a given period by factors of
production owned by the citizens of a country and valued at factor cost.

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e. GDPFC is the total market value of the final goods and services produced in a given period by
factors of production located within a country and valued at factor cost.
10. Answer : (b) <
TOP >
Reason : Transfer payments are money payments which are not associated with any current
production activity on the part of income receives.
11. Answer : (d) <
TOP >
Reason : M1 (narrow money) = Currency with public + Demand deposits with banks + Demand
portion of savings deposits with banks + other deposits with RBI
M2 = M1 + Post Office Savings Deposits
M3 (broad money) = M1 + Time deposits with banks
Thus, the difference between broad money (M3) and narrow money (M1) is the time
deposits with banks.
12. Answer : (a) <
TOP >
Reason : The economic process in an economy can be expressed in the form of a circular flow of
incomes and spending between the households and firms. In a two-sector economy, i.e. where there is
no government role, households provide firms with factors of production and receive factor prices from
firms. That means, households are the suppliers of factors of production and recipients of income.
13. Answer : (d) <
TOP >
Reason : Personal income is the income that is received by the individuals before paying
personal taxes. Personal income comprises of three components - personal saving, personal
consumption and personal income taxes. Corporate profits consist of dividends, undistributed profits
and corporate taxes. Personal income only includes dividends they are distributed to individuals, while
undistributed profits and corporate taxes are not given to individuals. Retained earnings are nothing but
the undistributed profits of businesses and hence are not included in the personal income.
14. Answer : (c) <
TOP >
Reason : If any firm earns more than normal profits, new firms will enter the industry in the long
run, leading to fall in good prices. This decline in the price reduces the volume of profits of the existing
firms. This process continues till all existing firms earn only normal profits. On the contrary, when
existing firms get losses, some of the firms leave the industry. This increases the price of good. This
process continues till the existing firms get normal profits.
(a) Product homogeneity in the industry ensures equal price for the good in the industry, but it does
not result in normal profits.
(b) Presence of large number of sellers and buyers in the industry does not allow individual buyer or
seller, however large, to influence the price by changing the purchase or output.
(c) Free entry and exit of firms in an industry ensures normal profits in the long run as higher profits
increases the entry of new firms, while losses make existing firms to move out of the industry.
(d) As (a) and (b) are not the answers, (d) cannot be the answer.
(e) As (b) is not the answer, (e) cannot be the answer.
15. Answer : (a) <

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TOP >
Reason : When the government levies a specific tax, buyers and sellers share the burden
depending on the price elasticities of demand and supply. The tax burden will be more on those who are
lesser sensitive to price changes. If cigarette companies pass much of the new tax on the consumers in
the form of higher prices, it implies that the demand for cigarettes is comparatively lesser elastic than
supply. The demand for cigarettes cannot be perfectly inelastic as part of the tax (although less) is borne
by the sellers.
16. Answer : (d) <
TOP >
Reason : Explicit costs refer to those costs that are made out-of-pocket and are recorded in
accounting books. Salaries paid to workers, medical expenses of an employee, advertisement expenses
and telephone bills are all out-of-pocket costs and are entered in the books of accounts. The amount
forgone by the firm’s owner by not working at another job represents the opportunity cost (implicit
cost) and hence is the answer. Note that the opportunity cost is the highest valued benefit that must be
sacrificed as a result of choosing an alternative.
17. Answer : (b) <
TOP >
Reason : When a rice miller can sell as much rice as he wants in the market at the current price;
which indicates that the market is a perfectly competitive market. The demand curve of any firm
operating in a perfectly competitive market is horizontal at the market price because of perfectly elastic
price demand. For a horizontal straight line, the slope would be zero. Hence (b) is correct.
18. Answer : (c) <
TOP >
Reason : In economics, cost includes opportunity costs. A normal return to management or
capital is the minimum payment necessary to keep those resources from moving to some other firm or
industry. Thus, economic cost includes a normal rate of profit. The term economic profit refers to profit
in excess of these normal returns. Thus, a firm earning normal profits represents that the firm is getting
zero economic profits but not zero accounting profits.
(a) A firm earning zero economic profit (= normal profits) generally would show a positive profit on
the income statement prepared by its accountants. This is because the normal returns to entrepreneurial
skill and capital supplied by the owners are not considered while computing accounting costs.
(b) MR = MC represents only profit maximizing condition of a firm and is not related to normal
profits.
(c) Zero economic profits signify that the firm is earning only normal rate of return (= normal
profits).
(d) A normal return to management or capital is the minimum payment necessary to keep those
resources from moving to some other firm or industry. Thus, the firm is having positive opportunity
cost.
(e) As (b) is not correct, (e) is not the answer.
19. Answer : (d) <
TOP >
Reason : Out-of-pocket (explicit) costs, indirect costs, private costs and fixed costs are all
recorded in the books of accounts of the company as payments are made to outsiders who supply labor
services, materials, power, transportation, etc. Implicit costs are not entered in the books of accounts,
which include costs of self-owned, self-employed resources and time cost, etc.
(a) Out-of-pocket (explicit) costs are those costs that require payment of money to outsiders. All out-

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of-pocket costs are entered in the books of accounts of a company.


(b) Indirect costs: The costs/expenses that cannot easily and accurately be separated and attributed to
individual units of production, except on arbitrary basis are called indirect costs. Although they are
indirect, they are recorded in the books since payment is made.
(c) Private costs are those that accrue directly to the individuals/firms engaged in a business activity.
All private costs excluding implicit costs are recorded in the books.
(d) Implicit costs: include costs of self-owned, self-employed resources and time costs. They are not
recorded in the books because no payment is made towards these costs.
(e) Fixed costs are explicit in nature and are recorded in the books.
Hence, (d) is the answer.
20. Answer : (e) <
TOP >
Reason : An expansionary monetary policy → increase in money supply → decrease in interest
rate → increase in consumption and investment → increase in aggregate demand → increase in output
and employment level → increase in price level.
When money supply is increased, the aggregate demand increases that in turn lead to
demand pull inflation. When inflation is anticipated, labors may demand higher wages, which may
result in wage push inflation. Supply stock inflation happens when there is a sudden drop in the supply
of goods and services because of varied reasons. An expansionary monetary policy does not cause
supply shock inflation
Hence the correct answer is (e).
21. Answer : (e) <
TOP >
Reason : (a) Normally, marginal cost falls initially, reaches a minimum and then gradually
increases after some point with the increase of output.
(b) Average variable cost falls initially, reaches a minimum and then gradually increases after some
point with the increase of output.
(c) As TFC remains constant, AFC falls continuously with the increase in output.
(d) Total variable costs increases with increase of output.
(e) The correct answer (e) because none of the above remains constant with the increase of quantity
of output.
22. Answer : (a) <
TOP >
Reason : Perfect competition refers to a market where there are large number of sellers and
buyers. There should be free exit and entry in the market should be. As this is possible only in
sugarcane cultivation, the answer is (a).
23. Answer : (c) <
TOP >
Reason : Diseconomies of scale refer to the forces causing the average cost of production to
increase as the output increases. Therefore the answer is (c).
24. Answer : (b) <
TOP >
Reason : (a) True. In perfect competition there are many sellers and buyers

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(b) Not true. In perfect competition firms do not have any price making power as there are many
sellers and the product is homogeneous.
(c) True. In perfect competition product sold by all the firms is assumed to be homogeneous.
(d) True. In perfect competition entry and exit of firms is free.
(e) True. In perfect competition buyers and sellers have access unlimited information which is
available free of cost.
25. Answer : (d) <
TOP >
Reason : C = 8 + 0.7Y
S = –8 + 0.3Y
At equilibrium, S = I
–8 + 0.3Y = 22
0.3Y = 30
∴ Y = 100
26. Answer : (d) <
TOP >
Reason : At break-even level of disposable income, savings are zero.
∴ S = –300 + 0.25Yd = 0
0.25 Yd = 300
Yd = = 1200.
27. Answer : (c) <
TOP >
Reason : The difference between marginal revenue gained by a firm and the marginal cost
incurred for producing the good indicates the additional profit the firm has gained by selling one
additional unit; which is known as marginal profit.
a. Net revenue = Total revenue – Total cost = Profits. Hence is not the correct answer.
b. Average revenue = Total revenue/Quantity sold.
c. Marginal profit = Marginal revenue – marginal cost
d. Marginal revenue = change in total revenue/change in units sold.
28. Answer : (b) <
TOP >
Reason : When the consumer is in equilibrium,
=
∴3 =
Py = 25.
29. Answer : (c) <
TOP >
Reason : Slope of the isoquant at any point is its MRTSLK. If MRTSLK is constant, the resulting
isoquant is a straight line. And isoquants are negatively sloped.
(a) If isoquant is concave to the origin, MRTSLK is increasing. Hence (a) is not the answer.
(b) If isoquant is convex to the origin, MRTSLK is decreasing. Hence (b) is not the answer.

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(c) As the isoquant is a straight line with negative slope, this indicates a constant MRTSLK.
Hence (c) is the answer.
(d) Is not the answer though the isoquant is a straight line as it is positively sloped.
(e) If two inputs are used in a fixed proportion, the isoquant is L-shaped.
30. Answer : (a) <
TOP >
Reason : WPI is the most widely used price index in India as it is available for most
commodities. 435commodities are covered in this. CPI on the other hand reflects the cost of living of a
particular group in the population. These groups are industrial workers, urban, non-rural employees and
agricultural labor. Though GDP deflator is a better index for inflation, it is available with a time lag of
about one year.

Part B: Problems
1. a. The inputs level will be optimum when MPi/Pi = MPj/Pj
Where MP is the marginal productivity of the factor input and P is price of the factor.
For KLL,
Category of labor MP (lights per week) Price (Rs.) MP/P
Unskilled workers 800 400 2.00
Factory technicians 900 600 1.50
Machinists 1100 700 1.57
Electricians 1200 800 1.50
For KLL the current level of labor input is not optimal as marginal output per rupee spent on unskilled
workers is more than other categories of labor.
b. For the current level of output cost can be minimized by employing more of unskilled workers and
machinists and employing less of factory technicians and electricians.
< TOP >
2. The demand function is Q = 7500 – 1500PA + 3.5Y + 150PC + 10 AA
At the current values, the quantity demanded is:
= 7500 – 1500(2.5) + 3.5(3000) + 150(3) + 10(30)
= 15000 packets.
Price elasticity of demand =
From the given demand function = –1500

Therefore, price elasticity of demand = –1500 × 2.5/15000


= – 0.25
Income elasticity of demand =
Where = 3.5 (from the given demand function)
Therefore, income elasticity of demand = 3.5 × 3000/15000 = 0.7
Promotional elasticity of demand =

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Where = 10
Therefore, promotional elasticity of demand = 10 × = 0.02
Option 1: Alpine can increase its sales by reducing the price.
Therefore, the new price should be equal to
17250 = 7500 –1500PA +3.5(3000) + 150(3) + 10(30)
17250 = 18750 – 1500PA
1500PA = 1500
PA = 1
Option 2 : Alpine can increase its sales by increasing promotional campaigns.
17250 = 7500 –1500(2.5) +3.5(3000) + 150(3) +10AA
17250 = 14700 + 10AA
AE = 255
< TOP >
3. a. NDPMP = GDPFC - Depreciation + Indirect Taxes - Subsidies
Depreciation = Gross domestic investment – Net domestic investment
= 12,000 – 8,000
= 4,000 MUC.
∴ NDPMP = 50,000 – 4,000+6,000 – 1,000
= 51,000 MUC.
b. NFIA = NNPMP – NDPMP
NNPMP = NNPFC + Indirect Taxes – Subsidies
= 47,000 + 6,000– 1000
= 52,000 MUC.
∴ NFIA = 52,000– 51,000
= 1,000 MUC.
c. Personal Income (PI) = NI – Corporate profit + Dividends + Transfer Payments
= 47,000 – 10,000 + 400 + 500
= 37,900 MUC.
d. Personal Savings = Personal Disposable Income (PDI)–Personal consumption expenditure
PDI = PI – Personal tax payments
= 37,900 – 5,000
= 32,900 MUC
∴ Personal savings (PS) = 32,900– 25,000
= 7,900 MUC.
< TOP >
4. High powered money = Monetary Liabilities of RBI + Government Money
Monetary liabilities of RBI = Financial Assets + Other Assets – Non-monetary liabilities

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Financial Assets = Credit to Government + Credit to


Banks + Credit to commercial sector + Net Foreign exchange assets
= 40,000 + 10,000 + 250+ 65,000
= Rs.1,15,250 crore
Other Assets = Rs.400 crore
Non-monetary liabilities = Government deposits + other non-
monetary liabilities + Net worth
= 500 + 600 + 12,000 = Rs.13,100
Crore
∴Monetary liabilities = 1,15,250 + 400 – 13,100= Rs.1,02,550
crore
Government money = 1,450
∴High powered money (H) = 1,02,550 + 1,450 = Rs.1,04,000 crore
Money supply (Ms) = H´m
Money multiplier (m) =
= = = 3.714
∴Money Supply
in the economy = 1,04,000 ´ 3.714
= Rs.3,86,256 crore.
< TOP >
5. a. Branding is one of the important means of differentiating a product. All the five brands in
Dabur’s straddle are household names in India. In fact the fast moving consumer goods industry is dominated
by brands, which is the most important differentiator in the industry. Dabur has also been effective in
associating brands with a theme like Vatika standing for herbal beauty.
Dabur can differentiate its products by improving the quality of its products or improving the services
associated with its products or providing its products at more convenient locations.
b. By altering characteristics of differentiated products, it is possible to produce a vast array of variations
on the general theme of that product. This is called brand proliferation. Advertising performs the useful
functions of informing buyers about their alternatives, thereby making markets work more smoothly.
Product differentiation is the unique characteristic of monopolistically competitive market as Dabur India is
facing. Dabur India is characterized by brand names continual product development and improvement. This
long-standing image allows the company to charge significantly higher prices for his product than those
charged for the rival brands.
Advertising and other costs incurred to sell more of a product without reducing its price must be added to
production costs to compute average cost of a product. Selling costs increase average cost and contribute to
higher prices.
Selling costs are costs incurred by a firm to influence the sales of its product. These cost include advertising
expenses, expenses for sales personnel, and other promotional expenses. When selling costs are added to
production costs, they increase the average cost of making goods available. This can be shown with the help
of a diagram.

Large advertising increases the average cost from AC0 to AC1.

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As a result of branding and advertising Dabur India produces more than it would otherwise. This reduces the
excess capacity. However it doesn’t benefit consumers because the price doesn’t fall to reflect the lower
average costs of production. Instead selling costs are added to production costs, resulting in the overall
increase in average cost.
< TOP >
6. a. Spending by the households (consumption expenditure) is an important component in any
economy. As equilibrium output in an economy (Y) is equal to aggregate demand (C+I+G+NX), changes in
any components of the aggregate demand would lead to multiple changes in the output (multiplier effect).
In both the economies, America and Japan, consumption expenditure is more than 50 percent of the GDP.
Americans with their high marginal propensity to consume kept the aggregate demand in the economy at a
high level thereby driving the economy to a higher growth path. Japanese, on the other hand had very high
marginal propensity to save, which kept the aggregate demand at a lower level leading to economic
stagnation.
b. One explanation for the fall in saving over the past two decades lies in a theory called the life-cycle
hypothesis. This supposes that during their working years individuals spend less than they earn, and thus
accumulate wealth, which they plan to draw on once they retire. So the more retired people there are in
relation to the number of workers, the lower the saving rate will be. The ratio of Japanese aged over 65 to
those of working age rose from 15% in 1980 to 28% in 2000. As this ratio increases, household savings in
the economy decline.
In Japan, when inflation soared in the 1970s, the erosion of the real value of wealth prompted households to save
more to rebuild their assets. As inflation fell, they needed to save less to maintain their real wealth. Therefore, as
inflation falls household savings may decrease.
< TOP >

Part C: Applied Theory

7. Hoping for a great demand for shopping spaces, the developers in the cities of Bangalore and Hyderabad are
building more number of shopping malls. It results in an increase in the supply of shopping spaces. When the total
supply is greater than the total demand, it leads to excess supply or glut.
If the demand for shopping space remains the same, when there is an increase in the supply, it leads the
equilibrium price of shopping space to fall and the equilibrium quantity to rise. This can be explained with the
help of demand and supply curves. If the supply curve shifts to the right, the demand curve remaining the same,
the equilibrium price will fall and the equilibrium quantity will rise. This is shown in the figure:

In this figure, D0D0 is the initial demand curve for shopping space and S0S0 is the initial supply curve of shopping
space. They intersect at the point E0 where the initial equilibrium price is OP0 and the initial equilibrium quantity
is equal to OQ0. Suppose that the demand curve remains the same, but the supply shifts to the right to the new
position S1S1.At the price OP0, the sellers want to supply OQ2 amount of shopping space but the buyers demand
OQ0. So there is an excess supply of Q0Q2 in the market. It leads the equilibrium price to fall from P0 to P1 and
equilibrium quantity rises from Q0 to Q1.
< TOP >
8. Inflation is an increase in the general level of prices in an economy that is sustained over a period of time.

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The inflation rate is used to measure the rate of change in the overall price level of goods and services that we
typically consume.
Sources of inflation:
The price level generally increases when the aggregate demand for goods and services exceeds aggregate supply.
If such a situation persists for a long period of time, it leads to inflation. In other words, we can say that demand-
pull factors create inflation in an economy. This is called demand-pull inflation. The main factors of demand pull
inflation can be summarized as increase in money supply, the government budget deficit, etc.
Inflation can also be caused by cost-push factors. When the cost of factors of production increases, the producers
or manufacturers that supply the goods and services reduce the supply. The aggregate demand for the goods and
services however remains the same. There is one major difference between demand-pull and cost-push inflation:
in demand inflation, the unemployment level remains at the minimum; in cost-push inflation, the unemployment
level increases to the maximum.
Demand-pull inflation
According to demand-pull inflation, the general rise in price level is because the demand for goods and services
exceeds the supply available at existing prices. In terms of AD-AS framework, the rightward shift in the AD curve
means an excess demand for goods and services at existing prices.
In figure 1, the AD increases to Y1 from Y0 because of the shift in the AD0 curve AD1.But at the price level P0 ,
the AS is Y0.Therefore, the excess demand is Y1– Y0.To eliminate the excess demand, the price level increases to
P1, where AD and AS are equal at Y2.

Figure 1
The factors causing a shift in the AD can be classified into real and monetary factors. Among the real factors are
fiscal actions like changes in the government spending and taxes. Among the monetary factors are changes in
money supply.
The real factors: The real factors which can cause a right ward shift in an AD curve are – an increase in the
government expenditure with no change in tax receipts, a decrease in the tax receipts with no increase in the
government spending, a rightward shift in the consumption function, investment function and export function.
The monetary factors: On the monetary side, demand-pull inflation may originate either through a decrease in the
demand for money or an increase in supply of money. A decrease in the demand for money or an increase in the
supply of money causes a rightward shift in the AD curve. In reality, a decrease in the demand of money is not
likely to originate inflation, but it is almost certain to intensify an ongoing inflation that has reached a rapid rate.
The greater the rate of inflation the costlier it becomes to hold money and smaller the amount of real balances the
public will want to hold at any level of real income and interest rate.
Cost Push Inflation
Cost-push theory of inflation explains the causes of inflation originating from the supply side.
In figure 2, when AS curve shifts leftward from AS0 to AS1, the price level increases from P0 to P1.
Figure 2

In cost push inflation theory, the causes for the leftward shift in the AS curve are identified as an increase in the
wage level not matched by the increase in the labor productivity, or an increase in the profit margins by those who
can exercise market power. Depending on the causes, there are three types of cost push inflation: wage- push
inflation, profit- push inflation and supply- shock inflation.
Wage push inflation occurs when trade unions demand an increase in the increase in the money wage at a rate that
is greater than the increase in productivity. This causes an increase in the labor cost per unit of output, and forces

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the producer to increase the price to cover the increased costs. This increase in price will lead to a higher cost of
living a fall in real wages. Again, workers will ask for a pay hike due to the fall in real wages. Wage push inflation
happens when a rise in the wage rate is accompanied by a rise in the price level.
Oligopolists and monopolists may, in their drive to increase profits, increase their prices more than the increase in
their costs. This is possible only in imperfect markets. Possibilities for this type of inflation are greater when the
prices of goods and services are administers by sellers.
Supply shock inflation arises from an increase in the cost of raw materials or shortages that occur as a result of
natural calamities like drought, flood, disease etc. Supply shocks lead to a drastic reduction in the supply of goods
and services.
< TOP >

< TOP OF THE DOCUMENT >

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