Posted by Anjali Kaur on Nov 28, 2021

Practice Test 6 – Macroeconomics

Practice Test 6 – Macroeconomics, covers topics of money and banking, national income, and some part of the Indian economy.

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1. Define margin requirement.

Answer. A margin is a difference between the market value of the securities offered by the borrowers against the loan and the amount of loan granted.

Margin requirement also means the discount fixed by the central bank on the assets which are kept as securities to the commercial banks.

2. Define open market operations.

Answer. It refers to the purchase and sale of government securities in the open market (public and commercial banks) by the central bank.

3. What is reverse repo rate and how it affects money supply?

Answer. The rate at which commercial banks lend money to the central bank is called the reverse repo rate.

If there is inflation or extra money supply in the economy, it implies excess demand for money in the economy. In such a case, the reverse repo rate is increased it encourages commercial banks to park their surplus funds with the central bank. This has a negative effect on the lending capacity of commercial banks. Demand for credit will reduce, less money will go to the economy, aggregate demand falls and excess demand is corrected.

If there is deflation in the economy or less money supply in the economy, it implies deficient demand for money in the economy. In such a case, the reverse repo rate is reduced it discourages the commercial banks to park their surplus funds with the central bank. Hence, lowering the reverse repo rate has a positive effect on the lending capacity of the commercial banks which raises the demand for borrowing from commercial banks, more money flows to the economy, purchasing power increases, aggregate demand increases, and deficient demand is corrected.

4. What is SLR and how does it affect money supply?

Answer. SLR is the minimum percentage of deposits of commercial banks (Net demand and time liabilities) which every bank is required to maintain with itself in the form of liquid assets like current account balances.

If there is inflation or extra money supply in the economy, it implies excess demand for money in the economy. In such a case, SLR is increased to control excess demand. The central bank withdraws additional purchasing power in the economy. There will be a contraction of credit, less money will flow in the economy, purchasing power in the economy falls, aggregate demand decreases, and excess demand is corrected.

If there is deflation in the economy or less money supply in the economy, it implies deficient demand for money in the economy. In such a case, SLR is decreased to control deficient demand. The central bank injects additional purchasing power into the economy which expands the demand for credit. Money flows in the economy, purchasing power increases, aggregate demand increases, and deficient demand is corrected.

5. What is the role of bank rate in controlling credit creation?

Answer. The bank rate or discount rate means the same in the case of credit control by the central bank.

The rate at which the central bank of a country lends money to the commercial banks to meet their long-term needs.

Let’s discuss the two cases to control credit in the economy:

If there is inflation or extra money supply in the economy, it implies excess demand for money in the economy. In such a case, the bank rate is increased which further increases the lending rate of commercial banks. It makes the credit costlier, demand for credit decreases, less money will go to the economy, purchasing power is reduced, aggregate demand in the economy falls and excess demand is corrected.

If there is deflation in the economy or less money supply, it implies deficient demand for money in the economy. In such a case, the bank rate is reduced, it decreases the lending rate by commercial banks, it makes the credit cheaper, demand for credit increases. More money flows to the economy, purchasing power increases, aggregate demand increases, and deficient demand is corrected.

6. Government of India has recently launched ‘Jan-Dhan Yojana’ aimed at every household in the country to have atleast one bank account. Explain how are the deposits made under the plan going to affect the national income of the country.

Answer. The deposits made under the plan are going to affect the national income of the country in the following way:

1. Opening more bank accounts means more bank deposits.
2. More deposits mean an increase in the lending capacity of the commercial banks.
3. More lending by banks means more investment in the country. 
4. More investment means more national income.

7. Explain ‘lender of last resort’ and ‘Bank of issue’ functions of the Central Bank.

Answer. Lender of last resort

As a lender of last resort it makes short-term credit available to them, that is, it gives financial loans to commercial banks against approved securities.

When a commercial bank faces a financial crisis and fails to obtain funds from other sources, then the central bank plays the vital role of ‘lender of last resort’ and provides them with financial assistance in the form of credit. This role of the central bank saves the commercial bank from bankruptcy. Thus, the central bank plays the role of guarantor for the commercial banks and maintains a sound and healthy banking system in the economy.

Bank of the issue

Bank of the issue means central banks have the currency authority. The Central Bank has the sole authority for issuing currency in the country.

For example, In India, the Reserve Bank of India has the sole authority for issuing paper currency notes except 1 Rupee note and coins which are issued by the Finance Ministry.

All the currency issued by Central Bank is its monetary liability that is, the Central Bank is obliged or is responsible to back the currency with assets of equal value.

8. Describe circular flow of money in two sectors.

Answer. In a simple economy, that is, where we have only two sectors namely: producer and household. It refers to the cycle of a generation of income in the production process and its distribution among various factors of production. It also includes the provision of service and payments from the Household sector to the Producer sector.

Let’s understand this step by step:

1. Factor services such as land, labor, capital, and entrepreneurship flow from household to producer sector, and this type of circulation where the money is not involved is called Real Flow.
2. Factor payments such as rent, wages, interest, and profits flow from the producer sector to household for their services and this type of circulation where the money is involved is called money or nominal flow.
3. Final goods and services, flow from the producer sector to the household sector and it is the real flow as money is not involved.
4. Final consumption expenditure on goods and services flow from household to producer sector in exchange for goods and services, as it involves payment for the goods purchased by the household. This is money flow.
5. We assume that there is No savings and investments. So, the total production of goods and services by the firms is equal to the total consumption expenditure on goods and services by the household.
   1. Factor payments by the firms should be equal to the factor income of the household.
   2. Consumption expenditure of household should be equal to the income of the producer sector

As shown below is the diagrammatic presentation of the circular flow of income in a simple economy with two sectors:

L- Labor who receives wages in return for their services

L- Land on which rent is paid as a payment.

K- Capital on which interest is paid

E-Entrepreneurship who receives final profit

9. Which is better: Real GDP or Nominal GDP? Discuss.

Answer.

Real GDP is considered to be better because of the following reasons:

1. Real GDP helps in determining the effect of increased production of goods and services as it is affected by a change in physical output. On the other hand, nominal GDP can increase even without any increase in physical output but due to a change in prices.
2. Real GDP is a better measure to make a periodic comparison in physical output over different years.
3. Real GDP facilitates international comparison of economic performance across the countries.
4. Real GDP reflects the growth of an economy.

10. Calculate GVA at FC:

Answer. GDPmp = Value of Output – Intermediate Consumption

Value of Output = Sales + Change in Stock

Value of Output = 400 + (-40) = 360

GDPmp = 360 – 250 (Purchase of raw material and intermediate consumption are same)= 110

GDPfc is same as GVAfc

GDPfc = GDPmp – NIT

NIT = Indirect tax – Subsidies

NIT = (20 + 30) – 0 = 50

GDPfc = 110 – 50 = 60

11. From the following data calculate GDPmp by income method:

Answer.

Income method

NDPfc = COE + OS + MI

NDPfc = 700 + 200 + 100 = 1000

COE = W&S + SSC by Employer

COE = 700 + 0 = 700

OS = R+R+I+P = 50 + 0 + 50 + 100 = 200

MI = 100

GDPmp = NDPfc + Depreciation + NIT = 1000 + 20 + 10 = 1030

Remember, “The key to success is to focus on goals, not obstacles”.

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