Management Development Institute, Gurgaon

Post Graduate Diploma in Management 2021-23

Mid-Term Examination, Term-II
Name of the Course: Microeconomic Environment & Policy
Name of the course Faculty: Prof. Subhalakshmi Sircar

Name: Rishav Jha Roll Number: 21P219

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Q1.a.

During the onset of the pandemic, the government focused on mending supply-side issues, to fix the
broken supply chains. Continuing to do so would be counterproductive because growth would not be
stable and is a short-term solution. Hence, the government should focus on addressing demand-side
issues to increase the aggregate demand, through increased government spending and reduction in taxes,
which would increase Disposable income and increase consumption, further increasing demand.

Q1.b.i.

In the case of an expansionary fiscal policy with a completely horizontal AS curve, there is expected to be
“

an increase in real output in terms of goods and services with no apparent change in price levels, as well as
a decrease in unemployment, as the increase in production would directly impact the labour market. ”

Q1.b.ii

In this case, Real GDP will remain constant despite price increases. It suggests that increased output prices
“

will not drive further output because the economy's labour and machinery inputs are fully utilised.
Potential GDP is the name given to this output. As a result, expansionary fiscal policy will have no effect on
output. ”

Q1.c.

In order to shift the composition of production from consumption to private investment, the government
must implement infrastructure plans backed by investment and low lending rates to allow businesses to
grow. In a deflationary situation, the real interest rate (nominal inflation rate) can be relatively high. As a
result, reducing deflation through government spending can actually lower real interest rates and support
private sector investment.

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Q2.a.

Average annual Income = $45,000

No. of years until retirement = 65-25 = 40 Years

No. of years expected to live from present = 75-25 = 50 Years

Total Annual Income = $45000 * 40 = $1,800,000

Annual consumption = $1,800,000/50 = $36,000 (Ans)

Q2.b.

Given, Autonomous consumption, Co = 80 ; Investment, Io = 70 ; Marginal Propensity to consume, MPS =

0.25; MPC = 1 – MPS = 1 – 0.25 = 0.75

Y=C+I+G (G = 0, since no Government expenditure)

C = 80 + 0.75*Y; -> Y = 80 + 0.75*Y + 70; -> 0.25Y = 150

Y = 150/0.25 = 600 (Ans.)

Q2.c

If the government tries to increase aggregate savings, aggregate demand would decrease due to reduction
in consumption. Consumer spending would reduce in anticipation of tougher economic times. This would
further depress the economy as businesses would react by laying off workers, leading to decrease in
output and unemployment. Overall GDP would decrease. Hence, doing ‘good’ (cutting spending), it would
cause ‘harm’. This is called paradox of thrift. To avoid this, savings should be used for investments.

Q.2.d.

To increase aggregate consumption spending, consumers should have more disposable income. This can be
done through tax cuts, increase in government transfers and increased government spending to boost
consumption and subsequently increase aggregate demand. Changes in fiscal policy to make it
expansionary, would increase consumption spending. Also, expansionary monetary policy measures, such
as reducing CRR, Repo rate, and buying back bonds through OMOs would increase consumption spending.