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Macroeconomics
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WORKBOOK
The Icfai University Press
# 52, Nagarjuna Hills, Hyderabad – 500 082

2. © 2004 The Icfai University Press.
All rights reserved.
No
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Ref. No. MACWB 04200404
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For any clarification regarding this book, the students
may please write to us giving the above reference
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3. Preface
04
The ICFAI University has been upgrading the study material so that it is amenable for self study
by the Distance Learning Students.
We are delighted to publish a Workbook for the benefit of the students preparing for the
examinations. The workbook is divided into three different parts.
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Brief Summaries of Chapters
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A brief summary of all the chapters in the textbook are given here for easy recollection of the
topics studied.
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Part I: Questions on Basic Concepts and Answers (with Explanatory Notes)
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Students are advised to go through the relevant textbook carefully and understand the subject
thoroughly before attempting Part I. Under no circumstances the students should attempt Part I without
fully grasping the subject material provided in the textbook.
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The students should attempt Part II only after carefully going through all the solved examples in
the textbook. A few repetitive problems are provided for the students to have sufficient practice.
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Part III: Model Question Papers (with Suggested Answers)
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The Model Question Papers are included in Part III of this workbook. The students should attempt
all model question papers under simulated examination environment. They should self score their
answers by comparing them with the model answers.
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Effective from April, 2003, the examinations for all the subjects of DBF/CFA (Level-I) consist
of only multiple-choice questions. Each paper consists of Part I and Part II. Part I is intended to
test the conceptual understanding of the students. It contains 40 questions carrying one point
each. Part II contains problems with an aggregate weightage of 60 points.
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Please remember that the ICFAI University examinations follow high standards that demand
rigorous preparation. Students have to prepare well to meet these standards. There are no shortcuts to success. We hope that the students will find this workbook useful in preparing for the
ICFAI University examinations.
Work Hard. Work Smart. Work Regularly. You have every chance to succeed. All the best.

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Contents
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Questions on Basic Concepts and Answers (with Explanatory Notes)
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Part I
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Brief Summaries of Chapters
Problems and Solutions
Part III :
Model Question Papers (with Suggested Answers)
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5. Detailed Curriculum
Overview of Macroeconomics: Microeconomics vs. Macroeconomics, Fundamental Concerns of Macroeconomic
Policy, Objectives and Instruments of Macroeconomics, Aggregate Supply and Aggregate Demand.
The National Income and Product Accounts: Gross Domestic Product, Two Measures of National Product:
Goods-Flow and Earnings-Flow, Business Accounts and GDP, The Problem of "Double Counting", Details of
the National Accounts.
Consumption and Investment: Consumption and Saving, The Consumption Function, The Savings Function,
Investment: Determinants of Investment, The Investment Demand Curve, Shifts in the Investment Demand Curve.
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Aggregate Demand and the Multiplier: The Downward-Sloping Aggregate Demand Curve, Shifts in
Aggregate Demand, Relative Importance of Factors Influencing Demand. Output Determination with Saving and
Investment, The Meaning of Equilibrium, Output Determination by Consumption and Investment, The
Multiplier, The Multiplier in the AS-AD Framework, The Paradox of Thrift.
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Government, International Trade, and Output: Impact of Fiscal Policy on Output, Fiscal Policy Multipliers,
Impact of International Trade on GDP.
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Money and Banking: Money Supply and Interest Rates: Components of Money Supply, Interest Rates: Real vs.
Nominal Interest Rates, The Demand for Money, Money's Functions, The Process of Deposit Creation, Balance
Sheet of the Central Bank. Credit Control by the Central Bank. The Effects of Money on Output and Prices: The
Monetary Transmission Mechanism, The Money Market, Supply of and Demand for Money, The Monetary
Mechanism, Monetary Policy in an Open Economy, Monetary Policy in the AD-AS Framework, Monetary
Effects in the Long Run.
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Economic Growth and Aggregate Supply: The Four Elements in Development: Human Resources, Natural
Resources, Capital Formation, Technological Change and Innovation. Theories of Economic Growth,
Determinants of Aggregate Supply, Aggregate Supply in the Short run and Long run.
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Business Cycles and Unemployment: Features of the Business Cycle, Business Cycle Theories,
Unemployment: Okun's Law, Impact of Unemployment, Economic Interpretation of Unemployment.
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Price Stability: Inflation: Definition of Inflation, Price Indexes, The Economic Impacts of Inflation, Modern
Inflation Theory: Prices in the AS-AD Framework, The Phillips Curve, Anti-inflation Policy.
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Classical, Keynesian and Post-Keynesian Macroeconomics: The Classical Tradition: Say's Law of Markets,
Policy Consequences, The Keynesian Revolution, Retreat from Keynes. The Monetarist Approach: The Quantity
Theory of Prices. Modern Monetarism, New Classical Macroeconomics: Rational Expectations, Implications for
Macroeconomics, Ultra-Classicism: Supply-Side Economics: Macroeconomic Policies.
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Economic Consequences of Debt: Budgets and Fiscal Policy, Definitions, Government Budget Policy,
Discretionary Fiscal Policy, Automatic Stabilizers, Fiscal Deficits: Concepts and Trends, Applications of
Cyclical and Structural Budgets. The Burden of Deficits and Debts, The Crowding-Out Controversy, CrowdingOut and the Money Market, Impact of Structural Deficits, Government Debt and Economic Growth, External vs.
Internal Debt.
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Policies for Growth and Stability: The Interaction of Monetary and Fiscal Policies.
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The Open Economy: International vs. Domestic Trade. Economic Basis for International Trade, The Principle
of Comparative Advantage, The Economic Gains from Trade, Protectionism : Supply-and-Demand Analysis of
Trade and Tariffs, The Determination of Foreign Exchange Rates, Floating Exchange Rate and Fixed Exchange
Rates. The Balance of Payments.
Strategies of Economic Development: The Backwardness Hypothesis, Industrialization vs. Agriculture, State
vs. Market, Growth and Openness.
International Financial Institutions: The International Monetary Fund (IMF), The World Bank, Asian
Development Bank, International Financial Corporation, Bank for International Settlements.
Macroeconomic Policies in India: An Overview of Monetary Policy, Fiscal Policy, Industrial Policy, Trade
Policy in India.
Current Developments.

6. Brief Summaries of Chapters
Macroeconomic Analysis: An Overview
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Macroeconomics is the study of economy as a whole. As a field of study it analyzes the
causes of major problems such as high unemployment, rampant inflation, low wages, low
economic growth, and mounting trade deficits. It deals with both the short-term fluctuations
in output, employment and prices that called the business cycle and the long-term trends in
output and standards of living called economic growth. It is, therefore, important to know
about the forces that act behind growth and cycles for understanding the science of
macroeconomics. Macroeconomic analysis attempts to explain why problems arise in an
economy and how these problems can be dealt with. It is, therefore, indispensable for
formulating and conducting macroeconomic policy. Macroeconomic policy operates within a
framework of goals and constraints. The core objectives of a macroeconomic policy include
high output level, full employment, stable prices, trade balance, rapid economic growth, etc.
Generally, economists measure the macroeconomic performance by examining some of the
key variables – Gross Domestic Product (GDP), the unemployment rate, and inflation. Thus,
macroeconomic analysis involves study and analysis of these key variables.
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Measurement of Macroeconomic Aggregates
The concepts like national income and national product are most significant in
macroeconomic accounting. As the accounting statement of a firm provides information on
the flow of revenues and expenses fully to show the firm’s performance, the national income
accounts supply similar information for the economy as a whole. They provide
comprehensive overview of how the economy is doing. Among the various aspects that shape
the economy is the nation’s capacity to produce goods and services and keep various factors
of production employed. The GNP growth rate, the most important indicator of the nation’s
economy, shows whether the nation’s income is expanding or contracting, and thus, it is the
broadest statistical aggregate of our economic output and growth. The estimates of GNP and
national income provide the policy makers and business community with the most useful tool
for analyzing an economy’s economic performance. In simple terms, GNP is the sum of all
final goods and services produced during a specified time period, usually a year, with each
class of goods and services measured at its market value, i.e. at price usually paid. In addition
to GNP, there are some other aggregates of national product such as GDP, NDP, and NNP
that measure a nation’s production of goods and services. GDP is the value – at current
market prices or factor prices – of the total final goods and services produced inside an
economy or country during a given time. By contrast, GNP is the value – at current market
prices or factor prices – of the total final goods and services produced during a year by the
factors owned by an economy or country. The difference between gross and net products is
depreciation. In words, depreciation is deducted from gross products to get net products.
When measuring GNP, or any other aggregate of national product, only the final value of
goods and services is to be considered. In other words, only the value added at each stage of
production process is considered while measuring GNP.
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It is important to distinguish between real and nominal values of macroeconomic aggregates.
When comparing data at different points in time, economists often use terms such as real
wages, real income or real GNP. The ‘real’ refers to the fact that the data have been adjusted
for changes in the level of prices. Thus real GNP in current rupees is estimated by deflating
the nominal GNP. This is done using GNP deflator. GNP deflator is a price index
constructed to a price index to reveal the cost of purchasing the items included in GNP during
the period relative to the cost of purchasing the same items in base year. Price indices are
measures of inflation. Apart from GNP or GDP deflator, there are two important price indices
– the Consumer Price Index (CPI) and the Wholesale Price Index (WPI). Consumer Price
Index (CPI) is a price index that is used to measure the cost of a fixed basket of consumer
goods in which the weight assigned to each good is the proportionate of expenditures on that
good by consumers in the base year. The principles of construction of WPI are quite
analogous to those behind CPI. WPI considers producer goods and wholesale prices in
contrast to CPI. Weights are based on the value of transaction in various items in the base
year.
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7. Measurement of National Income
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The Simple Keynesian Model of Income Determination
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There are three methods of calculating national income, and they are all conceptually
equivalent to each other. They are (a) output method, (b) the expenditure method, and (c) the
income method. The output method is followed either by valuing all the final goods and
services produced during a year or by aggregating the values imparted to the intermediate
products at each stage of production by the industries and productive enterprises in the
economy. The sum of these values added gives the gross domestic product at factor cost,
which after a similar adjustment to include net factor income from abroad gives gross
national product at factor cost. The expenditure method aggregates all money spent by
private citizens, firms and the government within the year, to obtain total domestic
expenditure at market prices. It aggregates only the value of final purchases and excludes all
expenditures on intermediate goods. However, since final expenditure at market prices
include both the effects of taxes and subsidies and our expenditures on imports while
excluding the value of our exports, all these transactions have to be taken into account before
we obtain gross national product by this method. The income approach to measuring national
income does not simply aggregates all incomes. It aggregates only incomes of residents of
the nation, corporate and individual, that obtain income directly from the current production
of goods and services. It aggregates the money payments made to the different factors of
production, i.e. factors income and excludes all incomes which cannot be considered as
payment for current services to production.
The principal tool of analysis in the Simple Keynesian Model of Income Determination
model is the ‘aggregate demand’. The focus of this model is only the goods market and the
influence of the money market on the goods market. The model is build assuming that prices
do not change at all and that firms are willing to sell any amount of output at the given level
of prices (the aggregate supply curve is perfectly elastic). Aggregate demand is the total
amount of goods demanded in the economy and is equal to the sum of consumption spending
(C), investment spending (I), government purchases (G), and net exports (NX).
AD = C + I + G + NX
Equilibrium level of output is that level of output at which the total desired spending on
goods and services (desired aggregate demand) is equal to the actual level of output (Y).
The concept of multiplier is a very useful one. The multiplier tells what the increase in the
level of equilibrium income would be for a unit increase in autonomous spending. Multiplier
is given by the ratio of increase in equilibrium income to increase in autonomous spending.
The value of the multiplier is the reciprocal of the marginal propensity to save, assuming all
other components of aggregate demand I, G and NX are constant and independent of the
level of income. The larger the marginal propensity to consume, the lower is the marginal
propensity to save, and thus larger is the value of the multiplier.
Multiplier, ∝ = 1/MPS
Taxes play an important role in determination of disposable income. When tax is considered,
the value of the multiplier is equal to 1/[1 – b (1 – t)], where, b is the marginal propensity to
consume and t is the rate of tax. Thus, a cut in the tax rate would, therefore, increase the
value of multiplier.
The value of multiplier in the above case is determined assuming that the other components
of aggregate demand, I, G and NX are constant and independent of the level of income. But,
in real scenario, the imports are dependent of the level of the income. Mathematically,
imports (M) = M(Y) = mY, where m is the marginal propensity to import = ∂M/∂Y. Thus, the
value of multiplier is equal to
1/[1 – b (1 – t) + m]
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Income Determination Model including Money and Interest
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In the simple Keynesian model of income determination, we have determined the level of
income assuming that the investment being autonomous. And therefore we completely
avoided the role of interest rates (and money supply) in determining the level of income. But,
we know that interest rates and money supply have a major role to play in the economy.

8. IS-LM model is constructed by introducing interest rate as an additional determinant of
aggregate demand. This model illustrates how goods market (IS curve) and assets market
(LM curve) interact and determine income jointly.
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The IS curve shows the combinations of interest rates and level of output such that planned
spending equals income. As interest rates and planned investment spending are inversely
related, the IS curve slopes downward. At equilibrium, (in goods market) Y = AD. But,
investment is a component of aggregate demand. Thus, the equilibrium output decreases
(increases) as interest rate rises (decreases), due to inverse relationship between interest rates
and planned investment expenditure. If the interest rate increases, ceteris paribus, interest
sensitive private investors reduce their investment spending, known as crowding out.
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Asset market is a market in which money, bonds, stocks, houses and other forms of wealth
are traded. The demand for money is influenced by the level of real income and the interest
rate. It depends on the level of real income because individuals hold money to pay for their
consumptions, which in turn, depend on income. The demand for money depends also on the
cost of holding money. The cost of holding money is the interest that is forgone by holding
money rather than other assets. LM curve shows the combinations of income and interest rate
that produce equilibrium in the money market. The LM curve slopes upward. Because, if
there is an increase in income, the demand for money rises and this excess demand push the
market interest rates up. The real money supply is held constant along the LM curve, and
therefore, a change in the real money supply should shift the LM curve that an increase in
real money supply shift the LM curve down and to the right whereas a decrease in the real
money supply shift the LM curve up and to the right.
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Points on the IS curve indicate equilibrium in the goods market and points on the LM curve
indicate equilibrium in the money market. For simultaneous equilibrium in both the goods
market and the money market, point indicating such equilibrium will have to lie on both the
IS and the LM curves. Such a point exists only at the intersection of the IS and LM curves.
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Crowding out happens due to increase in interest rates, and therefore, can be reduced by
increasing the money supply.
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Money is one of the most crucial elements of economic science. It acts as a medium of
exchange, unit of account, a standard of deferred payment and a store of value. Classical
economists viewed that money is demanded only for spending purposes. However, latter
Keynes recognized that money was held for other reasons too. In this view money would be
held as an asset, a non-interest-paying asset, whereby velocity is affected and tends to
change. According to him, the three motives for holding money are transactions, precaution
and liquidity or speculation.
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Fundamentals of Aggregate Demand and Aggregate Supply
The aggregate demand-supply model is the basic macroeconomic model for studying output
and price level determination. In short run, the interaction between aggregate demand and
aggregate supply determines the level of the output, employment, and capacity utilization as
well as the price level (the source of inflation). In the long run, a decade or more say,
aggregate supply is considered as the major factor behind economic development and wellbeing of a nation.
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The aggregate demand schedule (or curve) shows the combinations of the price level and the
level of output at which the goods and money markets are simultaneously in equilibrium. The
aggregate demand schedule (or curve) slopes downward owing to inverse relationship
between price level and the level of output demanded. In addition to price level, there are
other factors such as income levels, rate of interest, government policy, exchange rate,
expected rate of inflation and business expectations influence the aggregate demand in an
economy. When these factors or variables change, the aggregate demand curve will shift.
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In short run, the aggregate supply curve slopes upward from left to right for part of its range
because at any point in time there is a limit on the output of goods and services. This limit
increases as with increased production, the availability of idle resources decreases and ‘limit’
is reached when the production reaches full employment level of output. When the resources
available are fully employed the short run aggregate supply curve becomes vertical. At this
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9. point, further increases in price level will have no effect on output. In short, the aggregate
supply curve, in short run, slopes upward from left to right for a part of its range and
straightens at the end.
In the short run, the discrepancy between actual and expected price level causes changes in
output and employment. But in the long run, if all other things remain constant, the higher
price level will come to be accurately expected by firms, narrowing down the difference
between expected and actual price levels. This is important because in the long run, the costs
incurred by business firms rise as economic agents reach to higher prices.
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The higher level of output in the short run was possible only because the unanticipated rise in
the price level led to higher profits to business firms. As soon as the costs increase in line
with final prices, the incentive to produce higher levels of output disappears and the
production reverts to its original level. In this situation, the level of output will be at its
natural rate and deviations from this state are possible only when actual price level differs
from the expected price level in the short run. Thus, in the long run, the natural rate of output
is the equilibrium rate of output for the economy.
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In the long run, the natural rate of output is the level of output to which the economy will
tend to adjust in the long run. This indicates that in the long run the average price level has no
effect on the level of output (Y). Any unanticipated price rise in the short run will be offset in
the long run by an increase in costs as contracts with the suppliers of inputs are renegotiated.
Therefore, in the long run the output of an economy does not depend on the price level, but
on factors such as, labor import costs, capital stock, technological progress, etc. These factors
are not influenced by changes in the average price level and so is the case with aggregate
supply in the long run. Therefore, in the long run, the aggregate supply of an economy is
vertical at the natural rate of output.
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Most of the factors that affect the position of the aggregate supply curve in short run also
affect the position of the aggregate supply curve in the long run, with few exceptions. Some
of the important factors affect aggregate supply curve are change in costs of production,
supply shocks, investment spending and technological changes, availability of raw materials,
supply of labor, human capital and incentives.
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Money Supply and Banking System
Money is anything that serves as a commonly accepted medium of exchange. Money also
acts as a unit of value and a store of value. In past, commodities such as salt and oxen were
used as money but they failed to serve the purpose well. Latter, they were replaced by
precious metals such as gold, silver, etc. However, they too did not serve the purpose well.
All these were replaced by paper money as it has the basic features of good money, i.e.
portability, divisibility, durability, uniformity and storability.
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Determining what should be included in the money supply is not as easy as it appears. Money
is sometimes defined as anything generally acceptable as a medium of exchange. Four
definitions of money are commonly used – M1 to M4. M1 (known as narrow money) is made
up of currency with the public plus demand deposits with the banking system plus other
deposits with the RBI. M2 holds M1 plus post office savings bank deposits. M3 (known as
broad money) includes M1 plus time deposits with the banking system. And finally M4
includes M3 + total post office deposits (excluding national savings certificates).
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The Reserve Bank of India (RBI) issues money in the form of two rupee notes and above.
The central government also issues money in the form of one-rupee notes, coins and small
coins. The RBI currency plus the Government money constitutes the monetary base, which is
known as High Powered Money. The RBI currency together with the Government money
with the commercial banks is treated as Vault Cash. The deposits of the commercial banks
comprise of the balances maintained by the banks with the RBI. This is to ensure that the
commercial banks can meet all demands for withdrawals on the part of their depositors. The
banks may also choose to hold reserves over and above the statutory minimum, known as the
‘excess reserves’. The commercial banks are required to maintain with the RBI a minimum of
Cash Reserve Ratio (CRR) as specified by the RBI on a fortnightly basis.

10. Commercial banks have the ability to multiple the money supply. The money supply
multiplier depends on the Cash Reserve Ratio (CRR) specified by the RBI and deposit ratio.
CRR specifies the percentage of deposits that every commercial bank must keep on deposit
with the Reserve Bank of India. In its simplest form, the money multiplier approach is based
on Ms = m. H equation, where m is the money multiplier and Ms is the broad money (M3)
and H is the high-powered money. However, m is equal to c + 1/c + r where c is the currency
deposit ratio and r is the reserve ratio. Currency deposit ratio depends on the attitude of the
people. But, reserve requirement is at the control of the RBI. Thus, RBI changes the reserve
ratio in order to manipulate the money supply in the economy.
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The money supply in an economy is determined by the behavior of public in depositing their
income with the bank, the lending behavior of commercial banks, reserve ratio specified by
the RBI and some other factors.
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The supply of and demand for money combinely determine the equilibrium of money
markets. The money markets will be in equilibrium when the quantity of real balances
demanded equals the quantity supplied.
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A well-developed financial system is very essential for the smooth functioning of any
economy. One set of important statistical indicators that is used to look at the financial
development of a country is financial development ratios. These ratios are (i) Finance ratio,
(ii) Financial interrelations ratio, (iii) New issue ratio, and (iv) Intermediation ratio. Finance
ratio is the ratio of total financial claims issued during the year to national income of that
year. Financial interrelation ratio is the ratio of financial claims issued to net physical capital
formation. New issue ratio is the ratio of primary (new) issues by the non-financial sector to
the net physical capital formation. And intermediation ratio is the ratio of secondary issues to
primary issues.
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Aggregate Supply, Price Level and Employment: Macroeconomic
Equilibrium in the Classical Model
The aggregate supply curve describes the combinations of output and the price level, to
supply the given quantity of output. The amount of output that business firms are willing to
supply depends on the prices they receive for their goods and the amount they have to pay for
labor and other factors of production. Accordingly, the aggregate supply curve shows
conditions in the factor markets, especially, the labor market, as well as the good market.
From a historical standpoint it is very important to compare and contrast the views expressed
by the classical economists and J M Keynes. The main reasons are that the analysis has
different implications regarding a market economy’s tendency to adjust to full employment
and the relative effectiveness of monetary and fiscal measures.
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According to classicals, the economy will always be at its full employment level of output.
At the full employment level of output, any employment, which might exist, is voluntary and
is referred to as the ‘natural’ rate of unemployment, because output cannot be raised above its
current level even if the price level rises. There is no more labor available to produce any
extra output. Thus, the aggregate supply curve will be vertical (i.e. perfectly price inelastic
aggregate supply curve) at a level of output corresponding to full employment of the labor
force.
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This classical approach to analyzing economic behavior came under severe criticism due to
its unrealistic assumptions of wage price flexibility and the existence of voluntary
unemployment. In real world, all unemployment is certainly not voluntary. There are many
who wish to work but cannot find work implying the existence of involuntary unemployment.
J M Keynes and Keynesian economists disputed the classical assumptions and pointed out
that a perfectly efficient ‘wage price’ flexibility is far from real world. Keynesian aggregate
supply curve is based on the assumption that the wage does not change much or change at all
when there is unemployment, and thus the unemployment can continue for sometime.
5

11. Aggregate Supply, Price Level and Employment Macroeconomic
Equilibrium in the Keynesian Model
Mainstream economic thought before Keynes emphasized the importance of supply-side
aspects of macroeconomic system. The classical economists did not concern themselves with
demand issues. They had faith in Say’s Law of Markets. According to this law, a general
overproduction of goods relative to total demand is impossible since supply or production
creates its own demand. Say’s law is based on the view that people do not work just for the
sake of working, but they work to obtain the income required to purchase the desired goods
and services. The capacity to purchase the desired products is generated by the production
process in the form of wages and salaries, rent, interest and profits. Classical economists
believed that is possible to produce too much of same type of goods (implying full
employment) and not enough of other type (implying no overproduction). In case of any
discrepancies between demand and supply, the mechanism of wage-price flexibility would
come into play automatically.
•
The Great Depression and its adverse impact on world economy undermined the classical
view and provided the foundation for the Keynesian analysis of the Great Depression, which
was completely a demand side approach. Keynes rejected the classical view and offered a
completely new concept of output determination. He believed that spending induced business
firms to supply goods and services. From this he argued that if total spending fell due to
pessimistic or unfavorable expectations about future, then business firms would respond by
cutting production which in turn led to less spending and less output and employment. The
classical economists were also aware of this possibility, but they believed the labor surplus
would drive down wages, reducing costs and lowering prices until the surplus was eliminated
and the economy was directed to full employment within reasonable time. Keynes and his
followers rejected this view, arguing that wage-price flexibility is an impossible proposition,
particularly in a downward direction in modern economies characterized by large corporate
sectors and powerful trade unions. Keynes also introduced a completely different concept of
equilibrium. In the Keynesian framework equilibrium takes place at a less than full
employment level of output. The Keynesian view of less than full employment or less than
full capacity output could be explained as aggregate expenditure or aggregate demand leads
to current level of output and employment. The business sector will produce only the quantity
of goods and services it believes households (i.e. domestic consumers and investing
community), government and foreigners will plan to buy. If this aggregate expenditure –
consumption, investment, government spending and net exports – is less than the economy’s
full capacity output, output will fall short of its potential capacity, which is the full
employment level of output. When aggregate expenditure is deficient, there are no automatic
forces, as believed by classical economists, capable of assuring full employment. The result
is that the actual output will be less than capacity output which in turn results in prolonged
unemployment and decline in output. This was how Keynes explained the Great Depression
highlighting the drawbacks of self-regulating private enterprise economies.
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Post-Keynesian Macroeconomics – Monetarism, Rational Expectations and
Supply-side Economics
•
6
Keynesians suffered a major blow as their postulates failed to explain the happenings during
the post-1968 period when the rate of growth of output declined, the rate of inflation
increased coupled with rising unemployment. This paradox of stagflation is inconsistent with
the tenets of Keynesian economics that cyclical movements in prices and outputs relative to
trend are positively correlated. This led to reconsideration of theories underlying
policymaking and rival schools of thought such as Monetarist School, Rational Expectations
and Supply-side Economics (popularly known as Reaganomics). Supply-side economics
represent a return to orthodox classical economics and its recent more formal statement the
New Classical Macroeconomics.
The school of Monetarism argues that disturbances within the monetary sector are the
principal causes of instability in the economy. According to them, the money supply is the
principal determinant of the levels of output and employment in the short run and the price
level in the long run.

12. •
Rational Expectations School argues that expectations on the future values of economic
variables play an important role in macroeconomic analysis and economic analysis in
general. The hypothesis of rational expectations has three important implications for
macroeconomic analysis and policy.
The advocates of rational expectations school contend that their usefulness is limited,
because the parameters of the model will change when new policies are given
prominence over the others. Since estimates of the effects of the new policies are based
on the original set of parameters, the actual implications may be quite different. As a
result, economic models are considered not so helpful in selecting an appropriate policy
option.
b.
A W Phillips showed an inverse relationship between the ratio of change of money
wage rates and unemployment rate, it was argued that lower unemployment could be
obtained at the expense of higher inflation rates through more rapid increases in
affective demand. However, some economists argued that a trade-off existed in the
short run, but not in the long run. According to rational expectations, no trade-offs exist
even in the short run. It is because, if workers and business firms realize that any
disturbance leads to higher inflation, wages and prices (which are assumed to be
flexible in rational expectations model) will adjust automatically. Assuming full
employment in the economy, money wages and prices increase proportionately, leaving
the real wage and unemployment unaffected. Thus, according to rational expectations,
even though inflation has increased, the unemployment rate remains the same, implies
no trade-off between money wage rate and unemployment rate.
c.
Discretionary monetary and fiscal policy cannot be used to stabilize the economy.
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Supply side economics is a view emphasizing policy measures to affect aggregate supply or
potential output. This approach holds that high marginal tax rates on labor and capital
incomes reduce work effort and saving.
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Economic Fluctuations and Unemployment
A business cycle is a swing in total national output, income and employment marked by
widespread expansion or contraction in many sectors of the economy. Typically, a business
cycle is divided into four phases: (i) the recovery or revival of economic activity (ii) the
prosperity or expansion of the activity (iii) the recession or downturn in economic activity,
and (iv) the depression or contraction in the economic activity.
•
A number of theories are proposed to explain the cyclical behavior of business cycles, which
includes supply shock theory, multiplier-acceleration and Keynes. But, no theory answered
all problems.
•
The rate of unemployment is one of the key indicators of the conditions prevailing in an
economy. Fluctuations in the rate of employment lead to partial changes in the economy and
therefore considered as a barometer which points out the condition of an economy. The rate
of unemployment gradually decreases during recovery and rapidly decreases during boom or
prosperity. By contrast, unemployment rate rises sharply during depression and gradually
moves upward during recession. Unemployment rate and phases of business cycles are
closely knitted.
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Price Stability
•
An increase in the general level of prices in an economy that is sustained over a period of
time is called inflation. Inflation plays a major role in an economy. Inflation is a major
concern of the governments world over. The effect of inflation on the economy is widespread
in its reach, ranging from redistribution of income and wealth among different sections of the
society to the worsening of balance of payments position.
•
The inflation may be demand-pull or cost-push. A demand-pull inflation refers to increase in
price level due to increased or excess demand. Cost-push inflation refers to rise in general
level of prices due to increased cost of production.
•
The Phillips curve shows the relationship between inflation and unemployment. When
tracing the link between rate of change in wages and unemployment over nearly a century for
the United Kingdom, Phillips discovered an inverse relationship.
7

13. The Open Economy and Balance of Payments: India’s Balance of Payments
All countries have economic transactions with other countries. These consist of import and
export of goods and services, official and private gifts and donations, lending and borrowing
abroad and investment abroad in financial and physical assets. The Balance of Payments
(BoP) is a record of all transactions that a country has with the rest of the world during a
period.
•
The BoP is a regular double entry accounting record with transactions that increase the
availability of foreign exchange recorded as credits and those that use up foreign exchange
recorded as debits. Thus, exports are a credit item. The BoP is divided into a current account
consisting of transactions involving imports, exports, remittances and gifts and a capital
account, which consists of all transactions that affect the country’s foreign exchange assets or
liabilities.
•
The BoP data helps in analyzing whether a particular course of action is likely to be helpful or
not in eliminating or reducing a current account deficit. At the same time, BoP data cannot be
considered in isolation for predicting a movement in the exchange rates.
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Modern Macroeconomics: Fiscal Policy, Budget Deficits and the Government
Debt
Governments in modern economies play a very important role in the economic process. They
collect taxes, provide a variety of services and often undertake production and distribution of
goods using inputs purchased from the rest of the economy. They borrow on the capital
market and from financial institutions and are engaged in capital formation.
•
The levels in composition of taxes, the volume and composition of government expenditures
and the level of public debt all have significant microeconomic and macroeconomic effects.
Fiscal policy, narrowly interpreted, refers to actions governing and volumes of government
expenditure (and hence the resulting deficits or surpluses) and government borrowing. In a
broader sense it refers also to the structure of taxation, composition of expenditure, methods
of financing deficits and composition of public debt. Fiscal policy is normally the
responsibility of the finance ministry or the treasury.
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A glance at the development or evolution of monetary policy will reveal that its objectives
and emphasis have been undergoing significant changes. The monetary policy of any country
refers to the regulatory policy, whereby the monetary authority maintains its control over the
supply of money for the realization of general economic objectives such as stable prices, full
employment, etc. However, in the context of developing economies like India, monetary
policy acquires a still wider role and it has to be designed to meet the particular requirements
of the economy. Monetary policy as an instrument of economic policy has certain advantages
when compared to fiscal policy. The lag between the time when action is needed and when
action is actually taken is shorter in the case of monetary policy than fiscal policy. The
important tools of monetary policy are
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Minimum reserve requirements
–
Discount or bank rate
–
Open Market Operations (OMO).
As per minimum reserve requirements, the commercial banks are required to maintain a
minimum amount of balance with the Central Bank. This may be maintained either in the
form of chest cash or in the form of deposits. A certain proportion of the total deposit
liabilities, fixed by the Central Bank, is maintained by the commercial banks as ‘statutory
reserves’. The Central Bank’s power to set the reserve requirements provides it with great
powers over the lending behavior of the commercial banks. By changing the reserve
requirement from time to time, it can directly influence the lending capacity of the banking
system.

14. Bank rate or discount rate refers to rate at which commercial banks can rediscount their bills
with the Central Bank. By changing the bank rate, the Central Bank changes the cost of
money supply with the commercial banks and therewith influences the incentive of the banks
to borrow reserves.
•
Open market operations involve purchase and sale of securities (generally government
securities) by the Central Bank, to regulate the credit creating capacity of the commercial
banks. When the Central Bank purchases securities it makes cheque payment to the sellers.
The sellers deposit the cheques with the commercial banks, which automatically raise their
reserve base. An increase in the reserve base of the banks provides a basis to multiple
expansions of credit and deposits. Similarly, when the Central Bank performs open market
sale of securities, it results in decrease in the bank reserves. So it can be said that, an open
market purchase is expansionary in its effect and an open market sale is contractionary in its
effect from the point of view of credit creation.
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15. Part I: Questions on Basic Concepts
Macroeconomic Analysis: An Overview
1.
Which of the following variable(s) will come under stock variable(s)?
b.
Gross domestic product.
c.
Money supply.
d.
Exports.
e.
Both (a) and (c) above.
04
The relationship between aggregate consumption expenditure and aggregate income of
household sector is known as ________ function.
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2.
Consumer price index.
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a.
b.
Saving
c.
Expenditure
d.
Income
e.
None of the above.
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3.
Consumption
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b.
Gross Domestic Product and GDCF (Gross Domestic Capital Formation)
c.
National Disposable Income and Gross Domestic Product
d.
GDP and Aggregate Consumption
e.
National Disposable Income and Gross National Product.
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Gross Domestic Product and Gross National Product
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a.
Which of the following variable(s) will come under flow variable(s)?
Unemployment.
b.
Foreign exchange reserves.
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Consumption.
Money supply.
e.
Both (a) and (b) above.
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d.
The act of replacing worn out assets and creating new assets is capital formation. Then Gross
Domestic Capital Formation (GDCF) consists of
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Making good the depreciation on existing fixed assets
Adding to the stock of fixed assets
c.
Adding to inventories
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
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6.
Which of the following relationships is not correct?
a.
b.
Net domestic saving = Net national saving + Retained earnings of foreign companies.
c.
Gross domestic saving = Net domestic saving + Depreciation provision.
d.
Gross domestic investment = Gross fixed investment + Change in inventories.
e.
10
Net national savings = National Disposable Income (NDI) – Private consumption
expenditure – Government expenditure on current goods and services.
Gross domestic product = Consumption + Gross investment + Government expenditure
+ Exports.

16. Part I
If GDP is growing at g% per annum and population at p% per annum, the per capita GDP
must be growing at __________ %.
a.
b.
(g + p)/2
c.
(g – p)/2
d.
(p – g)
e.
None of the above.
How the prices of resources, goods and assets are determined
c.
How resources are distributed
d.
How production and household sectors interact through markets
e.
Both (b) and (d) above.
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How competition achieves economic efficiency under laissez faire
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The circular flow model of a free enterprise economy shows
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⎡1+ g ⎤
⎢
⎥ −1
⎣1+ p ⎦
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7.
Both variables have time dimension.
b.
Flow variables are always determined by stock variables.
c.
Stock variables are usually affected by flow variables.
d.
All flow variables need not have stock variable counterparts.
e.
Flow variables are partly determined by stock variables.
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10. Which of the following is a “leakage” from the circular flow of income?
Mr. Ramesh bought an Indian made color television for Rs.15,000.
b.
Mr. Babu bought a second hand refrigerator from his friend Rajesh.
c.
Mr. Harsha imported a brand new Ferrari car from Germany for Rs.10 lakh.
d.
Mr. Sujit paid Rs.10,000 to his personal secretary towards salary.
e.
Both (a) and (c) above.
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11. Which is the best indicator of economic development of a developing country like India?
National income deflator.
b.
GNP at current prices.
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Real national income.
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d.
Per capita real national income.
e.
GDP deflator.
Measurement of Macroeconomic Aggregates
12. If GNP deflator is raised by 40% then which of the following statements is correct?
a.
Nominal GNP will increase at least by 40%.
b.
Real GNP will increase at least by 40%.
c.
Both nominal GNP and real GNP will increase by 40%.
d.
Nominal GNP will increase by 40% but real GNP will decrease by 40%.
e.
Real GNP will increase by 40% but nominal GNP will decrease by 40%.
11

17. Macroeconomics
13. Which of the following will certainly increase real and nominal GNP?
a.
Production of more goods and services and decrease in prices.
b.
Production of more goods and services and rise in prices.
c.
Production of less goods and services and rise in prices.
d.
Production of less goods and services and decrease in prices.
e.
Production of less goods and services and rise in inflation.
14. In an economy narrow money is equal to the sum of ________.
RBI currency notes in circulation.
ii.
Rupee coins and notes in circulation.
iii.
Small coins.
iv.
Demand deposits with banks and other deposits with RBI.
a.
Both (i) and (ii) above
b.
Both (ii) and (iii) above
c.
Both (i) and (iii) above
d.
Only (i), (ii) and (iv) above
e.
All of (i), (ii), (iii) and (iv) above.
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15. In an economy “aggregate monetary resources” are equal to the sum of ________.
RBI currency notes in circulation.
ii.
Rupee coins and notes and small coins in circulation.
iii.
Time deposits with banks.
iv.
Demand deposits with banks and other deposits with RBI.
a.
Both (i) and (ii) above
b.
Only (ii), (iii) and (iv) above
c.
Only (i), (ii) and (iii) above
d.
Only (i), (ii) and (iv) above
e.
All of (i), (ii), (iii) and (iv) above.
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16. In country ‘X’, if NNP at market price remained constant and depreciation increased
compared to the previous year then GNP at market prices will _____.
Increase
b.
Decrease
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Increase by an amount equal to rise in depreciation
d.
Decrease by an amount equal to rise in depreciation
e.
Not change.
17. Which of the following method values the final goods and services produced during a year,
by aggregating the values imparted to the intermediate products at each stage of production
by the industries and productive enterprises in an economy?
a.
b.
Income method.
c.
Input method.
d.
Output method.
e.
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Expenditure method.
Saving method.

18. Part I
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18. The ________ measurement method of national income aggregates all the money spent by
private citizens, firms and the government within the year.
a. Expenditure
b. Income
c. Input
d. Output
e. Saving.
19. Which of the following ratios best describes the GNP deflator?
a. Nominal GNP to real GNP.
b. Real GNP to nominal GNP.
c. Nominal GNP to real GDP.
d. Real GNP to nominal GDP.
e. Nominal GDP to real GDP.
20. GDP at market price exceeds GDP at factor cost by the amount of revenue raised through
_______.
a. Direct taxes
b. Indirect taxes
c. Income tax
d. Tax on rents
e. Both (b) and (c) above.
21. Which of the following is not true in representing the GDP at market price and GDP at factor
price?
a. In GDP at factor price, indirect taxes are not considered.
b. In GDP at factor price, subsidies are not considered.
c. In GDP at market price, exports are considered.
d. In GDP at market price, exports are not considered.
e. In GDP at factor price, exports are considered.
22. Macroeconomics is the study of
a. Inflation
b. Unemployment
c. Growth
d. Both (a) and (b) above
e. All of (a), (b) and (c) above.
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23. If the average rate of inflation in the USA and Japan between the years 1960-1973 is 3.2%
and 6.1% respectively, then the growth rate of ______.
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a.
USA will be more
b.
Japan will be more
c.
USA will be twice that of Japan
d.
Japan will be twice that of USA
e.
No definite conclusion can be made.
24. In a closed economy savings are equal to __________ at the equilibrium level of income.
a.
Investments
b.
Wages
c.
Income-Investments
d.
Wages-Consumption
e.
None of the above.
13

19. Macroeconomics
25. Which of the following methods is/are used for measuring national income?
a.
Output method.
b.
Expenditure method.
c.
Income method.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
26. Net factor income from abroad is equal to
NNP at market prices – NDP at market prices
b.
NDP at market prices – Indirect taxes + Subsidies
c.
NDP at factor cost + Depreciation
d.
NDP at factor cost – Depreciation
e.
NNP at market prices + Depreciation.
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The difference between current and capital account
b.
The difference between merchandize export and imports
c.
Same as the balance of current account
d.
Same as the balance of capital account
e.
Same as the overall balance of payments.
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28. Personal disposable income is equal to _______
Wages and salaries – Personal income tax
b.
Wages and salaries + Dividends paid at home – Personal income tax
c.
Wages and salaries + Dividends paid at home + Factor income received from
abroad – Personal income tax
d.
Wages and salaries + Dividends paid at home + Factor income received from
abroad + Transfers from government – Personal income tax
e.
Wages and salaries + Dividends paid at home + Factor income received from
abroad – Transfers from government – Personal income tax.
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29. Personal income equals personal disposable income (Yd) plus
Personal savings
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Transfers from government
c.
Personal income taxes
d.
Dividend payments
e.
Both (b) and (c) above.
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30. The Net Domestic Savings of an economy is defined as
a.
b.
Net national savings plus retained earnings of foreign companies
c.
National disposable income less consumption of household and government sectors
d.
Gross national savings less depreciation provisions
e.
14
Net national savings less retained earnings of foreign companies
National disposable income plus consumption of household and government sectors.

20. Part I
e.
Services of a teacher.
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Purchase of groceries by a family.
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31. GDP at market prices is the sum of Consumption, Investment, Government spending and Net
Exports.
‘Net’ exports is
a. Gross exports minus depreciation
b. Exports minus imports
c. Gross exports earnings minus capital inflow
d. Export minus imports of merchandize
e. Imports and depreciation.
32. GDP at factor cost and GDP at market prices are both measures of output in the economy.
The item(s) that give(s) rise to the difference(s) in the two measures is/are
a. Direct taxes and subsidies
b. Direct taxes net of subsidies
c. Indirect taxes and subsidies
d. Direct taxes and depreciation
e. Indirect taxes and depreciation.
33. Which of the following is/are not included in the computation of GNP?
a. Spending for National Defense.
b. Rs.10,000 spent by a local government to fight crime.
c. The price paid for a stolen car.
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34. Macroeconomics is concerned with
The level of output of goods and services
b.
The general level of prices
c.
The growth of real output
d.
All of the above
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e. None of the above.
35. Real GNP increases
a. When there is an increase in the price level
b. When there is an increase in the output of goods and services
c. When there is an increase in the price level and/or the output of goods and services
d. All of the above
e. None of the above.
36. The circular flow of income for a private sector model shows
a. The flow of income between the household and business sectors
b. The flow of income between the government and business sectors
c. The flow of income between the household, business and government sectors
d. The flow of income to the household and government sectors
e. All of the above.
37. In a model in which there is no government, net investment, capital replacement or
international trade, the market value of final output equals
a. Aggregate consumption
b. The sum of the receipts of economic resources
c. The sum of wages, rent, interest and profit
d. All of the above
e. None of the above.
15

21. Macroeconomics
38. Which of the following is not included in gross investment?
a.
Business and residential construction.
b.
Expenditures on consumer goods.
c.
Additions to business inventory.
d.
Expenditures on machinery.
e.
None of the above.
04
39. In a model in which there is a household, business, government and foreign sector, GNP is
the sum of
Consumption, gross investment, government spending for goods and services, and net
exports
b.
Consumption, net investment, government spending for goods and services, and net
exports
c.
Consumption, gross investment, government spending for goods and services, and gross
exports
d.
Wages, rent, interest, profit and depreciation
e.
All of the above.
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o.
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02
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40. In a three-sector model,
Household saving always equals net investment
b.
Household saving always equals gross investment
c.
Household saving plus depreciation always equals gross investment plus government
spending
d.
Household saving plus taxes equals net investment plus government spending
e.
None of the above.
se
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ed
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ht
s
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41. Which of the following is not correct?
NNP – Direct taxes equals national income.
b.
NNP + Capital consumption allowances equals GNP.
c.
Gross investment equals net investment plus depreciation.
d.
Personal income equals disposable personal income plus direct taxes.
e.
None of the above.
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Pr
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a.
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Transfer payments
Ic
a.
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42. Personal income includes all of the following except
Undistributed corporate profits
c.
Personal income taxes
d.
Dividend payments
e.
Personal savings.
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Th
e
b.
43. Nominal GDP is
a.
b.
The total value of goods and services at prices corrected for inflation
c.
The total value of goods and services produced during periods of low unemployment
d.
The total value of goods and services measured at current prices
e.
16
The total value of goods and services net of exports
The total value of goods and services produced at full employment.

22. Part I
44. GDP at factor cost exceeds GDP at market price
a.
When the factor income from abroad is negative
b.
When the factor income from abroad is positive
c.
When depreciation on fixed capital exceeds income in investment
d.
When direct tax exceeds indirect tax
e.
When subsidies exceed indirect taxes.
45. The difference between Gross National Product (GNP) and Gross Domestic Product (GDP) is
Excess of subsidies over indirect taxes
b.
Depreciation
c.
Net foreign income from abroad
d.
Excess of indirect taxes over subsidies
e.
Personal disposable income.
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46. NDP does not include
Payments made for income taxes
b.
Depreciation allowances
c.
Undistributed profits
d.
Net exports
e.
The value added from intermediate goods.
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a.
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47. Which of the following is not correct?
NNP + Indirect taxes = National Income.
b.
GNP = NNP + Depreciation.
c.
Saving + Taxes = Investment + Government Spending.
d.
Personal Income = Disposable Income + Direct Taxes.
e.
Gross Investment = Net Investment + Depreciation.
Pr
es
48. National income is
s.
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a.
NDP at market prices
b.
NNP at market prices
c.
NDP at factor cost
d.
NNP at factor cost
ve
rs
i
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fa
Ic
GNP at market prices.
Th
e
e.
ty
a.
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04
49. Which of the following statements is/are true?
i.
Every increase in real GDP will necessarily improve the welfare of the people.
ii.
Foodgrains retained by the farmers are excluded from the computation of GDP.
iii.
GNP at market prices is also known as National Income.
iv.
Transfer payments are not taken into account while computing national income.
a.
Both (i) and (ii) above.
b.
Both (ii) and (iii) above.
c.
Both (iii) and (iv) above.
d.
Only (ii) above.
e.
Only (iv) above.
17

23. Macroeconomics
50. Which of the following is not included in GDP of India?
a.
Depreciation written off by Reliance Industries Ltd.
b.
Profits before tax earned by Ford Motors Ltd. in India.
c.
Salaries paid by Satyam Infoway to an American consultant at its Chennai office.
d.
Salaries paid by Microsoft USA to Indian programmers employed at New York.
e.
Dividends earned by a Foreign Institutional Investor in India.
51. GDP is not a very good measure of economic prosperity because
The expenditure and production methods to GDP yield different results because of
conceptual problems
b.
It does not include non-monetized transactions/activities
c.
It is purely a monetary measure
d.
It does not include environmental degradation
e.
Both (b) and (d) above.
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a.
o.
52. Which of the following statements is not true?
GDP deflator is also known as implicit price deflator.
b.
GDP deflator reflects the change in overall price level of the economy.
c.
GDP deflator is the most comprehensive index of prices.
27
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a.
GDP deflator reflects on the purchasing power of the people.
e.
GDP deflator measures economic growth.
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d.
Residential investment
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a.
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53. The difference between personal disposable income and personal income is
ed
Subsidies
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rv
c.
.IS
b. Indirect taxes
s
Personal taxes.
ht
e.
re
d. Transfer payments
s.
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lr
ig
54. When the addition to capital goods in an economy is more than the capital consumption
allowance, the economy experiences
Negative net investment
b.
Zero net investment
c.
Positive net investment
d.
Negative gross investment
e.
Zero gross investment.
fa
iU
ni
ve
rs
i
ty
Pr
es
a.
a.
Nominal GNP to real GNP.
b.
Real GNP to nominal GNP.
c.
Nominal GNP to real GDP.
d.
Real GNP to nominal GDP.
e.
None of the above.
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Th
e
Ic
55. Which of the following ratios best describes the GNP deflator?
56. Which of the following is an example of a government transfer payment?
a.
b.
Purchase of a new car for the Ministry of Finance.
c.
Funding of a clinic to provide free vaccinations.
d.
Free food coupons issued to persons in an anti-poverty program .
e.
18
Salary paid to a soldier.
Funding of a new bridge in an urban area.

24. Part I
57. Which of the following price indices is/are most widely used for determining of inflation in
India?
a.
Wholesale Price Index (WPI).
b.
GDP deflator.
c.
Consumer Price Index (CPI).
d.
Both (a) and (b) above.
e.
Both (b) and (c) above.
58. Which of the following is considered as an investment?
Arun deposits Rs.10,000 with a nationalized bank in a term deposit for a period of 5
years.
b.
Barucha invests Rs.5,000 in equity shares of a company.
c.
Charlie and Co. accumulates unsold inventory worth Rs.1,000 .
d.
Delta Corp. buys ten used vehicles to strengthen its transportation fleet.
e.
None of the above.
o.
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59. The net factor income earned within the domestic territory of a country must be equal to
Net Domestic Product at factor cost
b.
Net Domestic Product at market price
c.
Net National product at factor cost
d.
Net National Product at market price
e.
Personal income.
BN
60. Both dividends and corporate taxes are part of
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a.
Corporate profits.
ii.
National income.
i.
Personal income.
iv.
Personal disposable income.
a.
Both (i) and (ii) above
b.
Both (ii) and (iii) above
c.
Both (i) and (iii) above
d.
(i), (ii) and (iii) above
e.
(i), (ii) and (iv) above.
ni
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Pr
es
s.
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i
Th
e
a.
Ic
fa
iU
61. Which of the following indices necessarily gives higher weights to services like doctor fees,
railway and bus fares?
Consumer Price Index (CPI).
©
Wholesale Price Index (WPI).
c.
Index of Industrial Production.
d.
GNP deflator.
e.
20
04
b.
GDP deflator.
62. Which of the following would not be included in GDP?
a.
Bobby purchases a new suit to wear at work.
b.
Amok purchases a new Ford car.
c.
Community Bank purchases new computers for its loan office.
d.
Margaret grows tomatoes in her home garden
e.
Ford India produces but could not sell 100 cars.
19

25. Macroeconomics
The Simple Keynesian Model of Income Determination
63. The ratio of the change in equilibrium output to the change in autonomous spending that
causes change in output is called
a.
Marginal propensity to consume
b.
Marginal propensity to save
c.
Average propensity to save
d.
Multiplier
e.
Average propensity to consume.
20
04
04
64. In an economy consumption function is equal to 12 + 0.6Y [then which of the following
statements are true?
Marginal propensity to consume is 0.6.
ii.
Marginal propensity to save is 0.4.
iii.
Marginal propensity to consume is 0.4.
iv.
Marginal propensity to save is 0.6.
v.
Autonomous consumption demand is 12.
a.
Both (iii) and (v) above.
b.
Both (iv) and (v) above.
c.
Only (iii), (iv) and (v) above.
d.
Only (i), (ii) and (v) above.
e.
Only (ii), (iii) and (v) above.
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65. The “rachet effect” is the situation where households find
It difficult to adjust to rising incomes than falling income
b.
It easier to adjust to rising incomes than falling income
c.
Supply of goods not sufficient, due to low production
d.
That inflation is the only reason for high cost consumption
e.
It is difficult to save, due to low income.
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a.
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e
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Pr
es
s.
Al
66. Changes in subjective and objective factors of households
a. May cause upward or downward shifts of the consumption function
b. May cause upward shifts of the consumption function
c. May cause downward shifts of the consumption function
d. Never effect consumption function
e. May cause upward shift of saving function.
67. The slope of the consumption function represents _______.
a. Average Propensity to Save (APS)
b. Marginal Propensity to Save (MPS)
c. Marginal Propensity to Consume (MPC)
d. Average Propensity to Consume
e.
Level of Consumption in the Economy.
68. The balanced budget multiplier is not affected by
a.
b.
Marginal propensity to import
c.
Investment function of the economy
d.
Proportional income tax rate levied by the government
e.
20
Marginal propensity to save
Both (a) and (b) above.

26. Part I
69. Which of the following is false?
a.
The ‘naive consumption function’ assumes a constant marginal propensity to consume.
b.
The ‘naive consumption function’ assumes that the ‘autonomous’ component of
consumption is constant.
c.
The average propensity to consume can never exceed unity.
d.
As income increases, the average propensity to consume decreases.
e.
Both (c) and (d) above.
b.
A parameter whose value depends upon the level of disposable income
c.
A behavioral coefficient
d.
A dependent variable
e.
None of the above.
04
The autonomous part of consumption, independent of the level of income, Y
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70. In the equation C = C + cY, C is
ef
.N
o.
71. Which of the following statements is correct?
A variable is endogenous when its value is determined by forces outside the model.
b.
A change in an exogeneous variable is classified as an autonomous change.
c.
A variable is exogenous when its value is determined by forces within the model.
d.
A variable is autonomous when its value is determined by forces within the model.
e.
All of the above.
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72. In stating that C = f(Yd, W)
It is hypothesized that Yd is a more important determinant of C than W
b.
It is hypothesized that W is a more important determinant of C than Yd
c.
W and Yd are dependent variables explaining C
d.
Yd and W are independent variables explaining C
e.
Both (c) and (d) above.
ig
ht
s
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a.
s.
Al
lr
73. Equilibrium occurs in a two-sector model when
Saving equals investment
Pr
es
a.
Consumption plus investment equals the value of output
Planned saving equals planned investment
d.
Aggregate spending equals the revenues of the business sector
e.
All of the above.
fa
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ty
b.
c.
a.
Output should increase
b.
Output should decrease
c.
Output should not change
d.
Any of the above can happen
e.
None of the above.
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Th
e
Ic
74. When planned saving is greater than planned investment,
75. When the value of output exceeds planned spending
a.
There is unsold output, and the level of income will fall
b.
There is unsold output, and the level of income will rise
c.
There is no unsold output, and the level of income does not change
d.
Any of the above can happen
e.
None of the above.
21

27. Macroeconomics
76. By definition, the marginal propensity to consume
a.
Equals ΔC/ΔYd
b.
Is the behavioral coefficient c in the equation C = a + cYd
c.
Is the slope of the consumption function
d.
All of the above
e.
None of the above.
77. The value of the expenditure multiplier relates
b.
The change in autonomous spending to the change in income
c.
The change in consumption to the change in income
20
04
The change in income to the change in consumption
All of the above.
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d.
e.
04
The change in income to the change in autonomous spending
04
a.
78. A change in autonomous spending is represented by
b.
A shift of a spending line
c.
A change in a behavioral coefficient
d.
Both (a) and (c) above
e.
None of the above.
o.
A movement along a spending line
31
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a.
1-
79. When Ct = f(Yd, t – 1)
There is an imperfect relationship between consumption and disposable income
b.
There is no relationship between consumption and disposable income
c.
Consumption spending lags the receipt of disposable income by one period
d.
The receipt of disposable income lags consumption spending by one period
e.
Both (a) and (c) above.
s
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ig
ht
80. Dynamic multipliers occur when
The assumption of ceteris paribus is dropped
b.
The economy is not in equilibrium
c.
Consumption is unrelated to disposable income
d.
There is a lagged response between consumption and disposable income
e.
None of the above.
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Pr
es
s.
Al
lr
a.
Th
e
b.
20
04
©
There is net credit balance in the merchandize account
Foreign exchange outflows on account of imports of goods and services and gifts made
exceed inflows on account of exports of goods and services received
d. Decrease in Foreign Exchange Reserves
e. Increase in Foreign Exchange Reserves.
82. Which of the following will not result in an increase in the level of income?
a. An increase in autonomous spending.
b. A decrease in autonomous taxes.
c. An increase in autonomous transfers.
d. An increase in net tax revenues.
e. Both (a) and (d) above.
83. Ceteris paribus, an income tax
22
c.
There is net debit balance in the merchandize account
Ic
a.
fa
iU
81. A current account deficit implies that

28. Part I
a.
Increases the value of the expenditure and net tax revenue multiplier
b.
Increases the value of the expenditure multipier and decreases the value of the net tax
revenue multiplier
c.
Decreases the value of the expenditure and net tax revenue multiplier
d.
Decreases the value of the expenditure multiplier and increases the value of the net tax
revenue multiplier
e.
None of the above.
84. If the net export balance is zero, an increase in autonomous investment spending will
Increase the net export balance and the income level
b.
Increase the income level but make the net export balance negative
c.
Increase the income level and have no effect upon the net export balance
d.
Have no effect upon the income level but cause the net export balance to become
negative
e.
None of the above.
o.
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04
a.
ef
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85. An increase in the marginal propensity to import
Has the same effect upon the multipliers as an increase in the MPC
b.
Has no effect upon the multipliers
c.
Increases the value of the multipliers
d.
Decreases the value of the multipliers
e.
None of the above.
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86. When an investment spending is negatively related to the rate of interest, equilibrium income
in the goods market
Is unrelated to the rate of interest
b.
Is inversely related to the rate of interest
c.
Is positively related to the rate of interest
d.
Falls as the rate of interest decreases
e.
None of the above.
Pr
es
s.
Al
lr
ig
ht
s
re
se
rv
a.
87. Given the consumption function C = 256 + 0.85Y, we may infer that, as Y increases
Average propensity to consume remains constant
b.
The marginal propensity to consume and average propensity to consume will be
decreasing
c.
The average propensity to consume is constant but marginal propensity to consume will
be decreasing
Th
e
Ic
fa
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i
ty
a.
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20
04
d.
The average propensity to consume will be decreasing but marginal propensity to
consume will be constant
e.
Both the average and marginal propensity to consume will be constant.
88. Which of the following will not increase the value of multiplier?
a.
Increase in marginal propensity to consume.
b.
Increase in marginal propensity to save.
c.
Decrease in tax rate.
d.
Decrease in marginal propensity to import.
e.
None of the above.
89. When the balanced budget multiplier is equal to one, increase in government expenditure and
23

29. Macroeconomics
the tax revenue by 100 will
a.
Not change the equilibrium income
b.
Increase the equilibrium income by 100
c.
Increase the equilibrium income by less than 100
d.
Decrease the equilibrium income by 100
e.
Decrease the equilibrium income by more than 100.
90. Which of the following statements is true?
The value of Marginal Propensity to Consume (MPC) lies between zero and infinity.
b.
The value of multiplier lies between 0 and 1.
c.
The value of multiplier lies between 1 and infinity.
d.
The value of multiplier is the inverse of MPC.
e.
In the linear consumption function average propensity to consume is constant.
M
AC
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B
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04
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a.
o.
91. Which of the following statements is true?
Relative Income Hypothesis asserts that people can quickly and easily adjust their living
standards downwards but upward adjustment is very difficult.
b.
Permanent Income Hypothesis states that the transitory component of income
significantly influences the consumption behavior.
c.
Relative income hypothesis assumes that marginal propensity to consume and hence
multiplier are constant.
d.
Life Cycle Hypothesis states that the saving behavior of the individuals during their
working life is motivated by their desire to maintain consumption levels after
retirement.
e.
Relative Income Hypothesis states that marginal propensity to consume is lower for
increase in income than for decrease in income.
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92. On the basis of the Keynesian model of output determination, a multiplier of 3 implies that
An increase in consumption by Rs.3 will result in an increase in investment by Re.1
b.
An increase in investment by Re.1 will result in an increase in consumption by Rs.3
c.
An increase in investment by Re.1 will result in an increase in consumption by Rs.2
d.
An increase in investment by Re.1 will result in an increase in consumption by Rs.1
e.
An increase in income by Re.1 will result in an increase in investment by Rs.2.
ni
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Pr
es
s.
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a.
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93. Which of the following is true if the RBI increases Cash Reserve Ratio (CRR)?
Monetary liabilities of the RBI increases.
Ic
fa
a.
High-powered money in the economy decreases.
c.
The value of money multiplier decreases.
d.
Aggregate demand in the economy increases.
e.
Price level in the economy increases.
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20
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Th
e
b.
94. Consumption demand does not depend upon the level of
a.
Income
b.
Propensity to consume
c.
Propensity to save
d.
Consumer spending.
e.
Marginal efficiency of investment.
95. The slope of the consumption curve connotes
24

30. Part I
a.
Average propensity to save
b.
Average propensity to consume
c.
Marginal propensity to consume
d.
Marginal propensity to save
e.
Level of consumption in the economy.
96. Given that the marginal propensity to consume is larger, which of the following statements
are true.
Multiplier value will be larger.
iii.
Average propensity to consume will be larger.
iv.
Autonomous consumption will be higher.
a.
Both (i) and (ii) above
b.
Both (ii) and (iii) above
c.
(ii), (iii) and (iv) above
d.
(i), (ii) and (iii) above
e.
Both (iii) and (iv) above.
04
ii.
04
Marginal propensity to save will be larger.
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27
Income Determination Model Including Money and Interest
31
4-
02
97. The curve explains the combination of interest rates and levels of output at which planned
spending equals income.
IS
b.
LM
c.
MPC
d.
MPS
e.
AD.
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a.
ht
s
98. Which of the following statements is/are incorrect?
The IS curve shifts to the left if the tax rate increases.
b.
The IS curve shifts to the right if tax rate and government expenditure increases.
c.
The IS schedule shifts to the right if the interest rate falls.
d.
The IS schedule shifts to the right if the interest rate rises.
e.
Both (c) and (d) above.
ve
rs
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ty
Pr
es
s.
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lr
ig
a.
iU
ni
99. Which of the following statements is/are true regarding IS curve?
Larger the multiplier, steeper the IS curve.
Ic
fa
a.
Larger the multiplier, flatter the IS curve.
c.
As the taxes increase, the IS curve becomes steeper.
d.
As the taxes decrease, the IS curve becomes steeper.
e.
Both (b) and (c) above.
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Th
e
b.
100. An autonomous increase in investment
a.
Does not affect the IS curve
b.
Shifts the LM curve to the left
c.
Shifts the IS curve to the left
d.
Shifts the IS curve to the right
e.
Makes the IS curve flat.
101. The LM schedule shifts
25

31. Macroeconomics
a.
To the right, if the supply of money increases
b.
To the right, if the demand for money increases
c.
To the left, if the supply of money increases
d.
To the left, if the demand for money decreases
e.
Both (c) and (d) above.
102. At interest rate ‘r’ there is a simultaneous equilibrium in goods and money markets. If
interest rate increases from r to r1 then
Equilibrium in goods market will be at a point higher than the existing income
b.
Equilibrium in money market will be at a point higher than the existing income
c.
Equilibrium in goods market does not change but equilibrium in money market will be
at a point higher than the existing income
d.
Equilibrium in money market does not change but equilibrium in goods markets will be
at a point higher than the existing income
e.
Both (a) and (b) above.
o.
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103. Which of the following is true?
The LM curve is vertical if there is no speculative demand for money.
b.
The LM curve is horizontal if there is no speculative demand for money.
c.
The changes in money supply will have no effect on the LM curve, if the LM curve is
positively sloped.
d.
The changes in money supply will have no effects on the LM curve, if the LM curve is
negatively sloped.
e.
Both (b) and (d) above.
.IS
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104. The basic difference between IS and LM curve is that
IS curve explains money market and LM curve explains goods market
b.
IS curve explains goods market and LM curve explains money market
c.
IS curve explains money in circulation and LM curve explains goods in demand
d.
IS curve explains monetary policy and LM curve explains fiscal policy
e.
IS curve slopes from right to left and LM from left to right.
Pr
es
s.
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a.
ty
105. The LM schedule is a
Schedule of goods market equilibrium where the supply of goods equals the demand for
goods
b.
Schedule of monetary equilibrium where the supply of money equals the demand for
money
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Th
e
c.
Ic
fa
iU
ni
ve
rs
i
a.
Schedule of goods market equilibrium where the supply of goods equals the goods
produced
Schedule of goods market equilibrium where the supply of goods equals the external
demand for goods
e.
Both (a) and (d) above.
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d.
106. When IS curve shifts rightwards
a.
Income will fall but interest rates will rise
b.
Income will rise but interest rates will fall
c.
Both income and interest rates will fall
d.
Both income and interest rates will rise
e.
Income will decrease but interest rate will remain unchanged.
107. A shift in the IS curve would occur if there is a change in
26

32. Part I
a.
Autonomous government expenditure on goods and services
b.
Transfer payments made by the government
c.
Marginal propensity to import
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
108. The slope of the LM curve is dependent upon the
Money supply in the economy
b.
Price level in the economy
c.
Transactions demand function for money of the economy
d.
Money supply and price level in the economy
e.
Money supply, price level and transactions demand function for money of the economy.
B
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a.
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109. If investment demand is infinitely interest elastic
LM curve becomes horizontal
c.
IS curve becomes vertical
d.
IS curve becomes horizontal
e.
Both (b) and (c) above.
ef
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b.
o.
LM curve becomes vertical
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R
a.
Aggregate demand to the left
c.
Aggregate supply to the right
d.
Aggregate supply to the left
e.
None of the above.
31
b.
1-
Aggregate demand to the right
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110. An expansionary monetary and fiscal policy shifts
ht
s
111. The demand for money is
Positively related to the income level and the rate of interest
b.
Negatively related to the income level and the rate of interest
c.
Negatively related to the income level and positively related to the rate of interest
d.
Positively related to the income level and negatively related to the rate of interest
e.
None of the above.
ve
rs
i
ty
Pr
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s.
Al
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a.
An increase in the quantity of money demanded and an increase in the rate of interest
Ic
Th
e
a.
fa
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ni
112. Suppose the money supply and price level are constant, and the demand for money is a
function of income and the rate of interest. When the income level increases, there is
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An increase in the quantity of money demanded and a decrease in the rate of interest
c.
A decrease in the quantity of money demanded and a decrease in the rate of interest
d.
A decrease in the quantity of money demanded and an increase in the rate of interest
e.
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b.
None of the above.
113. Simultaneous equilibrium in the money (LM) and goods (IS) markets exists
a.
At an unlimited number of income levels and rates of interest
b.
At only one income level and rate of interest
c.
At an unlimited number of income levels and only one rate of interest
d.
At only one income level and an unlimited number of rates of interest
e.
None of the above.
114. A liquidity effect occurs when
27

33. Macroeconomics
a.
A reduction in government spending lowers the rate of interest
b.
A money supply increase lowers the rate of interest
c.
An increase in government spending increases the rate of interest
d.
A money supply increase raises the rate of interest
e.
None of the above.
115. A liquidity effect will normally result in an income effect because
Lower interest rates will increase the portfolio demand for money
b.
Lower interest rates will cause less crowding out
c.
Lower interest rates will increase interest sensitive spending
d.
Lower interest rates will cause more crowding out
e.
None of the above.
W
M
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116. A change in the money supply has a greater effect upon equilibrium income if
B
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a.
The private sector spending is more interest-sensitive
b.
The private sector spending is less interest-sensitive
c.
The expenditure multiplier is smaller than anticipated
d.
The interest-sensitive money holding to the rate of interest is more
e.
None of the above.
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a.
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117. In which of the following situations will an increase in the money supply have no effect upon
equilibrium income?
LM is steeply sloped and IS is relatively flat.
b.
LM is vertical and IS is steeply sloped.
c.
LM is steeply sloped and IS is vertical.
d.
LM is relatively flat as is IS.
e.
None of the above.
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118. Crowding out is more likely to occur when
The demand for money is interest-sensitive, and private sector spending is largely
interest-insensitive
b.
The demand for money is interest-sensitive, and private sector spending is
interest-sensitive
c.
The demand for money is interest-insensitive, and private sector spending is
interest-insensitive
d.
The demand for money is interest-insensitive, and private sector spending is
interest-sensitive
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e
Ic
fa
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ty
Pr
es
s.
Al
a.
e.
None of the above.
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119. Crowding out will occur when
a.
A decrease in the money supply raises interest rates which crowd out interest-sensitive
private sector spending
b.
An increase in taxes of the private sector reduces private sector disposable income and
spending
c.
A reduction in income taxes causes higher interest rates, which crowd out
interest-sensitive private sector spending
d.
A reduction in government spending causes induced consumption spending to fall
e.
None of the above.
120. Which of the following statements is not true?
28

34. Part I
a.
When the relative increase in the price level is greater than the relative increase in the
nominal money supply, the real money supply decreases.
b.
When the relative increase in the nominal money supply is greater than the relative
increase in the price level, the real money supply increases.
c.
When the price level decreases, ceteris paribus, the real money supply decreases.
d.
When the price level increases, ceteris paribus, the real money supply decreases.
e.
None of the above.
121. An increase in the price level
b.
Reduces the real money supply and shifts the LM schedule to the left
c.
Increases the real money supply and shifts the LM schedule to the right
d.
Increases the real money supply and shifts the LM schedule to the left
e.
None of the above.
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Reduces the real money supply and shifts the LM schedule to the right
o.
M
AC
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B
04
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a.
ef
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122. If real and nominal interest rates fall, then
Investment spending should fall, as well
b.
Investment spending should rise
c.
Consumption expenditure should fall as people save more
d.
The marginal propensity to save should rise, shifting the entire consumption schedule
e.
Investment spending should rise primarily to take up the slack left by lower
consumption expenditure.
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a.
b.
Gm = a.Gy – Gp
c.
Gm = a.Gp – Gy
d.
Gm = Gy + a. Gp
e.
Gm = a.Gy + Gp.
re
Gm = Gp – a. Gy
ve
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Pr
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s.
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ht
s
a.
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ed
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123. Given, growth rate of real output = Gy, income elasticity of demand is (alpha), acceptable
rate of inflation is Gp, the money stock growth target (Gm) is given by (all in percentage
terms)
124. When economists are concerned about the liquidity preference function, they are interested in
The relationship of the demand for money and the rate of interest
b.
The proportion of liquid (cash) reserves maintained by commercial banks
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iU
fa
Ic
Th
e
c.
ni
a.
The preference for a currency backed by gold
d.
A bank’s desire for accounts receivables as collateral
e.
The amount of money in circulation.
125. Transmission mechanism shows
a.
The interrelationship between the money market and the goods market
b.
Low increase in government expenditure increases income
c.
The relationship between income and consumption
d.
The relationship between income and saving
e.
None of the above.
126. Which of the following statements is/are true?
29

35. Macroeconomics
The elasticity of demand is the same at all points on a linear demand curve.
ii.
Interest rates are inversely related to investment expenditure.
iii.
An increase in money supply tends to increase interest rates.
a.
(i) only.
b.
(ii) only.
c.
(iii) only.
d.
(i) and (ii) only.
e.
(ii) and (iii) only.
04
i.
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127. A ‘supply shock’ such as failure of monsoon or increase in the price of oil
Causes a rightward shift of the aggregate supply curve and thus results in higher
equilibrium output and lower prices
b.
Causes a rightward shift of the aggregate supply curve and thus results in higher
equilibrium output and higher prices
c.
Causes a leftward shift of the aggregate supply curve and thus results in lower
equilibrium output and higher prices
d.
Causes a leftward shift of the aggregate supply curve and thus results in lower
equilibrium output and lower prices
e.
Causes a rightward shift of the aggregate supply curve and thus results in lower output
and higher prices.
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o.
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B
04
a.
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128. If transfer payments are increased, which of the following is true of I-S curve?
Slope of the I-S curve will increase.
c.
I-S curve will shift to the right.
d.
Slope of the I-S curve will decrease.
e.
I-S curve will not be affected.
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b.
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I-S curve will shift to the left.
ig
ht
s
re
se
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ed
a.
s.
Al
lr
129. If the demand for money is infinitely interest elastic, which of the following is true?
Changes in money stock are totally ineffective in influencing equilibrium output and
interest rate.
b.
Changes in autonomous expenditure are totally ineffective in influencing equilibrium
output and interest rate.
c.
Changes in money stock lead to changes in equilibrium rate of interest only while
equilibrium output remains unaffected.
Changes in autonomous expenditure affects only the equilibrium output while
equilibrium rate of interest remains unchanged.
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Th
e
Ic
d.
fa
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ni
ve
rs
i
ty
Pr
es
a.
e.
Changes in money stock lead to changes in both equilibrium output and rate of interest
while changes in autonomous expenditure affect only the interest rate.
130. Which of the following is not true with respect to IS curve?
a.
It shows the equilibrium in the goods market.
b.
It is positively sloped.
c.
If autonomous exports increase, it will shift to the right.
d.
If government expenditure decreases, it shifts to the left.
e.
It is vertical if the consumption and investment expenditures are not responsive to the
rate of interest.
131. The term ‘crowding out’ refers to the process by which
30

36. Part I
a.
Excessive investment is undertaken in the economy
b.
A rise in base money leads to a very tight monetary policy
c.
Increase in government deficit, due to a tax cut or an increase in government spending
reduces the funds available to investment spending
d.
Funds available for investment spending will be protected by all means
e.
Both (a) and (c) above.
132. Transaction demand for money
Varies positively with income and inversely with rate of interest
c.
Varies inversely with income and positively with rate of interest
d.
Varies inversely with income and rate of interest
e.
Does not depend on income and rate of interest.
04
b.
04
Varies positively with income and rate of interest
W
B
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a.
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fa
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ed
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AC
133. In an IS curve, as interest rate ‘i’ increases
a. Both consumption and investment decline
b. Both consumption and investment increase
c. Consumption increases, investment declines
d. Consumption declines, investment increases
e. Consumption and investment are unaffected.
134. Which of the following statements is correct?
a. GDP deflator = Real GDP/Nominal GDP.
b. Real rate of interest = Nominal rate of interest + Rate of inflation.
c. An increase in government expenditure is likely to cause a reduction in private
investment.
d. If the interest elasticity of demand for money is zero, the IS curve becomes vertical.
e. When the rate of interest increases, the IS curve shifts to the left.
135. In the IS-LM framework, an increase in autonomous government expenditure
a. Will result in an increase in income and decrease in interest rate
b. Will result in a decrease in income and increase in interest rate
c. Will result in an increase in both income and interest rates
d. Will result in a decrease in both income and interest rates
e. Will affect neither the income nor the interest rate.
136. If interest elasticity of demand for investment and consumption is zero
a. Equilibrium income depends solely on the position of L-M curve
b. Equilibrium income is determined solely in the goods market
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c.
Equilibrium income is determined by the positions of both the I-S and L-M curves
d.
Equilibrium income is unaffected by the positions of both the I-S and L-M curves
e.
Fiscal policy is totally ineffective in changing any of the real variables.
137. Japanese economy is facing the problem of liquidity trap. Which of the following statements
is not true about liquidity trap?
a.
Public is willing to hold whatever money is supplied at the current interest rate.
b.
LM curve is horizontal.
c.
Fiscal policy is more effective in increasing income.
d.
Monetary policy is ineffective in affecting interest rate.
e.
LM curve is vertical.
138. Which of the following better explains the inverse relationship between the interest rate and
31

37. Macroeconomics
the demand for money?
a.
The transaction demand for money.
b.
The speculative demand for money.
c.
The precautionary demand for money.
d.
The inflationary expectations.
e.
None of the above. The relationship between the interest rate and the demand for money
is direct, not inverse.
04
139. Which of the following statements is not true about IS-LM Model?
IS function represents the goods market equilibrium.
b.
LM function represents the money market equilibrium.
c.
Interest rate is a variable in both IS and LM functions.
d.
Goods and money markets interact to determine the equilibrium national income.
e.
IS curve is positively sloped.
o.
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B
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04
a.
b.
IS curve shifts to the right.
c.
LM curve shifts to the left.
d.
Interest rate falls.
e.
Interest rate increases.
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Disposable income remains constant.
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a.
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ef
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140. In the standard IS-LM model, which of the following is true if the government raises tax rate
and the Reserve Bank of India decides to hold the money supply constant?
ed
.IS
141. The LM curve shows
A positive relationship between rate of interest and level of income
b.
A negative relationship between rate of interest and level of income
c.
A negative relationship between rate of interest and level of investment
d.
A positive relationship between rate of interest and level of investment
e.
A positive relationship between level of investment and level of income.
Pr
es
s.
Al
lr
ig
ht
s
re
se
rv
a.
ty
142. An increase in government expenditure will
Shift both IS and LM curves to the right
b.
Shift both IS and LM curves to the left
c.
Not affect the position of LM curve but shift IS curve to the left
Not affect the position of IS curve but shift LM curve to the right
Th
e
Ic
d.
fa
iU
ni
ve
rs
i
a.
Not affect the position of LM curve but shift IS curve to the right.
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04
e.
143. The demand for money is a demand for real money balances for a given interest rate. If there
is an increase in the level of income because of increase in real money supply, which of the
following statements holds true?
a.
b.
LM curve shifts to the left.
c.
IS curve shifts to the right.
d.
LM curve shifts to the right.
e.
32
IS curve shifts to the left.
Both IS and LM curves shifts to the right.

38. Part I
Fundamentals of Aggregate Demand and Aggregate Supply
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Th
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Ic
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B
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144. Due to an increase in the real stock of money ___.
a. The LM curve and AD curve shift towards right
b. The LM curve shifts towards left and AD curve towards right
c. The AD curve and LM curve shift towards left
d. The AD curve shifts towards left and LM curve shifts towards right
e. Increase in the real stock of money will not have any effect on LM curve but shifts AD
curve towards right.
145. Due to fiscal expansion __________.
a. IS and AD curves shift towards right
b. IS and AD curves shift towards left
c. LM and AD curves shift towards right
d. LM and AD curves shift towards left
e. Fiscal expansion will not have any effect on LM, IS and AD curves.
146. The real stock of money in the economy increases due to
a. Increase in prices
b. Decrease in prices
c. Increase in interest rates
d. Decrease in interest rates
e. Both (b) and (d) above.
147. When price level increases
a. LM curve shifts towards right
b. IS curve shifts towards left
c. Aggregate supply curve shifts towards right
d. IS curve shifts towards right
e. LM curve shifts towards left.
148. If all the resources available are fully employed then aggregate supply curve in the long run
will become
a. Horizontal
b. Vertical
c. Parabola
d. Straight line with a positive slope of 45 degrees
e. Straight line with a negative slope of 45 degrees.
149. Which of the following factor/s is/are responsible for a change in aggregate demand?
a. Rate of interest.
b. Exchange rate.
c. Government policy.
d. Both (b) and (c) above.
e. All of (a), (b) and (c) above.
150. Which of the following factors is/are responsible for a change in aggregate supply?
a. Change in cost of production.
b. Supply shock.
c. Human capital.
d. Both (a) and (b) above.
e. All of (a), (b) and (c) above.
33