568 2

4.

SECTION A (Es )
Question 1 is compulsory. (15x2=30)

1. (i) Assume that the economy is closed (i.e. no

import or export). There is a decrease in taxes.
What happens to interest rate in Medium Run
due to the Labour Market?

(a) Increase

(b) Decrease

(c) Unchanged

(d) Indeterminate
568

(i) The permanent ineome of # eonuner n

Friedman' model of eonaumptio iN
(a) Present value of her invome/interet tate
(b) Present value ot her ineome Xinteret rate
(c) Interest rate/ Present value of her income
(d) None of the above

(ii)) Which of the following cvent inorcanos natural

rate of unemployment?

(a) Decrease in Government Spending

(b) Inerease in Real Money Supply

(c) Deerease in competition amongst firms

(d) Weakening of Labor Union

(iv) Assume that expected inflation follows n, ,

What inflation level is consistent with the
government maintaining output below the natural
level?

(a) Positive Inflation

(b) Negative Inflation

(c) Zero Inflation
P.T.0.
 4
568
above
(d) All of the

following variables will change in

(v) Which of the
response to a demand shock if
the long run in
fully?
prices are able to adjust
(a) Unemployment

(b) Output and unemployment

(c) Price level

(d) None of the above

(vi) The life cycle hypothesis implies that in a growing

economy with increasing social security benefits
for old-age people may
(a) Increase gross private savings
(b) Reduce gross private savings

(C) Increase gross government savings

(d) Increase aggregate savings

(vii) What happens to the short-run Aggregate Supply

curve as the money wage rate rises?

(a) the short-run aggregate supply curve shifts

rightward.
568 5

(b) the short-run aggregate supply curve shifts

leftward.

(c) the long-run aggregate supply curve shifts

rightward.
(d) both the long-run aggregate supply curve
and the short-run aggregate supply curve
shift leftward.

(vi) According to the pipeline theory, inventory

investment is

(a) Countercyclical
(b) Procyclical

(c) Both (a) and (b)

(d) Constant overtime

(ix) Which of the following best explains how an

economy could simultaneously experience high
inflation and high unemployment?
(a) The government increases spending without
increasing taxes.

(b) Inflationary expectations decline.

(c) Women and teenagers stay out of the labor
force.
P.T.0.
568 6

(d) Negative supply shocks cause factor prices

to increase.

between
(x) According to Friedman the covariance
is
current consumption and transitory income
(a) Greater than zero

(b) Less than zero

(c) Equal to zero

(d) Equal to 1

only
(xi) The modified Phillips curve tells us that the
way to reduce inflation is through
natural
(a) únemployment rates higher than the
rate

(b) expansionary fiscal policy

natural
(c) unemployment rates lower than the
rate

(d) contractionary fiscal policy

(xii) The natural rate of unemployment depends on

all of the following except:
(a) The level of unemployment insurance
(b) The mark-up
568
(c) The bargaining power of workers with firms
(d) Money supply

(xii) In terms of the Phillips Curve,

wage indexation
results in

(a) a.weaker/flatter relationship between

unemployment and changes in inflation.
(b) no effect on the
relationship between
unemployment and changes in inflation.
(C) a stronger/steeper relationship between
unemployment and changes in inflation.
(d) an ambiguous effect that depends on the
mark-up of firms.

(xiv) The stagnation thesis formed around 1940

was
based on the ground that

(a) If the marginal propensity to consume

(MPC)< average propensity to consume
(APC) is accepted, then government
expenditure share to GDP (g/y) must be
increasing with GDP (y) to balance the
drop in APC to maintain full-employment
demand.

P.T.0.
S68 8

(b) If MPC< APC is accepted, then gly must

be deereasing with y to balance the increase
in APC lo maintain full employment
demand.
(e) If MPC > APC is accepted, then g/y must
be inereasing withy to balance the drop in
APC to maintain full employment demand.
(d) If MPC =APC is accepted, then g/y must
be decreasing with y to balance the increase
in APC to maintuin full-employment
demand.

(xv) According to the Phillips curve, unemployment

will return to the natural rate when:

(a) Nominal wages are cqual to expected

wages

(b) Real wages are back at lkong-run equilibrium

level

(C) Nominal wages are growing faster than

inflation

(d) Inflation is higher than the growth of

nominal wages
68 9

(*)

() A

() fafta

(a) afa

P.T.O.
 12

A ?
568 13

() â
P.I.O.
568 14

() aft tMiA 3YT ygft (MPc) < stea gYT

qft (APC) ¥aR fT I, APC

I GDP (g/y) HI HHT R 3G GDP (y)

 15
8
(a) tt MPC < APC GR R fAI GGI

() fa MPC >APC AR R fRI IGT ,

() afe MPC =APC aR fu IGT ,

P.T.0.
 16
568

SECTION B (aS a)
8 questions.
Attempt any 6 out of the jollowing
marks. (6x5=30)
Each question carries 5

What are its

2. (a) Describe the concept of NAIRU.
determinants?

(b) Can NAIRU change with time and across

countries? (2+3)

3
(a) The Phillips curve is n. = te + (ut z)
Rewrite this relation as a relation between the
from the
deviation of the
unemployment rate
natural rate, inflation. and expected inflation.
 17

Onlinejob websites are getting popular amongst

(b)
with
job-seekers and enable them to connect
have
employers easily. What impact should this
unemployment in an
on the natural rate of
(3+2)
economy?

HaT
7,+ (4tz) - au, 3H

a stock using
4 Determine the price-earnings ratio for
arbitrage argument for financial investment. Can
he
measure be used to detect bubbles in the stock
tnis
(S)
market?

P.T.0.
568 18

S. "Disinflation typically leads to a period of higher

bonnt
unemployment." Explain. What is the basis of L
disinflation
assertion that the unemployment costs of
can be reduced significantly? Do you expect faster
disinflations to be associated with lower sacrifice
ratios? (5)

6 (a) Compute the real interest rate using the exact

formula and the approximation formula for i=4%;
I = 2%.

(b) Explain possible reasons for the firms to pay higher

than market-clearing wages. (2+3)

R UI i = 4%: °= 2%%.

(a) aT-THT0ET Hett

 19
optimising model of
Following the intertemporal
intertemporal consumption
consumption, derive the future-utility
rate (r) and
relation with the interest along with the
Provide a graph
discounting factor (o).
reasoning behind the typical consumption
economic
different relative magnitudes
path to be obtained for (3+2)
of r and d.

8. Discuss an alternative theory of consumption.that

modifies the intertemporal budget constraint used in
the intertemporal optimising models of consumption.
Flow does this alternative theory modify the
consumption path proposed in Ando-Modigliani's model
of consumption (i.e., Life Cycle Hlypothesis)? (5)

P.T.O.
 20
568
as well as Monetary policy cannot change
9 Fiscal policy
output in the medium run. Why is then
the level of
policy considered neutral but not fiscal
monetary
(5)
policy?

SECTION C (aG T)
Attempt any 3 out of the following 4 questions.
Each question curries 10 marks. (3x10=30)

10. In a faraway country, the total population is 5000

people (all of them non-institutional civilian people),
3000 are working and 250 are looking for a job.

(a) What is the size of the

labour force? What are
the participation rate and unemployment rate.
(3)
(b) In this
the
economy, the labour productivity is 1. And

wage-setting process is described by

 21

unemployment
Where Z is the
W =Z-100u,
iS
p government and u
provided by the Setting
insurance Price
unemployment rate. What is the Show
the level å = 1.5?
for a
mark-up
equation
graphically and mathematically. (2+1)

unemployment rate (show

it
natural
(c) What is the level of employment
natural
graphically as well), (2+1+1)
Z-5?
natural level of output if
and

h tr 250 a t
-HRA ARRE ), 3000 4

W
=Z-100u, G80 Z
pe

P.T.O.
 22
568

Z=5 ?

describe the
|1. How does Lucas's. supply relation
possibility of the output in any economy to deviate
characteristic(s) of
from its full capacity level? What
the rational expectation is (are) are required to prove
the policy effective proposition. Using the model
proposed by Sargent and Wallace (1976), explain
the possibility of ineffectiveness of expansionary
monetary policy to increase output from its full capacity
level. (2+2+6)
568 23

12. Explain the short-run variability and long-run constancy

of the ratio of consumer expenditure to income with
the level of income, in light of the Permanent Income
Hypothesis of consumption postulated by Friedman.
(10)

13. Suppose a house in X-Y city can be rented for

Rs. 30,000 monthly. The house depreciates at the rate
of 5 percent per year, the annual interest is 10 percent,
and mortgage iinterest is tax deductible, where the
relevant tax rate is 30 percent. Following the arbitrage
argument in residential investment,

(a) Determine the change in the house-price, in case

of a reduction in the downpayment rate from 25
to 15 percent, given the expected annual
growth
rate of the house-price is at 8 percent.
What do
you infer regarding the cause of the housing
price
bubble from this change in house-price.
(4+1)

P.T.O.
 24
568
change in the house-price, in case
Determine the
(b) in the
expected annual growth rate
increase
of an
house-price from 8 to 10 percent, given
of the percent. What do you!
downpayment rate 1s at 25
housing price bubble
cause of
infer regarding the (4+1)
in house-price.
from this change

15
() ¢ HIdH AÀ 25

8 aftTT

TAA & 25