Macroeconomics Questions and Answers

Answer: D

The non-classical principles are (ii) and (iv).

Classical economists held that supply creates its own demand (Say's law), that the rate of interest is flexible and equates saving and investment, that the economy corrects itself towards full employment, and that the government should not intervene. Statements (i), (iii) and (v) fit this view.

In classical theory money is only a medium of exchange, a veil; holding money as a store of value is Keynes's idea (liquidity preference), so (ii) is not classical. The claim that a capitalist economy is not self-equilibrating (iv) is also Keynesian, the opposite of the classical position.

Answer: C

It slopes downward because as the rate of interest rises, the opportunity cost of holding money rises.

Money held as cash earns no interest, so the interest rate is the opportunity cost of holding it instead of bonds. When the interest rate rises, holding idle money becomes more expensive and people demand less money, especially for speculative purposes; when it falls, they hold more. This inverse relationship gives the liquidity preference curve its downward slope.

The slope is about the demand for money, not the central bank's supply of it. The opportunity cost does change with the interest rate, and it rises rather than falls as the rate rises.

Answer: C

It is the Incremental Capital-Output Ratio.

The ICOR is the additional capital needed to produce an additional unit of output, \(\text{ICOR} = \frac{\Delta K}{\Delta Y}\). It expresses a technological relationship between the change in the capital stock (investment) and the change in output, and it is central to the Harrod-Domar model, where the growth rate equals the saving rate divided by the capital-output ratio.

The multiplier relates a change in income to a change in spending, not capital to output, and 'output coefficient' is not the standard name for this ratio.

Answer: D

This describes the Rational Expectations Approach.

The rational expectations hypothesis (Muth, later Lucas and Sargent) holds that people use all available information, including what they know about policy and how the economy works, to form expectations, so their forecasts are not systematically wrong.

Under adaptive expectations, people form expectations from past values only and correct them gradually after errors, so they lag behind events. The classical and Keynesian theories as such are not theories of how expectations are formed.

Answer: B

The multiplier is about 2.1.

With a proportional tax at rate \(t\), consumption depends on disposable income, so the effective marginal propensity to consume out of total income is \(b(1 - t)\).

\[ \begin{aligned} k &= \frac{1}{1 - b(1 - t)} \\ &= \frac{1}{1 - 0.75 \times 0.7} \\ &= \frac{1}{0.475} \approx 2.1 \end{aligned} \]

Ignoring the tax gives \(\frac{1}{1 - 0.75} = 4\), close to the 4.25 distractor. The tax leaks part of each round of spending out of the circular flow, which is why the multiplier is smaller.

Answer: A

The key's answer is that transfer payments are zero.

The balanced budget theorem compares an increase in government purchases of goods and services with an equal increase in taxes. Purchases add to demand in full, while the tax reduces consumption by only the MPC times the tax, so income rises by the amount of the spending.

If the extra spending took the form of transfer payments instead, it would raise demand only through recipients' consumption, by the MPC times the transfer, which exactly offsets the effect of the equal tax, and income would not rise at all. So the unit multiplier depends on the spending being on goods and services, with no transfer element. The other options are not conditions of the theorem.

Answer: A

GDP in an open economy is the sum of consumption, gross investment, government spending and net exports.

This is the expenditure method:

\[ \text{GDP} = C + I + G + (X - M) \]

Investment is taken gross, including the replacement of worn-out capital, because GDP is a gross measure; using net investment would give net domestic product instead. Exports must be net of imports, since spending on imports is not domestic production, so 'gross exports' is wrong. Wages, rent, interest, profit and depreciation describe the income method, and as listed they leave out indirect taxes less subsidies.

Answer: A

The match is fiscal policy with taxation (4), monetary policy with the cash reserve ratio (3), RBI with the issue of currency notes (1) and credit control with rationing of credit (2), the code 4 3 1 2.

The other codes mismatch fiscal and monetary policy, which is the main distinction in the question.

Fiscal policy is the use of taxation and spending by the government, monetary policy is carried out by the central bank through tools like the cash reserve ratio, the RBI issues currency notes, and credit control includes qualitative measures such as rationing of credit. The code 4 3 1 2 follows this classification.

Answer: D

A closed economy is one in which neither exports nor imports take place.

A closed economy has no economic dealings with the rest of the world: it does not trade goods or services across its borders, and in the strict model there are no international capital flows either. Everything produced is consumed or invested at home. An open economy, by contrast, exports and imports.

An economy with only exports is still open to trade. Control of the money supply and deficit financing are features of monetary and fiscal policy, which both open and closed economies can have.

Answer: C

The period is termed stagflation.

Stagflation combines stagnation and inflation: prices rise rapidly while output growth is low and unemployment high. It is usually caused by a supply shock, as in the oil price rises of the 1970s, and is hard to treat because measures that curb inflation also slow growth.

Stagnation alone means slow growth without the high inflation. A depression is a deep, prolonged fall in output, usually with falling prices. The take-off stage is W. W. Rostow's term for the start of rapid, self-sustaining growth, the opposite of stagnation.