Part I: Multiple Choice Questions

Q1. Suppose that real money demand is represented by the equation (M/P)d = 0.25*Y. Using the quantity equation, the income velocity of money is

a) 2.50

b) 3.00

c) 0.25

d) 4.00

e) None of the above

[1]

Q2. If income taxes are lowered, we can expect that the income velocity of money will

a) Increase due to an increase in income and the interest rate

b) Decrease due to an increase in saving and money supply

c) Decrease since people will save more

d) Remain fairly stable since both income and prices will increase

e) Decrease since money supply will increase

Q3. If a central bank believes that an economic disturbance will negatively affect GDP in the current quarter but will have little permanent effect, then it should

a) Sharply lower interest rates immediately to mitigate the effects of the disturbance

b) Sharply lower interest rates immediately and let financial markets know that they will be raised again next quarter

c) Undertake large open market sales now with the intention of making open market purchases later on

d) Sit on its hands since any policy action would destabilize the economy further

e) None of the above

Q4. Which of the following might have caused the shift in aggregate supply shown in the diagram below? Tick all the answers that apply.

a) An improvement in technology

b) A depreciation of the exchange rate

c) An increase in costs

d) A reduction in government expenditure

e) A cut in income tax

f) An increase in wage levels

Q5. If we were in a liquidity trap,

a) Investment would be totally interest insensitive

b) Fiscal expansion would be unlikely to drive interest rates up

c) Monetary policy would be more powerful than fiscal policy

d) An increase in government spending would be totally offset by a decrease in private investment

e) Crowding out would be made worse by the inability of monetary policy to accommodate fiscal policy

Q6. Which of the following is NOT included as investment in the national income accounts?

a) Investment in human capital

b) Investment in new knowledge

c) Government investment in a country's infrastructure

d) Financial investment (the buying of stocks and bonds)

e) All of the above

Q7. If we compare the effects on aggregate demand of a temporary investment tax credit for firms and a temporary income tax cut for households, we realize that

a) A temporary income tax cut is more effective since consumption is a larger portion of aggregate demand than investment

b) Neither one will change aggregate demand significantly since in both cases permanent rather than current income is important

c) Both will change aggregate demand significantly since individuals as well as firms want to take advantage of lower taxes while they can

d) The personal income tax cut will increase aggregate demand while the higher tax credit will lower aggregate demand

e) Temporary investment tax credits will help to simulate aggregate demand but temporary income tax cuts most likely will not

Q8. Which of the following would cause the shift in aggregate demand shown in the diagram below?

a) The government/RBI increase interest rates

b) Ms. Nirmala Sitharaman increases tax-free allowances in her budget

c) The rate of GST is increased

d) Controls on the level of bank lending are relaxed

e) The government allows tax relief on R&D spending

f) The rate of income tax is reduced Part II: Analytical Questions

Q9. If the US Federal Reserve unexpectedly raises interest rates, what could be its impact on the Indian economy, in the IS-LM open economy framework. Show it using an IS-LM diagram.

Q10. Suppose, the recent digitization initiatives of India, led by Prime Minister Mr. Narendra Modi, has increased availability and usage of ATM machines significantly.1

Using the Mundell-Fleming model, explain, with diagram, how this policy outcome affects country's exchange rate and trade balance for the following if:

(a) India maintains a floating exchange rate

(b) India maintains a fixed exchange rate.

Q11. The economic policies of President Ronald Reagan in the early 1980s, aka the Reaganomics, present some fascinating debates in macroeconomics. The President was attempting a tax cut revolution while the Federal Reserve, under Chairman Paul Volcker, was attempting to control inflation.

(a) President Reagan's tax policies were a crucial part of his economic plan. The most important policy tool was a massive tax cut (30 percent in three years). Use an IS-LM diagram to show how tax cuts would affect the economy. Assume that monetary policy does not change in this question.

(b) Now say that President Reagan's fiscal policies were expansionary while Volcker's monetary policy was contractionary. How would these two contemporaneous policies be represented in a single IS-LM diagram? Write a few sentences to explain your diagram. Can you say anything definitive about how output and interest rates would change?

Part III: Numerical Questions

Q12. Imagine that you are the Governor of the Reserve Bank of India (RBI). Assume, further, that the money supply in India has been growing at 12% per year. You have been called before the Parliament to explain the long-run effects of increasing the growth of the money supply to 15% per year. Assume that real GDP grows at 8% per year in the longer run and the income velocity of money remains stable. State and then

1 Assume perfect capital mobility and India as a small open economy.

explain the long-run effects of this change in money supply growth on each of the following variables (Give numerical estimates of levels and changes when possible):

a) Annual rate of inflation

b) Real interest rate

c) Nominal interest rate

d) Real GDP and real GDP growth.

Q13. Consider a closed economy described by:

C = 200 +0.5Y - 500 r

I = 200 - 500 r

L = 0.5 Y - 250 (r + ?e)

?e = 0

G = 150

M = 4900 (money supply)

Y0 = 1000

r is the real interest rate, ?e is expected inflation rate, L is real money demand and Yo is the equilibrium output.

What are the equilibrium levels of real interest rate, the price level, desired aggregate consumption and investment?