SJM School of Management Macroeconomics

IIT Bombay and WASHU September 10, 2021

Name: Sumeet Madwaikar Roll No. 20A278008

Macroeconomics – Final Exam
Max. Marks = 50, Last Date of Submission: September 13, 2021 (8 am)

Notes: The paper consists of three parts – Part A has 15 questions and each
question carries one mark. For every wrong answer in Part A, there is a
deduction of -1/2. Part B has 10 questions with total marks as 23. Part C
is based on the 6th Case (Demonetization) given to you in the booklet and
is of 12 marks. All parts are compulsory. For part A, tick-mark / circle/
bold on the sheet itself and for Parts B & C – write only on the space
provided. Since this is an individual assignment/exam, you are requested
not to discuss with other executives. Also, kindly do not use google or
any other search engine– you may use your notes and reading
material only.

PART A
1) Minimum wage Act
a. and unions both create structural unemployment.
b. and unions both create frictional unemployment.
c. creates frictional unemployment and unions create structural unemployment.
d. creates structural unemployment and unions create frictional unemployment.
e. none of the above

2) The natural rate of unemployment is the economist's notion of

a. cyclical employment.
b. full employment.
c. structural unemployment.
d. frictional unemployment
e. none of the above
3) The country of Timbaktu does not trade with any other country. Its GDP is $40 billion. Its
government collects $8 billion in taxes and pays out $4 billion to households in the
form of transfer payments. Consumption equals $30 billion and investment equals $4
billion. What is public saving in Timbaktu, and what is the value of the goods and
services purchased by the government of Timbaktu?
a. -$4 billion and $6 billion
b. $2 billion and $6 billion
c. -$2 billion and $8 billion
d. -$2 billion and $6 billion
e. None of the above
4) Institutions in the economy that help to match one person's saving with another person's
investment are collectively called the
a. Federal Reserve system.
b. banking system.
c. financial system.
d. monetary system.

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

5) GDP is not a perfect measure of well-being; for example,

a. GDP incorporates a large number of non-market goods and services that are of little
value to society.
b. GDP places too much emphasis on the value of leisure.
c. GDP fails to account for the quality of the environment.
d. All of the above are correct.
e. a and b only

6) A country reported a nominal GDP of Rs.120 billion in 2019 and Rs. 125 billion in 2018;
it reported a GDP deflator of 85 in 2019 and a deflator of 100 in 2018. Between 2018
and 2019,
a. real output and the price level both rose.
b. real output rose and the price level fell.
c. real output fell and the price level rose.
d. real output and the price level both fell.

7) A country has 100 million people, of whom 45 million are working age. Of these 45
million, 20 million have jobs. Of the remainder: 10 million are actively searching for
jobs; 5 million would like jobs but are not searching; and 10 million do not want jobs
at all. The official unemployment rate is ________.
a. 0.5
b. 0.33
c. 0.4
d. 0.43
e. 0.25
f. None of the above

8) High and unexpected inflation has a greater cost

a. for those who borrow than those who save.
b. for those who hold a little money than for those who hold a lot of money.
c. for those whose wages increase by as much as inflation, than those who are paid
a fixed nominal wage.
d. for savers in high income tax brackets than for savers in low income tax brackets.

9) Which of the following statements about GDP is correct?

a. GDP measures two things at once: the total income of everyone in the economy and
the total expenditure on the economy’s output of goods and services.
b. Money continuously flows from households to firms and then back to households,
and GDP measures this flow of money.
c. GDP is generally regarded as the best single measure of a society’s economic
well-being.
d. All of the above are correct.

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

10) Who would not be included in the labor force?

a. Rajesh, who is on temporary layoff
b. Bitan, who has retired and is not looking for work
c. Rashmi, who does not have a job, but has applied for several in the last week
d. All the above will be included in the labor force
e. None of the above is included in the labor force.

11) Suppose that because of a change in eating habits, bakeries need fewer workers and
baristas need more workers. This change would create
a. frictional unemployment.
b. structural unemployment.
c. both frictional and structural unemployment.
d. neither frictional unemployment nor structural unemployment
e. none of the above

12) If the public decides to hold less currency and more deposits in banks, bank reserves
a. decrease and the money supply eventually decreases.
b. decrease but the money supply does not change.
c. increase and the money supply eventually increases.
d. increase but the money supply does not change
e. none of the above

13) Suppose that the real exchange rate between the Indian and Kenya is defined in terms of
baskets of goods. Other things the same, which of the following will increase the real
exchange rate (that is increase the number of baskets of Kenyan goods a basket of Indian
goods buys)?
a. an increase in the number of Kenyan shillings that can be purchased with a dollar
b. an increase in the price of Indian baskets of goods
c. a decrease in the price in Kenyan shillings of Kenyan goods
d. All of the above are correct.

14) The ___________ lag for fiscal policy is generally ______ than it is for monetary policy.
a) recognition; shorter
b) recognition; longer
c) implementation; shorter
d) implementation; longer
e) none of the above

15) Which economy will fall in recession first?

a. Economy having low MPC
b. Economy having medium MPC
c. Economy having high MPC
d. Economy having high MPS
e. More information is needed to answer this

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

PART B (23 Marks)

1. India was a closed economy until 1991 and was characterized by:
Y = 200; C = 23 + 0.9(Y - T); I = 50 - 9r; G = 60 and T = 40 + 0.2Y
During the period, a firm producing fertilizer hired an IITB-WASHU EMBA graduate to suggest
should it invest or not. The graduate came out with a calculation indicating that if the firm
invests, it would realize a risk free return of 4 per cent. Should the firm invest or not? Explain!
Will your answer change if India becomes an open economy? Why? (3 marks)
Ans. Y (GDP) = C + I + G,
T= 40 + 0.2Y = 40 + 0.2X200 =80, C = 23 + 0.9 (Y-T) = 23 + 0.9 (200-80) = 131
So, 200 = 131 + (50 – 9r) + 60, therefore r = 4.56
If we compare this risk free returns of 4% with r in economy which is 4.56 it doesn’t make sense in
investing. It looks like risk free investment returns are lower than depreciation charged on investment
in GDP. So firm should not invest.
With opening of economy, firms will get advantage of exporting and more markets will be available,
plus there will be mechanism of determining equilibrium and more opportunities of investing will be
available within country in this case risk free return rate will improve.

2) Using Solow model, suggest what should be India’s productivity level from 2022 onwards
so as to overtake US by 2030? Use appropriate assumptions about other input parame-
ters. (2 marks)

Ans.

 Solow model has impact of 3 factors Investment, population and productivity/technology. In

attached model assumed that population in US is 1/3 of India whereas investment in India is
30% of US. All other factors are assumed to be same.
 Assuming all other factors remain same if productivity year on year increases to 5% for India
against 2% for US we will overtake US by 2030.
 Note that people employability is also important factor and with slight improvement in it
growth can be accelerated.

3) In the country of Blutonia, the working-age population is 150,000. There were 20,000
discouraged workers and 16,000 unemployed laborers. (2, 2)
 Unemployment rate = 16,000/130,000 = 12.31% and labor force participation rate =
130,000/150,000 = 86.67%
a. Suppose that 4,000 of the unemployed workers decided to give up looking for work. What
would be unemployment rate and the labour-force participation rate?
Ans. If 4,000 unemployed stops looking for jobs it will reduce unemployment rate to 9.52%
(12,000/126,000), revised labour-force participation will be 84% (126,000/150,000).

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

b. How would this change in unemployment change GDP? Do you think the prediction of
Okun's law is realistic in the situation? Explain.
Ans. The negative relationship between unemployment and GDP is called Okun’s Law, after
Arthur Okun, the economist who first studied it..
% Change in Real GDP = Relation between Real GDP & Unemployment (R) – 2 X the
Change in Unemployment Rate
In given example Unemployment reduces by 2.79%.
 Every percentage point the unemployment rate rises, real GDP growth falls by 2%
 In the scenarios above , % change in real GDP = R -2 X (9.52 – 12.31)= R + 5.58
 If we considered, R is 3 hence % change in real GDP = 8.58%.
 Here in Blutonia there is reduction in unemployment so GDP will improve.

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

4) Suppose a prime-ministerial candidate promises to increase the government budget surplus

and claims that doing so will stop Indian citizens from investing in foreign companies and
increase the value of the Rupees. Evaluate this promise. (2 marks)
Ans. A budget surplus occurs when income exceeds expenditures. A surplus is an indication
that a government's finances are being effectively managed. A budget surplus may
occurs when government brings in more from taxation than it spends. Budget surpluses
are not always beneficial as they can create deflation and economic growth. Budget
surpluses are not necessarily bad or good, but prolonged periods of surpluses or deficits
can cause significant problems.
 Budget surplus will take money out of the economy, thereby reducing the money
supply, and creating a deflationary environment.
 Allows governments to increase spending or reduce taxation in order to try and
stimulate the wider economy.
 Risk of the nation defaulting on its debt also reduces, which encourages more
investors to purchase government debt – as it is a safe investment. Interest rates
decline as there is more demand for government debt than there is from the
government to supply this debt – so investors are willing to take a lower rate.
 Surplus will be used to reduce existing debt that accumulated during periods of a
budget deficit. This helps the nation reduce its debt burden and increase its global
standing as a reliable debtor. So when the nation needs cash in the future, it can easily
obtain capital as investors trust in its ability to pay it back.

Indian citizen will invest more in foreign economy as they will get higher interest and it
will increase value of Indian rupees. So the promise of stopping investment out of
India is wrong.

5) A 2019 WASHU-IITB EMBA graduate suggests the finance minister that to increase tax
base, we should scrap income tax entirely but implement consumption tax with more
slabs. Do you agree? Explain!
Ans.
 Implementing slabs on consumption tax will be complex and should be avoided.
Consumption tax affects lower and middle income level were % spending of
consumption item is higher than saving. So any increase in this will increase price
level lowering standard of living.
 Income tax (Corporate & personal) contributes 55% + of total tax revenue. So
scrapping this tax is not advisable.
 There can be 3rd way that we can digitalize all transaction and even remove high
denomination notes forcing to do all transaction digitally. And introduce tax on bank
transaction rather than any income tax or consumption tax. This even very small % of
tax can give very high revenues. This can be very helpful to reduce black economy as
well. However this is very difficult to implement considering geographical spread and
diversity of our country.

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

6) On 9th Sep., RBI announced switching of currency to US dollar as the primary medium of
exchange. What might have made India to switch? (1)
Ans. Zimbabwe had hyperinflation and currency was devaluating every day. Zimbabwe was
only country who have no own currency and shifted to USD, now they have re-shifted to
Zimbabwe dollar.

Reasons for such changes can be:

1) Hyperinflation
2) Instability of currency
3) People loss confidence in their own currency
4) Economies which are too small and can have economies of scale for their own
currencies. This is may not be possible in India.

7) “Travelling in India is much costlier now than it was ten years ago,” says your American
friend. “Ten years ago, a dollar bought 44 Rs; this year, a dollar buys 72 Rs.” Is your
friend right or wrong? Given that total inflation over this period was 25 percent in the
United States and 100 percent in India, has it become more or less expensive to travel in
India? Write your answer using a concrete example -such as an American burger versus an
Indian burger - that will convince your friend. (2)
Ans. Given data says that inflation in US is 25% and inflation in India is 100%.

 So for example in India Burger was 44 INR (1 USD) 10 years back, today cost will be
88 INR equal to 1.22 USD (at exchange rate of 72 INR = 1 dollar) at 100% inflation.
 In US with 25% inflation price will change to 1.25 USD instead of 1 USD 10 years
back.

So logically even with 100% inflation in 10 years cost in India is lower than cost in US which
has 25% inflation as partly cost has been adjusted due to devaluation of currency. So
statement made that India is costlier today is not correct.

8) A major breakthrough in seed technology gives bumper crop of Cotton in 2019-20 in

Guntur region. Assuming Guntur is the only place producing Cotton, what would happen
to GDP deflator and WPI? Explain. (2)
Ans. Increase in Supply will reduce price if we assume that demand has not increased.

WPI turns the prices of many goods and services into a single index measuring the overall
level of prices. It takes into account the quantity of usage and hence weight
component in the index.
GDP deflator = Nominal GDP/Real GDP is implicit price deflator measures the price of
output relative to its price in the base year. It reflects overall level of prices in the
country.

Drop in cotton prices due to excess supply due to more production would reflect in drop of
fractions in both the GDP and WPI.

If we have to ensure that GDP & WPI don’t drop we have to create additional market for
cotton and it can be exported. Assuming that Guntur is only producing Cotton it can
easily also restrict supply and control prices. Cotton can be used to manufacture other
materials and stored in addition to exporting to new markets.

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

9) The GDP data indicates that the growth rate of Indian GDP has declined consistently from
2015 to 2019. An IITB-WASHU EMBA trained executive advises to Indian
government (GoI) that to boost economy, the government should give tax rebate. What
is the flaw in this advice? Justify. (2)
Ans. Tax rebate encourages taxpayer to make certain type of purchases or to get cash quickly
into consumer’s hands. However it will not necessarily every time increase tax
collection, hence fiscal deficit will increase due to revenue deduction. This will lead to
increase government borrowings which will reduce credit in economy.

10) The length of time between the short run and long run varies across sectors of the
economy. For the following industries, estimate the time it takes to reach the "long run"
based upon your knowledge of how quickly prices in this industry change in response to
the given shock. Describe the rational underlying each of your estimates. (1x4= 4)
Normally prices can be sticky or flexible depending on type of commodity but in longer –run
almost all prices are flexible.
a. Petrol prices after an announcement of a reduction in OPEC production
Ans. Petroleum product demand is relatively inelastic and reduction in production will create
market shortage and increase the prices.
Petrol prices will increase in market immediately in short run if OPEC production is reduced.
Countries dependence on crude oil and petrol in longer run will reduce as now countries are
looking forward for more sustainable from on energies.

b. Raymond catalog prices after an increase in the price of cotton used for making clothing
Ans. This are mainly sticky prices and Raymond as organization has sufficient stock or has
hedged out their Raw Material purchases to manage seasonality of prices. Typically it will
take few month for increase in prices and only permanent increase will be accommodated.
c. Orange juice prices after a severe drought destroys crops in Nagpur
Ans. Assuming that it is fresh Orange juice prices will increase immediately. However in
case of readymade packed Orange juice there will be impact of stock and price can be
sustained for some time say quarter.
However note that this is not essential commodity like Onion, so demand will also reduce to
adjust the supply stabilizing the prices.

d. Hyundai car prices after auto workers receive an increase in wages

Ans. In longer run it will increase the price but in shorter run prices will be sticky and
normally benchmarked with other manufacturers of similar brand equity and quality.
So in short period it will not have effect on price may take quarter or year to adjust.

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

PART C (4 marks each)

1) What were the objectives of India’s demonetization? What was its rationale?
Ans.
The government hoped to shift transactions from the cash economy to electronic
payment technologies, thereby permanently increasing the tax to GDP ratio and the size
of the formal economy. They also hoped on Behavioral change towards black money,
transaction shift from cash to e-payment. Additionally by channeling savings into the
formal monetary system, it hoped to positively affect long term growth. It hoped that it
will reduce money supply in black market.

Rationale of the decision was to fight against corruption, fake notes, black money and
terrorism financed by counterfeit notes.

India was ranked 76th among 168 countries. License Raj lead to bride-based system. Our
political eco system encouraged corruption.
Black money is running parallel economy, there is 10% contribution of cash in total black
money in addition to Real Estate, Gold, Foreign accounts abroad etc. Indian held 500
USD billion illegal funds in foreign tax havens in Feb 2012.
Fake notes & terror funding was common practice and it was even difficult to identify as
there was huge economy in cash transaction.

2) Evaluate the effectiveness of demonetization in achieving its stated objectives.

Ans. Demonetization was good methodology badly implemented. People were forced to find
loopholes as India was cash intensive economy with a whopping 78% consumer
payments via cash and cash was an essential payment medium for large labor-intensive
unorganized sector.
Various new modes of conversion were found:
a) Paying salaries to poor labour in advance in cash.
b) Depositing money in poor people account or opening fake account.
c) Bank participating in carter of converting money by opening FD in past dates.
d) Purchasing Gold on immediate basis
e) Donation to religious places and converting black to white by paying commission.
f) Bank note mafia with commissions

Top Google search was “how to convert black money to white”, which reflected the general
approach towards the demonetization, and this was not in line with Government’s expectation
for a behavioral shift.
The Reserve Bank of India (RBI) in its annual report mentioned, of Rs 15.41 lakh crore
demonetized currency notes of Rs 500 and Rs 1,000 denominations, only Rs 10,720 crore did
not reach to the banks or the RBI. This means that only 0.7 per cent of demonetized currency
notes were junked against Government’s expectation of approximately Rs 3 lakh crore of
demonetized currency notes would not come back to the banking system, thus reducing the
black money to a larger extend.

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SJM School of Management Macroeconomics
IIT Bombay and WASHU September 10, 2021

In Jan’17 Bloomberg estimated that 97 percent of the scrapped notes had been returned to the
banking system by Dec 30 2016. In such calculation only about $7.08 Bn of the total value of
$236.23 Bn of scrapped notes had not been returned to the system.
The economic survey 2016-17 estimated the impact of demonetisation on real GDP as
negative, but no more than 0.25 to 0.5 percent relative to the baseline of 7 percent.
Investment was expected to increase as repo and bank lending rates dropped in a scenario of
surplus liquidity due to cash deposits.
Liquidity and uncertainty effects associated with the demonetization exercise set the
economy back significantly from its pursuit of growth.
Demonetization affected GDP via demand side and supply side. On demand side, there were
issues on limited currency access which reduced demand for discretionary items. On supply
side, there were limited access to cash to pay wages in informal sector which disrupted
production. Reduction in income for workers, affected consumption.
Impact on formal sector was less compared to informal sector, considering the cash
transactions involved. Within organized sector, real estate was majorly affected. Unorganized
sector accounted for 45% of GVA and 82% of total employment; MSME with high labor
intensity and cash reliance (for working capital) contributed 49.86 % of India’s exports also
suffered.
Both Liquidity effects & Uncertainty effects were there due to the demonetization.

3) If you were advisor to the prime minister of India, how would you recommend that
the government tackle corruption and black income in the economy?
Ans. Below can be some tipping points:
 Initiative on digitalization of all transaction.
 Scrap all high value notes and limit to small denomination of notes. However to be
done step wise and not like demonetarization.
 Increase taxation base to include agriculture.
 Include all political parties and donations under slap of taxation
 Include all religious organization under strict monitoring
 Incentivize tax payer by giving special benefits
 Strict reconciliation of assets for all government employees and politicians.
 All property and gold transactions to be done only digital and linked to PAN &
Addhaar.
 All accounts outside India to be monitored and sign international treaty to seize these
funds if illegally transferred.

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