Reason Based & Extra Questions - Problem & Measure To Correct Excess and Deficient Demand | Crash Course of Macro Economics -Class 12 - Commerce PDF Download

Reason Based question’s

(Q1) When margins are raised, demand for loans is negatively impacted 

Ans: True , When margins are raised , the difference between the market value of the security offered for loans and value of loans granted becomes high. It is now expensive for the people to take loans from the banks. Therefore, demand for loans reduces in the economy. 

(Q2) Repo rate of interest is paid by commercial bank and Reverse Repo rate is paid by RBI.

Ans: True , when commercial banks get loans from RBI and when commercial banks park their surplus funds with RBI.

(Q3) Are the following statements true or false?  Give reasons.

(a) Excess demand does not affect the level of output.

(b) During deficient demand, equilibrium is determined at full employment level.

(c) Deficient demand spreads voluntary unemployment.

(d) During inflationary situations, the central bank aims at increasing the cost of borrowing money.

(e) The central bank reduces the margin requirements during deficient demand.

Ans: 

(a) True , Because excess demand is a post full employment situation.

(b) False ,  During deficient demand, economy attains under employment equilibrium.

(c) False , it spreads involuntary unemployment

(d) True , the central bank raises the bank rate which raises the cost of borrowing 

(e) True,  Reduction in margin requirements increases the credit creation power of banks.  It will increase the availability of credit.

(Q4) Excess demand raises the real value of the output 

Ans: False.  Excess demand increases the nominal value of the output in the economy.In other words increases the price level

(Q5) Monetary Methods are generally more effective than the Fiscal method in controlling inflation.
Ans: False , Monetary methods are the methods used by the central Bank.  Fiscal methods are the methods used by the government.  They both are complimentary to each other rather then being substitutes of each other.

(Q6) Deflationary gap can be corrected by increasing the level of AD.

Ans: True , Deflationary gap can be corrected by increasing the level of AD. Because it is the deficiency of AD that cause deflationary gap.

(Q7) Once equilibrium GDP is achieved, the level of output is the same; no matter it is       underemployment equilibrium or full employment equilibrium.

Ans: False , GDP level is lower corresponding to underemployment equilibrium    compared with full employment equilibrium.

(Q8) Repo rate should be lowered in a situation of inflationary gap.

Ans: False ,  Repo rate should be increased in a situation of inflationary gap in order to lower money supply in the economy, Implying that AD should reduce.

(Q9) Full employment implies zero unemployment when nobody is ever unemployed in the economy.

Ans: False , Even in a state of full employment, there is always some minimum level of the unemployment, called natural unemployment.

(Q10) Wage-price spiral is the consequence of deficient demand.

Ans: False , It is the consequence of excess demand. In this situation , wages catch prices & prices catch wages.Output cannot increase as resources are already fully employed.

(Q11) Fiscal policy always aims at raising additional revenue for the government.

Ans: False , Fiscal policy aims at maintaining a fiscal balance in the country which may require additional revenue or additional expenditure by the government.

(Q12) The government intervention through fiscal and monetary policies is not required in the market economies which are governed by the market forces of demand and supply

Ans: False , Keynes supported the existence of market economies. But even he suggested that the government intervention in these economies is essential , when there are inflationary/deflationary gaps. It is only through government intervention ( through autonomous investment by the government) that the low level equilibrium trap can be broken in the market economies

(Q13) During inflation, credit creation by the commercial banks is beneficial for the banks, but not for the economy

Ans:  True ,It would further increases the money supply. It creates the situation of excess demand and leads to further increase in the price level in the economy.

(Q14)  An excess of aggregate demand over aggregate supply always implies a situation of inflationary gap.

Ans: False , It  will lead to inflationary gap only when AD > AS corresponding to full employment level of output.  If AD > AS before that level, then it will not lead to inflationary gap.

(Q15)  State whether the following statement is True or False with reasons 

(a) Underemployment equilibrium indicates that excess capacity is available in the economy.
Ans: T

(b) To correct the deflationary gap, the government should increase taxation
Ans: F

(c) Market rate of interest tends to be positively related to the bank rate.
Ans: T

(d) Margin requirement is raised by central bank with a view to increase money supply
Ans: F

(e) A reduction in government spending leads to fall in the income and purchasing power of the people
Ans: T

(f) When AD < AS , demand for inputs increases leading to rise in their prices.
Ans: F

(g) By selling securities to the public, money supply in the economy can be reduced.
Ans: T

(h) Excess demand represents over full employment situation.
Ans: T

(i) To control deficient demand, government should increase public borrowing.
Ans: T

(j) Deficient Demand has no impact on the output, income and employment
Ans: F

(k)  Purchase of securities in the open market by the commercial banks reduces their credit crediting power.
Ans: T

EXTRA QUESTION ’S

(Q1) “RBI has reduced Bank Rate from 7.25% to 6.75% on 29th Sept., 2015.’ (The Economic Times) Analyse its economic value from viewpoint of (a) Households (b) investors & (c) Economy.

Ans : 

(a) Impact on Households ::  A cut in bank rate followed by market rate of interest will induce borrowings for purchase of consumer durables like houses, cars and electric gadgets, etc.  This implies direct monetary benefit to the households.

(b) Impact on Inventors :: Clearly a cut in market rate of interest will reduce the cost of borrowing money capital.  As a result, investment is expected to increase thereby providing more scope for profit to the investors.

(c) Impact on Economy :: Increase in consumption expenditure on consumer durables coupled with investment expenditure will increase aggregate demand.  As a result, level of planned output will rise thereby raising the level of GDP.  With raise in growth rate of GDP, the economy will get scope for further development.

(Q2) Even when the general price level is rising (in the wake of inflation) industrial production is shrinking. How do you explain such a situation of stagflation in India ?

Ans: During inflation , real income of the people tends to shrink. This causes a fall in AD ,  prompting a cut in production. Planned output becomes lower than the potential output and a situation of excess capacity (unutilised capacity) emerges in the economy. This also result in high cost of inputs in the wake of inflation. Thus, industrial production starts shrinking even when the general price level is rising. 

(Q3) Underemployment is a critical feature of the Indian economy. Can we really explain it in terms of the deficiency of demand ?

Ans: Prof. Keynes blames deficiency of demand for underemployment. But in countries like, India,it is related to the lack of production capacity. What India lacks is not demand to generate employment, but production capacity (capital) to engage the surplus labour force .

(Q4) Finance Minister says : If rate of interest goes up, demand for loans will fall.  

Industry Minister says : If demand for loans falls, rate of interest will go down. 

Who among the two is correct ?

Ans: Both are correct. Finance Minister is taking interest rate as a cause and is         examining its impact. Industry Minister is taking demand for loans as a cause and examining its impact.

Interests of one section of society always need to be balanced with other sections of the society.

(Q5) If income of a consumer rises by Rs. 1,20,000 then expenditure will be increased by   consumer. What will be his thinking in case of increase in consumption ?

Ans: He would like to increase his consumption but such increase in consumption will be less than increase in income. This is known as Keynesian Psychological Law of Consumption

(Q6) If in an economy seasonal unemployment exists with voluntary unemployment, then what do you think is it the situation of full employment ?

Ans: Yes , it is a situation of full employment with existence of seasonal as well as voluntary unemployment. 

(Q7) In an economy, total demand made by all households is 2000 quintals of rise, but by employing all its available resources it can produce only 1500 quintals of rice. What is this situation called and what will be its impact on economy ?

Ans: Inflationary gap.

(Q8) If Mr. Bharat takes a loan @ 10% which he wants to invest in a new project which will give him a return @10% he should go for this investment or not.

Ans: Yes, only if  the expectation of future prospects he can do so.

(Q9) The consumption expenditure of an involuntary unemployed worker is not zero, even at zero level of income. Why ?

Ans: It happens because minimum consumption (known as autonomous consumption) is needed for survival, even at zero level of income.

(Q10) In India, unemployment is a major problem. If aggregate demand is equal to aggregate supply, can it be said that economy has full employment equilibrium ?

Ans: No. Equality between aggregate demand (AD) and aggregate supply (AS) only indicates the equilibrium position of the economy. It is not necessary that this equality is always achieved at full employment level. It means, equality between AD and AS can occur at full employment level, underemployment level or over full employment level.

(Q11) Reserve Bank of India has reduced CRR from 4.25% to 4%.  Will this step help in controlling inflation in India?  Name any one value violated in the question.

Ans: This step is not likely to check inflation because a cut in CRR is supposed to release more liquidity in the economy.  This will increase lending capacity of commercial banks resulting in more consumption expenditure and investment expenditure.  Hence, this step may prove inflationary instead of checking price rise.

Value violated  :: Social responsibility

(Q12) “ Both excess demand and deficient demand are bad for an economy, but of the two deficient demand is worse.” Explain.

Ans: But of these two evils deficient demand is worse.  Excess demand creates inflation.  Thus, takes away the half bread of the poor by reducing the purchasing power of money.  But deficient demand spreads unemployment and throws the poor out of work/job.  It thus takes away the whole of the bread.

(Q13)  “ Rate cut to promote growth: RBI does not agree ”

(a) Give one argument in support of rate cut.   (b) Why does the RBI not agree ?

Ans: (a) A rate cut will result in a fall in rate of interest.  This will benefit investors and result in fast growth.

(b) RBI believes that at this stage any cut in repo rate will only prove inflationary and not growth engine.

(Q14) “ There is no reason to worry about mild inflation.  It produces favourable effects in an economy.” Explain.

Ans: A mild inflation has favourable effect on output and employment in an economy. When prices rise immediately , profits of business community increase.  As a result of it, the level of output and employment in the economy rises.

(Q15)  “ RBI announces a rate cut; industry cheers. ”

(a) What is the rate being referred to ?
(b) Why is industry happy ?

Ans: (a) Repo rate has emerged as the policy rate for the RBI ( earlier it used to rely on Bank rate )

(b) A cut in repo rate means that the rate of interest at which commercial banks borrow from the RBI has come down.  This benefit is passed on to the borrowers.

(Q16) “ Rate cuts might not be imminent ” - Reserve Bank of India. Why RBI is not ready to cut the rates ? Write your opinion.

Ans: Here, rate cut refers to repo rate. The RBI believes that a cut in repo rate is going to fuel retail inflation which is already high. Hence, a cut in repo rate (which will increase money supply in the economy) is not recommended.

(Q17) “ Government lauds its own policies for 10% growth in nominal national income ”.

(a) Is the government right ?
(b) What is the flaw ?

Ans: (a) No,change in nominal national income is not a correct indicator of growth.

(b) Change in real national income measures growth of the economy.  A 10% growth can be disaggregated as follows: 6% due to inflation + 4% real growth = 10% in nominal national income.

(Q18) The Reserve Bank of India aims to make the credit costly for the general public in order to reduce the availability of credit.  What should be done ?

Ans: The Reserve Bank of India should increase the repo rate.  An increase in repo rate increases the costs of borrowing from the central bank.  It forces the commercial banks to increase their lending rates, which discourages borrowers from taking loans.  It makes the credit costly for the general public and reduces the availability of credit 

(Q19)  Name the situation under which aggregate demand is insufficient to eliminate involuntary unemployment.
Ans: Deficient demand.

(Q20) In the present scenario when the industrial growth is low , do you think a cut in repo rate by the RBI would accelerate the pace of industrial growth ?

Ans: If repo rate is cut , industrial growth is expected to accelerate in two ways as under : 
(a) Cost of investment would reduce.

(b) Consumer loans would become cheaper

(Q21) Why has the Government in India failed to combat inflation even when a series of     monetary measures are available in the textbook of macroeconomics ?

Ans: Monetary measures of combating/controlling inflation focus largely on lowering the demand for goods and services by making the availability of credit costlier and difficult. It does not address supply side of the problem.

(Q22) Do you think tackling slowdown in industrial production (due to low investment) should be the priority of the Government in India rather than the high rate of inflation ?

Ans: Indian economy has been driven into complex situation of slowdown in industrial production along with a high rate of inflation . If industrial production is to be increased up, cost of credit (rate of interest) must be lowered by the commercial banks. But, if interest rate is lowered and demand for credit rises , thelevel of AD would rise which further fuel the rate of inflation . It is, thus, recommended that the government should proceed very cautiously. While the industrial sector needs a big-push, the government must ensure that problem of inflation is simultaneously solved.

(Q23) How will the flow of funds in the money market increase, if CRR is phased out by the central bank ?

Ans: CRR makes it mandatory for the commercial banks to keep some cash reserves (as a percentage of their deposits) with the central bank. These are idle cash reserves from the viewpoint of the commercial banks. If CRR is phased out , these cash reserves can be productively utilised by the commercial banks. Cash reserves can add to the stock of liquid assets of the banks, and accordingly, enhance their capacity to create credit (on the basis of the existing SLR) . Accordingly , flow of funds in the money market will increase.

(Q24) Media reports say that the rate of inflation during 2015-16 will fall from 7 percent in 2014-15 to 5 percent. Does this mean all the goods and services will cheaper become. Give reasons.

(Q25) The government of XYZ country is facing the problem of excess demand. The finance minister is comtemplating the option to increase the rate of taxation in the country. Will this help in solving the problem of excess demand ?

(Q26) How, in your opinion, the engine of GDP growth can gain momentum, breaking the deadlock of deflation ? Write two points.

(Q27) Suppose the economy is in the grip of recession .To overcome the recession, the government undertakes a new project with huge investment . Justify the step undertaken by the government.

(Q28) As a part of RBI’s credit control policy, what is the objective of quantitative instruments of credit control?