Macroeconomics Questions and Answers

Answer: C

The correct matching is a-ii, b-i, c-iii, d-iv.

• The inventory approach to the transactions demand for money: William Baumol (1952), with Tobin.
• Adaptive expectations: Edmund Phelps, who used them in his expectations-augmented Phillips curve.
• The upper turning point of the trade cycle, set by the full-employment ceiling: John Hicks's trade cycle model.
• The permanent income hypothesis: Milton Friedman (1957).

Baumol for the inventory approach and Friedman for permanent income fix the ends of the code; only one option also gives Hicks the upper turning point.

Answer: B

If investment is totally interest-insensitive, fiscal policy is effective.

When investment does not respond to the interest rate, the IS curve is vertical. Monetary policy works by changing the interest rate, which now has no effect on spending, so shifting the LM curve leaves income unchanged. Fiscal policy shifts the vertical IS curve directly, and there is no crowding out of investment, so income changes by the full multiplier.

That rules out the options saying fiscal policy is ineffective or that monetary policy is effective, and the option calling both ineffective.

Answer: A

The long-run Phillips curve will not be vertical if price inflation only partially takes into account expected price inflation.

In the expectations-augmented Phillips curve, inflation equals expected inflation (multiplied by a coefficient) minus a term in unemployment. In the long run actual and expected inflation are equal. If the coefficient on expected inflation is one, the only consistent unemployment rate is the natural rate, so the long-run curve is vertical. If it is less than one, a trade-off survives and the curve is steep but not vertical.

Full adjustment gives the vertical curve, the opposite case. No adjustment at all, or zero expected inflation, describes the original short-run curve rather than the long-run case the question asks about.

Answer: A

The LM curve shifts to the left.

When the Reserve Bank sells government bonds in open market operations, buyers pay with money drawn from the banking system, so bank reserves and the money supply fall. With a smaller real money supply, money market equilibrium at any given income requires a higher interest rate, so the LM curve shifts left (upward). This is contractionary monetary policy.

A rightward shift follows open market purchases. A vertical or horizontal LM curve describes particular interest elasticities of money demand (the classical and liquidity trap cases), not the effect of a change in money supply.

Answer: C

The IS curve becomes Vertical.

The IS curve shows combinations of income and interest rate at which planned investment equals saving. It slopes downward because a lower interest rate raises investment and hence income. If investment does not respond to the interest rate at all, a fall in the rate raises neither investment nor income, so equilibrium income is the same at every interest rate and the IS curve is vertical.

A horizontal or flatter IS curve corresponds to highly interest-elastic investment, the opposite case, and the IS curve does not slope upward under normal assumptions.

Answer: B

Rigid money wages generate an Upward sloping aggregate supply curve.

In the complete Keynesian model the money wage is fixed in the short run. When the price level rises, the real wage falls, firms hire more labour, and output increases. Output therefore rises with the price level, giving an upward-sloping aggregate supply curve up to full employment.

A vertical aggregate supply curve belongs to the classical model, where flexible money wages keep the economy at full employment whatever the price level. A horizontal curve corresponds to rigid prices or to the extreme Keynesian case of deep unemployment, and a downward-sloping AS curve is not a standard case.

Answer: B

The answer is (S) is correct and (R) is incorrect.

In the classical model, flexible wages and prices clear the labour market, so output is always at the full-employment level. Any equilibrium therefore occurs at full employment, and the Assertion is correct.

The Reasoning gives the wrong mechanism. The classical aggregate supply curve is vertical at full-employment output, not positively sloped: because money wages adjust proportionally to prices, a change in the price level leaves the real wage and employment unchanged. A positively sloped AS curve belongs to the Keynesian model with rigid money wages, in which equilibrium can occur below full employment.

Answer: C

Fiscal policy fails because the balance of payments is in surplus, the currency appreciates and net exports go down.

In the Mundell-Fleming model with perfect capital mobility, a fiscal expansion shifts the IS curve right and puts upward pressure on the domestic interest rate. Capital flows in, creating a balance of payments surplus. Under a flexible exchange rate the currency appreciates, making exports dearer and imports cheaper, so net exports fall. The fall in net exports offsets the fiscal stimulus until income returns to its original level.

The options with a deficit or a depreciation reverse the direction of the capital flow, and a depreciation would raise net exports, not lower them.

Answer: A

The utility function is influenced by the Average consumption of the economy.

James Duesenberry's relative income hypothesis (1949) holds that a household's satisfaction depends not on its absolute consumption but on its consumption relative to that of others, typically the average of the society or reference group around it. Through this 'demonstration effect' people try to keep up with the consumption standards they observe. Duesenberry also argued that consumption depends on the highest previous income the household has reached, the 'ratchet effect'.

The options naming marginal consumption, or only the lowest or highest consumption in the economy, do not describe his comparison with average consumption.

Answer: A

Autonomous investment of ₹ 100 crores is needed.

The investment multiplier is the reciprocal of the marginal propensity to save:

\[ \begin{aligned} k &= \frac{1}{MPS} = \frac{1}{0.2} = 5 \\ \Delta I &= \frac{\Delta Y}{k} = \frac{500}{5} = 100 \end{aligned} \]

So ₹ 100 crores of extra investment raises income by ₹ 500 crores. ₹ 1000 crores multiplies by 2 instead of dividing by 5, ₹ 400 crores uses the MPC (0.8) in place of the MPS, and ₹ 500 crores ignores the multiplier.