INDIAN INSTITUTE OF TECHNOLOGY DELHI, HSS Department

MINOR EXAM, 23 March 2023

HUL 312 (DISTRIBUTION AND GROWTH)

Max Marks = 30; Weight in overall evaluation = 20%; Duration: One Hour

PART A: Questions 1 and 2. Give brief answers; 3 marks each.

Question 1: Given below are the figures from India’s Central Government budget
for 2020-21 (all in trillions of Rupees): Revenue receipts = 16.3; Capital receipts =
18.8; Borrowings (or debt-creating capital receipts) = 18.2; Total expenditure = 35.1;
Capital expenditure = 4.2; interest payments = 6.8
What were India’s revenue deficit and fiscal deficit in 2020-21? (3 marks)

Answer:

Revenue expenditure = Total expenditure -- Capital expenditure = 35.1 – 4.2 = 30.9

Revenue deficit = Revenue expenditure -- Revenue receipts = 30.9 – 16.3 = 14.6

Fiscal deficit = Total expenditure – (revenue receipts + non-debt creating capital

receipts)
non-debt creating capital receipts = Capital receipts – Borrowings ==18.8 – 18.2 =
0.6
Fiscal deficit = 35.1 – (16.3+0.6) = 18.2

(Marks given only if the basic steps are shown).

Question 2: What are the items on the asset and liability side of the balance sheet of
a central bank? What are the items on the asset and liability side of the balance sheet
of commercial banks? (3 marks)

Central Bank Balance Sheet

Liability Asset

1. Currency with the public (CP) 1. Credit to government

2. Cash with commercial banks (CB) 2. International reserves (foreign assets)

3. Commercial banks’ deposits with the

3T. Credit to commercial banks
Central Bank
Commercial Bank Balance Sheet

Liability Asset

1. Deposits (Demand and Time) 1. Credit to the private sector

2T.Loans from the Central Bank 2. Cash with commercial banks (CB)

3. Commercial banks’ deposits with the

Central Bank
4. Credit to the government
Note: ‘T’ in 2T indicates the short-term or temporary nature of credit received by the
commercial banks.

Full marks can be given even if ‘2T.Loans from the Central Bank’ and ‘3T. Credit to
commercial banks’ are missing

PART B: Answer any three questions choosing from Questions 3, 4, 5, and 6.

Answer in not more than 400 words. Eight marks each.

Question 3: π is profit share or profits as a share of nominal output (PX). P is the

price level and X is output in real terms. W is nominal wage per worker and L is the
total number of workers in the economy. What will happen to the growth of output in
the economy if there is an increase in the profit share? Will output growth accelerate
or decelerate if the economy is demand constrained? Will your answer be different if
the economy is supply constrained? Explain.

Answer:

Nominal output (PX) = Inputs + WL + πPX

or value added = WL + πPX

πPX = Profits and WL = wage payments

Expenditure = Consumption + Investment

Wages lead to consumption

Profits lead to saving, which may (or may not) in turn translate into investment.

If profit share (of value added) increases, there will be a corresponding decline in the
share of wages
In a demand constrained economy, there is not enough demand for the output that is
produced. Businesses may not want to invest in new factories and machinery during
such a period.

If the economy is demand constrained: an increase in profit share and the

corresponding fall in wage share will lead to a further decline in overall demand.

Wages are the main source of consumption demand in the economy. A fall in wages
leads to fall in consumption expenditures. Output growth will decelerate.

In a supply constrained economy, machines and labour are already operating at their
full capacity. Workers are fully employed. More savings needed to increase the
productive capacity beyond the current limit. A rise in profit share will help increase
saving and thereby accelerate output growth.

Question 4: The per capita income of the US is much higher than the per capita
income of China. Nevertheless, we have seen that the direction of the flow of saving
has been from China to the US, and not vice versa. What do you think are the
economic reasons for such a phenomenon ((Hint: your answer may touch on the
following: current account balance, saving flow between countries, exchange rate
determination, and foreign exchange reserves).
………………………..
Answer:

A country with a current account surplus is actually transferring a part of its saving to
the rest of the world (it is producing more than it is consuming; therefore, the income
it produces is higher than the consumption within the country.).

China has been having a current account surplus and the US having a current account
deficit. Therefore, China has been transferring a part of its saving to the rest of the
world while the US has been receiving saving from the rest of the world.

In fact, a large part of the saving flow has been from China to the US. The saving
flow occurs when China purchases US treasury bods or debt papers issued by the US
government.

China’s purchase of US treasury bonds has been linked to its export-oriented

industrialization strategy.

As China exports more goods to the rest of the world, there will be a rise in demand
for the Chinese currency. That could lead to an appreciation of the currency, which
will in turn result in a fall in demand for Chinese goods in the export markets.

China’s Central bank purchases US treasury bonds to avoid appreciation of the

Chinese currency.
When private agents sell US dollars and buy Chinese currency (when they buy
Chinese goods)

China’s Central bank buy US dollars and sell Chinese currency.

Bonus points.

The hard earned saving by China’s workers (whose wages rose much slower than profits
and overall incomes in China) has been transferred to fuel a consumption boom in the
US. Hence the argument by Hung Ho-Fung that China has been behaving as ‘America’s
Head Servant’.

It is notable that, from the mid-2000s onwards, China has been trying to make a switch
in its economic growth strategy described above. China has been implementing policies
that will allow wages and domestic consumption to increase and at the same time shift to
more innovative industries.

Question 5: What was the context in which Keynes argued that private investment
is guided by ‘animal spirits’? And why is consumption regarded as endogenous? What
are the implications of these for aggregate demand and output in the economy?

Answer:

Investment decisions by entrepreneurs are linked to what Keynes described as

“marginal efficiency of investment.” That is, investors would compare the cost of
investment (the amount needed to set up, for instance, a factory) against the present
discounted value (PDV) of future returns from the investment

we expect a particular investment to provide the following stream of future returns: Rt

in period t, Rt+1 in period t+1, and so on.

PDV = Rt + Rt+1/(1+r) + Rt+2/(1+r)2 +…..+ Rt+n/(1+r)n Here r is rate of discount or

rate of interest.

An entrepreneur will decide to go ahead with the investments as long as the cost of
investment (C ) is at least equal to the PDV.

As can be seen from the above discussion, there are two factors that affect an
entrepreneur’s decision to invest. One is the rate of interest. As the rate of interest
comes down, larger investments will become viable for the entrepreneur. The other is
the expected stream of future returns from investment. There is a certain degree of
uncertainty with respect to expectations about future. Hence investments by the
private sector may be volatile.
Consumption regarded as endogenous or passive because consumption depends on
income: higher the income levels, higher is the consumption. It cannot independently
increase the overall incomes. On the other hand, investment is autonomous or
independent:

The implication is that an increase in investment will lead to a much larger overall
increase in incomes.

The multiplier effects of an increase in investment

Question 6: Write about any one of the following:

1. Thomas Piketty's book Capital in the Twenty-First Century (especially Chapters 3,
5 and 11).
2. Indian economy during the colonial period
3. On the role of state in industrial development (building on the work of Alice
Amsden on South Korea; or Mariana Mazzucato’s (2011) The Entrepreneurial
State, especially the US; or on the semiconductor industry; or the experience of
Apple and Foxcon).
(Please give references; you are also encouraged to acknowledge the names of
students whose presentations were useful while preparing for this question)

Jayan Jose Thomas