XCELLON INSTITUTE - SCHOOL OF BUSINESS PGP GM BATCH 2010-12 Course: Macroeconomics MID TERM EXAM TERM 2 Total Marks:

: 100 Date: 28/03/2011 Duration: 3 hours

SOLUTION
Q. 1. Marks: 3 Microeconomics examines the behavior of individual decision-making unitsbusiness firms and households. Macroeconomics deals with the economy as a whole; it examines the behavior of economic aggregates such as aggregate income, consumption, investment, and the overall level of prices. Aggregate behavior refers to the behavior of all households and firms together. On the basis of this knowledge, please, classify the following items by putting a tick mark () in appropriate cell in table given below. Item Surta Mehtas annual income Rate of Inflation in China Total Annual Production (in Rs) at GM factory in Gujarat US Dollar Indian Rupee Exchange Rate Rate of unemployment in the US Subsidies provided by Indian govt during year 2008-09 Microeconomic variable Macroeconomic variable

Q.2. Marks: 15 There are three kinds of policy that the government has used to influence the macroeconomy: Fiscal policy, Monetary policy and Growth or supply-side policies. Fiscal policy refers to government policies concerning taxes and spending. Monetary policy consists of tools used by the Federal Reserve to control the quantity of money in the economy. Growth policies are government policies that focus on stimulating aggregate supply instead of aggregate demand. With this knowledge, read the article given below and answer the questions at the end of it; Thu, Mar 24, 2011 | Updated 12.14PM IST 22 MAR, 2011, 05.49PM IST,PTI Repeated rate hikes by RBI hurting India Inc: Assocham NEW DELHI: Reserve Bank's repeated hikes in key policy rates is hurting Indian corporates as it increases their cost of production and squeezes profit margins, industry body Assocham today said.

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It also asked the government to invest more in the infrastructure sector, besides reducing the wasteful expenditure as a means to curb rising inflation. "If the economy continues to use monetary policy without fiscal consolidation of appropriate degree, higher interest rates will continue to fuel high cost of production and squeeze profit margins of India Inc ," an Assocham study said. The RBI has hiked its short-term lending (repo) and borrowing (reverse repo) rates eight times since March, 2010, with a view to tighten liquidity supply for curbing inflation. Its latest hike of 25 basis points each in repo and reverse repo rates was announced last week. Assocham said the country is pursuing a high growth strategy even as it has to deal with high inflation on account of increase in price rise of food items and other commodities. High interest rates, on account of increase in repo and reverse repo rates, will affect attractiveness of investing in the industry and deter future projects, it said. The Finance Minister had in his Budget speech had stressed that rising inflation could be tackled without compromising on economic growth. The study said a large part of the inflation problem stems from rising food prices that is caused due to supply shortage. Even though some food article prices are now cooling, the food articles index is still hovering at 10 per cent from last year. "This has spurred a more broad-based inflation in manufactured goods," Assocham Secretary General D S Rawat said. Food inflation during the first week of March was 9.42 per cent. Even headline inflation has been above 8 per cent, since February, 2010. Non-food manufactured products inflation rate jumped to 6.1 per cent in February from 4.8 per cent in January, the study said. At the same time, the industrial production dropped to 5.5 per cent in Q3 FY211 from 9.1 per cent in the previous quarter. The production trends of consumer non-durables display another growth challenge, with performance sliding to minus 1.9 per cent in Q3 from 1.5 per cent in Q2 FY11. More worryingly, the growth in capital goods sector -- that reflects future industrial growth prospects - has tumbled to to 6.9 per cent in Q3 FY11 from 21.3 per cent in Q2, the study said. "This indicates not only the present sluggishness, but also a certain dip in the performance of industrial sector in the short-term mainly due to rising input cost," Rawat said. He said the price stability objective continues to be elusive, despite monetary action. (2a) Which microeconomic factors of Indian corporate are being affected negatively by Reserve Bank's repeated hikes in key policy rates? (Marks: 3) it increases their cost of production and reduces profit margins. (2b) Assocham also asked the government to invest more in the infrastructure sector, besides reducing the wasteful expenditure as a means to curb rising inflation. In what type of policies can the Indian govt incorporate these suggestions Monetary, Fiscal or Growth policies? Answer clearly. (Marks: 3) Fiscal Policy as it deals with planned and unplanned expenditure by the govt. (2c ) Assocham study said a large part of the inflation problem stems from rising food prices that is caused due to supply shortage. In what type of policies can the Indian govt use to solve this problem Monetary, Fiscal or Growth policies? Answer clearly. (Marks: 3) high growth policy to increase the supply of food items. (2d) Which Macroeconomic variable in the article reflects future industrial growth prospects? (Mark: 1) the growth in capital goods sector reflects future industrial growth prospects. What does it reflect? (Marks: 2)
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It has fallen to 6.9 per cent in Q3 FY11 from 21.3 per cent in Q2, which indicates a decline in growth in capital goods as well as manufacturing as a whole, because capital goods are used primarily in manufacturing activities. (2e) Now take a look at the diagram given below.

An expansion, or boom, is the period in the business cycle from a trough up to a peak, during which output and employment rise. A contraction, recession, or slump is the period in the business cycle from a peak down to a trough, during which output and employment fall. Refer again to the data mentioned in the Assocham study above. In which phase of business cycle Indian economy seems to be positioned at present? Mention facts from the article to support your answer. (Marks: 3) I feel that India is recovering from a recession as pointed by the arrow in the diagram. The industrial production dropped to 5.5 per cent in Q3 FY211 from 9.1 per cent in the previous quarter. The production trends of consumer non-durables display another growth challenge, with performance sliding to minus 1.9 per cent in Q3 from 1.5 per cent in Q2 FY11. Thus, growth is taking place at a reduced rate. More worryingly, the growth in capital goods sector -- that reflects future industrial growth prospects -- has fallen to to 6.9 per cent in Q3 FY11 from 21.3 per cent in Q2. This indicates not only the present sluggishness, but also a certain dip in the performance of industrial sector in the short-term mainly due to rising input cost.

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Q.3.

Marks: 5

Firms

Households

Fill in the two blank squares of the diagram above by placing the entities HOUSEHOLDS and FIRMS correctly. Q. 4 Marks: 6 A firms value added is the value of its output minus the value of the intermediate goods the firm used to produce that output. A farmer grows a kg of cotton and sells it to a textile processor for Rs.100/-. The textile processor processes the cotton into cotton textile and sells it leading fashion designer Rohit Valaya for Rs. 500/-. The fashion designer Valaya uses the cotton textile to make a dress and sells it to Surta Mehta for Rs. 2000/-. Surta Mehta wears the beautiful dress and goes to Xcellon to attend Sustantivo. Using the information given above, (4a) Compute value added at each stage of production. Show all steps. (Marks: 4) Stage 1 - A farmer grows a kg of cotton and sells it to a textile processor for Rs.100/-. Value Added = Rs. 100 Stage 2 - The textile processor processes the cotton into cotton textile and sells it leading fashion designer Rohit Valaya for Rs. 500/-. Value Added = Rs. 500 Rs. 100 = Rs. 400 Stage 3 - The fashion designer Valaya uses the cotton textile to make a dress and sells it to Surta Mehta for Rs. 2000/-. - Value Added = Rs. 2000 Rs 500 = Rs. 1500

(4b) Compute Gross Domestic Product in this example. Show all steps. (Marks: 2) GDP = value of final goods produced = = sum of value added at all stages of production = 100 + 400 + 1500 = Rs. 2000 Q.5. Marks: 5 Suppose an automobile manufacturer produces Rs. 100 crore worth of cars during a financial year, but only sells Rs. 90 crore worth of cars. PDF Created with deskPDF PDF Writer - Trial :: http://www.docudesk.com

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Does this violate the expenditure = output identity? NO Where does the unsold output go? Y = C + I + G + NX where Y = GDP = the value of total output = C + I + G + NX = aggregate expenditure Unsold output goes into inventory, and is counted as inventory investmentwhether the inventory buildup was intentional or not. In effect, we are assuming that firms purchase their unsold output. In this example, Y = 100 crore = C (90 crore) + I (10 crore) Q.6. Marks: 4 The words available to you to fill in the blanks are; value, price, intermediate, final, current, modern, average, constant, base, latest, abnormal. Select the appropriate word and fill in the blanks below to give meaning to lines. GDP is the Value of all final goods and services produced. Nominal GDP measures these values using current prices. Real GDP measures these values using the prices of a base year. Q. 7. Marks: 10

(7a) Name the sector selected by your group for Project Work in Macroeconomics. (Mark:1) ____________________________________________________________________ (7b) What could be the impact of Union Budget 2010-11 on this sector as per the assignment submitted by your group?!! (Marks:3) ____________________________________________________________________ ____________________________________________________________________ ____________________________________________________________________ (7c) Take a look at the diagram below;

Create a similar diagram for the sector you have selected for your project work. Identify and mention clearly various inputs, process and output. (Marks: 6) Different answer for different groups. To be discussed in class.

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Q.8. 2006 Price (Rs) Good A Good B Good C 30 40 50 Quantity (kgs) 100 150 350 2007 Price (Rs) 35 45 40

Marks: 12 Quantity (kgs) 110 200 360 2008 Price (Rs) 45 45 40 Quantity (kgs) 140 210 200

GDP Deflator = 100 x (Nominal GDP / Real GDP) Using the data given in the table above, compute nominal GDP in each year. Also compute real GDP and in each year using 2006 as the base year. Compute GDP deflator for corresponding year. Also find the Rate of Inflation using the values computed for GDP Deflator.

Show you calculation and write answer in appropriate cells of table below. (Marks: 6)

Nominal GDP 2006 =(30x100)+(40x150)+(50x350) = 26500 2007 =(35x110)+(45x200)+(40x360) = 27250 2008 (45x140)+(45x210)+(40x200) = 23750 Q.9. Take a look at the equation below;

Real GDP =(30x100)+(40x150)+(50x350) = 26500 =(30x110)+(40x200)+(50x360) = 29300 =(30x140)+(40x210)+(50x200) = 22600 Marks: 6

GDP Deflator 100 93.00341297 105.0884956

Inflation Rate n.a. --6.996587031 = --7 12.08508261

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(9a) Fill in the blanks below; (Marks: 3) The GDP deflator is a weighted sum of prices. The weight on each price reflects that goods relative importance in GDP.

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(9b) Can the weights change over time? Yes. (Mark: 1) Explain why.(Marks:2) Because weights are the variables shown in each bracket. As the quantity produced changes the weight will change. Q.10. Marks: 6 The Consumer Price Index (CPI) is a weighted average of prices relative to their value in the base period. The weight on each price relative reflects that goods relative importance in the CPIs basket. Note that in CPI the weights remain fixed over time. Now use your common sense and fill in the blanks using appropriate option. Two options available to you are CPI and GDP Deflator. Select only one of these two to fill in the blank. (10a) Prices of domestically produced Capital goods are included in GDP Deflator. (10b) The basket of goods changes every year for GDP Deflator. (10c) prices of imported Consumer goods are excluded from GDP Deflator. Q.11. Marks: 15

Market prices are the prices at which goods and services are sold in various markets to households and firms. Factor costs are the actual production costs at which goods and services are produced by the firms and industries in an economy. Factor costs are really the costs of all the factors of production such as labor , capital, energy, raw materials like steel etc that are used to produce a given quantity of output in an economy. Factor costs are also called factor gate costs since all the costs that are incurred to produce a given quantity of goods and services take place behind the factory gate ie within the walls of the firms, plants etc in an economy. With this knowledge, refer to the tables containing Statements 3, 4, 5 and 6 below and answer the following questions; (11a) In year 2008-09, which Economic Activity or Industry has contributed the highest to India's GDP at Factor Cost (at 2004-05 prices)? Statement 3- trade, hotels, transport & communication Rs. 1,084,764 crore. (11b) Compared to Statement 3, all the corresponding values are higher in Statement 4. Why Because Statement 4 is using current prices, which might have increased since 2004-05. (11c) Refer to Statement 5 and identify values of C, I, G and NX (at 2004-05 prices) for year 2008-09. Change in stocks and valuables can be clubbed with I. C = 2655533, I = 1471161 + 59812 + 58673, G = 512126, NX = X-M = 1094929 1369202 (11d) Which of the four statements appear to be following the equation C+I+G+NX to calculate GDP? Statements 4 & 5 (11e) Referring to Statement 3,4, 5 and 6, which one appears to be higher for year 2008-09 --- GDP at Factor Cost (at 2004-05prices) or GDP at Market Prices (at 2004-05prices)? Why? GDP at Market Prices are higher at 2004-05 prices as well as at current prices, because market prices are also likely to include factor costs + all other costs incurred after the goods leave the factor gaters, e.g. advertising, transportation costs, various duties, etc.

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Q.12. Fill in the blanks.

Marks: 13

(a) Production Function States the relationship between inputs and output. (b) The long run is defined as the period of time taken to vary all factors of production. (c) Fixed costs are the costs that are not related directly to production rent, rates, insurance costs, admin costs, etc. They can change but not in relation to output. (d) Marginal cost is the cost of adding one more unit of production. (e) Diminishing marginal returns results from adding successive quantities of variable factors to a fixed factor. (f) In the long run, increases in capacity can lead to increasing, decreasing or constant returns to scale. (g) If TR = P x Q, then AR = TR/Q = PQ/Q = Price. (h) Economic Profit takes into account Explicit and Implicit Costs. (i) Expenditure equals income because every rupee spent by a buyer becomes income to the seller. (j) Y = C + I + G + NX, where NX = Exports Imports = Net Exports. (k) GDP is product produced within / inside a country's borders. (l) Changes in real GDP can only be due to changes in quantity because real GDP is constructed using constant base-year prices. (m) GNP Net income earned from abroad = GDP

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