Institute of Management Technology, Ghaziabad

End Term Exam (Term – I) Take Home Exam

(Time Duration: 04 hrs)
Batch 2020 - 22

Answer-sheet

Enroll. No.: 200601039 Name: Tushar Gupta

Section: BFS

Date: 26/10/20 Term: I

Subject: Economics & Monetary Policy

Faculty Name: Dr. Manas Paul

Answer No.1
I. Increase in GDP of India = R.5000
Increase in GNP of USA = RS.5000
II. Such a situation can arise when the government keeps on increasing the flow of money
in the market through open market operations but there is no increase in the aggregate
output because individuals propensity to consume has decreased and they are holding
on to the money introduced by the government in the market, this can lead to a
liquidity trap.
III. Equation of IS Curve,
i= (A/B)-(Y/alphaG*b)

here b is the sensitivity towards interest rate, so if b=0, then the IS curve is vertical.
 IV. According to me, transfers to people around lowest income group will turn out to be
more effective than reducing tax for corporates because the lower income groups have
a MPC (marginal propensity to consume) closer to 1, i.e. they consume all of their
disposable income. So any increase in their disposable income would increase the
Aggregate Demand.
AD= C+G+I+NX, here C= C’ +c(Y+TR-yt)
V. In the short run, Expansion in the fiscal policy will lead to crowding out and would not
maximize the economic output. To achieve maximum output, monetary policy and fiscal
policy are needed to be implemented simultaneously.
VI. As the output/income has decreased, it will shift the IS curve to the left which will then
lead to a new equilibrium with reduced ouput and reduced interest rates.
VII. The equation for demand of money states the
L=kY-hi,

Here k&h, defines the sensitivity of the demand on Y and i. It’s harder to predict the
shift in k and h in the situation of economic shock, so a change in interest rates is
preferred by the central banks.
VIII. Buy back of securities worth 100000 crores,
1) Balance sheet- Cash decreases by 100000 crores and assets increase by 100000
crores
2) Base Money – increases by 100000 crores
3) Money Supply – it is given that multiplier is 3, so money supply = 300000 crores
IX. Headline inflation is more prone to being affected because of Natural Disasters than
core inflation because they include resources such as Fuel and Food which are more
volatile to economic shocks.
X. Following the LM curve theory RBI can influence the exchange rates by open market
operations by issuing or buying bonds which further alters the money supply in the
market.

A2) a- Per Capita Income

Per Capita Income is defined as the measure of average income of every individual in a specific
geographical area within a given period of time.
Given:

At the beginning of the term At the end of the term

GDP1= 50000 GDP2= 250000

Population 1 = 100 Population 2 = 50

Per Capita GDP= GDP/Population Per Capita GDP= GDP/Population

= 50000/100 = 250000/150
= 500 (G1) = 1666.67 (G2)

Change Per Capita GDP = (G2-G1)/G1

= (1666.67 – 500)/500
=2.33
Change Per Capita GDP = 2.33
So the change in Per Capita GDP referred to by the government is 2.33 or 233.34%

b- As per my own studies, the GDP Deflator ratio rose from 01 to 05 in the reign of the current
Government which shows that there might just be an increase in price level rather than an
increase in actual output produced by the state. This shows that there has been inflation over
the five year period of the incumbent Government.
The GDP price Deflator helps us understand how the prices have inflated over a period of time.

At the beginning of the term At the end of the term

GDP deflator ratio=1 GDP deflator ratio=5

Nominal GDP= 50000 Nominal GDP= 250000

GDP Deflator ratio = Nominal GDP/Real GDP GDP Deflator ratio = Nominal GDP/Real GDP
1 = 50000/RGDP 5 = 250000/RGDP
RGDP = 50000/1 RGDP =250000/5

Real GDP = 50000 Real GDP = 50000

Nominal GDP is the total sum of value of goods and services produced within a year inside a
geographical boundary using the current price. Real GDP shows the value of output generating
considering the inflation and this is a more accurate measure to calculate real growth.
The computation above shows that when the change in price level is considered, it is clear that
there has not been any real growth in output produced by the State as the Real GDP hasn’t
changed during the period of the Incumbent Government.

c- The Real Per capita GDP is the measure of the economic output generated by a state divided
by the total population, adjusting for the current price levels, i.e. Inflation.

At the beginning of the term, At the end of the term,

Real GDP= 50,000 Real GDP= 50,000

Population= 100 Population= 150

Real Per Capita GDP = Real GDP/ Total Real Per Capita GDP = Real GDP/ Total
Population Population
= 50000/100 = 50000/150
= 500 = 333.33

So, the Real GDP per capita was 500 at the So, the Real GDP per capita was 333.33 at the
beginning of the period of the incumbent end of the period of the incumbent
Government. Government.

The above computation shows that though the Nominal GDP has increased over time, but the
GDP per capita in the real sense has decreased.
A4) a

In the short run, an expansion in the fiscal policy would shift the IS curve to the right from IS1 to
IS2. Hence the equilibrium which was earlier at point a will now shift to point b thus changine
the rate of interest from I1 to I2. But as per the given condition we have to keep the interest
rate constant so we need an expansion in the monetary policy too to introduce a flow of money
to the market thus decreasing the interest rate and bringing it back to I1. Doing so the LM curve
will shift from LM1 to LM2 and hence the new equilibrium point would be c. now at point c, the
interest rates a constant with the level of income increased from Y1 to Y2.
Now we know that, Aggregate Demand, AD= C+I+G+NX.
Here C= C’ + cY where Y is the income level. Hence any increase in Y, income level, will lead to
an increase in the total consumption and thus boosting the GDP of the country.
For Investment, IS curve says that , I= I’-bi
where b is the sensitivity towards change of interest. As here we are keeping the interest rate
constant, b would be zero, hence Investment would be unaffected.

b- The Crowding Out Effect

It is a situation when government implements expansionary fiscal policies to increase the
spending in the public sector. This leads to a decrease in the availability of funds in the market
for the investment needs of the private sector. Government then borrows money to fulfill the
Increase in spending which reduces the net amount of funds available in the market and thus
increases the interest rates. This increase in the interest rates leads to an inability of the private
sector to borrow as much, thus crowding out the Private sector.
When an Economy is working at full scale, increase in government spending does not increase
the aggregate demand as it is fulfilling the increase by crowding out the private sector. Though
at a time of recession when the economy is at a downfall, crowding out can help improve the
economy by reducing unemployment and increasing the flow of money in the market.
When the Expansionary Fiscal policy is implemented, it will shift the demand curve from
DM1 to DM2, thus increasing the interest rate from R1 to R2.

In a perfect situation, the net income level should have been Y2 but due to the crowding
effect because of governments increase in spending, the interest rates rose and the net
ouput attained was till Y3. It can also be seen from the IS curve equation where an
increase in the interest rate reduces the total investment and hence reduces the total
output.
Money Demand Equation states that, MD= kY-hI
Where, k is the income sensitivity,
Y is the income level
H is the interest sensitivity
& I is the rate of interest
In a perfect interest elastic situation, the interest sensitivity is equal to infinity, i.e. no
increase in money supply would alter the interest rate or income level. Such situation is
called a liquidity trap and monetary policy is useless here.