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Question Paper

Economics (CFA520): October 2007

Answer all questions.


Marks are indicated against each question.

1. The demand for most products varies directly with the change in consumer income. Such products are
known as
(a)
(b)
(c)
(d)
(e)

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Normal goods
Prestigious goods
Complementary goods
Inferior goods
Substitute goods.
(1 mark)
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2. The situation of market equilibrium occurs when


(a)
(b)
(c)
(d)
(e)

Demand for the goods is greater than supply of the goods


Quantity demanded for the goods equals quantity supplied of the goods
The price, sellers ask for the goods is less than the price consumers pay of those goods
There exist a shortage of the supply of the goods
Demand for the goods is less than supply of the goods.
(1 mark)

3. Essexx Design Inc. produces very costly and attractive sports watches. Now Sofex Inc. introduced a
stylish sports watch in the market. The watches of Essexx Design Inc. and Sofex Inc. are considered to
be perfect substitutes. The cross elasticity of demand between these watches is
(a)
(b)
(c)
(d)
(e)

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Infinity
Positive, less than infinity
Zero
Less than zero
One.
(1 mark)
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4. Which of the following does not cause a shift in the demand curve?
(a)
(b)
(c)
(d)
(e)

Change in the price of the good


Change in the income of the buyers
Change in the personal preferences
Change in the price of the related goods
Change in the consumer patterns.
(1 mark)
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5. The demand and supply functions of a commodity are estimated as


Qd = 100 P
Qs = 20 + 3P
The equilibrium price and quantity of the good are
(a)
(b)
(c)
(d)
(e)

Rs.60 and 40 units respectively


Rs.40 and 60 units respectively
Rs.50 and 50 units respectively
Rs.30 and 70 units respectively
Rs.70 and 30 units respectively.
(1 mark)

6. Current demand for apples in a city is 1,000 boxes per week. In the city, price elasticity of demand for
apples is 1.25 and income elasticity of demand is 2.00. For the next period, if per capita income is

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expected to increase by 7% and price of apples is expected to increase by 10%, demand for apples is
expected to be
(a)
(b)
(c)
(d)
(e)

875 boxes per week


1,000 boxes per week
1,250 boxes per week
1,140 boxes per week
1,015 boxes per week.
(2 marks)
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7. The falling part of a total utility curve indicates


(a)
(b)
(c)
(d)
(e)

Increasing marginal utility


Decreasing marginal utility
Zero marginal utility
Negative marginal utility
Indeterminate marginal utility.
(1 mark)

8. The difference between the price an individual is willing to pay and the price he or she actually pays is
(a)
(b)
(c)
(d)
(e)

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Producer cost
Monopolist profit
Economic profit
Producer surplus
Consumer surplus.
(1 mark)

9. Marginal utilities of goods A and B are 500 utils and 1,000 utils respectively. The price of good B is
Rs.200. If the consumer is in equilibrium, the price of good A is
(a)
(b)
(c)
(d)
(e)

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Rs. 60
Rs. 70
Rs. 80
Rs. 90
Rs.100.
(1 mark)

10. If the average product of labor (APL) is 30L


(a)
(b)
(c)
(d)
(e)

L2,

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the maximum possible total product (TPL) is

2,000 units
4,000 units
6,000 units
8,000 units
12,000 units.
(2 marks)

11. Average productivity of labor for a firm is 50 when labor employed is 100 units. When labor employed
is increased to 104 units, average productivity of labor declines to 48 units. At current input level the
marginal productivity of labor is
(a)
(b)
(c)
(d)
(e)

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1 unit
2 units
1 unit
2 units
5 units.
(1 mark)

12. Production function for a firm is Q = 100L 0.1L2. If 10 units of labor are used, average productivity of
labor is
(a)
(b)
(c)
(d)

90 units
99 units
100 units
200 units

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(e)

220 units.
(1 mark)
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13. Which of the following represents the Marginal Rate of Technical Substitution (MRTS)?
(a)
(b)
(c)
(d)
(e)

Slope of the isocost curve


Slope of the indifference curve
Slope of the isoquant curve
Slope of the budget line
Slope of the average cost curve.
(1 mark)
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14. Maximum point on the average product curve is reached when


(a)
(b)
(c)
(d)
(e)

Marginal product is zero


Marginal product is maximum
Marginal product is minimum
Marginal product is negative
Marginal product equals average product.
(1 mark)
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15. The point beyond which no rational firm would employ labor is
(a)
(b)
(c)
(d)
(e)

When the average product of labor is equal to marginal product of labor


When the marginal product of labor is maximum
When the marginal product of labor is zero
When the total product of labor is zero
When the average product of labor is zero.
(1 mark)

16. If the total cost function is TC = 200 4Q + 6Q2 and the output is 4 units, the marginal cost is
(a)
(b)
(c)
(d)
(e)

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Rs.24
Rs.32
Rs.44
Rs.35
Rs.41.
(2 marks)
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17. The cost schedule of a firm is given below:


Output (units)
1
2
3
4
5

Total Fixed Cost (Rs.)


100
100
100
100
100

Total Variable Cost (Rs.)


50
150
350
650
1, 050

The average fixed cost of producing 4th unit of output is


(a)
Rs.100
(b)
Rs. 50
(c)
Rs. 20
(d)
Rs. 25
(e)
Rs.500.
(1 mark)
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18. A firm will shut down its operations in the short run if
(a)
(b)
(c)
(d)
(e)

It incur losses
Fixed costs exceed its revenue
Average variable costs exceed its average revenue
Total revenue falls short of total cost
Total fixed cost exceeds its total variable costs.
(1 mark)

19. Mr. Sachin can earn money from various activities. His hourly earnings from cricket is Rs.5,000, acting
Rs.30,000, coaching Rs.10,000 and ceremonies Rs.15,000. The opportunity cost of an hour of coaching
for Sachin is
(a)
(b)
(c)
(d)
(e)

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Rs. 5,000
Rs.10,000
Rs.15,000
Rs.30,000
Rs.40,000.
(1 mark)
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20. Increasing marginal costs with increase of output implies


(a)
(b)
(c)
(d)
(e)

Decreasing average returns


Decreasing average fixed costs
Decreasing average variable costs
Decreasing total costs
Decreasing average costs.
(1 mark)

21. Lixan Imaging is a Mumbai based image digitization company, specializing in digitizing visual
collections. It has developed a project-based model incorporating best practices into the digitization
workflow. The vertical distance between total variable cost and total cost of Lixan Imaging is equal to
(a)
(b)
(c)
(d)
(e)

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Marginal cost
Average variable cost
Total fixed cost
Average fixed cost
Average total cost.
(1 mark)
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22. The total revenue and total cost functions of Nike Shoe Company are
TR = 400Q

TC = 600 +70Q + Q2

What is the profit maximizing output for the firm?


(a)
(b)
(c)
(d)
(e)

100 units
110 units
140 units
180 units
200 units.
(2 marks)

23. Mr. Akash, the manager of The Fast Trak Corp., a shoe manufacturing company develops dozens of
dramatically different methods of making shoes, which decreases the Fast Trak Corp.s variable costs of
producing shoes. The Fast Trak Corp. faces the following average variable cost function:

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AVC = 300 10Q + 0.5Q2


Fixed costs are Rs.150. What is the minimum possible average variable cost?
(a)
(b)
(c)
(d)
(e)

Rs.225
Rs.250
Rs.275
Rs.300
Rs.325.
(2 marks)

24. In perfect competition, the long run equilibrium price is equal to


I.
II.
III.

Marginal Revenue.
Average Cost.
Marginal Cost.

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IV.
(a)
(b)
(c)
(d)
(e)

Average Revenue.
Both (I) and (III) above
(I), (II) and (III) above
(I), (III) and (IV) above
(II), (III) and (IV) above
All (I), (II), (III) and (IV) above.
(1 mark)
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25. The horizontal demand curve for a firm is one of the characteristic features of
(a)
(b)
(c)
(d)
(e)

Oligopoly
Monopoly
Monopolistic competition
Perfect competition
Duopoly.
(1 mark)
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26. In the long run, which of the following is true of a firm in a perfectly competitive industry?
(a)
(b)
(c)
(d)
(e)

It operates at its minimum average cost


The price is more than the average fixed cost
The marginal cost is greater than marginal revenue
The fixed cost is lower than the total variable cost
The price is equal to minimum of average variable cost.
(1 mark)

27. Neelam Pvt. Ltd. is operating in a perfectly competitive industry. If the firm doubles its output during
the year, then
(a)
(b)
(c)
(d)
(e)

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Price of the product falls more than proportionately


Price of the product falls less than proportionately
Price of the product falls proportionately
Price of the product remains same
Price of the product rises.
(1 mark)

28. Which of the following conditions are necessary in the short run equilibrium in monopolistic
competition?
(a)
(b)
(c)
(d)
(e)

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Marginal cost = Marginal revenue


Price = Average total cost
Price = Marginal revenue
Price = Marginal cost
Price = Average fixed cost.
(1 mark)
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29. The following is the cost function of Manish & Co., a sole producer of oil paints.
C = 100 + 20Q
Manish & Co. can segregate the market into two different sub markets A and B. The demand
functions for the two markets are estimated as
PA = 50 QA
PB = 30 0.5QB
The output at which the monopolist makes the maximum profit is
(a)
(b)
(c)
(d)
(e)

50 units
35 units
25 units
40 units
30 units.
(2 marks)

30. Media Soft, a multimedia firm enters a monopolistically competitive market. The demand and cost
function faced by Media Soft are given as

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P = 10,000 20Q
TC = 3,00,000 + 2,197Q 20Q2 + Q3
The short run equilibrium output of the firm is
(a)
(b)
(c)
(d)
(e)

11 units
51 units
61 units
71 units
81 units.
(2 marks)

31. The industry demand function for a product in a duopoly is P = 500 2Q. The reaction functions of the
two firms are as follows:

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Q1 = 380 2Q2
Q2 = 200 Q1
Equilibrium price of the product is
(a)
(b)
(c)
(d)
(e)

Rs.100
Rs.180
Rs.200
Rs.380
Rs.400.
(2 marks)

32. Ring tone, a firm specializing in mobile handsets, faces a monopolistically competitive market. In the
long run, the company will earn only normal profits because of
(a)
(b)
(c)
(d)
(e)

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Advertising outlay incurred for the product


Freedom of entry and exit
Product differentiation
Downward sloping demand curve
Small size of the market.
(1 mark)
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33. If a monopolist faces an upward shift in marginal cost curve, then


(a)
(b)
(c)
(d)
(e)

The price increases and output decreases


Both the price and output will increase
The price decreases and output increases
Both the price and output will decrease
Both the price and output will remain constant.
(1 mark)

34. Which of the following is not a common characteristic of perfect competition and monopolistic
competition?
(a)
(b)
(c)
(d)
(e)

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Large number of sellers


Free entry
Homogeneous product
Large number of buyers
Free exit.
(1 mark)

35. Best Cereals Inc. (BCI) produces and markets Tasties, a popular ready-to-eat breakfast cereal. The
demand and supply functions of Tasties are as follows:
QD = 150 3P
QS = 50 +10P

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If excise tax of Rs.3 is imposed on Tasties, the proportion of tax that will be borne by the consumers is
(a)
(b)
(c)
(d)
(e)

88%
77%
63%
56%
44%.
(2 marks)

36. The total cost function and demand function of a good are estimated to be TC = 100 5Q + 2Q2 and Q
= 100 P respectively. If the current output is 5 units, the average profit is
(a)
(b)
(c)
(d)
(e)

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Rs. 50
Rs. 60
Rs. 65
Rs. 70
Rs.120.
(2 marks)
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37. For a firm, the average cost function is estimated as

AC =

+ 20 + 4Q.

What is total variable cost for the firm at an output of 15 units?


(a)
Rs. 100
(b)
Rs. 750
(c)
Rs.1,200
(d)
Rs.1,300
(e)
Rs.2,100.
(2 marks)
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38. In a perfectly competitive market, the marginal revenue curve


(a)
(b)
(c)
(d)
(e)

Slopes downward
Slopes upward
Is vertical
Is horizontal
Is absent.
(1 mark)
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39. The following data is taken from National Income Accounts of a country:
Particulars
GNP at market prices
Transfer payments
Indirect taxes

173

Personal taxes

203

Consumption of capital

190

Undistributed corporate profits

28

Corporate tax

75

Subsidies

20

Personal income in the country is


(a)
(b)
(c)
(d)
(e)

1,363 MUC
1,121 MUC
1,230 MUC
1,296 MUC
1,496 MUC.

Million Units of Currency


(MUC)
1,700
242

(2 marks)
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40. The following is the information from National Accounts of an economy:


Particulars
Direct taxes
Indirect taxes
Factor income paid abroad
Factor income received from abroad
Depreciation
Subsidies
National income
The GDP at market prices is
(a)
24,800 MUC
(b)
30,200 MUC
(c)
68,400 MUC
(d)
52,350 MUC
(e)
45,600 MUC.

MUC
2,400
11,400
12,000
9,000
12,000
6,000
48,000

(2 marks)
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41. Which of the following statements is true?


(a)
(b)
(c)
(d)
(e)

Net national product at factor cost plus depreciation equals gross national product at market
prices
National income minus corporate profits minus personal taxes plus transfer payments equals
personal income
Personal disposable income minus personal taxes equals personal consumption
Gross domestic product at market prices minus net factor income from abroad equals gross
national product at market prices
Per capita income equals the summation of national income and population.
(1 mark)
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42. Gross domestic product is the market value of


(a)
(b)
(c)
(d)
(e)

All goods and services exchanged in an economy


All goods and services exchanged in an economy during a year
All final goods and services exchanged in an economy during a year
All transactions in an economy during a year
All final goods and services produced in an economy during a year.
(1 mark)
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43. Consumption function for an economy is estimated to be


C = 1,000 + 0.80 Yd
Which of the following is true if Yd is zero?
(a)
(b)
(c)
(d)
(e)

Consumption is zero
Savings are Rs.1,000
Income must be greater than taxes
Dissavings are Rs.1,000
Savings are zero.
(1 mark)

44. In an economy the marginal propensity to consume is 0.70 and marginal propensity to import is 10%.
Assuming that the investment is autonomous and increases by 1,000 MUC during the year, the income
in the economy increases by
(a)
(b)
(c)
(d)
(e)

625 MUC
2,500 MUC
3,000 MUC
4,000 MUC
5,000 MUC.
(2 marks)

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45. The consumption function for a two sector economy is C = 1,800 + 0.5Y and investment is an
autonomous component. If equilibrium income is 4,400 MUC, what is the investment in the economy?
(a)
(b)
(c)
(d)
(e)

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2,600 MUC
200 MUC
400 MUC
2,650 MUC
7,200 MUC.
(1 mark)
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46. The investment multiplier explains the change in national product due to change in
(a)
(b)
(c)
(d)
(e)

Consumption expenditure
Investment expenditure
Government expenditure
Export
Import.
(1 mark)

47. The IS function and LM function in an economy are estimated to be Y = 4,800 + 0.5Y 50i and Y =
4,600+ 400i respectively. The investment function in the economy is 1,600 100i. If the government
spending increases by 200 MUC, which of the following is true about the interest rate in the
economy?
(a)
(b)
(c)
(d)
(e)

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Increases from 10.00% to 10.50%


Increases from 10.00% to 10.25%
Increases from 10.00% to 12.00%
Increases from 10.00% to 15.00%
Increases from 10.00% to 10.80%.
(2 marks)
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48. Which of the following shift the LM curve to the right?


I.
II.
III.

Increase in money supply.


Purchase of bonds by the RBI.
Decrease in the price level.

(a)
(b)
(c)
(d)
(e)

Only (I) above


Only (II) above
Both (I) and (II) above
Both (II) and (III) above
All (I), (II) and (III) above.
(1 mark)

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?
(a)
(b)
(c)
(d)
(e)

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52.5 MUC
55.5 MUC
62.5 MUC
500.0 MUC
100.0 MUC.
(2 marks)
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50. Which of the following is true if the prices of factor inputs increase in an economy?
(a)
(b)
(c)
(d)
(e)

Aggregate supply curve shifts to the left


Aggregate supply curve shifts to the right
Aggregate demand curve shifts to the right
Aggregate demand curve shifts to the left
Both aggregate supply and demand curves remain constant.
(1 mark)

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51. In the short run, if an economy emerges from a recession,


(a)
(b)
(c)
(d)
(e)

Aggregate demand shifts left, the price level decreases and real output decreases
Aggregate demand shifts right, the price level increases and real output increases
Aggregate supply shifts right, the price level decreases and real output increases
Aggregate supply shifts left, the price level increases and real output decreases
Aggregate supply shifts right, the price level increases and real output increases.
(1 mark)

52. The central banks monetary liabilities as on June 30, 2007 stood at 10,500 MUC and Government
money at 1,500 MUC. The currency deposit ratio is estimated to be 0.25. If the Central bank intends to
maintain the money supply at 48,000 MUC, what should be the reserve ratio specified by the Central
bank?
(a)
(b)
(c)
(d)
(e)

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6.25%
8.10%
9.10%
5.00%
4.25%.
(2 marks)
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53. The following are the excerpts from the balance sheet of the Central bank of a country:
Particulars
Notes in circulation
Other deposits
Other non-monetary liabilities
Statutory and contingency reserves
Credit to Central Government
Shares & loans to financial institutions
Central bank claims on Commercial banks
Net foreign exchange assets
Other assets

MUC
900
450
900
3,780
10,080
4,950
3,150
1,350
450

If the government money is 225 MUC, the high powered money in the economy is
(a)
(b)
(c)
(d)
(e)

14,850 MUC
15,750 MUC
16,425 MUC
16,650 MUC
15,525 MUC.
(2 marks)

54. As on March 31, 2007, monetary liabilities of the central bank are 1,200 MUC and government money
is 50 MUC. If the currency deposit ratio is 0.20 and the central bank specifies a reserve ratio of 5%,
money supply in the economy will be
(a)
(b)
(c)
(d)
(e)

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5,000 MUC
5,500 MUC
6,000 MUC
6,550 MUC
6,600 MUC.
(2 marks)
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55. Which of the following does not affect the balance sheet of Reserve Bank of India?
(a)
(b)
(c)
(d)
(e)

Central governments borrowings from RBI


Loan taken by one commercial bank from the other
Refinancing of NABARD loans
Increase in reserves of commercial banks
Increase in net foreign exchange assets.
(1 mark)

56. An important difference between the approaches of the Classical economists and Keynesian economists

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to achieve a macroeconomic equilibrium is that


(a)
(b)
(c)
(d)
(e)

Keynesian economists actively promote the use of fiscal policy while the classical economists do
not
Keynesian economists actively promote the use of monetary policy to improve aggregate
economic performance while classical economists do not
Classical economists believe that monetary policy will certainly affect the level of output while
Keynesians believe that money growth affects only prices
Classical economists believe that fiscal policy is an effective tool for achieving economic
stability while Keynesians do not
Keynesian economists actively promote the use of rational expectations while the classical
economists do not.
(1 mark)
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57. Which of the following is true for a classical aggregate supply curve?
(a)
(b)
(c)
(d)
(e)

Aggregate supply curve is horizontal


Aggregate supply curve is positively related to real output
Aggregate supply curve is negatively related to real output
Aggregate supply curve is unrelated to price level
Aggregate supply curve is rectangular hyperbola.
(1 mark)
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58. According to Keynesian theory, full employment refers to a situation where there is
(a)
(b)
(c)
(d)
(e)

Zero unemployment
Natural rate of unemployment
Least demand for labor
Least supply of labor
Demand for goods which is less than supply.
(1 mark)

59. The Chief Economist to the Government told the Cabinet that the people cannot be influenced if the
government increases its spending during election years, as people will anticipate this kind of behavior
as previous governments used to do so. The economist is an advocate of
(a)
(b)
(c)
(d)
(e)

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Classical economics
Rational expectations
Keynesian economics
Supply-side economics
Monetarism.
(1 mark)
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60. Unemployment that results from the normal workings of the labor market is a combination of
(a)
(b)
(c)
(d)
(e)

Frictional and structural unemployment


Cyclical and structural unemployment
Frictional and cyclical unemployment
Frictional and disguised unemployment
Higher quantity demanded and lower quantity supplied in the labor market.
(1 mark)
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61. Which of the following would you suggest to counter a recession?


(a)
(b)
(c)
(d)
(e)

Decrease in government expenditure


Decrease in transfer payment
Decrease in the discount rate
Decrease in the money supply
Increase in the tax rate.
(1 mark)

62. Which of the following is not a major determinant of economic growth?


(a)
(b)

Tastes and preferences of consumers


Technological advancement

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(c)
(d)
(e)

Natural resources
Physical capital
Human resources.
(1 mark)
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63. Inflation accompanied by a slowing of economic activity is


(a)
(b)
(c)
(d)
(e)

Known as deflation
A result of a stagnant aggregate supply
A result of fiscal stimulus
Known as stagflation
Known as a recession.
(1 mark)
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64. The Phillips curve shows the short run trade off between
(a)
(b)
(c)
(d)
(e)

Inflation and unemployment


Unemployment and output
Inflation and the nominal interest rate
The nominal interest rate and investment
Inflation and output.
(1 mark)
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65. Economic growth is said to have occurred when there is an increase in


(a)
(b)
(c)
(d)
(e)

Interest rate
Aggregate demand
The rate of inflation
Productive capacity
Wage rate.
(1 mark)
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66. Which of the following policy measures is considered as fiscal policy measures?
(a)
(b)
(c)
(d)
(e)

The government cuts taxes or raises spending to get the economy out of a slump
The government changes the quantity of money supplied to affect the price level, interest rates,
and exchange rates
The government stimulates aggregate supply to stimulate the potential growth of output and
income
The government changes the statutory liquidity ratio
The government restricts imports and stimulates exports.
(1 mark)
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67. Expansionary monetary policy affects the goods market because


(a)
(b)
(c)
(d)
(e)

It raises interest rates and leads to lower investment spending


It lowers interest rates and raises investment spending
It leads to an expansionary fiscal policy
It lowers both interest rates and investment spending
It lowers both interest rates and exports.
(1 mark)

68. If the government increased its spending and the Reserve Bank of India increased the money supply,
which of the following would we expect to happen in the short run?
(a)
(b)
(c)
(d)
(e)

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Increases in both output and the price level


A decrease in output and an increase in the price level
Decreases in both output and the price level
Ambiguous changes in both output and the price level
A decrease in price level and an increase in output.
(1 mark)

69. A current account deficit implies that


(a)

There is net debit balance in the merchandise account

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>

(b)
(c)
(d)
(e)

There is net credit balance in the merchandise account


Foreign exchange outflows on account of imports of goods and services and gifts made exceed
inflows on account of exports of goods and services received
Decrease in Foreign Exchange Reserves
Increase in Foreign Exchange Reserves.
(1 mark)

70. Which of the following is true if, for a given period, there is no change in the foreign exchange reserves
of a country?
(a)
(b)
(c)
(d)
(e)

Balance in the current account is equal to the balance in capital account


Surplus (deficit) in the current account is equal to deficit (surplus) in the capital account
Current account balance is zero
Trade balance is zero
Capital account balance is zero.
(1 mark)
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71. In balance of payments statement, short term inflows and outflows of capital are recorded in
(a)
(b)
(c)
(d)
(e)

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Current account
Capital account
Official reserves account
Errors and omissions account
Transfer payments account.
(1 mark)
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72. Who among the following will be benefited most from unanticipated inflation?
I.
Creditors.
II.
Debtors.
III. Retirees earning fixed income.
IV. Employees whose salaries are linked to the consumer price index.
(a)
(b)
(c)
(d)
(e)

Only (I) above


Only (II) above
Both (I) and (II) above
Both (II) and (III) above
Both (III) and (IV) above.
(1 mark)
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73. Which of the following best describes an expansionary fiscal policy?


(a)
(b)
(c)
(d)
(e)

Increase in government spending and increase in money supply


Increase in government spending and decrease in taxes by the same amount
Decrease in government spending and decrease in money supply
Decrease in government spending and increase in taxes
Increase in government spending and increase in taxes.
(1 mark)
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74. In the short run, an increase in the governments budget deficit is most likely to reduce
(a)
(b)
(c)
(d)
(e)

Interest rate
Inflation
The demand for imported goods and services
Unemployment
Money supply.
(1 mark)

75. The following information is available from balance of payments of an economy:


Item
MUC
Trade balance
5,000
Current account balance
2,000
Capital account balance
7,000
The foreign exchange reserves of the country will

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>

(a)
(b)
(c)
(d)
(e)

Decrease by 5,000 MUC


Decrease by 2,000 MUC
Remain unchanged
Increase by 5,000 MUC
Increase by 2,000 MUC.
(2 marks)
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76. Financial assets of the RBI does not include


(a)
(b)
(c)
(d)
(e)

RBIs credit to government


Credit to commercial banks
RBIs credit to commercial sector
Net foreign exchange assets with RBI
Furniture and buildings of RBI.
(1 mark)
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77. The following information is taken from Union Budget for the year 2006:
Rs.
(crore)
Revenue Receipts
Tax Revenue (Net)
Non-tax Revenue
Capital Receipts
Recoveries of Loans
Other Receipts
Borrowings & Other Liabilities
Non-plan Expenditure
On Revenue Account
(Of which, interest payments is Rs.1,17,390 crore)
On Capital Account
Plan Expenditure
On Revenue Account
On Capital Account
The revenue deficit for the year 2006 was
(a)
Rs.95,300 crore
(b)
Rs.95,377 crore
(c)
Rs.90,300 crore
(d)
Rs.94,500 crore
(e)
Rs.97,735 crore.

1,72,965
72,140
17,680
12,000
1,35,524
2,70,169
26,640
70,313
43,187

(2 marks)
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>

78. Consider the following information:


Particulars
Earnings on loans and investments from abroad
Earnings on loans and investments to abroad
Import of services
Private remittances to abroad (transfers)
Private remittances from abroad (transfers)
Exports of services
Merchandize exports
Merchandize imports
The current account balance for the country is
(a)
700 MUC (Surplus)
(b)
700 MUC (Deficit)
(c)
500 MUC (Deficit)
(d)
500 MUC (Surplus)
(e)
Zero.

MUC
500
2,200
4,000
500
500
2,000
15,000
12,000

(2 marks)

Suggested Answers
Economics (CFA520): October 2007
1.

2.

3.

4.

Answer : (a)
Reason : In case of normal goods, a given increase in income results in increase of demand. Normal goods can
be further classified into luxury good or necessary goods based on the value of the income elasticity
of demand. If the value of income elasticity is more than one, it signifies that the good is a luxury
item. Since, the value of the income elasticity of demand is not known; we can classify the good to
be normal goods.
a.
In case of normal goods the quantity demanded increases/decreases with the increase/decrease
in the income levels of the consumers.
b.
In case of necessities, though there would be positive change in the quantity demanded of the
good for a given change in the income, the percentage change in the quantity demanded would
be less than the percentage change in the income. Since, we do not know the value of the
income elasticity of demand; we cannot classify the good as luxury or necessary good.
c.
Complementary goods are those which are jointly used to satisfy a want. Cross elasticity of
demand, and not income elasticity of demand, is used to determine the relationship between the
two goods.
d.
In case of inferior goods percentage change in the quantity demanded is negative with the
change in the income. Hence, (d) is not the correct answer.
e.
In case of Luxury goods, the percentage change in quantity demanded is greater than the
percentage change in the income. Since, we do not know whether the percentage change in
quantity demanded is greater than the percentage change in the income, we cannot classify the
good to be luxury good.
Answer : (b)
Reason : When total quantity demanded in the market equals total quantity supplied, the market is said to be
in equilibrium.
Answer : (a)
Reason : The cross-elasticity of demand between two perfect substitutes is infinity.
Here, the smallest possible increase (decrease) in the price of one good causes an infinitely large
increase (decrease) in the quantity demanded of other good.
Answer : (a)
Reason : Movement of the demand curve implies that the change in the price of the good will lead to change
in the demand for the good. For instance, fall in the price leads to extension in the demand curve.
Similarly increase in the price of good leads to contraction in the demand for the good. A shift in the
demand curve is caused by a change in any non-price determinant of demand. The curve can shift to
the right or left. The factors that are responsible for shift in the demand curve may be listed out as
follows:

Income of the consumers

prices of other goods (substitutes or complements)

a.

Tastes and preferences of consumers.


It is appropriate in this instance because it is not the factor that is responsible for the shift in the
demand curve but it represents the movement along the demand curve.
It is not appropriate in this instance because it is one of the factors that is responsible for shift in
the demand curve.
It is not appropriate in this instance because it is one of the factors that is responsible for shift in
the demand curve.
It is not appropriate in this instance because it is one of the factors that is responsible for shift in
the demand curve.
It is not appropriate in this instance because it is one of the factors that is responsible for shift in
the demand curve. The correct answer is (a).

b.
c.
d.
e.
5.

Answer : (d)
Reason : 100 P = - 20 + 3P

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6.

or P = Rs.30
Q = 100 P = 100 30 = 70 units.
Answer : (e)
Reason : Qd =
1000
ep

1.25

ey

2.00

ed

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1.25 =
% change in Q = 12.5%
ey

2.00 =
% change in Q = 14.00%
Net effect is = 14.00 12.5 = 1.5%
1000 1.5% = 15
7.
8.

9.

Answer :
Reason :
Answer :
Reason :

Answer :

Demand for apple is expected to be = 1000 + 15 = 1015 boxes per week.


(d)
When marginal utility becomes negative, it implies that the total utility has start diminishing
(e)
Consumer surplus is the difference between the willingness price and actual price for a consumer.
a.
Producer costs represent the cost incurred by the producer in producing the good.
b.
Monopolist Profit: Economic profit generated as a result of a firms market control. Its termed
monopoly profit as a reflection of the most prominent market structure with market control
monopoly.
c.
Economic Profit: The difference between business revenue and total economic cost. This is the
revenue received by a business over and above the minimum needed to produce a good.
d.
Producers Surplus: The revenue that producers obtain from selling a good over and above the
opportunity cost of production. This is the difference between the minimum supply price that
sellers would be willing to accept and the price that is actually received.
e.
Consumer Surplus is the satisfaction that consumers obtain from a good over and above the
price paid. This is the difference between the maximum demand price that the consumer would
be willing to pay and the price that he actually pays.
The correct answer is (e).
(e)

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Reason :

PA
10.

= Rs.100.
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Answer : (b)
Reason :

APL= 30L

L2

TPL = APL L = 30L2 L3


TPL can be maximized when MPL = 0
Therefore, TPL / L = 60L 3L2 = 0
L (60 3L) = 0
L =0 or L = 20.
Output can be maximized by employing 20 labors.
Maximum possible TPL = 30(20)2 (20)3 = 12,000 8,000 = 4,000 units.
11.

12.

Answer : (b)
Reason : TP (when labor = 100 units) = 100 x 50 = 5000
TP (When labor = 52 units) = 104 x 48 = 4992
Thus, MP = (4992 5000)/(104 100) = -8/4= -2 unit.
Answer : (b)
Reason :

The production function for a firm Q = 100L


APL =

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0.1L2

= 100 0.1 L.

When L = 10, APL = 100 0.1(10) = 100 1 = 99 units.


13.

14.

15.

16.

Answer : (c)
Reason : The slope of the isoquant represents the Marginal Rate of Technical Substitution (MRTS) between
labor (L) and capital (K). MRTS is equal to the ratio of the marginal productivities of two factors.
a.
The slope of the isocost curve represents ratio of wages (w) and interest (r).
b.
The slope of the indifference curve signifies marginal rate of substitution of goods (MRS).
c.
The slope of the isoquant curve signifies the marginal rate of technical substitution (MRTS)
between labor and capital.
d.
The slope of the budget line represents ratio of price of good X and good Y.
e.
The slope of the average cost curve only shows the rate of change in average cost curve with
respect change in output.
Answer : (e)
Reason : When marginal product (MP) is greater than average product (AP), AP will be increasing. When MP
< AP, AP will be decreasing. Therefore, AP is maximum when AP is equal to MP.
When MP=0, total product is maximum and AP will be decreasing. Hence option (a) is not the
answer.
When MP is maximum, AP is less than MP and AP will be increasing. Hence option (b) is not the
answer.
When MP is minimum, AP will be decreasing. Hence option (c) is not the answer.
When MP is negative, AP will be decreasing. Hence option (d) is not the answer.
Answer : (c)
Reason : A rational firm always employs labor up to the point when the marginal product of labor is zero. If
the firm employs beyond that point, it reduces the efficiency of the fixed factors, which results in a
fall in the total product instead of rising.
(a) Is not the answer because a rational firm will employ labor when the average product of labor
is equal to marginal product of labor.
(b) Is not the answer because a rational firm will employ labor when the marginal product of labor
is maximum.
(c) Is the answer because no rational firm would employ labor when the marginal product of labor
is zero.
(d) Is not the answer because when the labor is zero, the total product of labor will be zero.
(e) Is not the answer because when the labor is zero, the average product of labor will be zero
Answer : (c)
Reason : When Q = 4, MC = 12Q 4 = 12(4) 4 = 44.

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17.

18.

Answer :
Reason :

19.

Answer :
Reason :

20.

Answer :
Reason :

21.

Answer :
Reason :

22.

Answer :
Reason :

23.

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Answer : (d)
Reason : AFC = TFC/Q
Average Fixed Cost of Producing 4 units = 100/4 =Rs.25
(c)
When the variable costs of the firm exceed its revenue, it can reduce the losses by shutting down its
operations. Even if its fixed costs exceed its revenue, the firm may not shut down its operations
because the firm can reduce its fixed cost loss through sales.
a.
In the short run, the firms will continue their operations even though they incur losses.
b.
If the revenue is more than variable costs, it can reduce the losses caused by fixed costs.
c.
When the variable costs of the firm exceed its revenue, it can reduce the losses by shutting
down its operations
d.
If total revenue is more than total costs it signifies losses. In the short run, the firms will
continue their operations even though they incur losses.
e.
Revenue is more important to take a decision on continuation of operation.
(d)
Opportunity cost of an hour of coaching for Sachin is equal to the best opportunity forgone because
of coaching i.e. acting Rs.30,000.
(b)
a.
When marginal cost is increasing with the increase of output, average returns may be
increasing or decreasing.
b.
When output is increasing, average fixed costs decreases whether or not marginal cost is
increasing or decreasing.
c.
When marginal cost is increasing with the increase of output, average variable costs may be
increasing or decreasing.
d.
When MC is rising, TC also increases
e.
When marginal cost is increasing with the increase of output, average costs may or may not
increasing.
(c)
The total cost curve is deduced from the total fixed cost and the total variable cost. The total cost is
represented as the vertical integration of the total fixed cost and total variable cost. So, the vertical
distance between TVC and TC is equal to total fixed cost.
(a) Is not the answer because the vertical distance between TVC and TC is not equal to marginal
cost.
(b) Is not the answer because the vertical distance between TVC and TC is not equal to average
variable cost
(c) Is the answer because the vertical distance between TVC and TC is equal to total fixed cost
(d) Is not the answer because the vertical distance between TVC and TC is not equal to average
fixed cost.
(e) Is not the answer because the vertical distance between TVC and TC is not equal to average
total cost.
(b)
Profit maximizing output is determined where MR = MC.
MR= 400 Q
MC = 70 + 2Q

400 Q = 70 + 2Q
3Q = 330
Q = 110 units.
Answer : (b)
Reason :

Minimum possible AVC is where


But

= 10 + Q

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=0

But

= 10 + Q
10 + Q = 0
Q = 10

24.

Answer :
Reason :

25.

Answer :
Reason :

26.

Answer :
Reason :

27.

Answer :
Reason :

AVC = 300 10 (10) + 0.5 (10)2 =Rs. 250.


(e)
The demand curve is horizontal to x-axis implies that the producers can produce as much as quantity
of output to the given level of price. Therefore, the producer under perfect competition is a pricetaker. The long-run equilibrium, all the existing firms get normal profits because of free entry and
exit of firms. Hence the equilibrium condition in the long run for a firm would be P = AR = MR =
MC.
Hence, the correct answer is (e).
(d)
Perfect competition is a form of market structure which represents a market without rivalry among
the individual firms. When the product is similar and identical, given all other conditions, a perfectly
competitive firm can only be a price taker. The price of the good is determined by the market forces.
The demand curve is horizontal to x-axis implying that the producers can produce as much as
quantity of output to the given level of price.a.Oligopoly is a form of market structure where there
are few sellers. The demand curve is indeterminable because of the interdependence between the
firms and it depends on the reaction curves of the competitor.b.Monopoly is a form of market
structure where there is only one producer of the good. The demand curve is downward sloping
implying that the producer is a price-maker. The distinguishing feature of this form of market
structure is that the average costs of production continually decline with increased output as a result
of which average costs of production will be lowest when a single large firm produces the entire
output demanded.c.Monopolistic competition is a market structure where there are many firms
selling closely related but non-identical goods. The demand curve is downward sloping because of
product differentiation.d.The demand curve in the perfect competition is horizontal to x-axis
implying that producer can produce as much as the quantity of output for a given level of price.e.The
demand curve of a duopolist is indeterminate because of high degree of interdependence between the
firms. Hence, the correct answer is (d).
(a)
A perfectly competitive firm cannot earn abnormal profits in the long run because new firms enter
into the industry and competition reduces the price of the good. Conversely, when the firm gets
losses in the long run, it would move out of the industry. Thus, an existing firm only gets normal
profits in the long run. In perfect competition, normal profit is possible only when the firm operates
at its minimum average cost.
a.
In perfect competition, normal profit is possible only when the firm operates at its minimum
average cost.
b.
It is not appropriate in this instance because in the long-run all inputs are variable and there are
no fixed costs.
c.
It is not appropriate in this instance because marginal cost greater than marginal revenue is not
a desirable situation for a firm to continue in the industry.
d.
It is not appropriate in this instance because fixed cost lower than total variable cost does not
indicate any thing. Further, there would be no fixed costs in the long-run.
e.
It is not appropriate because P = Min. AVC only indicates shut down point in the short run.
Hence, the correct answer is (a).
(d)
There exists large number of buyers and sellers in a perfectly competitive industry. When there are
large number of buyers and sellers no individual seller, however large, can influence the price by
change the output. Since the firm is operating in a perfectly competitive market, the price remains the
same even if the firm doubles its output.
(a)

Is not the answer because in a perfectly competitive industry, if the firm doubles its output
during the year, then price of the product does not fall more than proportionately

(b)

Is not the answer because in a perfectly competitive industry, if the firm doubles its output
during the year , price of the product does not fall less than proportionately

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28.
29.

Answer :
Reason :
Answer :
Reason :

(c)

Is not the answer because in a perfectly competitive industry, if the firm doubles its output
during the year price of the product does not fall proportionately

(d)

Is the answer because in a perfectly competitive industry, if the firm doubles its output during
the year, price of the product remains same

(e) Is not the answer because insufficient data cannot be the answer.
(a)
Each firm is earning only normal profits that is the point where, marginal revenue = marginal cost.
(c)
MRA = MC;

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TRA = 50QA QA2


MRA = 50 2QA
50 2QA =20
QA = 15;
TRB = 30QB 0.5QB2;
MRB = 30 QB;
MRB = MC;30 QB = 20;
QB = 10;
30.

Total output, Q = 15 + 10 = 25 units.


Answer : (b)
Reason : Given, P = 10,000 20Q

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TC =300,000 + 2197Q 20Q2 + Q3


TR = P.Q = 100,00Q 20Q2
MR =10,000 40Q
MC = 2,197 40Q +3Q2
MR = MC gives
10,000 40Q = 2,197 40Q + 3Q2
or 7803 = 3Q2
Q 2 = 2601 which gives Q =
31.

= 51

Hence the correct answer is 51 units


Answer : (a)
Reason : By solving the reaction functions of the firms, the industry output can be derived.
Q1 =
380 2Q2
(I)
Q2

200 Q1

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(II)

Putting the equation (II) in (I)


Q1 =
380 2 (200 Q1)
or, Q1

380 400 + 2Q1

or, Q1 = 20
or, Q1 = 20.
Q2 = 200 20 = 180.
The equilibrium output for the industry Q = Q1 + Q2 = 20 + 180 = 200.
32.

P = 500 2(200) = Rs.100.


Answer : (b)
Reason : (a) It is not the answer as economies of scale just means advantages of large-scale production. The

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reason for tangency of price with average cost curve is that there is freedom of entry and exit of firms.
(b) It is the answer as freedom of entry ensures that all firms earn only normal profits while exit
ensures that the loss making firms exit the industry and the others make normal profits.
(c) It is not the answer as product differentiation is not a reason for the firms attaining normal
profits.
(d) It is not the answer as downward sloping demand curve does not in itself mean normal profits
(e) It is not the answer, as a downward sloping demand curve in itself does not mean normal
profits.
Hence the correct answer is (b)
33.

34.

35.

36.

Answer : (a)
Reason : When a monopolist faces an upward shift in his marginal cost curve, the price of his product will
increase while the quantity demanded will decrease
Answer : (c)
Reason : The difference between perfect competition and monopolistic competition is with regard to type of
product which they produce. Producer under perfect competition produces homogeneous goods while
the producer operating under the conditions of monopolistic competition produces differentiated
products. Large number of sellers is a common characteristic feature of both perfect competition and
monopolistic competition. Free entry and exit is also common characteristic feature of perfect and
monopolistic competition. Homogeneous product is the characteristic feature of only perfect
competition. Differentiated product is the characteristic feature of monopolistic competition. Hence
it is not the common feature of perfect and monopolistic competition. Large number of buyers is also
common characteristic feature of both perfect competition and monopolistic competition. Large
number of sellers and homogeneous product are the features of perfect competition. Hence the
correct answer is (c).
Answer : (b)
Reason : When tax is imposed,
Qs = 50 + 10(P 3) = 50 + 10P 30
Or, Qs = 20 + 10P
At equilibrium, 20 + 10P = 150 3P
Or, 13P = 130
P = 10
Earlier equilibrium price, 150 3P = 50 + 10P
Or, 100 = 13P
Or, P = 100/13 = 7.7
Increase in price = 10 7.7 = Rs.2.3. Thus, the burden borne by the consumer is 2.3/3 = 76.67% =
77%
Answer : (d)
Reason : Profit = TR TC
TR = P x Q
P = 100 Q

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Hence, TR = (100 Q) Q = 100Q Q2

37.

Hence, profit = 100Q Q2 (100 5Q + 2Q2)


Average profit function: 100 Q 100 /Q +5 2Q
Thus, if current output is 5 units, average profit will be 100 5 20 +5 10 = 70.
Answer : (c)
Reason : AC = 100/Q + 20 + 4Q
TC = 100 + 20Q + 4Q2
TVC = 20Q + 4Q2
At output 15,
TVC = 20(15) + 4(15)2
= 300 + 900 =Rs. 1200

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38.

39.

Answer : (d)
Reason : Perfect competition is a form of market structure which represents a market without rivalry among
the individual firms. The characteristics of perfect competition are: Large number of buyer and
sellers Homogeneous product No barriers to entry Perfect information Perfect mobility of factors of
production. There are large numbers of buyers and the demand curve which is the marginal revenue
curve is horizontal to the x-axis implying that the producer can produce as much as the quantity of
output for a given level of price. All the additional goods can be sold at the market price only, hence
in a perfect competition, P = MR = AR. Hence the correct answer is (d).
Answer : (e)
Reason : Personal Income = National Income Undistributed corporate profit corporate tax + Transfer
payments
National Income = GNP at market price Depreciation (consumption of capital) Indirect taxes +
Subsidies
= 1,700 190 173 + 20
= 1,357

40.

Answer :
Reason :

41.

Answer :
Reason :

42.

Answer :
Reason :

43.

Answer :
Reason :

44.

Answer :

Personal Income = 1,357 28 75 + 242


= 1,496 MUC
(c)
National income = NNP at factor cost
NNP at factor cost = GDP at market price Indirect taxes + subsidies + NFIA Depreciation
Or, GDP at market price = NNP at factor cost + Indirect taxes subsidies - NFIA + Depreciation
= 48000 + 11400 6000 ( 3000) + 12000 = 68400 MUC.
Where NFIA = (Factor income received from abroad Factor income paid abroad) = (9000
12000) = -3000 MUC
(b)
National income minus corporate profits minus social security taxes plus transfer payments equal
personal income. This is the true statement.
(e)
Gross domestic product is the market value of all final goods and services produced in an economy
during a one-year period.
(d)
If Yd is zero, consumption is Rs. 1000, which is autonomous consumption. This consumption is
financed by dissavings or borrowing. Hence dissavings are Rs.1000
(b)

Reason :

Multiplier = 1/(1 MPC + MPI) = 1/(1 0.70 + 0.1) =

45.

46.

47.

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= 2.5

Thus if investment increases by 1,000, income increases by 1000 2.5 = 2,500 MUC.
Answer : (c)
Reason : Y = C + I
Y = 1800 + 0.5 Y + I
0.5 x 4400 = 1800 + I
I = 400.
Answer : (b)
Reason : The investment multiplier explains the change in national product due to change in investment
expenditure.
Answer : (e)
Reason: At equilibrium, IS = LM
Y = 4800 + 0.5Y 50i
Y = 9600 100i
IS function

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48.

Answer :
Reason :

49.

Answer :
Reason :

50.

Answer :
Reason :

51.

Answer :
Reason :

52.

Answer :
Reason :

Y = 4,600+ 400i LM function


Thus at simultaneous equilibrium,
9600 100i
= 4,600+ 400i
Or, 5000 = 500i
Or, I = 10.00
When government spending increase by 200, the IS function becomes
0.5Y= (4800 + 200) 50i
0.5Y = 5000 50i
Or, Y = 10000 100i
Thus, at equilibrium,
4,600+ 400i = 10000 100i
Or,500i = 5400
Or, I = 10.80.
(e)
An increase in nominal money supply, a decrease in the price level, or a purchase of bonds by the
RBI increases real money stock, which shifts the LM curve to the right.
(c)
At simultaneous equilibrium,
0.5Y = 2860 60i (or) Y = 5720 120i is equal to Y = 2600 + 400i
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% = 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.
(a)
Aggregate demand (supply) curve is a curve showing relationship between the level of real domestic
output demanded (available) at each possible price level. The aggregate demand shows the overall
demand for goods and services produced in a country. Thus, AD = C + I + G + NE. A shift in the
aggregate demand curve takes place if the any of the factor other than price levels affect the
aggregate demand. Aggregate supply, on the other hand, shows the overall supply of goods and
services at various price levels. Any factor other than price level that affect the aggregate supply
results in shift in aggregate supply curve. Increase in the factor input prices reduces the incentive for
production that lead to reduction in aggregate supply. A reduction in supply because of any other
factors other than price level is shown by a leftward shift in the aggregate supply curve. A shift in the
aggregate demand curve is caused by changes in the consumption spending, investment spending,
government spending and net export spending. Changes in the prices of factor inputs do not affect
aggregate demand. Hence, statement (a) is correct.
(b)
If an economy is reviving from a recession, in the short run, there will be an increase in the demand.
This increase in demand causes an increase in price which in turn results in a rise in real output.
(a)
High powered money = monetary liabilities + government money = 10,500 + 1,500
= 12,000
Ms = H
48,000

12,000

(1 + 0.25)/(0.25 + r) = 4

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53.

Answer :
Reason :

54.

Answer :
Reason :

=
1 + 4r = 1 + 0.25
4r
=
0.25
r
=
0.0625
=
6.25%.
(e)
High powered money = Monetary liabilities of central bank + Government money
Monetary liabilities of central bank = Financial Assets + Other assets Non-monetary liabilities
Financial Assets = Credit to government + claims on commercial banks + credit to commercial
sectors + foreign exchange assets
= 10,080+ 3,150 + 4,950 + 1,350= 19530
Non-monetary liabilities = 900+ 3780 = 4680
Monetary liabilities of central bank = 19,530 + 450 4,680 = 15,300
High powered money = 15,300 + 225 = 15,525 MUC
(c)
Stock of high powered money ( H)
= monetary liabilities of the central bank + government money = 1,250 MUC
Current deposit ratio (Cu) =
0.20
Reserve ratio (r)
=
0.05
Money supply Ms

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55.

Answer :
Reason :

56.

Answer :
Reason :

57.

Answer :
Reason :

58.

Answer :
Reason :

59.

Answer :
Reason :

= 4.8 1,250
= 6,000 MUC
(b)
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.
(a)
An important difference between the approaches of the classical and Keynesian economists use to
achieve a macroeconomic equilibrium is that Keynesian economists actively promote the use of
fiscal policy; the classical economists do not. Classical economists believe intervention can be destabilizing and advocate laissez- faire economy. Therefore the answer is (a).
(d)
According to classical economist, aggregate supply curve is a vertical straight line. Hence it is
unrelated to the price level.
(b)
According to Keynesian theory the term full employment refers to a situation where there is natural
Rate of unemployment.
(b)
According to rational expectations school, discretionary monetary and fiscal policy cannot be used to
stabilize the economy. Proponents of rational expectation argue that consumers and business firms

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60.

61.

62.

63.
64.

65.

66.

67.

68.

69.

70.

anticipate the implications of rise in government spending. Moneywage rate and prices will rise, but output and
employment will remain the same. So government can no longer fool the people by increasing its
spending during elections years. So the answer is (b).
Answer : (a)
Reason : Frictional unemployment is a short-run job/skill matching problem while structural unemployment is
a long-run matching problem.
Answer : (c)
Reason : To counter the recession the fiscal and monetary policies should be expansionary.
a.
Decrease in government expenditure is a contractionay fiscal policy. This measure will worsen
the recessionary situation.
b.
Decrease in government expenditure is a contractionay fiscal policy. This measure will worsen
the recessionary situation.
c.
Decrease in the discount rate increase money supply in the economy and is an expansionary
monetary policy. This will counter the recession by increasing the aggregate demand in the
economy.
d.
Decrease in money supply is a contractionary monetary policy. This measure will worsen the
recessionary situation.
e.
Increase in the tax rate is a contractionary fiscal policy. This measure will worsen the
recessionary situation.
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:
a.
Improvement in technology
b.
Natural resources
c.
Capital
d.
Human resources
Change in tastes and preferences of consumers only affect the demand of an individual good or
services, and it does not increase the production capabilities of an economy.
Answer : (d)
Reason : Slowing of economic activity accompanied by inflation is defined as stagflation.
Answer : (a)
Reason : Phillips curve in the short-run shows an inverse relation between inflation and unemployment. But in
the long run there is no trade-off because Phillips curve is vertical in the long-run.
Answer: (d)
Reason: Economic growth, by definition, is said to occur hen there is an increase in the productive capacity
of the nation, shifting the production possibility frontier to the right.
Answer : (a)
Reason : Fiscal policy refers to policies pertaining to government spending and taxation. The overall conduct
of these policies play an important role in maintaining economic stability in the economy.
Answer : (b)
Reason : Expansionary monetary policy effects the goods market because it lowers interest rates and raises
investment spending.
Answer : (a)
Reason : If the government increased its spending and the Reserve Bank of India increased the money supply,
it will lead to increases in both output and the price level in the short run.
Answer : (c)
Reason : Current account captures the transactions related to trade in goods and services, transfer payments
and factor incomes. If foreign exchange out flow on account of these is more than inflows, the
current account is in deficit.
Answer : (b)
Reason : Because of the double entry concept underlying the recording of transactions, BoP account must
always be in balance. Thus, Balance in current account + Balance in capital account + Change in

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reserves = Zero. When there is no change in the foreign exchange reserves, then balance in current account +
balance in capital account = zero (or) balance in current account = - (balance in capital account).

71.

72.

73.
74.

75.

76.

77.

a.

Balance in current account + Balance in capital account = Change in reserves. When balance in
current account + balance in capital account is zero, then balance in the current account =
Negative balance in capital account. Hence, statement (a) is not correct.

b.

There will be no change in the foreign exchange reserves of a country only when surplus
(deficit) in current account is equal to deficit (surplus) in capital account.

c.

Current account balance may or may not be zero when the change in foreign exchange reserves
of a country is zero.

d.

Trade balance (exports imports) may or may not be zero when the change in foreign exchange
reserves of a country is zero.

e.

Capital account balance may or may not be zero when the change in foreign exchange reserves
of a country is zero.

Answer : (b)
Reason : Though the outflows or inflows of capital are short term, they are still recorded in the capital
account.
Answer : (b)
Reason : The real value of repayments in the future will fall with an increase in the inflation causing an
increase in the wealth of the debtors. With the same reasoning the wealth of the creditors, retirees on
fixed income, employees whose salaries are linked to the CPI will decrease for an increase in the rate
of inflation.
Answer : (b)
Reason : Expansionary fiscal policy refers to increase in government spending and decrease in taxes.
Answer : (d)
Reason : When the budget deficit increases, there is higher expenditure undertaken by the government, which
will mean more public work projects. This will further boost employment and reduce unemployment.
Answer : (d)
Reason : Change in foreign exchange reserves = Current account balance + Capital account balance
= 2,000 + 7,000 = 5,000 MUC. i.e. increase by 5,000 MUC.
Answer : (e)
Reason : Financial assets of the banking system consist of all those assets (loans, foreign exchange assets)
which are which are under the control of the banks, including the central banks.
(a) RBIs credit to government is considered as a financial asset, as the government is liable to
return to the RBI and also gives a nominal return.
(b) Similarly is the case with the other banks credit to the government, as said above is part of the
financial asset of the banking system.
(c) Credit given to the commercial sector also gives a return to the bank hence it is part of the
financial assets of the banking system.
(e) Buildings are physical assets and not financial assets and are shown as other assets in the
balance sheet of the bank.
Answer : (b)
Reason : Revenue Deficit
=
Revenue expenditure Revenue Receipts
Revenue Expenditure
=
Non-plan revenue expenditure +
plan revenue expenditure
=
2,70,169 + 70313
=
Rs.3,40,482 Cr
Revenue Deficit

=
=

78.

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3,40,482 (1,72,965 + 72,140)


Rs.95,377 Cr.

Answer : (b)
Reason : Current account balance = Credit (Current account) debit (Current account)

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= [Earnings on loans and investments from abroad + Private remittances from abroad (transfers) +
Exports of services + Merchandize exports] [Earnings on loans and investments to abroad + Private
remittances to abroad (transfers) + Import of services + Merchandize imports] = [500 + 500 + 2,000
+ 15,000] [2,200 + 500 + 4,000 + 12,000]
= 18,000 18,700 = 700i.e. 700 MUC (Deficit)
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