www.svc.ac.in Sri Venkateswara College : MacroEconomics Model Question Paper

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Model Question Paper
MACROECONOMICS
Dept. of Economics

Answer all Sections :
Section - I :
1. The following functions are estimated for the Indian Economy (12 marks)
Consumption function C=200+0.75Yd
Investment function I=400-50i
Govt. purchases G=200
Taxes T=0.2Y
Real demand for money L = 0.5Y – 75r
Nominal money supply Ms = 900
Price level P=2
(Here: Yd stands for disposable income; Y stands for income and i stands for interest rate in percentage points. All other figures are in $ billions)
1. Write down the equations for the IS (1 mark) and LM curve (1 mark). Solve the system for equilibrium level of real income and real interest rate (1 mark)

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2. Suppose the govt. purchases are raised from 200 to 350 and the nominal money supply is raised from 900 to 1000. What is the magnitude of shift in IS and LM curves (2 mark)? What are the new equilibrium level of income, interest rate and the extent of crowding out (3 mark)?
3. When govt. purchases are raised from 200 to 350 (in the above question), what should be the corresponding increase in real money supply to realize the full simple Keynesian multiplier? (2 mark)
4. With the initial values of monetary and real sector values derive the equation for aggregate demand curve? (2 mark)

Section –II :
a. Derive the aggregate demand curve and show the effects of an increase in nominal money stock on aggregate demand curve? (6 marks)
b. What is crowding out? Explain with the help of the diagrams the situation of full crowding out and zero crowding out? (7 marks)
Or
c. Income tax as automatic stabilizer (6 marks)
d. Full employment budget surplus (7 marks)

Section – III :
a. How would the LM curve look like in a classical world? If this really were the LM curve that we thought best characterized the economy, would we lean toward the use of fiscal or monetary policy? (Assume your goal is to affect the level of output) (6 marks)
b. What is an IS curve? Explain the factors, which affects its slope (for a three sector economy with tax as a function of income and downward sloping Investment Demand Schedule)? (You have to derive the IS schedule algebraically and also diagrammatically and explain what factors affect the slope through algebra and diagrams). How does the
decrease in govt. expenditure affect the IS curve? (7 marks)
OR
c. What is liquidity trap? If the economy were stuck in one, would you advise the use of monetary or fiscal policy? (Your goal is to increase the real output) (6 marks)
d. Explain why the slope if IS curve is a factor in determining the working of monetary policy? (7 marks)

Section - IV :
a. Explain diagrammatically and in words how and why fiscal policy (i.e. increase in G) has same effect on income when the interest elasticity of investment is zero and interest sensitivity of the demand for money is infinite? (6 marks)
b. Explain diagrammatically and in words how two alternative programmes for contraction affect interest rate and income. One is the removal of an investment subsidy; the other is the rise in autonomous taxes. (6 marks)
OR
c. Explain diagrammatically and in words how and why the income (kY) and interest sensitivity (hi) of the demand for real balances affect the slope of the LM schedule? (6
marks)
d. Suppose the govt. cuts income taxes (autonomous). Show in the IS-LM model the impact of tax cut under two assumptions : (1) the govt. keeps interest rates constant through an accommodating monetary policy. (2) The money stock remains unchanged. Explain the difference in results. (6 marks)