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Past Paper IEF
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Certificate in Accounting and Finance Stage Examination
The Institute of 5 September 2019
Chartered Accountants 3 hours – 100 marks
of Pakistan Additional reading time – 15 minutes
Section A
Q.1 (a) Briefly explain why the production possibility curve is downward sloping and concave
to the origin. (03)
(b) What do you understand by the term ‘Market economy’? What are its main features?
Also state any four drawbacks of market economy. (05)
Q.2 (a) Describe the concept of long-run equilibrium of a firm under monopolistic
competition with the help of a diagram. (08)
(b) With the drop in price of smartphones from Rs. 80,000 to Rs. 70,000, the quantity
demanded by the consumers, in a particular market, increases from 20,000 phones to
30,000 phones per month. Calculate the elasticity of demand under percentage
method and identify the type of elasticity. (02)
Q.3 (a) What do you understand by ‘Reserve price’? Describe any six factors which may
influence the reserve price of a seller. (07)
(b) Show a graphical interaction of marginal cost, average variable cost, average fixed
cost and average total cost curves. (Explanation of the graph is not required) (02)
Q.4 Briefly describe the following diagram and the concept it depicts: (08)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(i) Which one of the following statements is NOT true for a planned economic system?
(a) Productive resources are state owned (b) Auto-adjusted price mechanism
(c) Full employment is possible (d) Less duplication of resources
(iii) Which one of the following assumptions does NOT confer to the law of demand?
(iv) Which one of the following assumptions is related to the law of variable proportion?
(a) Continuous improvement in techniques of production
(b) All factors of production are proportionately varied
(c) There is no scarcity of the factors of production
(d) The factors are able to be combined to make a product
(vi) Which one of the following defines the economic growth rate?
(a) Increase in real investment (b) Increase in GDP
(c) Increase in real GDP (d) Increase in GDP deflator
(viii) A expansionary fiscal policy combined with a restrictive monetary policy would result
in:
(a) budget deficit to decrease (b) taxes to increase
(c) government expenditure to decrease (d) interest rates to increase
(ix) Which one of the following is NOT an outcome of the central bank’s expansionary
monetary policy?
(a) Increase of money supply in the economy
(b) Decrease in market rate of interest
(c) Increase in exchange rate
(d) Increase in aggregate demand
(x) Which one of the following is NOT part of the country’s current account?
(a) Export of goods (b) Foreign direct investment flows
(c) Unilateral transfers to other countries (d) Imports of services
(xi) Which one of the following is NOT a cause of cost push inflation?
(a) Increase in the price of raw material
(b) Fall in interest rates
(c) Increase in firm’s profit margins
(d) Exchange rate depreciation
(xii) What would be the velocity of circulation of money in an economy in which the
average price level is 1.8, real GDP is Rs. 260 billion and the nominal money supply is
Rs. 117 billion?
(a) 4.0 (b) 3.2 (c) 4.8 (d) 0.8
(xiii) The use of exchange control to overcome balance of payment deficit results in:
(a) decrease in imports (b) decrease in exports
(c) decrease in price level (d) decrease in national income
(xiv) Under which of the following circumstances, the value of the multiplier would be
higher?
(a) When both marginal propensity to consume and marginal propensity to import
are low
(b) When marginal propensity to consume is low and marginal propensity to import
is high
(c) When marginal propensity to consume is high and marginal propensity to
import is low
(d) When both marginal propensity to consume and marginal propensity to import
are high
(xv) Which one of the following will NOT be the result of devaluation of domestic
currency on the foreign exchange market?
(a) Export becomes less expensive in terms of foreign currency
(b) Imports become more expensive in terms of domestic currency
(c) Export volumes will increase
(d) Import volumes will increase
Section B
Q.6 (a) From the following data, compute GDP, GNP and NNP at market price:
Rs. in billion
Domestic consumption 290
Taxes on expenditures 76
Government expenditures 57
Capital formation 65
Exports 89
Imports 83
Subsidy 18
Net property income from abroad 11
Capital depreciation 25 (04)
(b) Describe three different types of Injections and Withdrawals from the Circular Flow
of Income. (06)
Q.7 (a) What is ‘Demand-pull inflation’? Briefly describe how fiscal and monetary stimulus
may cause demand-pull inflation. (05)
Q.8 (a) What do you understand by ‘Liquidity preference theory’? Describe the influence of
the motives identified by Keynes, on the liquidity preference of an individual. (07)
(b) Describe any three short-run factors which may affect marginal efficiency of capital
and investment. (03)
(b) The importance of public finance can be easily understood by its functions. Describe
any two main functions of public finance as emphasized by Musgraves. (04)
(c) Assume in a closed economy with no government intervention, Rs. 1 billion increase
in investment results in Rs. 5 billion increase in consumption. Compute the value of
marginal propensity to consume. (03)
Q.10 (a) Briefly describe any three tools which are available to the Central bank for controlling
money supply in an economy. (06)
(b) There are different types of financial instruments that can be classified as money. State
four types of money categorised by its liquidity. (04)
Q.11 (a) Describe the concept of ‘Deflationary gap’ with the help of a diagram. (04)
(b) Briefly describe the term ‘Derivatives’ and state the main objective of exchange traded
derivatives. (03)
(c) State three advantages and three disadvantages of direct taxation. (03)
Q.12 (a) What is ‘Balance of payment’? Describe any five causes due to which a country may
have a deficit in balance of payments. (07)
(b) Briefly describe the monetary measures which may be taken by the government to
correct balance of payments deficit. (03)
(THE END)
Section A
Q.1 (a) Briefly describe the following diagram and the concept which it reflects. (04)
(b) What is meant by ‘Costs of production’? Briefly describe implicit and explicit costs
and give two examples of each. (04)
Q.2 (a) What is an indifference curve? Briefly explain three main characteristics of
indifference curves. (06)
(b) Describe the concept of ‘change in supply’ with the help of a diagram. (05)
Q.3 (a) What do you understand by the laws of increasing returns and diminishing returns?
List four basic assumptions underlying the law of diminishing returns. (04)
(b) How does the law of increasing returns apply to the industrial sector? (03)
Q.4 (a) Mixed economy is a system in which free markets coexist with government
intervention. Explain the role of the government in a mixed economy. (06)
(b) What do you understand by the term ‘Goods’ as commonly used in economics?
Briefly describe ‘Public goods’ and give two examples of public goods. (03)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(ii) Following data has been provided to the Chief Executive Officer of a monopoly firm:
Marginal revenue Rs. 10 Marginal cost Rs. 11
Average revenue Rs. 16 Average cost Rs. 12
To maximise profit the firm should:
(a) reduce price and increase output
(b) reduce price and reduce output
(c) increase price and increase output
(d) increase price and reduce output
(iv) A price floor set above the market equilibrium price is likely to cause:
(a) excess supply
(b) excess demand
(c) a decrease in price and a decrease in the quantity traded
(d) an increase in price and an increase in the quantity traded
(vi) Which of the following factors is NOT used in the multiplier formula?
(a) Marginal propensity to save (b) Marginal propensity to import
(c) Marginal propensity to tax (d) Marginal propensity to export
(viii) Which of the following is NOT part of a country’s Gross Domestic Product?
(a) Company profit (b) Net income from abroad
(c) Salaries of school teacher (d) Investment expenditure
(ix) Which of the following measures is likely to boost a country’s rate of economic
growth?
(a) Tax cuts (b) Reduction in tax rebates
(c) Reduction in subsidies (d) Decrease in government spending
(x) Which one of the following is most likely to lead to a rise in aggregate demand?
(a) Decrease in government expenditure (b) Decrease in income tax rate
(c) Increase in autonomous savings (d) Increase in rate of interest
(xi) If an excess demand for money exists in the economy, then as the money market
moves towards equilibrium, the short term interest rates are expected to:
(a) fall as treasury bill prices rise (b) fall as treasury bill prices fall
(c) rise as treasury bill prices rise (d) rise as treasury bill prices fall
(xiv) A contractionary monetary policy in an open economy with a flexible exchange rate
would possibly steer the economy towards a:
(a) higher domestic interest rate and exchange rate appreciation
(b) higher domestic interest rate and exchange rate depreciation
(c) lower domestic interest rate and exchange rate appreciation
(d) lower domestic interest rate and exchange rate depreciation
(xv) Which of the following financial markets usually acts as an intermediary between
those looking to raise finance, and those looking to invest?
(a) Capital market
(b) Derivation market
(c) Money market
(d) Both (a) and (b)
Section B
Q.6 (a) Define ‘Average propensity to consume’ and ‘Marginal propensity to consume’. How
are these calculated? (04)
(b) Briefly describe ‘Autonomous investment and Induced investment’. Who may
undertake such investments? In respect of each of the above types of investment, draw
investment curve and give two examples. (06)
(Note: Explanation of the curves is not required)
Q.7 (a) What do you understand by ‘Consumer price index’ (CPI)? Also explain how it is
calculated. (04)
(b) Briefly describe four costs associated with high inflation. (06)
(b) State two advantages and two disadvantages of indirect taxation. (04)
Q.9 (a) The problems of barter system led to the evolution of money in its current form.
Discuss how money resolved these problems. (03)
(b) State two advantages and two disadvantages of credit money. (04)
Q.10 (a) Exchange rate may either be fixed or floating. State three advantages of each of these
types of exchange rates. (06)
Q.11 (a) What is meant by the term ‘Coincident economic indicators’ in the context of
assessment of a country’s economic stage in a business cycle? Also identify the
economic characteristics which are usually observed during recessionary periods. (05)
(b) State four types of difficulties which are usually associated with the measurement of
national income. (03)
(c) Compute the multiplier, if in an economy, out of every additional Rs. 100 of national
income, 8% is saved, 15% is paid in taxes and 17% is leaked from the economy in
imports. (02)
Q.12 (a) Briefly describe how the level of aggregate demand may reduce when a central bank
changes the reserve requirements for commercial banks. (05)
(b) What do you understand by the term ‘Inverse J curve’? Explain the concept with the
help of a diagram. (05)
(THE END)
Theory of oligopoly suggests that once a price has been determined, it will not
change except to react to a competitor’s price change.
This means that members of a non-collusive oligopoly face a kinked (Bend) demand
curve as the reaction of competitors to a price change depends on whether price is
increased or decreased.
Price increase
If the oligopolist raises price above P0 the rivals will maintain their price in order to
make the firm lose customers. Demand will move along the more elastic portion of
the demand curve to the left of Q0.
Price decrease
If the oligopolist cuts price below P0 then rivals will cut price too and hence there
will be little or no increase in demand. The firm will be forced on to the less elastic
portion of its demand curve to the right of Q0.
Explicit costs are the costs that have been incurred and have also been booked as an
expense. These are the expenses that are paid out costs and involve cash outflows
from the business.
Examples:
Examples include: salaries paid to the employees, prices of materials, overheads etc.
Implicit costs are the costs that have already been incurred but are not separately
shown as an expense while calculating the total cost of production.
Examples:
Examples include: salary of the entrepreneur, return on entrepreneur’s own
investment etc.
Suppose SS is the supply curve before the change. S' S' shows a decrease in supply
because at the same price PM ( = P' M') less is offered for sale, i.e., OM' instead of
OM. S" S" shows an increase in supply because at the same price PM (= P" M") more
is offered for sale, i.e., OM" instead of OM.
The law of increasing return operates as long as the plant is producing below
capacity. The increase in the marginal return continues till the plant begins to
produce its full capacity.
Ans.4 (a) In a mixed economy, government plays an important role to overcome the
inadequacies of free market economy. It includes:
(b) Goods:
In economics, goods refer to the products that satisfy human needs or wants and
provide utility.
Public goods:
A public good is a good whose benefits are social or collective.
Examples:
national defense system
highway network
Computation:
The formula for its computation is as under:
𝐶
𝐴𝑃𝐶 =
𝑌
Computation:
The formula for its computation is as under:
∆𝐶
𝑀𝑃𝐶 =
∆𝑌
Examples:
Construction of highways
Street lighting
Other infrastructure projects
Induced investment:
Investment which varies with change in national income is called induced
investment
Examples:
Improvements to machinery
Human capital (i.e. staff training that will generate an economic return)
New assets
(i) Forecasting
The fiscal policy is devised around predictions of various economic activities.
For the fiscal policy to work as desired, these predictions need to be
reasonably accurate. However, making reasonably accurate prediction is not
easy.
(iv) Tax
Raising taxes to reduce deficit reduces Aggregate Demand. Moreover, it may
cause demotivation to work. Consequently a fall in productivity might be
observed and Aggregate Supply may fall.
Change the pattern of demand: the government can alter the demand for a
product say imported and luxury goods.
Can correct externalities: if a product causes direct external costs (e.g. health
costs associated with alcohol or cigarettes), the tax can be used to lower
down the consumption.
MV is the value of total expenditure in a period which must be equal to the value of
goods and services sold in the same period which is PT. The equation is useful as an
explanation of inflation when certain assumptions are made and which, if accepted,
means that the average price level (P) is solely determined by changes in the money
supply (M).
(iii) Income
It refers to the overseas activity that leads to a flow of money back to the
country. For example, interest received from direct investment, the activities
of subsidiaries and dividends earned from owning shares in foreign firms, etc.
Ans.12 (a) The central banks are able to reduce the level of aggregate demand in an economy
by changing the reserve requirements, as described hereunder:
(i) When a central bank increases the level of reserves that the commercial
banks must hold, the commercial banks have to reduce the level of loans that
they give out. A certain reduction in the level of reserves that commercial
banks must hold translates, through the multiplier effect, in a much bigger
contraction in the overall money that they loan out. This causes the money
supply to decline.
(ii) As the money supply contracts, money becomes “tight” (i.e. less available and
more expensive). This reduced level of money in the economy raises the
interest rate, and reduces the amount of credit available in the economy.
Consequently interest rates rise and firms/individuals looking for investment
are discouraged from borrowing, and spending more money.
(iii) As a result of the above aggregate demand reduces.
The inverse J-curve shows how in the short run, the surplus may further increase
before decreasing. This concept is depicted below:
The inverse J curve effect is observed in trade balances because the stronger
currency initially translates into more cheaper imports and costlier exports, leading
to a bigger initial trade surplus.
The lag is caused by the fact that importers and exporters have to honor pre-existing
contracts, so the trade volumes initially remain unchanged even though the
exchange rate and relative prices have changed.
Therefore, in the above diagram, starting from Point B, the surplus first increases in
the short-run and goes down into a deficit as time goes on.
(THE END)
Section A
Q.1 (a) The basic economic problem is the scarcity of resources and the multiplicity of ends.
Discuss how following participants in an economy make decisions to deal with that
problem:
(i) households (ii) firms
(iii) government in market economy (iv) government in mixed economy (06)
(b)
From the above diagram of Production Possibility Frontier, describe what the
following points/curve depict:
(i) point G (ii) point H (iii) curve XY (03)
Q.2 Consider the following schedule that pertains to the product of a firm engaged in the
manufacture and sale of consumer products:
Q.4 (a) Explain the concept of economies and diseconomies of scale with the help of long run
average cost curve. Also mention two factors that lead to economies and diseconomies
of scale. (07)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(i) In deciding what products to produce, the central planners in a planned economy
would give least priority to:
(a) size of economy’s labour force
(b) production capabilities of the economy’s factories
(c) consumer preferences
(d) type of raw materials produced by the economy
(ii) Which of the following would most likely result in failure of price cartel under
oligopoly?
(a) Non-availability of close substitutes
(b) Existence of control over supply
(c) Price elasticity of demand is elastic
(d) Presence of agreement on allotted quota of supply
(iv) A consumer with fixed income at his disposal would maximize his utility at a point
where:
(a) marginal utility per rupee from each good is same
(b) marginal utility from each good is same
(c) marginal utility from each good is maximized
(d) marginal utility per rupee from each good is maximized
(viii) When the national income is in equilibrium, an increase in investment causes the
equilibrium to change. Which change of equivalent value would bring national income
to its original equilibrium level?
(a) Decrease in government spending (b) Increase in government spending
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(c) Decrease in government taxes (d) Increase in exports
Introduction to Economics and Finance Page 3 of 4
(ix) A central bank is likely to increase interest rates when economy is in a phase of:
(a) prosperity (b) downturn (c) recession (d) trough
(x) For reducing inflationary pressure, the most appropriate combination of policies for a
central bank would be:
(a) increase reserve requirement, reduce discount rate and sell government securities
(b) increase reserve requirement, increase discount rate and sell government
securities
(c) increase reserve requirement, reduce discount rate and buy government securities
(d) increase reserve requirement, increase discount rate and buy government
securities
(xi) Given below is the Consumer Price Index (CPI) of a country for four years:
Year 2014 2015 2016 2017
CPI 500 550 600 650
Based on the above schedule, which of the following statements is correct?
(a) The rate of inflation has been consistently rising from 2015 to 2017
(b) The rate of inflation in 2016 is 10%
(c) The rate of inflation is the highest in 2017
(d) The rate of inflation has been consistently falling from 2015 to 2017
(xii) The expectation of fall in prices would result in:
(a) shift of current consumption curve to the left
(b) shift of current consumption curve to the right
(c) no change on current consumption curve
(d) shift of current savings curve to the left
(xiii) A firm is operating in an industry where many firms are producing similar products.
Each firm is able to set prices of its products without affecting the market place as a
whole. The firm is most likely operating in:
(a) monopoly (b) oligopoly
(c) perfect competition (d) monopolistic competition
(xiv) Which of the following statements is correct regarding instruments of financial
market?
(a) Derivatives are equity instruments traded on money market
(b) Certificate of deposits are subject to higher default risk than treasury bill
(c) Debentures are short term money market instruments
(d) Both (a) and (b)
(xv) The basic concept which underlies the accelerator theory of investment is:
(a) investment depends on the level of savings
(b) investment is inversely related to the rate of interest
(c) investment is determined by the volume of commercial bank lending
(d) investment in an economy is a function of output
Section B
Q.6 (a) What do you understand by ‘Marginal efficiency of capital (MEC)’? Explain the
relationship between rate of interest and the level of investment with reference to MEC
with the help of a diagram. (08)
(b) Explain the impact of decrease in interest rates on firms and individuals. (02)
Q.7 (a) Sometimes the governments weaken the domestic currency deliberately with the
objective of reducing balance of payments deficits by making imports more expensive
and exports less expensive. Describe the factors upon which the effectiveness of such
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policy depends. (05)
Introduction to Economics and Finance Page 4 of 4
(b) Why do governments interfere to influence the foreign exchange rates? List the policy
instruments available to a government to influence the foreign exchange rates. (05)
Q.8 (a) Explain four main canons of taxation as suggested by Adam Smith that are usually
considered by a government while designing the tax system of the country. (08)
(b) There is a series of events that occur throughout the business cycle but there are certain
indicators that can be identified and used to assess at what stage the economy is in.
List any two such indicators under the headings of:
(i) Leading economic indicators (ii) Lagging economic indicators (02)
Q.9 (a) Discuss the non-monetary corrective measures which a country may take to overcome
its current account deficit. (04)
(b) From the following data, compute the overall balance of payments of the country duly
segregated between current and capital accounts:
Net balance
Balance of payment item
(in billion)
Investment income (15)
Portfolio investment flows 10
Overseas transfers 25
Trade in goods (75)
Short-term banking flows (5)
Foreign direct investment flows 20
Trade in services 20
Changes to reserves of gold / foreign currency 15 (06)
Q.10 Monetary policy can play a vital role in influencing the use of money and credit within an
economy in order to achieve certain objectives.
Briefly discuss:
(a) objectives of monetary policy and how these objectives can be achieved. (05)
(b) limitations of credit creation in achieving economic objectives. (05)
Q.11 (a) The economy is in equilibrium at the point where short run aggregate supply (value of
output produced within an economy) is equal to aggregate demand (level of demand
for goods and services). Explain the equilibrium of economy with the help of a diagram
where a government has increased its spending and there is a rise in wage rates. (07)
(b) List any three factors that may cause a shift in:
(i) aggregate demand curve (ii) short-run aggregate supply curve (03)
Q.12 (a) From the following data, compute Gross National Product (GNP) at market price and
at factor cost:
Rs. in billion
Consumers’ expenditures 450
Taxes on expenditures 175
Government spending 120
Capital formation 140
Exports receipts 50
Imports payments 110
Subsidy 15
Net property income from abroad 10
Capital depreciation 40 (05)
(b) Briefly discuss the main features of:
(i) mutual funds (ii) derivatives (05)
Note:
The suggested answers are provided for the guidance of the students. However, there are alternative
solution(s) to the questions which are also considered by the Examination Department while marking
the answer scripts.
(ii) Firms
These are businesses/organizations having limited factors of production (land, labor,
capital and enterprise). They attempt to allocate scarce factors of production between
potential products and services where profit is maximized.
(ii) Point H
This point depicts that given the production capacity of an economy, it is not
attainable.
(iii) Curve XY
It depicts all possible combinations of two alternative goods that an economy can
produce with the resources available to it.
At Rs. 150
Revenue = 150 × 20
= Rs. 3,000
At Rs. 120
Revenue = 120 × 24
= Rs. 2,880
The decline in price resulting in less increase in QD resulting in total revenue decreasing,
therefore PED is inelastic i.e. less than unity.
Percentage method
(b) Recommendation
Since the price elasticity of demand for the firm’s goods is inelastic (less than unity), the
firm should seek either to increase the price or maintain it because the reduction in price
would result in reduced revenue.
Ans.3 (a) The consumer is said to be in equilibrium when maximum possible satisfaction is obtained
from the individual’s purchases / when budget line and indifference curve are tangent, at
the prices prevailing in the market and given the amount of money the individual possesses
for making purchases.
(b)
The initial equilibrium of the consumer is at E where indifference curve (IC1) is tangent to
budget line AB. The fall in price of good X (assuming consumer income and price of Y
remain constant) would result in new equilibrium at E' as consumer would buy more of
good X and less of good Y. This price effect is an aggregate of income effect and
substitution effect.
The change in price would result in increase in real income of consumer. To determine the
substitution effect, the effect of increase in real income is eliminated so that consumer
remains at original indifference curve (IC1). To achieve this, a dotted line CD parallel to
budget line AB1 is drawn. The new budget line is tangent to IC1 at E''.
E to E'' represents the substitution effect and E'' to E' represents income effect. E to E'
represents the price effect which is the aggregate of substitution effect and the income effect.
Ans.4 (a)
It can be seen from the above diagram that initially as the output of the firm increases, the
unit cost declines i.e. firm is achieving economies of scale due to large scale of production
and long run average cost curve goes down.
After certain level of output is reached, average cost curve remains constant. This point is
called minimum efficient scale as unit costs are minimized because of maximization of
economies of scale. In the above diagram, this level of output is Qmes.
Any further increase in production level results in rising unit costs due to inefficiencies
generated by diseconomies of scale which in the above diagram is depicted by the rise in
long-run average cost curve.
Control – too big firm may be difficult to manage and management may lose control
Local/firm’s infrastructure – there might be strains on local/firm’s infrastructure as
the scale of activities increases.
Market is divided into sub-markets and each such sub-market is absolutely separate
i.e. it should not be possible to freely transfer units of the commodity from one sub-
market to another.
It should not be possible for the buyers in the dearer market to freely sneak into the
cheaper market to take advantage of the low price.
Ans.6 (a) MEC can be explained as the rate of discount that would make the present value of the
prospective yields from the capital asset equal to its supply price.
There is an inverse relationship between the rate of interest and the level of investment i.e.
higher the rate of interest, lower the level of investment and vice versa. This relationship in
terms of MEC, can be explained with the help of following diagram:
In the above diagram, MEC curve represents the level of investment that will take place in
the economy at various levels of interest rate. At interest rate ro, investment Io is
marginally efficient i.e. has a net present value of 0 (or its internal rate of return equals rate
of interest). All points to the left of the MEC have a positive net present value. If the
interest rate falls to r1, then further investment would become feasible up to total
investment I1 which is now marginally efficient.
(b) A decrease in interest rate would impact firms and individuals as follows:
Firms would be encouraged to invest more as it would be easier for firms to earn an
adequate return on project since cost of investment has reduced.
Individuals would be discouraged to save more as their savings would give low return
and they would likely incline towards more consumption.
Ans.7 (a) The effectiveness of policy of devaluing the domestic currency depends on:
(b) Governments often interfere to influence the foreign exchange rates because of the
following reasons:
(i) To stabilize the currency against the pressures of short-term speculations.
(ii) To stimulate demand for exports or to reduce imports.
Ans.8 (a) Four main canons of taxation as suggested by Adam Smith are explained below:
Ans.9 (a) A country may take any or combination of following non-monetary measures to overcome
current account deficit:
(i) Increasing import duties by means of tariff thereby, making the imports expensive.
(ii) Fixing the quantity of goods that may be imported by means of quotas to restrict the level
of imports.
(iii) Helping exporters to promote locally manufactured goods in international market by
organizing exhibitions, trade fairs and striking diplomatic deals.
(iv) Encouraging manufacturing and consumption of locally produced goods and services /
import substitution by means of providing specialist training, subsidies and tax reliefs.
Capital account
Foreign direct investment flows 20
Portfolio investment flows 10
Short-term banking flows (5)
Changes to reserves of gold / foreign currency 15
Capital account balance 40
Ans.10 (a) Objectives of monetary policy and the means to attain them:
(i) Price stability to keep the inflation low by managing the supply of money.
(ii) Economic growth by encouraging consumption and investments.
(iii) Exchange rate stability by effective utilization of policy instruments.
(iv) Full employment by encouraging consumption and investments by allowing resources
to be fully utilized.
(v) Credit control by regulating commercial banks through central bank (discount rate
policy, reserve requirements, open market operations, etc.).
(i) The initial size of money supply. If initial size of money supply is lower, less credit
would be created and vice versa.
(ii) Liquidity preference of people. In period of high inflation, people may not wish to
hold their money in banks that would mean less money is available to banks thereby
less credit would be created.
(iii) Availability of quality securities. If high valued collateral assets are not available, less
credit would be created and vice versa.
(iv) Economic conditions of trade and business. In the period of depression, investors
would be less inclined to borrow thereby limiting the role of credit creation.
The existing equilibrium is at point A. An increase in government spending would shift the
aggregate demand curve outwards (i.e. from AD1 to AD2) and now the equilibrium is
determined at point B. However, rise in wage rates would shift the short-run aggregate
supply curve inwards (i.e. from SRAS1 to SRAS2) and the new equilibrium is determined
at point C which would mean that increase in government spending has been cancelled out
by increase in wage rates and output level returns to the same level as before.
Derivatives
Derivative is merely a contract between two parties.
Its price is dependent on one or more underlying asset(s).
They are traded over the counter (OTC) and/or on an exchange.
(THE END)
Section A
Q.1 (a) What do you understand by the term ‘Capital formation’? Briefly describe the stages
involved in the process of capital formation. (04)
(b) Following data relates to a country Ruritania which is capable of producing the
following combinations of consumer goods and capital goods with a given quantity of
resources and technology:
Required:
(i) With the help of above data, draw a production possibility curve. (03)
(ii) Ruritania, after full utilization of its resources, is currently producing 70 units of
consumer goods. What would be the opportunity cost to Ruritania in terms of
capital goods if it decides to produce 50 more units of consumer goods? (01)
Q.2 (a) Define the law of ‘Equi-marginal utility’ and list the assumptions underlying the law.
Also describe any two limitations of the law of equi-marginal utility. (07)
(b) List the factors which determine the price elasticity of demand of a commodity. Briefly
describe what characteristics of a commodity are indicated by a negative or a positive
sign of ‘Income elasticity of demand’ and ‘Cross price elasticity of demand’ of that
commodity. (06)
Q.3 Describe the following diagram and the concept which it depicts. (06)
Q.4 (a) Briefly describe why the short-run average cost curve is U shaped. (05)
(b) Describe the law of variable proportion. Also state the assumptions on which the law of
variable proportion is based. (03)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(i) The mode of Islamic financing where a financial expert offers services for managing
investment; and the investor and the expert share profits, is called:
(a) Ijara (b) Mudaraba (c) Musharaka (d) Murabaha
(iii) If the demand equation for a good is Qd = 20 – P and the supply equation is
Qs = 6 + 1.5 P and the price is set equal to 2.4 above the equilibrium level, there will be
an excess:
(a) demand of 6 units (b) supply of 6 units
(c) demand of 12 units (d) supply of 18 units
(iv) The price of a product is Rs. 3 and the quantity supplied is 10 units. When price is
increased to Rs. 7 the quantity supplied increases to 12 units. The supply is:
(a) perfectly elastic (b) elastic
(c) inelastic (d) perfectly inelastic
(v) Which of the following may NOT be regarded as strength of a collusive oligopoly?
(a) production techniques and costs of all the firms are similar
(b) there are no barriers on entry of new firms
(c) similar products are produced by the firms
(d) the market is stable
(vi) Assume that marginal propensity to consume out of disposable income is 0.8 and the
rate of tax is 30% of total income. Under the simple Keynesian model, what would be
the total change in national income if government increases public spending by Rs. 150
million?
(a) Rs. 187.5 million (b) Rs. 341 million (c) Rs. 525 million (d) Rs. 750 million
(vii) Assume that in 2017 the nominal gross domestic product of a country is Rs. 500 billion
and the price index is 200. If the price index was 150 in 2010 what would be the real
gross domestic product of the country in 2017 computed in terms of 2010 prices?
(a) Rs. 125 billion (b) Rs. 166.67 billion (c) Rs. 375 billion (d) Rs. 666.7 billion
(viii) Which of the following marks the beginning of a contraction in the business cycle?
(a) Peak (b) Trough (c) Expansion (d) Recession
(ix) Government may increase the money supply through open market operations but such
measures are likely to result in short-term interest rates to:
(a) rise and increase the demand for money
(b) rise and reduce the demand for money
(c) fall and increase the demand for money
(d) fall and reduce the demand for money
Based on the above data, the aggregate demand for the economy would be:
(a) Rs. 625 billion (b) Rs. 850 billion (c) Rs. 650 billion (d) Rs. 825 billion
(xiii) Which of the following policy combination is likely to solve a deficit on the current
account of the balance of payment in an economy with a floating exchange rate?
(a) Decrease interest rates and increase income tax rates
(b) Increase interest rates and decrease income tax rates
(c) Decrease interest rates and decrease income tax rates
(d) Increase interest rates and increase income tax rates
(xiv) Suppose in an economy, the average price level is 1.3, real value of national output is
Rs. 230 billion and the quantity of money in circulation is Rs. 103 billion. The velocity
of circulation would be:
(a) 2.90 (b) 1.60 (c) 0.72 (d) 0.58
(xv) The most effective macroeconomic policy to increase output under fixed exchange rates
and perfect capital mobility would be:
(a) an expansionary monetary policy (b) a revaluation of the domestic currency
(c) an expansionary fiscal policy (d) an increase in taxes
Section B
Q.6 (a) Identify and describe the stage of business cycle which eventually takes the economy
into recession. (04)
(b) Alongside the benefits of economic growth, certain costs are also associated with it.
Identify and discuss the costs associated with economic growth. (06)
Q.7 (a) What is a capital market? State its main objectives. (03)
(b) What do you understand by the term ‘Derivatives’? State the main objective of
exchange traded derivatives. (03)
(c) The current account, the capital account and the financial account make up country’s
balance of payments.
Q.8 (a) State Keynes’ Psychological Law of Consumption and the allied propositions. (04)
(b) Briefly describe any four objective factors which influence the consumption function in
an economy. (06)
Q.9 (a) Identify four main objectives of fiscal policy and briefly describe how these objectives
may be achieved. (04)
(b) In recent times, public expenditure has increased enormously. Briefly describe any four
principal causes of growing public expenditure of nations. (06)
Q.10 (a) What do you understand by the term ‘Bank’? Briefly describe the following:
(i) Retail bank (ii) Specialized bank (iii) Investment bank (06)
Q.11 (a) What is meant by ‘Exchange rate’? Briefly describe the impact of fall in exchange rate
on a country’s exports and imports. (04)
(b) Illustrate with the help of a diagram, how the government may stop exchange rate
from falling. (06)
Where Y is the national income and Yd is the disposable income which is equal to
70% of the national income.
Required:
Calculate the following, showing necessary workings:
(i) equilibrium level of national income. (02)
(ii) fiscal surplus/deficit, if the rate of taxation is 30%. (02)
(b) According to the monetary economist Milton Friedman, a trade-off exists between
unemployment and wage inflation but only in the short-run. In the long-run, no such
trade-off exists.
Explain, with the help of a diagram, the arguments put forward by Friedman in this
regard. (06)
(THE END)
(iii) The consumer has a given scale of preference for the goods in consideration
(iv) The consumer has perfect knowledge of utility derived from goods
(v) Wants and goods are substitutable
(vi) Prices of goods remain unchanged
(vii) Consumer income is fixed
(viii) The marginal utility of money is constant
Ans.3
The above diagram depicts the concept of long run equilibrium of a firm under perfect
competition.
In perfect competition every purchaser and seller is so small relative to the entire market
that he cannot influence the market price by increasing or decreasing his purchases or
output. Therefore, the market price remains the same regardless of firm’s output.
The demand curve is completely horizontal, which means that sale of each additional unit
produces the same revenue and therefore MR=AR=P(Price). MC is the marginal cost
curve which depicts the increase in cost on account of production of each additional unit.
With the sale of each additional unit the total profit of the firm would increase till such
time that the MC remains below the Marginal Revenue Curve i.e. PL. The profit will be
maximum at point R where MC curve cuts PL from below because above this point each
additional unit will cost more than the revenue it would generate. At this stage (i.e. point
R) Marginal Cost would be equal to Marginal Revenue and the firm would be producing
OM units.
In the long run, the firms are able to increase /decrease their output by varying their
equipment. Therefore, in the long run no firm is in a position to earn super normal profits
and all firms earn normal profit which is depicted by the area OPRM where the total cost
and total revenue of the firm are the same.
Average fixed cost will fall as the level of output rises. Spreading fixed costs over a
larger amount of output is a major reason why (short-run) average costs per unit
falls as output increases.
The standard assumption about the variable costs is that up to a certain level of
output, the variable cost per unit is more or less constant (e.g. wages and material
costs per unit of output remain unchanged).
Nevertheless, there is evidence that average variable costs rise when output
increases beyond a normal capacity level.
Average variable costs will therefore begin to rise at some point, even if there are
no overtime payments or use of more skilled labour.
As variable costs per unit rise, the average total cost per unit will rise too.
Hence the curve falls on account of spread of fixed costs and rises when the
variable costs start rising after a certain level, thus giving the curve a U shape.
Ans.6 (a) The stage of business cycle which takes the economy into recession:
Downturn is the stage where the economic activity begins to slow down.
When demand begins to decrease, firms begin to scale back their production and
investment plans. There is a steady decline in output, profits, prices and
employment as demand falls, and firms respond by reducing their output.
Banks reduce the credit they issue, firms reduce orders that they place, and people
begin to lose their jobs, which further decreases the level of aggregate demand. This
eventually takes the economy into a state of recession.
(i) Inflation:
When economy grows too quickly, Aggregate Demand exceeds Aggregate
Supply because of which economic growth is not sustainable as it results in
positive output gap which prompts the firms to push up their prices.
(iii) Inequality:
More often increase in the rate of economic growth results in an increased
level of inequality because the growth may benefit a small section of the
society more than the others.
The capital market provides long-term debt and equity finance for the government
and corporate sector.
(b) Derivatives:
Derivative is an instrument whose price is dependent on one or more underlying
asset(s). It is a contract between two parties. The price of a derivative changes with
the change in the underlying asset(s).
(i) High level of Employment: The state expenditure are directed towards public
projects thereby creating employment with productivity.
The investment bank can also aid companies with acquiring funds, and
facilitate a number of transactions through utilising the financial markets.
As the exchange rate falls, imports look less attractive as imported goods become
more expensive for both the direct consumer and the domestic producer using them
for further processing. Consequently, country’s demand for imports contracts.
(b) How the government may stop exchange rate from falling:
Suppose the government wishes the rate to be at Rt. Policy options are:
Increase the domestic interest rate and hence shift the demand curve for rupees
from D to D1.
Purchase the surplus rupees (Qs-Qd) using foreign exchange reserves.
Deflate the economy to reduce the demand for imports. This will shift the supply
curve of rupees from S to S1.
(b) With the help of a diagram, explanation of the arguments put forward by Milton
Friedman with regard to long run Phillips curve and a trade-off between
unemployment and inflation:
Milton Friedman’s argument was that each short-run Phillips curve (SRPC) is
based upon a fixed expectation of inflation. If there is an increase in the expectation
of inflation, then this would cause the SRPC to shift higher.
At point B, firms’ costs and individuals’ wage demands increase, meaning output
falls, unemployment rises, and hence SRPC1 shifts to SRPC2.
Therefore, in the short run, a trade off may occur, however in the long run, it is not
possible to expand beyond the long-run Phillips curve (LRPC).
(THE END)
Section A
Q.1 (a) Economic problems affect different agents within an economy in different ways.
(b) What do you understand by the term ‘Planned economy’? How resource allocation
choices are made in a planned economy? Also state any three benefits of planned
economy. (05)
Q.2 (a) Describe the law of demand. Support your answer with the help of a diagram. (05)
(b) Briefly describe any four exceptions to the law of demand. (06)
Q.3 Explain the concept of consumer equilibrium with the help of indifference curve analysis. (08)
Q.4 Briefly describe the following diagram and the concept which it depicts. (08)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(ii) Smart phones have become the latest craze. Everyone wants to have the smart phone
and its sales are increasing. Therefore, the factory has increased production. This is an
example of:
(a) circular flow (b) due process
(c) opportunity cost (d) consumer sovereignty
(iii) Which of the following would unambiguously occur when there is a simultaneous
decrease in demand and supply?
(a) An increase in equilibrium price
(b) A decrease in equilibrium price
(c) An increase in equilibrium quantity
(d) A decrease in equilibrium quantity
(iv) Which of the following is held constant along the demand curve?
(a) Price (b) Quantity (c) Income (d) Both (a) and (b)
(vii) If the reserve requirement is 20% and banks hold no excess reserves, an open market
sale of government securities of Rs. 60 million by the central bank will:
(a) increase the money supply by up to Rs. 300 million
(b) decrease the money supply by up to Rs. 300 million
(c) increase the money supply by up to Rs. 12 million
(d) decrease the money supply by up to Rs. 12 million
(ix) Along with the benefits, certain costs are also associated with economic growth. These
include:
(a) high unemployment (b) decrease in tax revenue
(c) inflation (d) stagflation
(x) Which of the following is NOT a major determinant of the consumption function?
(a) Political instability (b) Real income
(c) Distribution of wealth (d) Changes in fiscal policy
(xi) Which of the following is a non-monetary measure for correcting current account
deficit?
(a) Exchange rate depreciation (b) Tariffs
(c) Interest rate appreciation (d) Exchange control
(xiii) Which of the following measures is NOT likely to boost a country’s rate of economic
growth?
(a) Tax cuts (b) Tax rebates
(c) Reduction in subsidies (d) Increase in government spending
(xv) The restrictive monetary policy in an open economy with flexible exchange rate is
most likely to result in:
(a) higher interest rates and an exchange rate appreciation
(b) higher interest rates and an exchange rate depreciation
(c) lower interest rates and an exchange rate appreciation
(d) lower interest rates and an exchange rate depreciation
Section B
Q.6 (a) Explain the concept of ‘Marginal propensity to save’ and how it is calculated. Also
explain any four determinants of savings. (07)
(b) Briefly describe the concepts of ‘Autonomous and Induced consumption’. (03)
Q.7 (a) Draw a diagram of the circular flow of national income. (04)
(b) Briefly discuss any two causes each of ‘Cost-push inflation’ and ‘Demand-pull
inflation’. (06)
Q.8 (a) What is ‘Credit money’? Give two advantages and disadvantages of credit money. (06)
(b) ‘Central bank uses monetary policy to achieve number of objectives in an economy.
However, due to conflicting situations, it is not possible to achieve all of these
objectives at once’.
Briefly describe any two conflicts which may exist between these objectives. (04)
Q.9 (a) Describe the principle of accelerator. Also state the assumptions underlying the
principle of accelerator. (05)
Q.10 (a) Briefly explain ‘Liquidity preference theory’. Briefly describe the three motives,
identified by Keynes which determine an individual’s demand for holding money in
liquid form. (07)
(b) What is meant by ‘Keynesian liquidity trap’? Identify any two policies which may
help in breaking out of the liquidity trap. (03)
Q.11 (a) What is meant by ‘Regressive’, ‘Proportional’ and ‘Progressive’ taxes? Give one
example of each of the above types of taxes in the context of Pakistan. (06)
(b) State any eight characteristics which are important for creating a good system of
taxation. (04)
Q.12 (a) Briefly explain ‘Balance of payment’, ‘Balance of trade’ and ‘Terms of trade’. (06)
(b) Describe any four corrective measures which may be adopted to improve the balance
of payment position in Pakistan. (04)
(THE END)
Ans.1 (a) The economic problem affects different agents within an economy in different ways.
In the simplest form of an economy, the main types of agents are as follows:
(iii) Government/state:
It governs over society through a combination of customs, exercises and
laws.
Productive resources are state owned and the state decides how they should be used
for the common good.
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The demand curve shows how the quantity purchased varies with the variation in
price. Along OX are represented the quantities of the good purchased and along OY
the prices. At the price OP, OM quantity is purchased, at OP’ the quantity
purchased is ON and at OP’’ the quantity is OL. As the price falls, more quantity is
purchased, and vice-versa.
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Ans.3 The consumer is said to be in equilibrium when the maximum possible satisfaction is
obtained from the individual’s purchases, at the prices prevailing in the market and the
amount of money the individual possesses for making purchases.
(i) AM is the budget line (consumer’s price line). Each point on the line represents a
combination of quantities of products A and B which the consumer can buy at the
prevailing prices, given the amount of money the individual has to spend on the two
products. Hence the equilibrium must be on some point on this line.
(ii) Each point on the indifference curve represents the same level of satisfaction. The
level of satisfaction increases as the individual moves from lower indifference curve
to higher indifference curve i.e. the individual is at a lower level of satisfaction at the
combinations represented by IC1 and at a higher level of satisfaction when on IC2
and so on.
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(iii) IC3 is the highest indifference curve to which the individual can go, given the money
and the prices of the goods in the market. The price line is tangent to the
indifference curve at point P which is the point of maximum satisfaction because all
other points on the curve are beyond the budget line.
(iv) Thus the consumer will be in equilibrium when the individual purchases OH
quantities of product A and OJ quantities of product B.
Ans.4
The above diagram depicts the concept of long run equilibrium of a firm under
monopolistic competition.
In the long run the firms earns normal profit as new firms enter the industry and starts
production due to which supply increases and the price falls. The average revenue curve is
more elastic (i.e. flatter), since large number of substitutes are available in the long-run.
AR is a tangent to the LAC at P. The equilibrium output in the long-run is OM and the
corresponding price is MP (=OP’). Therefore, at this point the firm is in equilibrium as
both average revenue and average cost is MP and the firm is earning normal profits.
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Determinants of savings:
(i) Level of income
Saving is determined by the level of income. There is a direct relation
between the two i.e., savings increase as the level of income increases.
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Induced consumption:
When a change in disposable income “induces” a change in consumption on goods
and services, that changed consumption is called “induced consumption”.
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(b) Mutual conflicts which may exist between the objectives of monitory policy:
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(iii) Leakages:
Leakages from the circular flow of income would lower the value of multiplier
and extra spending in the economy would have nominal effect, particularly
where there is a high marginal propensity for imports.
Transactions motive:
Individuals need money to meet their day-to-day requirements of purchases of
goods and services. The need to hold money for transactions arises because the
payments and receipts of individuals are not exactly synchronised. The liquidity
preference or transactions demand for money will increase either by an increase in
the real national income or an increase in the general price level or any combination
of the two.
Precautionary motive:
Individuals keep money in hand or with banks as a precautionary measure to meet
any unforeseen fluctuations in receipts and payments. The precautionary demand
for money arises due to uncertainty regarding the timing and size of payments and
receipts. The higher the level of national income, the larger amounts of money
balances that would be needed for precautionary purposes, reflecting higher
liquidity preference.
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Speculative motive:
The holding of money has an opportunity cost in the form of income foregone by
not using the money to purchase an income bearing asset e.g. a bond. When
interest rates are high, individuals will hold lesser amounts for speculative purposes
and therefore have low liquidity preference. When the interest rates tend to be low,
individuals will retain large amounts in anticipation of increase in interest rates and
would have high liquidity preference.
The policies that may help in breaking out of liquidity trap are as follows:
Fiscal policy:
It is an important instrument in raising aggregate demand, for example running a
larger budget deficit by increasing public expenditure or reducing taxes.
Example
(i) Sales tax at the rate of 17%.
(ii) Toll for accessing roads, bridges etc.
Progressive taxation:
It refers to a situation where the percentage of income paid in taxes increases as
income increases. The principle of progressive tax is: “higher the income, higher the
rate.”
Example
(i) Income tax on salaries in Pakistan
(ii) Tax on rental income from property
Proportional tax:
Also called a flat-rate-tax is charged at the same percentage on all income levels i.e.
the tax as a percentage of income remains constant as income increases.
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Example
(i) Income tax on companies
(ii) Tax on commercial importers
Balance of trade:
Balance of trade is a record of a country’s international trade transactions (import
and export of goods) with other countries during a given period of time. The
Balance of trade is in deficit when a country’s imports exceeds its exports.
Terms of trade
The quantity of domestic goods that a country must give up to obtain a unit of
imported goods is called the terms of trade.
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(THE END)
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Certificate in Accounting and Finance Stage Examinations
The Institute of 9 March 2017
Chartered Accountants 3 hours – 100 marks
of Pakistan Additional reading time – 15 minutes
Section A
Q.1 (a) What do you understand by the term ‘Factors of production’? What types of factors
of production are used by a school? (03)
(b) Briefly describe any four core features of Islamic economic system. (04)
Q.2 Describe the Law of ‘Diminishing marginal utility’. Support your answer with the help of a
schedule and a diagram. (07)
Q.3 (a) Define the concept of ‘Price elasticity of supply’ and how it may be calculated.
Identify the factors which would increase the price elasticity of supply. (05)
(b) What do you understand by ‘Reservation price’? Briefly describe three factors which
may affect the reservation price. (05)
Q.4 (a) Define the term ‘Economies of scale’? Describe any four ways by which a firm may
achieve internal economies of scale. (06)
(b) What is meant by ‘Oligopoly’? List any four advantages and disadvantages of
Oligopolies. (05)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(i) Which of the following concepts is NOT illustrated by the production possibility
curve?
(a) Efficiency (b) Opportunity cost
(c) Equity (d) Trade-off
(iii) With 50 units of labour, a firm can produce 1,800 units of output. With 60 units of
labour the firm can produce 2,100 units of output. The marginal product of labour is:
(a) 0.33 (b) 3 (c) 30 (d) 300
(iv) Which one of the following will NOT shift the demand curve for a normal good to
the left?
(a) A fall in consumers incomes
(b) A rise in the price of a complementary good
(c) A fall in the price of the substitute good
(d) A rise in the price of the normal good
(v) Which one of the following is NOT a barrier to entry into a monopoly market?
(a) Significant economies of scale
(b) Heavy potential advertising costs
(c) Large capital requirements
(d) Constant returns to scale
(vi) The inverse relationship between rate of interest and level of investment is shown
by:
(a) supply curve
(b) the marginal efficiency of capital curve
(c) demand curve
(d) indifference curve
(ix) Murad pays a tax of Rs. 100 on his income of Rs. 1000 while Sohail pays a tax of
Rs. 200 on his income of Rs. 800. Identify the tax system prevailing in the country.
(a) Progressive (b) Regressive
(c) Proportional (d) Equitable
(x) The Phillips curve indicates that there is a trade-off between the objectives of:
(a) inflation and economic growth
(b) inflation and unemployment
(c) inflation and balance of payments
(d) inflation and exchange rate
(xiii) The protective measure of a government where only a fixed amount may be
imported into a country refers to:
(a) Import tariff (b) Export tariff
(c) Quota (d) Import substitution
(xiv) Whenever a commercial bank’s desired reserve ratio exceeds its actual reserve ratio
the bank will:
(a) call in loans and reduce reserves
(b) call in loans and increase reserves
(c) make additional loans and reduce reserves
(d) make additional loans and increase reserves
(xv) Which of the following is most likely to result from revaluation of a country’s
exchange rate?
(a) Exports will become less competitive
(b) Imports will become more expensive
(c) Inflation will rise
(d) Export volumes will rise
Section B
Q.6 (a) Illustrate the concepts of ‘Nominal interest rate’ and ‘Real interest rate’. (05)
(b) Illustrate the process through which the central bank may reduce the level of
aggregate demand in the economy using open market operations. (05)
Q.7 (a) What is inflation? Briefly state any four harmful effects of inflation on the economy. (05)
(b) Explain the concept of ‘Natural rate of unemployment’ with the help of a diagram. (05)
Q.8 (a) What is meant by ‘Economic growth’? Briefly describe the benefits of economic
growth. (08)
(b) In an open economy, the marginal propensity to consume is 0.7 and the proportion
of additional income that is spent on imported goods is 20%. National income is
Rs. 100,000,000 and the current account is in balance. What would be the new
equilibrium of national income if the government increases its expenditure by
Rs. 50,000,000? (02)
Q.9 (a) Define ‘Money market’. Briefly describe any two marketable instruments traded on
money markets. (04)
(c) Compute the velocity of circulation of money in an economy using the Quantity
Theory of Money, where the average price level is 1.8, real GDP is Rs. 28,726
billion and the nominal money supply is Rs. 12,926 billion. (02)
Q.10 (a) ‘Income method measures the national income after it has been distributed and
appears as income earned or received by individuals of the country’.
List the items which are excluded from the computation of national income under
the income method. (03)
(b) Explain with the help of a diagram, the equilibrium of aggregate supply (AS) and
aggregate demand (AD) under neo-classical approach. (07)
Q.11 (a) Briefly describe the main functions of ‘Public finance’ as stated by Musgrave. (06)
Q.12 What do you understand by ‘J curve’? Explain with the help of a ‘J curve’, how in the
short-run the current account deficit may get worse before improving. (10)
(THE END)
(i) Land – The school needs land for constructing the school building,
assembly hall, playground, etc.
(ii) Labour – Both qualified and trained teachers and semi-skilled labours are
required for running the school.
(iii) Capital – Capital investment in building, furniture, laboratory equipment,
computers, library books, stationery, etc. is required.
(iv) Enterprise – School management which manages all the above
resources efficiently.
The law of diminishing marginal utility can be explained by the following diagram
drawn with the help of above schedule:
In the above diagram, the marginal utility of different glasses of water is measured on
the y-axis and the units (glasses of water) on X-axis. The marginal utility curve has a
downward slope. It intersects the X-axis at the point of 6th unit of the commodity (point
"F") where the marginal utility becomes zero. When the MU curve goes beyond this
point, the MU becomes negative. So there is an inverse functional relationship
between the units of a commodity and the marginal utility of that commodity.
Where:
Percentage change in quantity supplied
New quantity supplied − old quantity supplied
=
Average quantity supplied
Factors:
The following factors would increase the price elasticity of supply:
(i) Greater availability of stocks
(ii) Greater ability of firms to switch resources to and from substitutes in
production
(iii) Increased ease of entry and exit to and from the market
(iv) Shorter length of production process
(v) Availability of excess production capacity
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(b) Reservation price:
It is the minimum price a firm is willing to receive for its good.
(iii) Objectives
The nature of objectives also plays a key role in the determination of the
reservation price for the firms. For instance; a firm penetrating the market
may set a lower reservation price as compared to the firm which dominates
the market.
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(b) Oligopoly:
An industry dominated by a few large suppliers is called Oligopoly.
Advantages of oligopoly:
(i) Members of an oligopoly might be able to set prices (though this might be
illegal).
(ii) Oligopolists are able to make large profits as there are few players in the
market.
(iii) Barriers to entry allow an oligopolist to maintain profits in the long term.
(iv) Customers are easily able to make price comparisons among the few
players existing in the market and chose the best alternative.
Disadvantages of oligopoly:
(i) Price setting in an oligopoly might prove disadvantageous to customers.
(ii) Innovation of small players in the industry is stifled.
(iii) An oligopolist is able to make good profits on an on-going basis so there
may be no incentive for product improvement.
(iv) Oligopolistic industries can suffer from price wars.
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SECTION B
For instance if a borrower pays Rs. 10 on every 100 rupees lent to him. The
nominal interest rate is 10%.
For instance; if a bond compounds annually and has a nominal interest rate of
10% and the inflation rate is 6% then the real interest rate is only 4%.
Harmful effects:
(i) Increase in cost of living:
Due to inflation, cost of living rises, the working classes are hard hit.
Wages do not rise at the rate prices are rising. Those sections of society
who have fixed incomes, like salaried class, face difficulty in buying their
daily needs.
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(iv) Less exports and more imports:
If rate of inflation in a country is higher than its major trading partners, its
exports will become relatively more expensive and imports relatively
cheap. As a result, the balance of trade will suffer, affecting employment in
export industries and in industries producing import-substitutes.
(b) Even when the labour market is in equilibrium, there is a level of unemployment
in the economy which is unavoidable. This is known as the natural rate of
unemployment.
In the above diagram, real wage rate is measured on the y-axis and
employment of labour on x-axis. Where, D(L) is the demand curve, S(L) is supply
curve. The “workforce” includes those who are actively supplying their labour, as
well as those who are voluntarily unemployed.
L1 shows the equilibrium between the supply and demand for labour at the wage
level W 1.
L2-L1 workers in the workforce choose not to partake at a given wage level.
These people are those who make up the level of natural unemployment in the
economy.
Benefits of Growth:
Following are benefits of economics growth:
(i) Higher Employment/lower unemployment
Real economic growth gives rise to higher employment. This is because
with higher levels of output, firms tend to employ more workers.
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(iii) Enterprise confidence
Sustained economic development casts a positive impact on company
profits and raises business confidence.
1 ÷ [1 − (0.7 − 0.2)] = 1 ÷ 5 = 2
(c) The equation for velocity of circulation of money as per quantity theory of money
is as follows:
M×V=P×Y
Where:
Ans.10 (a) The items which are excluded from the computation of national income under
the income method are:
(i) Transfer Payments (e.g. state pension, unemployment benefits and other
social payments) which are ignored to avoid double counting the income:
(ii) Income gained from stock appreciation. This is due to inflation and not a
rise in output.
(iii) Private transfers of cash from one person to another.
(iv) Income not declared to the tax authorities (the “black” or “shadow”
economy).
(v) Activity such as subsistence farming and barter transactions.
In the above diagram, price level is measured on y-axis and real national output
on x-axis. AD is the aggregate demand curve whereas LRAS is the long run
aggregate supply and SRAS is the short run aggregate supply curve.
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The macro economy is in equilibrium at the point where SRAS (value of output
produced within an economy) is equal to AD (level of demand for goods and
services).
The reason why equilibrium does not arise at the intersection of LRAS and AD
is that LRAS is the productive potential in the economy. Whereas SRAS is what
is actually being supplied in the macro economy, and is therefore what
equilibrium should be based upon.
If the general price level is above the equilibrium point, then firms will
persistently find that their stocks remain unsold. This then indicates that they
should cut back on further production, to reduce the level of inventory.
If, however, the general price level is below the equilibrium point, then demand
will outstrip supply, stocks will quickly become run down, thus signaling to
producers that they should increase supply.
The budgetary policy divides the total resources among private and social
goods by which the mix of social goods is chosen.
(i) Forecasting
The fiscal policy is devised around predictions of various economic
activities. For the fiscal policy to work as desired, these predictions need
to be accurate. However, the coming events of economic instability
cannot be predicted accurately.
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Ans.12 Concept of ‘J curve’ in correcting the current account deficit:
J curve refers to the trend of a country’s trade balance following a devaluation or
depreciation under a certain set of assumptions.
Assuming that the economy starts at point A. Following devaluation, the deficit
increases before it swings up to a surplus with the passage of time. The reason for the
deficit is the time lag and elasticity of demand and supply. Producers and consumers
will take time to adjust to the currency change. Supply may be inelastic in the short run
as producers may have already entered into contracts and not be able to respond to
the price changes. Thus export revenues may not immediately increase. However,
imports may become more costly and demand for them may be relatively inelastic,
thus increasing the deficit.
(THE END)
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Certificate in Accounting and Finance Stage Examinations
The Institute of 8 September 2016
Chartered Accountants 3 hours – 100 marks
of Pakistan Additional reading time – 15 minutes
Section A
Q.1 (a) Explain the concept of Production Possibility Curve (PPC) with the help of a diagram. (07)
(b) Briefly discuss how the concept of PPC is useful in explaining the economic concept
of ‘scarcity’. (03)
Q.2 (a) Define Price Elasticity of Demand. Identify and briefly explain the factors which
determine the Price Elasticity of Demand. (06)
(b) Compute the price elasticity of a product if an increase in the price of the product from
Rs. 10 per unit to Rs. 11 per unit causes a decrease in its demand from 2.5 million
units to 1.9 million units. (03)
Q.3 The following data refers to the total revenue and total costs of a firm at various output
levels:
(a) Calculate the firm’s fixed cost and the marginal cost at each level of output. (03)
(b) Determine the level of output at which the firm would optimise its profits. Also
determine the amount of profit that the firm will make at the desired level of output. (05)
Q.4 What do you understand by the term Perfect Competition? With the help of an appropriate
diagram, explain the Equilibrium of a Firm under perfect competition in the long run. (08)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(iii) Which of the following will always increase when a manufacturing business increases
its output?
(a) Fixed costs
(b) Marginal cost
(c) Total costs
(d) Average variable cost
(vi) Which of the following situations would cause the value of the multiplier to fall?
(a) A fall in the level of government expenditure
(b) A rise in the marginal propensity to consume
(c) A rise in the marginal propensity to save
(d) A fall in business investment
(vii) Which of the following does not normally happen in the recession phase of the
business cycle?
(a) A fall in the level of national output
(b) A rise in the rate of inflation
(c) A rise in the level of unemployment
(d) All of the above
(xi) Which of the following constitute(s) injection into the circular flow of income?
(a) Investments by businesses
(b) Government expenditures on goods and services
(c) The value of exports
(d) All of the above
(xii) The following data relates to the economy of a country during a one year period:
Rs. in billion
Exports 288
Investment 166
Savings 117
Government expenditure 150
Imports 335
Taxes 199
(xiv) Which of the following is the main distinguishing factor between capital and money
markets?
(a) Transaction costs
(b) The amounts involved
(c) Time to maturity
(d) Risk involved
Section B
Q.6 (a) Discuss the concept of Consumer Price Index (CPI). State any three limitations of
CPI as a measure of inflation. (06)
(b) Briefly discuss any two measures that may be adopted for controlling inflation if an
economy is facing:
cost-push inflation
demand-pull inflation (04)
(b) Explain how the central banks are able to reduce the level of aggregate demand in an
economy by changing the reserve requirements of commercial banks? (08)
Q.8 (a) Identify and briefly explain the different phases of business cycle. (06)
(b) List any eight indicators which would confirm the stages of business cycle the
economy is in. (04)
Q.9 (a) What is meant by ‘direct taxation’ and ‘indirect taxation’? Give two examples of each
type of taxation. (04)
(b) State any three advantages and three disadvantages of direct and indirect taxation. (06)
Q.10 (a) Discuss gross investment and explain its relevance to the accelerator principle. (03)
(b) Consider the following information and determine the rate of change of gross
investment for each of the following five years (year 1 to 5) using the accelerator
principle based on the following data:
Q.11 (a) Define capital market and list any four types of organizations that operate in the
capital market. (04)
(b) If a government wishes to raise money through the capital market, explain the choice
of instruments that are available to it. Also state what matters it would consider while
raising the money through capital market. (06)
Q.12 (a) Briefly discuss five main causes of disequilibrium in the balance of payments. (05)
(b) State and briefly describe the impact of any five measures that a government may take
to rectify the disequilibrium in the balance of payments. (05)
(THE END)
SECTION-A
A.1 (a) The Production Possibility Curve (PPC) represents all possible combinations of alternative
goods an economy can produce with the available resources within the given state of
technology.
For the purpose of simplicity the curve is based on two products only i.e. X and Y and we
assume that all the resources are allocated for producing the two goods only.
The curve indicates that the economy can produce a number of combinations such as 60
units of X and 100 units of Y or 90 units of X and 60 units of Y and so on.
The cost of an item measured in terms of the alternatives forgone is called its opportunity
cost. Thus, if an economy produces 60 units of X and 100 units of Y (point H) instead of
producing 90 units of X and 60 units of Y (point J), then the opportunity cost of producing
(100-60) more units of Y would be the lost production of (90-60) units of X.
If the economy produces lesser quantities, it would not be utilizing the full resources
whereas quantities in excess of those represented by the curve cannot be produced on
account of limited resources.
(b) Since scarcity forces an economy to forego one choice for another, PPC is useful in
explaining how choices can be made and the ways in which the scarce resources may be
allocated towards achieving the optimal production. PPC can also be used to show how
change in the long run affects the resources that are available in the economy.
A.2 (a) Price elasticity of demand is the measure of the responsiveness of the quantity demanded of
a product to any changes in its price.
(ii) Percentage/ratio of income: The higher ratio of the product’s price to the consumers’
income, the higher is the elasticity, as people are careful while purchasing the good.
(iii) Necessity/nature of commodity: The more necessary a product is, the lower the
elasticity of demand, as people will buy it no matter what the price is, such as
medicine, wheat etc.
(iv) Time/Emergency: Elasticity of demand is higher in the long run, as more and more
people stop demanding the good if high price persists.
(v) Goods having several uses:
Certain goods have different uses e.g. electricity is a necessity for certain uses, while
for other uses it is a comfort or luxury. Elasticity will be measured depending upon
the use. More important the use is more inelastic the demand would be and less
important the use is, more elastic the demand would be.
(b) Method 1
P1 Rs.10, P2 Rs.11
Q1 2,500,000, Q2 1,900,000
Change in Demand Q1 Q 2
A.3 (a) Fixed costs have to be paid even when output is zero and no production is taking place.
The firm's fixed costs are therefore Rs. 22 million at zero output.
(b) The firm aims to maximize profits and it will do this where the marginal revenue gained
from selling the last unit is equal to the marginal cost of producing that unit. The only
output level where marginal revenue equals marginal cost is 8 million units, where both
MR and MC are Rs. 10 million [Refer to Annexure A for working]. The firm will thus
produce 8 million units.
Profit equals total revenue minus total cost. At 8 million units this is Rs. 88 million Rs. 54
million = 34 million.
Annexure A
Output Costs MC MR Revenue
Units in million -------------------- Rs. in million --------------------
0 22 - 0 0
1 28 6 12 12
2 32 4 12 24
3 35 3 12 36
4 36 1 11 47
5 37 1 11 58
6 40 3 10 68
7 44 4 10 78
8 54 10 10 88
9 65 11 9 97
A.4 In perfect competition every purchaser and seller is so small relative to the entire market that he
cannot influence the market price by increasing or decreasing his purchases or output.
The equilibrium of a firm under perfect competition and in the long run is depicted by the
following diagram:
Under perfect competition the same price prevails in the market and hence sale of each additional
unit produces the same revenue and therefore MR=AR=P(Price). MC is the marginal cost curve
which depicts the increase in cost on account of production of each additional unit. With the sale
of each additional unit the total profit of the firm would increase till such time that the MC
remains below the Marginal Revenue Curve i.e. PL. The profit will be maximum when the MC
curve cuts PL from below because after this point each additional unit will cost more than the
revenue it would generate. At this stage Marginal Cost would be equal to Marginal Revenue and
the firm would be producing OM units.
In the long run, the firms are able to increase /decrease their output by varying their equipment.
Therefore, in the long run no firm in a position to earn super normal profits. If price increases and
the firms start earning super profits, other firms enter the market or existing firms increase their
output. If price decreases and there are below normal profits, firms exit the market.
SECTION-B
A.6 (a) Consumer price index (CPI) is a measure of the weighted average of prices of a basket of
goods and services. It is calculated by taking price changes for each item in the
predetermined basket, averaging them, and then weighing them based on the importance of
each.
If the price of bread increases from Rs.150 to Rs.165 (10%) then the new price in indexed
terms would be 110. The reason that the items are “weighted” is that certain goods and
services are said to contribute to the cost of living more than others.
(b) The central banks are able to reduce the level of aggregate demand in an economy by
changing the reserve requirements, as described hereunder:
(i) When a central bank increases the level of reserves that the commercial banks must
hold, the commercial banks have to reduce the level of loans that they give out.
(ii) A certain reduction in the level of reserves that commercial banks must hold
translates, through the multiplier effect, in a much bigger contraction in the overall
money that they loan out. This causes the money supply to decline.
(iii) As the money supply contracts, money becomes “tight” (i.e. less available and more
expensive). This reduced level of money in the economy raises the interest rate, and
reduces the amount of credit available in the economy. Consequently interest rates
rise and firm individuals looking for investment are discouraged from borrowing, and
spending more money.
(iv) The effect of tight money reduces the level of aggregate demand, causing a drop in
output, employment and inflation.
Downturn
In this phase, economic activity begins to slow down. When demand begins to
decrease, firms begin to scale down their production and investment plans. There is a
steady decline in output, profits, prices and employment as demand falls, and firms
respond by reducing their output. Banks reduce the credit that they issue, firms cancel
orders that they place, and people begin to lose their jobs, which further decreases the
level of aggregate demand.
Depression
With high unemployment levels, low incomes, low consumer demand and low
investment, the economy slips into a state where output remains very low. There is
under-utilisation of resources. Business confidence is extremely low, as profits and
prices go lower and lower.
Recovery
At this stage, there is an increase in levels of economic activity as demand begins to
increase slightly. With an increase in demand, production increases, causing an
increase in investment. This causes a steady rise in output, incomes and business
confidence. Assets in the economy begin to be utilised again, and levels of GNP start to
increase.
(b) Indicators of business cycle that confirms at which stage the economy is:
Leading economic indicators
Index of business confidence
Manufacturers’ new orders
New building permits for private housing
Money supply
Indirect taxation:
A tax that increases the price of a good, meaning that the impact of tax is passed on to the
buyer/consumer.
Examples:
Sales tax
Custom duty
Excise duty
A.10 (a) The amount of investment required for all new investment plus the amount required to
service the fall in value of existing capital
The accelerator principle asserts that investment levels in an economy are positively related
to a change in the rate of GDP
In order to meet the fixed capital output ratio, a firm needs to invest in new capital and also
cover the depreciation of capital from the previous year.
A.11 (a) Capital market is the financial market which is largely used to raise long-term finance and
capital.
The main types of organisations that operate in the capital markets are as follows:
Corporations
Commercial banks
Stock exchanges
Investors
Non-bank institutions (insurance companies/leasing companies/mortgage banks etc.)
(b) The way in which a government would raise money through the capital markets by issuing
the following instruments:
Debentures: A debt instrument where there is no physical asset for use as collateral.
Instead, the government’s creditworthiness is considered by investors to adjudicate the
risk involved.
Bonds: The investors buy debt from the government in exchange for a fixed return at
various points of time, and then the principal (amount paid for it).
The matters which the government may consider while raising money from capital markets
are:
Rate of interest that needs to be paid to investors
Length of time to pay back
The risk factor of them not returning money to investors
Alternative methods of raising capital (increasing taxes, etc.)
A.12 (a) Following are some of the causes of disequilibrium in balance of payment:
Natural factors
Natural calamities like drought or flood may easily cause disequilibrium in balance of
payments. These natural calamities can adversely affect agricultural and industrial
production. Exports may decline and imports may go up, causing a deficit in the country’s
balance of payment.
Trade cycles
Business fluctuations caused by the operation of trade cycles may also result in
disequilibrium in country’s balance of payments. For instance, if there occurs a recession, it
may induce a fall in the exports and exchange earning of the country concerned resulting in
a disequilibrium in the balance of payments.
Political instability
Political instability results in disrupting the productive potential within the country, thereby
causing a decline in exports.
Relatively high rate of inflation
High rate of inflation as compared to other countries makes the goods produced by that
country relatively expensive. As a result, its exports decline and the balance of payment
runs into a deficit.
Trade restrictions by other countries
Sometimes other countries impose heavy custom duties or fix quotas or ban imports from a
country. It results in lower exports of that country.
Inelastic demand for machinery and industrial goods
The demand for these goods by less developed countries is inelastic because these less
developed countries have no choice since there is shortage of such goods in these countries
and to increase their growth rate they are going to need such goods. Hence their imports
remain high.
(b) The following measures are usually taken to correct a disequilibrium in the Balance of
Payments:
(i) Depreciation or devaluation of the home currency which makes the imports costlier
and uncompetitive, whereas exports become more competitive.
(ii) Protectionist measures resulting in either partial restriction or complete ban on
imports or increase in cost of imports.
(iii) Domestic deflation by reducing the supply of money and thereby aggregate
domestic demand so that the quantity of imported goods decreases.
(iv) Increase in domestic interest rate to attract deposits from foreign countries.
(v) Import substitution to reduce the overall quantity of imports.
(vi) Exchange control regulations to restrict outflows of funds from the home country.
(vii) Stimulating exports by providing subsidies and tax holidays to export-oriented
industries.
(THE END)
Section A
Q.1 Free market economy permits private ownership and control of factors of production.
However, it is argued that it often results in exploitation of weak economic agents because
of which government has to intervene to control and regulate the economy in several ways.
In the light of above, explain the role of government in a mixed economy. (06)
Q.2 Explain the law of variable proportions. Discuss the various stages of law of variable
proportions with the help of a diagram (schedule not required). Also explain at which stage
a rational producer would stop production. (10)
Q.3 (a) One of the characteristics of a monopolist is the ability to engage in price
discrimination. Describe the term ‘Price Discrimination’. Briefly explain the conditions
which must exist to enable the monopolist to exercise the power of price discrimination
effectively. (04)
(b) Monopolist will be in equilibrium at that price-output level at which his profits are
maximized. Explain the price-output equilibrium of a monopolist with the help of a
diagram. (08)
Q.4 (a) What do you understand by ‘Change in Quantity Supplied’ and ‘Change in Supply’? (02)
(b) Briefly explain any five factors that are responsible for ‘Change in Supply’. (05)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(i) The demand curve for the product of a firm operating under conditions of perfect
competition would be:
(a) identical to the marginal revenue
(b) intersecting the marginal revenue curve at the point where marginal cost is equal
to marginal revenue
(c) intersecting the average variable cost curve at its lowest point
(d) perfectly inelastic
(ii) Shahid has employed 25 workers to whom he pays wages at the rate of Rs. 150 per
day. He is now intending to increase the wage rate of all workers by Rs. 20 per day in
order to attract one additional worker. Given that all other costs remain constant, the
marginal cost of labour per day would be:
(a) Rs. 20 (b) Rs. 170 (c) Rs. 670 (d) Rs. 4,420
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Introduction to Economics and Finance Page 2 of 4
(iii) Farhan has fixed income which he spends on only two goods i.e. X and Y. Farhan’s
total utility will be maximized when he distributes his total income in a manner that:
(a) average utility of last unit of X purchased is equal to the average utility of last
unit of Y purchased
(b) marginal cost of last unit of X is equal to marginal cost of last unit of Y
(c) total utility of good X is equal to the total utility of good Y
(d) marginal utility of last unit of X purchased is equal to the marginal utility of last
unit of Y purchased
(iv) The level of structural unemployment would most likely be reduced by:
(a) increase in the level of consumer expenditure
(b) increase in research and development grants for technology
(c) increase in labour mobility
(d) both (a) and (b)
(v) Which of the following represents a withdrawal from the circular flow of national
income?
(a) A rise in consumption
(b) A deficit on the balance of trade
(c) A surplus on the balance of trade
(d) A rise in public investment
(vi) If there is an increase in investment in an economy by Rs. 250 million and marginal
propensity to consume is 3/4, then overall effect on the total output of the economy
would be:
(a) Rs. 1,000 million (b) Rs. 333.33 million
(c) Rs. 187.50 million (d) Rs. 750 million
(vii) Mohsin pays income tax of Rs. 2,500 on his earnings of Rs. 20,000. Danish pays
Rs. 4,000 income tax on his earnings of Rs. 32,000. Kinza pays Rs. 5,000 income tax
on her earnings of Rs. 40,000. The income tax system is:
(a) regressive (b) proportional (c) progressive (d) equitable
(xi) Which of the following cannot be used as a tool to correct balance of payments
disequilibrium?
(a) Floating exchange rate
(b) Fixed exchange rate
(c) Domestic interest rate
(d) Buying / selling of domestic currency by central bank
(xii) In an economy where demand for imports is price inelastic and demand for exports is
price elastic, an appreciation in the value of domestic currency would result in:
(a) increase in imports spending and decrease in exports revenue
(b) increase in exports revenue and decrease in imports spending
(c) increase in imports spending as well as exports revenue
(d) decrease in imports spending as well as exports revenue
(xiii) The instrument that may be issued by government in capital market to raise money
for a long-term investment is:
(a) certificate of deposits (b) commercial paper
(c) preference shares (d) bonds
(xv) In which of the following options consumer sovereignty is in the order of highest to
lowest?
(a) Market economy, mixed economy, planned economy
(b) Mixed economy, market economy, planned economy
(c) Market economy, planned economy, mixed economy
(d) None of the above
Section B
Q.6 (a) The following data relates to the economy of a country over a one year period:
Rs. in billion
Domestic consumption 230,000
Taxes on expenditures 69,000
Government expenditures 51,750
Capital formation 58,650
Exports 80,500
Imports 74,750
Subsidy 5,750
Net property income from abroad 4,750
Capital depreciation 23,000
(b) Identify any six types of difficulties that are commonly faced in measuring National
Income. (03)
Q.7 (a) What do you understand by the term ‘Multiplier’? With the help of a diagram show
the multiplier effect of an increase in investment by Rs. 100 million on the equilibrium
level of income where marginal propensity to save is 1/3. (06)
(b) Briefly explain any four measures by which government may influence the level of
private investment in an economy. (04)
Q.8 (a) Define Phillips Curve. Explain the trade-off between unemployment and wage
inflation with the help of a Phillips Curve. (08)
(b) Describe the type of unemployment that is generally observed during a period of
recession in an economy. (02)
Q.9 (a) Governments often seek to achieve certain objectives by influencing the exchange
rates. Identify any three such objectives. (03)
(b) Governments often follow a policy of deliberately weakening the domestic currency
by reducing its parity value within a fixed rate system. Identify the purpose of
following such policy and also discuss the factors upon which effectiveness of such
policy depends. (07)
Q.10 (a) Commercial banks play a vital role in creation of credit money in an economy.
Describe the process of credit creation by commercial banks by means of advancing
loans, with the help of an example. (06)
(b) Briefly discuss any four factors which might limit the commercial banks’ ability to
create credit money in an economy. (04)
Q.11 (a) What do you understand by ‘Terms of Trade’? Briefly explain whether improved
terms of trade always mean a fall in the balance of payments deficit. (04)
(b) Briefly explain various monetary and non-monetary measures which may be taken by
the government to correct balance of payments deficit. (06)
(THE END)
A.1 In a mixed economy, government plays an important role to overcome the inadequacies of free
market economy. It includes:
A.2 According to the law of variable proportions, when more and more units of variable factor of
production (labour) are applied, holding the quantities of fixed factor of production (capital/land)
constant, marginal product (MP), average product (AP) and total product (TP) would continue to
increase up to a certain point after which the MP, AP and TP would start to decrease and finally
becomes negative.
The stages of law of variable proportions can be explained with the help of following diagram:
Stage I:
In this stage, AP is maximum (R) whereas TP increases initially at increasing rate (L) and
thereafter it increases at diminishing rate (L to M). MP also increases initially and reaches its
maximum (N) however, later on it begins to diminish and becomes equal to AP (O). In this stage
MP exceeds or is equal to AP.
Stage II:
In this stage, TP continues to increase at diminishing rate and reaches its maximum point (G).
Correspondingly MP diminishes rapidly and becomes zero (C). AP starts from its maximum (R)
and thereafter it begins to decrease. In this stage, MP is less than AP.
Stage III:
In this stage, TP starts diminishing, AP also continues to decline and MP turns negative thus law
of variable proportions firmly manifests itself.
A rational producer will not opt to stop production at Stage I because his fixed factor will remain
underutilized and he will be foregoing the opportunity of increasing production by increasing the
quantity of the variable factor whose average product continues to rise throughout in Stage I. He
will also not choose Stage III where not only average product is falling but also the total product
is falling and marginal product is negative. He would opt to produce in Stage II, where the
marginal product continues to remain positive. The producer will employ the variable factor up
to the point where marginal product equals to marginal cost.
A.3 (a) Price discrimination can be described as the action of selling the same product to different
groups of buyers at different prices in order to maximize profits.
It can be seen from the above diagram that up till OQ output, marginal revenue (MR) is
greater than marginal cost (MC) but beyond OQ the MR is less than MC. Therefore, the
monopolist will be in equilibrium at the output OQ where MR is equal to MC and profits
are the greatest.
The price at which output OQ is sold in the market can be known from looking at AR.
Corresponding to equilibrium output OQ, the price on the AR is QP′ = OP. Thus, given
the cost-revenue situation, the monopolist will be in equilibrium at the output OQ and will
be charging price equal to QP′ = OP.
Thus, the total profit earned by the monopolist in the equilibrium position is equal to the
rectangle P′LCP i.e. the shaded area.
A.4 When the supply of a commodity changes due to a change in its price, it is said to be a change in
(a) quantity supplied. It is represented by the movements on the same supply curve. When supply of
a commodity changes due to change in non-price factor, it is said to be a change in supply. It is
represented by the shifting of supply curve from its original place.
A.7 (a) Multiplier can be explained as the ratio of change in income to change in investment.
In the above diagram, SS is the saving curve and II is the investment curve. These two
curves intersect at point E and hence, the equilibrium level of income is determined. If now
there is an increase in investment by Rs. 100 million, then II curve will shift to the position
of I’I’ and the two curves I’I’ and SS will intersect at point E’ which would be the new
equilibrium level of income. Hence, the diagram shows that an increase in investment by
Rs. 100 million would increase the national income by Rs. 300 million (1 ÷ MPS × change
in investment). Thus the value of multiplier is equal to 3.
(b) The government may influence the level of private investment in an economy by taking
any or combination of the following measures:
(i) Control interest rates
By altering the interest rates, government may influence the level of private
investment in an economy. If intention is to encourage higher volume of
investments, interest rates are reduced and vice versa.
(ii) Provide direct encouragement to investing firms
By offering investment grants, perhaps directed at particular region, by lowering the
cost of investment i.e. cost of doing business, by improving the rule of law, by
providing tax incentives etc. government may stimulate the level of private
investment in an economy.
(iii) Technological developments
Government may encourage technological developments by financing research
schemes of its own as well as those of private firms which may inspire the level of
private investment in an economy as well.
(iv) Business confidence
In order to influence the level of private investment, government may stimulate the
business confidence by pursuing an economic policy for continued growth consistent
with the stated goals.
(v) Volume of consumption
Government by following specific policy may affect the volume of consumption
which would affect the level of investment in an economy. For instance, by
regulating money supply government may influence the volume of consumption
which would affect investment levels with the influence of the accelerator.
(vi) Government spending
By increasing or lowering government spending, government may influence the level
of private investment. For example, expenditure on infrastructure would create
demand which may stimulate the investment from private sector.
A.8 (a) According to the Phillips Curve (PC), there is a trade-off between unemployment and wage
inflation i.e. when unemployment falls, labour shortages may begin to occur resulting in
skilled labour to be in a position to put an upward pressure on wages. On the other hand, at
high levels of unemployment, labour does not have the bargaining power to increase their
wages; therefore, wage inflation is likely to stay low. This relationship can further be
explained with the help of PC diagram:
At point A, the rate of unemployment is U1 and wage inflation rate is W1. As rate of
unemployment reduces from U1 to U2, wage inflation rate increases from W1 to W2 i.e.
point B on PC. It can be seen that as resources are near full capacity, demand for labour is
high therefore enabling them to demand high wages. On the contrary, when
unemployment rate increases from U1 to U3, wage inflation reduces from W1 to W3 i.e.
point C on PC which indicates that there is a spare capacity in the economy, labour is in
excess supply and ready to work at low wages to a level where wage inflation may even be
negative.
A.9 (a) Governments often seek to influence the exchange rates to achieve following objectives:
(i) To stabilize the currency against the pressures of short-term speculations.
(ii) To provide greater stability and protection to domestic producers by restricting the
competition from foreign traders.
(iii) To stimulate demand for exports or to reduce imports thus correcting the
disequilibrium in balance of payments.
(b) The purpose of following a policy of currency devaluation is to boost exports by making
them economical and more competitive in a global market while discouraging the imports
by making them more expensive thus balance of payments deficit improved.
The effectiveness of following a policy of devaluation is dependent on:
(i) Price elasticity of demand for imports
If the demand for imported goods and services is inelastic then a rise in the price of
imports will not significantly reduce the volume demanded. It would however,
increase total expenditure on imports thus deepening the deficit. Demand for
imports may be price inelastic due to:
Firmly entrenched preferences for overseas goods
Lack of flexibility of domestic firms to replace imports
Dependence on imported raw materials and other essential items
A.10 (a) The process of credit creation by commercial banks by means of advancing loans can be
understood with the help of following example:
Example
Assume that bank A receives a deposit of Rs. 100 from a customer. It would lend say Rs.
80 to another customer after accounting for reserve requirement (assuming 20% in our
example). The borrower would draw a cheque of Rs. 80 i.e. the entire amount of the loan
and give it to someone who would deposit it in bank B.
Bank B after satisfying the required reserve ratio would generate a loan of Rs. 64. Second
borrower would draw a cheque of Rs. 64 for the entire amount of the loan and give it to
some other person who would deposit it in bank C.
This process continues and banking system is able to create money supply of around Rs.
400 from the initial deposit of Rs. 100 as shown hereunder:
Therefore, the maximum deposit creation in our example = (100 – 20) × 1÷20%
= Rs. 400/-
(b) The following factors may affect the commercial banks’ ability to credit creation in an
economy:
(i) Total amount of cash
The amount of credit is dependent on the initial size of the money supply. The larger
the total amount of available cash, the more credit can be created and vice versa.
(ii) Size of reserve ratio
If reserve ratio requirement is high, less amount of money would be available with
banks for lending and there would be less credit creation.
(iii) Liquidity preferences
How much cash people want to hold? If say, there is high inflation, then people may
not wish to hold their money in banks where the real value is set to diminish thus
reducing the ability of commercial banks to create credit money.
(iv) Central bank policies
The central bank may limit the commercial banks’ credit creation ability by means of
monetary policy. It may utilize a number of instruments (for e.g. open market
operations) to control credit money in an economy.
(v) Availability of quality securities
Banks do not issue credit to everyone. They would only grant credit if they can
receive a high value asset in return from the borrower. If this is not possible, then
credit may not be created.
(vi) Lack of investment opportunities
In a period of downturn or recession, the demand for credit would be reduced
significantly as investors might not be willing to avail credit facilities.
Non-monetary measures
(i) Tariffs
These are duties placed upon imports. They increase the price of imports, making
them less attractive to the domestic market.
(ii) Quotas
A government may fix the maximum quantity or value of a commodity to be
imported during a given period. By restricting imports through the quota system, the
deficit may be reduced and balance of payments position be improved.
(iii) Export promotion
A government may promote domestic goods and services on the international
market through organizing exhibitions and trade fairs as well as striking diplomatic
deals.
(iv) Import substitution
A country can reduce the level of imports by becoming more self-reliant and
producing these goods and services domestically. This can be done by providing
specialist training, subsidies and tax concessions.
Section A
Q.1 In view of the scarcity of means and the multiplicity of ends, the economic problem lies in
making the best possible use of resources to get maximum satisfaction. Briefly discuss how
resources are allocated under different economic systems to optimize their use. (06)
Q.2 (a) (i) The quantity demanded for Alpha decreases from 300 units to 250 units, when
the price of Beta increases from Rs. 50 to Rs. 55.
(ii) The quantity demanded for Gamma increases from 400 units to 450 units, when
the price of Delta increases from Rs. 100 to Rs. 125.
(b) State why firms need to know XED of their products. (03)
Q.3 State and explain the law of Equi-Marginal Utility with the help of a diagram, assuming
there are only two commodities i.e. A and B and the consumer has limited income at his
disposal. (08)
Q.4 (a) Oligopoly is the situation where industry is dominated by a few large suppliers. Briefly
discuss any six features of oligopoly. (06)
(b) When oligopolists fix prices by collusion among themselves, they are known as cartel.
Discuss the factors that are responsible for the success / failure of price cartel. (04)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(i) During the year, a flood destroyed significant portion of agricultural land used to
produce rice. What would be the short-run effect on supply diagram for rice?
(a) A movement down the existing supply curve
(b) A movement up the existing supply curve
(c) A shift to the right of the supply curve
(d) A shift to the left of the supply curve
(ii) Islamic mode of financing includes an arrangement in which a person participates with
his money and another with his efforts/expertise. This mode of financing is known as:
(a) Ijara (b) Mudaraba (c) Musharaka (d) Murabaha
(iii) Demand for cars decrease when their prices increase. However, demand may also
decrease when income of consumers decrease. Price and income elasticities of cars are
said to be:
(a) elastic; negative (b) elastic; positive
(c) inelastic; negative (d) inelastic; positive
(v) Which of the following statement is correct with respect to relationship between the
average cost curve and marginal cost?
(a) Average cost curve will slope downwards when marginal cost is less than average
cost
(b) Average cost curve will slope upwards when marginal cost is less than average
cost
(c) Average cost curve will slope downwards when marginal cost is more than
average cost
(d) There is no direct relationship between average cost curve and marginal cost
(vi) A Pakistani resident makes an investment in a company resident in United States. This
transaction will be recorded in Pakistan as:
(a) credit in current account (b) debit in current account
(c) credit in capital account (d) debit in capital account
(vii) Preference shares enjoy certain privileges over ordinary shares. Which of the following
is NOT a privilege of preference shares?
(a) First right to dividend
(b) Greater voting rights
(c) First right to assets in the event of liquidation of a company
(d) Both (b) and (c)
(x) The basic concept which underlies the accelerator theory of investment is:
(a) investment depends on the level of savings
(b) investment is inversely related to the rate of interest
(c) investment is determined by the volume of commercial bank lending
(d) investment in an economy is a function of output
(xi) According to the Quantity Theory of Money, if the money supply is Rs. 125 million,
the average price level is Rs. 5 and national output is Rs. 300 million, the velocity of
circulation of money is:
(a) 4 (b) 8 (c) 12 (d) 16
(xii) Farhan lost his job when Orient Bank closed its operations in Karachi. He received
various offers but remained unemployed because he wanted a job in a bank only.
Farhan’s unemployment would be termed as:
(a) frictional unemployment (b) structural unemployment
(c) demand-deficient unemployment (d) seasonal unemployment
(xiv) Which of the following instruments would be expected to give the lowest yield?
(a) Sovereign bonds (b) Corporate bonds
(c) Certificates of deposit (d) Shares
(xv) Consider the following with reference to circular flow of national income:
(A) subsidy on agricultural produce
(B) import of capital goods
(C) export of consumer goods
(D) levy of withholding tax
Which of the above represent injections into the circular flow of national income:
(a) (A) and (B) only (b) (B) and (D) only
(c) (A) and (C) only (d) (C) and (D) only
Section B
Q.6 (a) The rate of interest and marginal efficiency of capital (MEC) determine the level of
investment in an economy. Explain the relationship between rate of interest and MEC
with the help of a diagram. (07)
(b) The MEC curve shifts outwards when expected rate of return increases. Briefly discuss
any three other factors that might cause an outward shift in MEC curve. (03)
Q.7 (a) There are various objectives of monetary policy but it is not possible to satisfy all of
them simultaneously. Briefly describe the conflicts that may exist between various
objectives of monetary policy. (06)
(b) Monetary policy may bring about many advantages but in the real economy, there are
certain limitations to its effectiveness. Discuss any four such limitations. (04)
Q.8 Output is determined where savings of all of the households in an economy are equal to the
desired investment opportunities. Explain the equilibrium between savings and investments
with the help of diagram. (10)
Q.9 (a) What do you understand by Demand-pull inflation and Cost-push inflation? (04)
(b) Briefly discuss the probable causes of Demand-pull inflation and Cost-push inflation. (06)
Q.10 (a) An important objective of a central bank is to reduce inflation. Briefly describe how the
central bank uses money market operations to achieve this objective. (03)
(b) What role does a central bank play for a government? (07)
(b) List the ways through which government can promote the exports of a country in the
short-term. (02)
Q.12 (a) Frequent exchange rate variations may not be desirable. However, an absolute rigidity
of exchange rates in face of drastic changes may be equally harmful. Give arguments in
favour of floating exchange rates. (03)
(b) Indirect taxes are usually unavoidable and broaden the tax base. Specify the probable
advantages and disadvantages of indirect taxes. (07)
(THE END)
Ans.1 Allocation of resources to optimize their use under different economic systems is discussed as
follows:
( )
Where,
(b) Information regarding XED is vital for firms when making production plans or setting price
of products. XED indicates the effect on demand for products due to change in price of
substitute or complement products. This knowledge allows the firms to develop strategies
to reduce their exposure to the risks associated with price changes by other firms, such as a
rise in the price of a complement or a fall in the price of a substitute.
Ans.3 According to the law of Equi-Marginal Utility, a consumer maximizes his total utility with his
limited income when marginal utility of the last rupee spent on each commodity is equal. This is
achieved at marginal rate of substitution i.e. marginal utility of A divided by marginal utility of B
is equal to price of A divided by price of B. This can be explained with the help of following
diagram:
In the above diagram, MN is the budget line representing the combination of two goods i.e. A
and B that the consumer can afford with limited income at his disposal. U, U 1 and U2 are various
indifference curves. An indifference curve that lies to the right of another represents a higher
value of satisfaction than the other. However, the budget line constrains the maximum utility
available to the consumer. Therefore, U1 is attainable, but inefficient whereas U2 is unattainable.
The consumer maximizes his total utility at a point on an indifference curve that is tangential to
the budget line. In above diagram, consumer maximizes his total utility at point O which is
tangent to budget line. Also, at point O, marginal utility per rupee spent on good A equals the
marginal utility per rupee spent on good B. At no other point could the consumer have a higher
utility given the constraints of the budget line.
(b) The failure or success of price cartels under oligopolistic market depends on following
factors:
Ans.6 (a) There is an inverse relationship between the rate of interest and marginal efficiency of
capital (MEC) i.e. higher the rate of interest, lower the MEC and vice versa. As long as the
MEC is greater than interest rate, firms will continue to invest. When MEC = rate of
interest, equilibrium investment is determined. Thereafter, investment would only increase,
when either the rate of interest falls or MEC rises.
In above diagram, MEC curve represents the level of investment that will take place in the
economy at various levels of interest rate. At interest rate ro, investment Io is marginally
efficient i.e. has a net present value of 0 (or its internal rate of return equals rate of interest).
All points to the left of the MEC have a positive net present value. If the interest rate falls to
r1, then further investment would become feasible up to total investment I1 which is now
marginally efficient.
(b) The following other factors might cause an outward shift in MEC curve:
Ans.7 (a) The following conflicts may exist between various objectives of monetary policy:
Ans.8 The equilibrium between savings and investments with the help of diagram is explained as
follows:
The curve II indicates the intended investment levels which for the purpose of simplicity are
assumed to remain same at each level of GDP and therefore a horizontal line. The curve SS
represents saving levels that are primarily dependent on disposable income. In above diagram,
saving and investment curves intersect at point E. This point corresponds to a level of GDP given
at point M and represents equilibrium level of output in an economy. At this level of output, the
desired saving of households equals the desired investment of firms.
It is important to note that saving and investment would always tend to be in equilibrium in the
long-run. Whenever there is disequilibrium, the forces of demand and supply would bring them
back to an equilibrium position as explained below.
Consider point A, where desired saving of households is higher than the desired investment of
firms. Increase in savings mean decrease in consumption and consequent reduction in demand.
As a result, firms would cut back production and lay off workers until investments and savings
are in equilibrium and therefore, new output level would be determined.
Similarly consider point B, where desired saving of households is lower than the desired
investment of firms. In response to increased demand, firms would continue to increase
production and employ more workers until investment and saving are in equilibrium and
therefore, new output level would be determined.
Cost-push inflation:
In cost-push inflation, the prices of goods rise due to persistent increase in the cost of
production of goods, while their demand remains consistent.
Fiscal stimulus will increase aggregate demand in the economy. Given the effects of
multiplier, an increase in government spending would result in greater increase in
demand which would lead to demand-pull inflation.
Monetary stimulus such as fall in interest rates, buying of government securities etc.
would trigger an increase in demand and may lead to a situation where ‘too much
money chasing too few goods’. The surplus demand would increase the price level
and therefore, demand-pull inflation.
When people in an economy anticipate higher inflation, they may demand higher
wages to protect their real income. Higher wages would increase the costs to a firm
which would ultimately fulfill the expectation of higher inflation. When higher
inflation materializes, people expect it to be higher in the following period as well and
hence the chain of events continues. This is called the wage-price spiral.
An increase in the price of raw materials and other inputs would give rise to cost-push
inflation. For example, imposition of indirect taxes would cause the higher costs to
firms which would ultimately pass on to end consumers resulting in cost-push
inflation.
The exchange rate depreciation would make exports cheaper and imports more
expensive. In an economy where demand for imports is inelastic, exchange rate
depreciation would lead to cost-push inflation.
Ans.10 (a) Central bank can reduce inflation by contracting the money supply in an economy. Money
supply can be contracted by means of money market operations i.e. selling of government
securities. Purchase of securities by commercial banks would reduce the cash available with
them which would lead to decrease in investment and spending thus weakening the
inflationary pressure.
Issuer of currency:
The central bank has monopoly of issuing currency which is done keeping in view the
overall objectives within an economy.
Economic stability:
Central bank undertakes to ensure economic stability in a country. For example in
order to overcome inflationary pressure, it controls the money supply in an economy
by means of monetary policy.
(iii) Income
It comprises of overseas activity that leads to a flow of money back to the country.
For example, interest received from direct investment, the activities of subsidiaries
and dividends earned from owning shares in foreign firms etc.
(b) The ways through which government can promote the exports of a country in the short-
term:
(i) Organization of exhibitions and trade fairs to create awareness among overseas
importers.
(iii) Exchange rate control to ensure exports are not adversely affected by exchange rate
fluctuations.
The need for government intervention in the foreign exchange markets is eliminated
allowing its policy instruments to concentrate on internal issues such as
unemployment and inflation.
Acts as a shock observer. Variations in the rates of exchange act as a check against
inflationary and deflationary forces.
Indirect taxes can correct externalities. If a product causes direct external costs (e.g.
unwanted imports or products involve health costs associated with alcohol or
cigarettes etc.), indirect taxes can be used to mitigate them.
Indirect taxes have wider coverage and are usually unavoidable. Being part of final
price of product, indirect taxes cannot be easily avoided.
Unlike direct taxes which are charged against income, indirect taxes facilitate
consumers to make a choice by simply not consuming certain products.
Indirect taxes are regressive. Every consumer of the taxed commodity pays the same
tax regardless of his/her income which promotes unequal distribution of wealth.
The incidence of indirect taxes is inevitably passed on the consumers in the form of
increased prices which causes cost-push inflation.
Indirect taxes may be uncertain as it is not always possible to anticipate the collection
on account of tax imposed on a particular commodity.
As indirect taxes are incorporated in the price of commodity, it may not promote
civic consciousness among tax payers as they might not feel the burden of taxes.
(THE END)
Section A
Q.1 (a) What do you understand by the term “Production Possibility Curve” (PPC)? Why is
PPC downward sloping and concave to the origin? (04)
Q.2 (a) Illustrate with the help of a diagram, how new equilibrium market price of a good is
achieved when price of substitute good increases. (06)
(b) List any four factors which are responsible for each of the following:
Change in demand (02)
Change in supply (02)
Q.3 (a) What do you understand by “economies of scale”? Briefly discuss any four factors that
contribute towards achievement of economies of scale. (07)
(b) Explain economies and diseconomies of scale with the help of long run average cost
curve. (04)
(b) Briefly describe the reasons on account of which a firm under perfect competition acts
as a ‘price taker’ rather than a ‘price maker’. (05)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(ii) Which of the following is more likely to be found in a free market economy than in a
planned economy?
(a) An even distribution of wealth
(b) An incentive to innovate
(c) Production of goods for benefit of society as a whole
(d) Full employment of labour
(iii) A firm with existing sales of 1,000,000 units per annum is planning to increase the
price of a product from Rs. 100 to Rs. 120 per unit. If price elasticity of demand for
that product is 1.25, assuming no other changes, the sale of the firm after price
increase would be:
(a) 1,250,000 units
(b) 750,000 units
(c) 1,200,000 units
(d) 800,000 units
(iv) If the government sets the maximum price of a product below the market equilibrium
price, it would lead to:
(a) excess demand
(b) excess supply
(c) market equilibrium
(d) economies of scale
(vi) If marginal revenue is Rs. 50 and marginal cost is Rs. 40, the firm seeking profit
maximization would:
(a) increase price
(b) reduce output
(c) reduce price
(d) increase output
(ix) In a given economy, out of every additional Rs. 1,000 of national income, Rs. 200 is
taken in taxes, Rs. 100 is spent on imports and Rs. 500 is spent on domestically
produced goods. The multiplier is:
(a) 1.25
(b) 2
(c) 2.5
(d) 1.67
(xi) Net National Product (NNP) can be arrived at from Gross National Product (GNP)
by:
(a) deducting depreciation
(b) adding indirect taxes
(c) deducting indirect taxes and adding depreciation
(d) adding depreciation
(xii) Long Run Aggregate Supply (LRAS) curve is a vertical line because it is:
(a) dependent on price level and signifies the upper limit of the capacity in the
economy
(b) dependent on price level and signifies the lower limit of the capacity in the
economy
(c) independent of price level and signifies the upper limit of the capacity in the
economy
(d) independent of price level and signifies the lower limit of the capacity in the
economy
(xiii) Which of the following is a monetary measure for correcting the current account
deficit?
(a) Quotas
(b) Export promotion
(c) Import substitution
(d) Exchange rate depreciation
(xv) The main difference between an investment bank and a commercial bank is that
investment bank:
(a) does not accept deposits
(b) does not underwrite shares
(c) does not assist companies in acquiring funds
(d) none of the above
Section B
Q.6 (a) Briefly describe three different approaches to measure National Income. (06)
(b) Differentiate between “Autonomous” and “Induced” investments. Give any two
examples of each. (04)
Q.7 (a) Discuss the Keynes’ Psychological Law of Consumption and the related propositions. (04)
(b) Identify three reasons why people prefer to hold money in liquid form. (03)
(c) Discuss how introduction of money has resulted in overcoming the shortcomings of
barter system. (04)
Q.9 (a) Distinguish between ‘Money Market’ and ‘Capital Market’. Identify any three
institutions which operate in each market. (06)
(b) Identify any two capital market instruments that are available to the government for
financing its expenditure. What factors the government should consider before raising
finances through these instruments? (04)
(b) Describe the measures that are available to a central bank for restricting credit creation
ability of commercial banks. How such measures affect the process of credit creation? (08)
Q.11 (a) What do you understand by the term ‘Derivative’? List different ways in which
derivatives are traded. (03)
Q.12 (a) Illustrate with the help of a diagram, the concept of deflationary gap in the economy. (04)
(b) Various sources of short-term and long-term credit are available to the firms. Briefly
discuss any two sources in each case. (06)
(THE END)
Ans.1 (a) The Production Possibility Curve (PPC) represents the maximum number of
combinations of two alternative goods an economy can produce with the available
resources within the given state of technology.
The reason for downward slope of PPC is that in order to increase the production of
one good, resources must be diverted from the production of other goods, hence
decreasing its output.
The PPC is concave to the origin because some of the resources in the economy are
more efficient at producing one type of goods and some are more efficient at
producing the other type of goods.
Ans.2 (a) When price of a substitute good increases, the demand for the good under
consideration increases.
The following diagram shows how an increase in price of A affects equilibrium price
and equilibrium quantity of B:
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Change in supply
– Change in cost of inputs
– Change in indirect taxes or subsidies
– Change in price of substitutes in production
– Change in price of complements in production
– Change in state of technology
Ans.3 (a) Economies of scale – Cost reductions achieved in case of / reduction in cost per unit
resulting from large scale production are known as economies of scale.
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(b)
As the firm expands, it is able to take advantage of economies of scale because in the
long run, average cost falls. After a certain level of output is reached, all economies
of scale have been achieved and this point on the average cost curve is called
minimum efficient scale i.e. Qmes in diagram above. Further increase in output
beyond this point can result in the average cost per unit to rise, leading to
diseconomies of scale. These are often a result of managers/staff losing
control/motivation as production increases beyond a certain point.
Ans.4 (a) Equilibrium of the firm is the point at which the firm has no incentive either to
expand or contract its output. A firm would not change its level of output as it is
earning maximum profits at this point.
(b) On account of following reasons, the firm under perfect competition acts as ‘price
taker’ rather than ‘price maker’:
(i) Large number of buyers and sellers – under perfect competition, there are
large number of buyers and sellers, so no single buyer or seller is able to
influence the market price of the product.
(ii) Homogenous product – the products produced by all firms are standard or
identical under perfect competition which means no individual producer can
charge more for a good as none of the goods are superior in any way.
(iii) Free entry– under perfect competition, there is a free entry thus the existing
producers are not in a position to increase prices freely.
(iv) Perfect knowledge of price – the buyers and sellers are fully aware of the
price prevailing in the market and hence the same price prevails throughout
the market under perfect competition.
(v) Transport costs are zero or very insignificant – under perfect competition,
transport costs are negligible thus price discrimination at different locations is
not possible.
(vi) Perfect factor mobility – under perfect competition, factors of production are
perfectly mobile, hence no firm is in a position to manipulate price by
controlling factors of production.
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Introduction to Economics and Finance
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Certificate in Accounting and Finance – Spring 2015
It is important to note that only ‘final’ goods and services are included. It does
not include intermediate goods because inclusion of intermediate goods
would result in double counting.
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Introduction to Economics and Finance
Suggested Answers
Certificate in Accounting and Finance – Spring 2015
Induced investment:
This type of investment is associated with private enterprises in pursuit of
maximizing profit. As the margin increases, more and more amount will be invested
until the economic gains no longer outweigh the costs. It is dependent on the level of
income.
Ans.7 (a) According to Keynes Psychological Law of Consumption, people increase their
consumption as their income increases, but not by as much as their income
increases.
There are three propositions that can be inferred from this law:
(i) Aggregate consumption can increase due to increased aggregate income, but
the increase in aggregate consumption will be less than the increase in
income. This is because as basic necessities are fulfilled, people begin to save
additional income, hence savings increase.
(iii) The increase in income will lead to increased consumption or savings. It is not
possible for an increase in income to lead to a decrease in consumption and
savings.
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Introduction to Economics and Finance
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Certificate in Accounting and Finance – Spring 2015
Ans.8 (a) Quantity theory of money states that there is a direct relationship between changes in
the money supply and the rate of inflation. The theory is based on equation MV=PT.
MV is the value of total expenditure in a period which must be equal to the value of
goods and services sold in the same period which is PT. The equation is useful as an
explanation of inflation when certain assumptions are made and which, if accepted,
means that the average price level (P) is solely determined by changes in the money
supply (M).
(b) People prefer to hold money in liquid form due to the following reasons:
(i) To pay for goods and services.
(ii) To meet unforeseen circumstances.
(iii) To take advantage of market movements regarding future changes in the rate
of interest or bond prices.
Ans.9 (a) Following are the distinguishing features of money market and capital market:
(b) The two main capital market instruments that are available to government are:
(i) Debentures/ Term Finance Certificates
(ii) Sovereign Bonds / Municipal Bonds
Ans.10 (a) Financial intermediary is an institution which links lenders with borrowers by
obtaining deposits from lenders and then re-lending them to borrowers. They provide
a link between savers and investors.
(b) Role of central bank to restrict the ability of commercial banks to create credit:
To control commercial banks credit creation ability, the central bank must be able to
control either directly or indirectly, the commercial banks liquidity position, upon
which their ability to create credit is based.
The following measures are available to a central bank to restrict the ability of
commercial banks to create credit:
Ans.11 (a) Derivative can be defined as an instrument whose price is dependent on one or more
underlying asset(s). It is a contract between two parties. The price of a derivative
changes with the change in underlying asset(s).
There are two main ways that derivatives can be traded i.e. over the counter (OTC)
and through an exchange.
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Put option:
It is an agreement which allows a person the option to sell an asset at a certain
price. If the price of the asset decreases, then exercising a put option results in
profit for the investors because they are able to sell at a price which is higher
than the prevailing price of the asset.
(ii) Swaps:
It is an agreement whereby the parties agree to exchange a series of cash flows
for a set period of time. Usually, at the time the contract is initiated, at least
one of these series of cash flows is determined by a random or uncertain
variable, such as an interest rate, foreign exchange rate, equity price or
commodity price. Often one party has ‘fixed’ rate, while the other has
‘floating’ rate. The exchange is done in view of market outlook or risk
appetite.
Ans.12 (a) When the equilibrium in the economy is at less than its production potential, there
exists a deflationary gap.
The deflationary gap can be explained with the help of following diagram:
OR
In the above diagram, short run aggregate supply is shown by the line SRAS and
aggregate demand by the line AD.
The actual level of national income is at the intersection of AD and SRAS i.e. at Ye
whereas Yf is the national income at full employment.
The gap between actual level of national income and national income at full
employment i.e. Ye and Yf is called a deflationary gap, as the price level is below of
what it would be with full employment in the economy.
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(i) Shares:
These are units of ownership in a financial asset, or corporation. They entitle
the holder to an equal distribution of future profit offered as dividend.
(THE END)
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Certificate in Accounting and Finance Stage Examinations
Section A
Q.1 (a) State the meaning of ‘price elasticity of supply’. Briefly discuss different types of
elasticity of supply. (05)
(b) Briefly explain the factors which determine the price elasticity of supply. (05)
Q.2 The following data refers to the revenue and costs (in million rupees) of a firm.
Output (units) 0 1 2 3 4 5 6 7 8
Total revenue - 50 100 150 200 250 300 350 400
Total costs 110 140 162 175 180 185 194 219 269
(a) Briefly explain the concept of fixed costs with reference to the above data. (02)
(b) Determine the marginal revenue at each level of output and interpret the results. (04)
(c) What level of output will the firm aim to produce and what would be the amount of
profit that the firm will make at this level? (04)
Q.3 Briefly discuss the important features of ‘Islamic economic system’. (08)
Q.4 (a) State the main features of monopoly and name any one organisation which operates
under monopoly. (03)
(b) Briefly explain the ‘monopolist’s equilibrium’ with the help of a schedule. (04)
Q.5 Select the most appropriate answer from the options available for each of the following
Multiple Choice Questions (MCQs). Each MCQ carries ONE mark.
(ii) If peas and beans are substitutes of each other, an increase in the price of peas will:
(a) increase the quantity of beans demanded
(b) increase the price of beans and the quantity sold
(c) decrease the quantity of peas sold
(d) all of the above
(iv) ABC Limited employs 100 skilled workers at a wage rate of Rs. 2,800 per week. To
attract 10 more workers it raises the wage rate to Rs. 3,000 per week. The marginal
cost of employing the extra workers is:
(a) Rs. 20,000 (b) Rs. 30,000 (c) Rs. 50,000 (d) Rs. 200
(v) The financial market which is used to raise short term finance is called:
(a) capital market (b) money market
(c) derivative market (d) bond market
(xiii) Under perfect market conditions, the supply curve of a firm is the same as:
(a) MC curve (b) MR curve (c) AR curve (d) AC curve
(xiv) An option that protects profit after the underlying asset has experienced a significant
gain is called:
(a) forward (b) collar (c) swap (d) call option
(xv) An instrument whose price is dependent on one or more underlying asset(s) is called:
(a) share (b) certificate of deposit
(c) derivative (d) treasury bill
Section B
Q.6 (a) An increase in ‘GDP’ and ‘financial innovation’ are the two important factors that
influence the total demand for money in an economy.
Briefly explain with the help of suitable diagrams, how each of the above factors
affects the quantity of money demanded in an economy. (06)
(b) What is Keynesian liquidity trap? Identify any three policies which can help to break
out of the liquidity trap. (04)
Q.7 (a) What do you understand by the terms ‘floating exchange rate’ and ‘fixed exchange
rate’? List three advantages of each of the above types of exchange rates. (07)
(b) Identify the reasons why a government may want to influence exchange rate. (03)
Q.8 Analyse the effect of imposition / increase of indirect taxes on producers and consumers
and its relationship with the elasticities of demand and supply. (10)
Q.9 (a) Explain what is meant by the term ‘balance of payments deficit’. (03)
(b) Discuss the difference between ‘financing’ a balance of payments deficit and
‘correcting’ that deficit. (07)
Q.10 (a) Describe the four major objectives of a government’s economic policy. (06)
(b) What role does monetary policy play in achievement of the above objectives? (02)
(c) List any four tools that a central bank may use to implement its monetary policy. (02)
Q.12 (a) What is meant by the term ‘Recession’? What economic characteristics are commonly
observed during recessionary periods? (06)
(b) Briefly describe ‘Demand deficient unemployment’ and ‘Structural unemployment’. (04)
(THE END)