Economics Icap Chapterwise Past Papers.pdf

2020
CAF-02 Economics
E C Chapter-wise ICAP past paper with

examiner comments and Marking
plan
(Aut14-Spr-20)
O By the Grace of Almighty Allah, I am pleased to present the Chapterwise questions
and answers of Economics (with examiner’s comments & Marking plan) for CAF-02.
This volume contains ICAP papers of last 12 attempts.
Compiled by;
Shaan Rehman (SRTG)

Compiled by; Shaan Rehman [Introduction to Economics]
Chapter # 01
Fundamentals of Economics
Q.1; Aut-14
Briefly discuss the important features of ‘Islamic economic system’. ? (08 marks)
Answer;
Examiner comment;
Q.2; Spr-15
What do you understand by the term “Production Possibility Curve” (PPC)? Why is
PPC downward sloping and concave to the origin? (04 marks)
Answer;
1
Examiner comment;
Q.3; Spr-15
Under what conditions would PPC shift outwards? (03 marks)
Answer;
Examiner comment;
Q.4; Aut-15
In view of the scarcity of means and the multiplicity of ends, the economic problem
lies in making the best possible use of resources to get maximum satisfication.
Briefly discuss how resources are allocated under different economic systems to
optimize their use. (06 marks)
Answer;
Allocation of resources to optimize their use under different economic systems is discussed as
follows:
(i) Planned economy:
In a planned economy, the decisions and choices about resource allocation are made by the
government. Money values are attached to resources and to goods and services, but it is the
government that decides what resources should be used, how much should be paid for
them, what goods should be made and what their price should be.
2
(ii) Market economy:

In a market economy, the decisions and choices about resource allocation are left to market
forces of demand and supply, and the working of the price mechanism. What producers
will make and what consumers will buy are kept in balance by price that producers will
want for their output and the price that consumers are willing to pay.
(iii) Mixed economy:
In a mixed economy, the decisions and choices about resource allocation are shared by
private sector and government. When private sector is unable to supply due to the absence
of appropriate profitability, government acts to ensure a minimum level of supply of such
commodities by introducing subsidies into a market. Similarly, government ensures that
supply of excess or unwanted commodities may not occur by imposing quotas.
Examiner comment;
Marking plan;
Q.5; Spr-16
Free market economy permits private ownership and control of factors of production.
However, it is argued that it often results in exploitation of weak economic agents
because of which government has to intervene to control and regulate the economy
in several ways. In the light of above, explain the role of government in a mixed
economy. (06 marks)
Answer;
3
Examiner comment;
Marking plan;
Q.6; Aut-16
Explain the concept of Production Possibility Curve (PPC) with the help of a
diagram. (07 marks)
Answer;
4
Examiner comment;
Marking plan;
Q.7; Aut-16
Briefly discuss how the concept of PPC is useful in explaining the economic concept
of ‘scarcity’. (03 marks)
Answer;
Examiner comment;
Marking plan;
Q.8; Spr-17
What do you understand by the term ‘Factors of production’? What types of factors of
production are used by a school? (03 marks)
5
Answer;
Examiner comment;
Marking plan;
Q.9; Spr-17
Briefly describe any four core features of Islamic economic system. (04 marks)
Answer;
6
Examiner comment;
Marking plan;
Q.10; Aut-17
Economic problems affect different agents within an economy in different ways.
Define three main types of such agents in an open economy.
(03 marks)
Answer;
Examiner comment;
Marking plan;
7
Q.11; Aut-17
What do you understand by the term ‘Planned economy’? How resource allocation
choices are made in a planned economy? Also state any three benefits of planned
economy. (05 marks)
Answer;
Examiner comment;
Marking plan;
8
Q.12; Spr-18
What do you understand by the term ‘Capital formation’? Briefly describe the stages
involved in the process of capital formation. (04 marks)
Answer;
Capital formation:
Capital formation is the net capital accumulation for a particular country and refers to the additions or
increase in the stocks of capital in that country. Capital goods include machines, tools, factories, transport
equipment, materials, electricity, etc.
Stages involved in the process of capital formation
The process of capital formation involves the following three stages:
(i) Creation of savings:
When the average level of income is high then people tend to save more. An increase in the volume of real
savings releases resources which otherwise would have been devoted to the production of consumption
goods.
(ii) Mobilization of savings:
It involves transfer of savings from the households to businesses for investment.
(iii) Investment of savings:
Investment of savings in real capital is integral for the capital formation. This can only happen if there are
enough entrepreneurial ventures and businesses that are willing to take risks and embrace uncertainty.
Examiner comment;
Most of the candidates were able to correctly define the term ‘Capital formation’.
However, with regard to the stages involved in the process of capital formation,
many candidates were only able to list the three stages without description. Few
candidates envisaged consumption, distribution and innovation to be the stages
involved in the process of capital formation.
Marking plan;
Mark(s)
 Definition of ‘Capital formation’ 1.5
Up to 01 mark for describing each stage of capital formation 2.5
Q.13; Spr-18
Following data relates to a country Ruritania which is capable of producing the
following combinations of consumer goods and capital goods with a given quantity
of resources and technology:
9
Required:
(i) With the help of above data, draw a production possibility curve. (03 marks)
(ii) Ruritania, after full utilization of its resources, is currently producing 70 units
of consumer goods. What would be the opportunity cost to Ruritania in terms of
capital goods if it decides to produce 50 more units of consumer goods? (01 mark)
Answer;
(i) Production possibility curve:
(ii) Opportunity cost of producing 50 more units of consumer goods would be 40 units of capital goods.
10
Examiner comment;
The candidates were required to draw a production possibility curve (PPC) with the
given set of data. Majority of the candidates correctly plotted the PPC but failed to
label the diagram correctly and could not secure full marks on it. Many candidates
also lost marks by using improper scale on both x and y-axis which resulted in a
straight line PPC.
Majority of the candidates also failed to appreciate that opportunity cost in sub-part
(ii) of part 1(b) would be 40 units of capital goods.
Marking plan;
 Plotting the production possibility curve 3.0
 Determining the opportunity cost 1.0
Q.14; Aut-18
The basic economic problem is the scarcity of resources and the multiplicity of ends.
Discuss how following participants in an economy make decisions to deal with that
problem:
(i) households (ii) firms
(iii) government in market economy (iv) government in mixed economy
(06 marks)
Answer;
(i) Households
These are individuals having limited income at disposal. They attempt to allocate scarce income
between goods and services to attain maximum satisfaction.
(ii) Firms
These are businesses/organizations having limited factors of production (land, labor, capital and
enterprise). They attempt to allocate scarce factors of production between potential products and
services where profit is maximized.
(iii) Government in market economy
Governments in market economy has low or no interference in the allocation of resources. It relies on
the market and price mechanism for allocation of resources by allowing freedom to other economic
participants to decide.
(iv) Government in mixed economy
In mixed economy, only some very critical decisions are taken by the government with regard to
allocation of resources for the purpose of ensuring minimum or maximum supply of goods and services.
11
Examiner comment;
The question required a brief discussion on how specific participants in an economy
make decisions to deal with the economic problem. The answers related to households
and firms were mostly satisfactory but the students were unable to clearly differentiate
between decisions made by Governments in market economy and mixed economy
resulting in giving similar answer in either case.
Some students discussed circular flow of income which was totally irrelevant.
Marking plan;
Marks
1.5 marks for discussing decision making by each participant of the economy for Mark(s)
allocation of scarce resources to meet unlimited ends 6.0
___________________________________________________________________________________________________________________
Q.15; Aut-18
From the above diagram of Production Possibility Frontier, describe what the
following points/curve depict:
(i) point G (ii) point H (iii) curve XY
(03 marks)
Answer;
(i) Point G
This point depicts a situation where resources are not being fully utilized.
(ii) Point H
This point depicts that given the production capacity of an economy, it is not attainable.
(iii) Curve XY
It depicts all possible combinations of two alternative goods that an economy can produce with the
resources available to it.
12
Examiner comment;
This part was well attempted and many candidates secured full marks. However, a
number of students could not perform well in sub-part (iii). Many students wrote lengthy
explanations whereas only a one-line answer for each sub-part was sufficient.
Marking plan;
01 mark for describing each of the given point/curve 3.0
Q.16; Spr-19
Mixed economy is a system in which free markets coexist with government
intervention. Explain the role of the government in a mixed economy. (06 marks)
Answer;
In a mixed economy, government plays an important role to overcome the inadequacies of free market
economy. It includes:
(i) Distribution of income
To correct the unequal distribution of income and wealth that may exist under free market system,
government needs to reallocate income in an economy. Quite often this involves raising taxes on high
earners or luxury items and spending them on providing facilities for general public.
(ii) Price control
To restrain the monopolies that may exploit consumers by charging exorbitant prices under free
market economy, government sometimes acts to control prices for certain essential goods and services,
either by becoming the supplier for such commodities or imposing strict regulations on suppliers.
(iii) Production of merit goods
Government might introduce subsidies when there is a lack of incentive for suppliers to produce the
desired quantity of merit goods.
(iv) Framework of law
The government regulates and controls commercial activity to prevent possible excesses or shortages
that might occur in a completely free market due to manipulation by influential traders and
manufactures, etc.
Examiner comment;
The roles such as distribution of income, price control, production of merit goods, framework of law etc.
Were mentioned without elaborating on them as to why and how the income is distributed or the price
is controlled by the government.
13
Marking plan;
1.5 marks for explanation of each role of government in a mixed economy 6.0
Q.17; Aut-19
Briefly explain why the production possibility curve is downward sloping and
concave to the origin. (03 marks)
Answer;
Production Possibility Curve (PPC):
The PPC is downward sloping and concave to the origin because of the following reasons:
Downward sloping:
The reason for being downward sloping is that in order to increase the production of one good,
resources must be diverted from the other, hence decreasing the production of that good. This
happens due to scarcity of resources.
Concave to the origin:
The reason for being concave to the origin is because of increasing marginal rate of transformation
(MRT) or opportunity cost. some of the economy’s resources are better at producing Good A, and some
are better at producing Good B. Increasing MRT means more and more unit of one good is to be
sacrificed to get an additional unit of another good. This change in the opportunity cost of producing
each good, at various levels of production, is what causes the curve to be concave.
Examiner comment;
 Although majority of the examinees answered it well, some of the examinees mixed up the
concept of marginal rate of transformation with marginal rate of substitution.
 Examinees mixed up the concept of Production Possibilities Curve (PPC) with the concept of
consumer equilibrium.
Marking plan;
Explaining the reasons for the downward slope of PPC 1.5
Explaining the reasons why PPC is concave to the origin 1.5
____________________________________________________________________________________________
14
Q.18; Aut-19
What do you understand by the term ‘Market economy’? What are its main features?
Also state any four drawbacks of market economy. (05 marks)
Answer;
Market economy:
It is an economic system in which production and prices are determined by the free forces of
demand and supply that is unrestricted competition between privately owned business instead
of government. Government’s role is restricted to legislation, foreign affairs, peace and security,
and currency issuance.
Features:
Following are some of the main features of market economy:
 Reliance on the market and price mechanism to allocate resources
 Private ownership and control of factors of production
 Self-interest and profit motive motivate economic decisions
 Wages and other factor payments are set by the market.
Drawbacks:
Market economy has following drawbacks:
i. Inequalities of income will lead to socially undesirable resource allocation
ii. Ignores social costs of production and consumption decisions
iii. Danger of emphasis on luxuries rather than necessities
iv. Failure to plan long-term
Examiner comments;
 Examinees correctly explained the definition of Market economy, however, they failed to
elaborate its main features. Majority of the answers were only confined to self-interest, profit motive
and laissez faire.
 Some of the examinees wrongly considered the drawbacks of market economy as its features.
Marking plan;
Definition of market economy 1.0
Stating main features of market economy 2.0
0.5 mark for each drawback of market economy 2.0
15
Q.19; Spr-20
Discuss any four essential features of ‘Islamic economic system’.
(04 marks)
Answer;
(i) Allah is the sustainer:

This describes the belief that Allah has created all the resources available to man and is responsible for
feeding and nourishing all the creatures and human beings. Islam encourages people to do their best to
earn a livelihood using all lawful (Halal) and fair means whilst dissuading idleness.
(ii) Allah is the true owner of everything:
Human beings are merely a trustee of resources but have authority for using them but such authority is
subject to certain guiding principles that are required to be complied with.
(iii) State ownership:
Islamic system neither proposes nor prohibits establishing state owned enterprises. Therefore, a free
market exists where entrepreneurs can profit so long as they abide by the other rules of the Islamic
economic system.
(iv) Practicing of moderation:
Islam aims for a fair distribution of resources and so the people are taught to share wealth where they can.
In this regard, it proposes a moderate life style and opposes extravagant as well as excessive misery.
Q.20; Spr-20
What is ‘Division of labour’? Describe any three disadvantages of division of labour.
(04 marks)
Answer;
Division of labour:
Division of labour is the splitting of the production process into a number of individual operations and
making each operation the special task of one worker. It involves greater levels of specialization among the
workers.
Disadvantages:
(i) Loss of flexibility:
When workers specialize too much, it may be difficult for them to perform other tasks in the event of
changes in demand.
(ii) Monotony:
Since the workers perform the same task over and over again, they may get bored. This could result in
making mistakes, higher sickness rates and higher labour turnover.
(iii) Loss of skills/Decline in craftsmanship:
By breaking the production process into a series of separate, simple and often repetitive tasks, workers are
not challenged. This could result in loss of interest in acquiring new skills.
16
Chapter # 02
Microeconomics
Q.1; Spr-15
List any four factors which are responsible for each of the following:
Change in demand (02 marks)
Change in supply (02 marks)
Answer;
Examiner comment;
Q.2; Spr-16
What do you understand by ‘Change in Quantity Supplied' and ‘Change in Supply'?
(02 marks)
Answer;
1
Examiner comment;
Marking plan;
Q.3; Spr-16
Briefly explain any five factors that are responsible for ‘Change in Supply'.
(05 marks)
Answer;
Examiner comment;
2
Marking plan;
Q.4; Spr-15
Illustrate with the help of a diagram, how new equilibrium market price of a good
is achieved when price of substitute good increases? (06 marks)
Answer;
Examiner comment;
3
2
Q.5; Spr-17
What do you understand by Reservation price ? Briefly describe three factors which
may affect the reservation price? (05 marks)
Answer;
Examiner comment;
Marking plan;
Q.6; Aut-17
Describe the law of demand. Support your answer with the help of a diagram.
(05 marks)
4
Answer;
Examiner comment;
Marking plan;
Q.7; Aut-17
Briefly describe any four exceptions to the law of demand.
(06 marks)
5
Answer;
Examiner comment;
Marking plan;
Q.8; Spr-19
Describe the concept of ‘change in supply’ with the help of a diagram?
(05 marks)
6
Answer;
Change in supply:
When supply of a commodity changes due to change in non-price factor, it is said to be a change in supply. It is
represented by the shifting of supply curve from its original place as shown in the following diagram:
Suppose SS is the supply curve before the change. S' S' shows a decrease in supply because at the same price PM
( = P' M') less is offered for sale, i.e., OM' instead of OM. S" S" shows an increase in supply because at the same
price PM (= P" M") more is offered for sale, i.e., OM" instead of OM.
Examiner comment;
Incomplete diagrams were prepared.
Diagrams lacked proper explanation.
Candidates wrongly deliberated on the concept of change in quantity supplied instead of change in supply.
Marking plan;
Preparation of labelled diagram 2.0
Describing the concept of change in supply 3.0
Q.9; Aut-19
What do you understand by ‘Reserve price’? Describe any six factors which may
influence the reserve price of a seller. (07 marks)
Answer;
Reserve price:
The price below which a seller refuses to sell his product is called the reserve price.
Factors which may influence the reserve price of a seller:
Following are some of the factors which may influence the reserve price of a seller
Future price:
It depends upon the seller’s expectations regarding the future price. If he expects a high future
price, the reserve price will be higher and vice-versa.
7
Future costs:
If the costs are expected to fall, the reserve price will be lower and vice-versa.
Liquidity preference:
The more urgent is the seller’s need for cash; the lower will be the reserve price.
Stock carrying cost/period:
In case of higher carrying cost or longer carrying period the reserve price would be
lower.
Nature of goods:
If the goods are perishable, the seller cannot keep them for long periods and consequently
the reserve price will be low. Consequently, in case of durable goods the reserve price will be high.
Past costs:
Although past costs are not relevant, yet, some obstinate seller’s attach too much importance to
costs incurred in the past and fix a high reserve price though it may result in a greater loss.
Examiner comment;
Most of the examinees correctly defined the reserve price. However, many of them failed to identify and
describe all the six required factors which may influence the reserve price.
Some examinees did not read the question properly and described the reserve price from buyer’s perspective.
Marking plan;
Definition of reserve price 1.0
01 mark for describing each factor which may influence the reserve price 6.0
Q.10; Spr-19
What do you understand by the term ‘Goods’ as commonly used in economics?
Briefly describe ‘Public goods’ and give two examples of public goods.
(03 marks)
Answer;
Goods:
In economics, goods refer to the products that satisfy human needs or wants and provide utility.
Public goods:
A public good is a good whose benefits are social or collective.
Examples:
national defense system
highway network
Examiner comment;
Fresh air and water resources were incorrectly mentioned as the examples of public goods
.
Marking plan;
Economic definition of the term ‘Goods’ 1.0
Definition of public goods 1.0
0.5 mark for each example of public goods 1.0
____________________________________________________________________________________________
8
Q.11; Spr-20
What would be the effect of a rise in price of a substitute good on the equilibrium
market price of a good that it is being substituted for? Illustrate your answer with
the help of a diagram. (06 marks)
Answer;
When price of a substitute good increases, the demand for the good that it is being substituted for
increases.
The following diagram shows how an increase in price of A affects equilibrium price and equilibrium
quantity of B:
Initially, equilibrium is at P0Q0. Increase in price of good A causes an increase in demand for good B
resulting in shifting of demand curve to right, from DD to D’D’. Consumers are now willing to buy Qd
quantity (point b) but producers are willing to sell only Q0 quantity (point a). This shortage of supply over
demand (Qd-Q0) causes an upward pressure on the price. As the price rises, the excess demand falls
because quantity demanded decreases while quantity supplied increases. The supply curve intersects the
new demand curve at point c, so the new equilibrium price is P1 (up from P0) and the new equilibrium
quantity is Q1 (up from Q0).
9
Chapter # 03
Demand and Supply ; elasticities
Q.1; Aut-14
State the meaning of ‘price elasticity of supply’. Briefly discuss different types of
elasticity of supply. (05 marks)
Answer;
Examiner comment;
Q.2; Aut-14
Briefly explain the factors which determine the price elasticity of supply.
(05 marks)
1
Answer;
Examiner comment;
Q.3; Aut-15
(i)The quantity demanded for Alpha decreases from 300 units to 250 units, when
the price of Beta increases from Rs.50 to Rs.55.
(ii) The quantity demanded for Gamma increases from 400 units to 450 units,
when the price of Delta increases from Rs.100 to Rs.125.
For each of the above cases, you are required to:
 determine the Cross Price Elasticity of Demand (XED) and (04 marks)
 on the basis of XED determined above, comment on whether the goods are
substitutes or complements. (04 marks)
Answer;
2
Comment on whether the goods are substitute or complement

(i) Alpha and Beta are complements because of a negative cross price elasticity of
demand which indicates that when the price of Beta increases, the demand for Alpha
decreases. The coefficient is greater than one, indicating they are close complements.
(ii) Gamma and Delta are substitutes because of a positive cross price elasticity of
demand which indicates that when the price of Delta increases, the demand for
Gamma increases. The coefficient is less than one, indicating they are weak
substitutes.
Examiner comment;
3
Marking plan;
Q.4; Aut-15
State why firms need to know XED of their products. (03 marks)
Answer;
Information regarding XED is vital for firms when making production plans or setting
price of products. XED indicates the effect on demand for products due to change in
price of substitute or complement products. This knowledge allows the firms to develop
strategies to reduce their exposure to the risks associated with price changes by other
firms, such as a rise in the price of a complement or a fall in the price of a substitute.
Examiner comment;
Marking plan;
Q.5; Aut-16
Define Price Elasticity of Demand. Identify and briefly explain the factors which
determine the Price Elasticity of Demand. (06 marks)
Answer;
4
Examiner comment;
Marking plan;
Q.6; Aut-16
Compute the price elasticity of a product if an increase in the price of the product
from Rs. 10 per unit to Rs. 11 per unit causes a decrease in its demand from 2.5
million units to 1.9 million units. (03 marks)
5
Answer;
Examiner comment;
Marking plan;
Q.7; Spr-17
Define the concept of ‘Price elasticity of supply’ and how it May be calculated.
Identify the factors which would increase the price elasticity of supply.
(05 marks)
6
5
Answer;
Examiner comment;
Marking plan;
Q.8; Spr-18
List the factors which determine the price elasticity of demand of a commodity.
Briefly describe what characteristics of a commodity are indicated by a negative or
a positive sign of ‘Income elasticity of demand’ and ‘Cross price elasticity of
demand’ of that commodity. (06 marks)
Answer;
Factors which determine the price elasticity of demand of a commodity:

Following are the factors which determine the price elasticity of demand:
7
(i) The availability of substitutes

(ii) The proportion of consumer’s income spent
(iii) The number of uses of a commodity
(iv) Complementarity between goods
(v) Time period
Classification of the goods according to the sign of IED and XED:
Income elasticity of demand (IED):
 A normal good will always have a positive income elasticity of demand, because as income
increases, demand for the product also increases.
 An inferior good will always have a negative income elasticity of demand, because as income
increases, demand for the product will decrease, as consumers switch to better alternatives.
Cross price elasticity of demand (XED):
 A complementary good has a negative cross price elasticity of demand, because the two factors
i.e. Good A’s price, and Good B’s quantity move in opposite directions.
 A substitute good has a positive cross price elasticity of demand, because the two factors i.e.
Good A’s price, and Good B’s quantity move in the same direction.
Examiner comment;
The first part of this question required candidates to list the factors which determine
the elasticity of demand whereas the second part was related to the characteristics
indicated by the negative or a positive sign of ‘Income elasticity of demand’ and
‘Cross price elasticity of demand’ of a commodity.
The first part was performed well by majority of the candidates. However, some
candidates deliberated on factors affecting the demand instead of elasticity of
demand.
In the second part, majority of the candidates were only able to identify the type of
commodity which bears a positive or a negative sign both in case of income elasticity
and cross price elasticity of demand but could not elaborate on the reason behind
such sign. A number of candidates lacked clarity and mixed up the characteristics of
both income elasticity and cross price elasticity of demand.
Marking plan;
 Up to 0.5 mark for each factor 2.0

 Reasons for positive and negative income elasticity of demand 2.0
 Reasons for positive and negative cross price elasticity of demand 2.0
8
Q.9; Aut-18
Consider the following schedule that pertains to the product of a firm engaged in
the manufacture and sale of consumer products:
From the above schedule:

(a) determine the price elasticity of demand using expenditure method and
percentage method. (04 marks)
(b) recommend the course of action the firm may adopt along with appropriate
justification. (02 marks)
Answer;
9
Examiner comment;
(a)In this part of the question, the students were required to calculate the price elasticity of
demand using expenditure method and by percentage method. About 40% of the students
performed well in this part as they knew the formulas and also applied them correctly.
Many students confused expenditure method with percentage method and vice versa and
some students even attempted arc and point methods. Some students performed the
calculation part of the expenditure method correctly but interpreted the result incorrectly.
(b)This part was poorly attempted. Majority of the students did not read the question
carefully. Rather than commenting on the inelasticity of demand, as calculated in part (a),
many candidates tried to elaborate the relative benefits and drawbacks of the two
methods of calculation. Many students gave general recommendations while discussing
the concept of elasticity instead of giving specific recommendation based on the given
situation. Some students even suggested to adopt one method over other to respond to the
given price elasticity of demand.
Marking plan;
(a)  Determination of price elasticity of demand under expenditure method 1.5
 Determination of price elasticity of demand under percentage method 2.5
(b) Recommendation with justification 2.0
Q.10; Aut-19
With the drop in price of smartphones from Rs. 80,000 to Rs. 70,000, the quantity
demanded by the consumers, in a particular market, increases from 20,000 phones
to 30,000 phones per month. Calculate the elasticity of demand under percentage
method and identify the type of elasticity.
(02 marks)
Answer;
10
Examiner comment;
 Only few examinees were able to correctly compute and identify the type of elasticity of demand.
 Most of the answers remained incomplete. Many of those who although correctly computed the
elasticity of demand failed to identify that it was a relatively elastic demand. Some of them thought
that it was an inelastic demand while others considered it to be perfectly elastic.
 Many examinees switched the numerator with the denominator in the formula and arrived at a
wrong result.
Marking plan;
Computation of the elasticity of demand under percentage 1.5
method
Identification of the type of elasticity 0.5
______________________________________________________________________________________________________________
Q.11; Spr-20
Briefly explain the concept of Relatively Inelastic Demand by using the diagram.
(03 marks)
Answer;
Relatively Inelastic Demand:
Demand is relatively inelastic when the percent change in quantity demanded, i.e. area designated by B
in the above diagram, is less than the percent change in price, i.e. area designated by A in the above
diagram.
In case of relatively inelastic demand, a decrease in price from OPo to OP1 would result in increase in the
quantity demanded from Oqo to Oq1.
______________________________________________________________________________________________________________
11
Chapter # 04
Utility Analysis
Q.1; Aut-15
State and explain the law of Equi-Marginal Utility with the help of a diagram,
assuming there are only two commodities i.e. A and B and the consumer has limited
income at his disposal. (08 marks)
Answer;
According to the law of Equi-Marginal Utility, a consumer maximizes his total utility with his
limited income when marginal utility of the last rupee spent on each commodity is equal. This is
achieved at marginal rate of substitution i.e. marginal utility of A divided by marginal utility of B
is equal to price of A divided by price of B. This can be explained with the help of following
diagram:
In the above diagram, MN is the budget line representing the combination of two goods i.e. A
and B that the consumer can afford with limited income at his disposal. U, U1 and U2 are
various indifference curves. An indifference curve that lies to the right of another represents a
higher value of satisfaction than the other. However, the budget line constrains the maximum
utility available to the consumer. Therefore, U1 is attainable, but inefficient whereas U2 is
unattainable.The consumer maximizes his total utility at a point on an indifference curve that is
tangential to the budget line. In above diagram, consumer maximizes his total utility at point O
which is tangent to budget line. Also, at point O, marginal utility per rupee spent on good A
1
equals the marginal utility per rupee spent on good B. At no other point could the consumer
have a higher utility given the constraints of the budget line.
Examiner comment;
Marking plan;
Q.2; Spr-17
Describe the Law of ‘Diminishing marginal utility’. Support your answer with the
help of a schedule and a diagram. (07 marks)
Answer;
2
Examiner comment;
Marking plan;
Q.3; Aut-17
Explain the concept of consumer equilibrium with the help of indifference curve
analysis. (08 marks)
3
Answer;
Examiner comment;
Marking plan;
4
2
Q.4; Spr-18
Define the law of ‘Equi-marginal utility’ and list the assumptions underlying the
law. Also describe any two limitations of the law of equi-marginal utility.
(07 marks)
Answer;
Equi-marginal utility:
According to the law of Equi-Marginal Utility, a consumer maximizes his total utility with his limited income
when marginal utility of the last rupee spent on each commodity is equal.
Assumptions of Law of Equi-Marginal Utility:
(i) The consumer behaves rationally and seeks to maximize his total satisfaction
(ii) Utility is measurable in cardinal terms/quantitative terms
(iii) The consumer has a given scale of preference for the goods in consideration
(iv) The consumer has perfect knowledge of utility derived from goods
(v) Wants and goods are substitutable
(vi) Prices of goods remain unchanged
(vii) Consumer income is fixed
(viii) The marginal utility of money is constant
Limitations of the Law of Equi-Marginal Utility:
Consumer expenditure may not conform to the law due to the following limitations:
(i) Consumers do not make conscious calculations
The operation of the law involves calculations and comparison of the expected satisfaction from an amount
of money spent on alternative goods and services. However, consumer expenditure is also based on habit
rather than conscious calculation and comparison of utility per unit of currency.
(ii) Consumer ignorance
Consumers may be unaware of other available alternatives. In this case no substitution could take place
and the law would not operate.
(iii) Custom and fashion
Some purchases are made based on custom or fashion rather than on the basis of a rational appraisal of
utility. This would distort the operation of the law.
(iv) Indivisibility of goods
The operation of the law assumes that goods and services are divisible so that the optimum point might be
reached. However, this may not be the case in practice. This prevents the marginal utilities from becoming
equalised.
(v) Underlying assumptions
The operation of the law rests on a series of assumptions which might not hold in practice.
5
Examiner comment;
This part required definition of law of ‘Equi-marginal utility’, the assumptions underlying the law and its
limitations. Generally, the candidates seemed to lack conceptual understanding. Some students only wrote
that when the marginal utility of the two commodities is equal it is called Equi-Marginal Utility without
referring to maximisation of total utility and consumer’s limited income. Some candidates did not
comprehend the question correctly and explained the concept of indifference curve. However, the
assumptions and the limitations were correct in most cases although most of the candidates could not
mention all the assumptions.
Marking plan;
 Definition of ‘Law of Equi-marginal utility’ 1.0
 0.5 mark for each assumption 4.0
 01 mark for each limitation 2.0
Q.5; Aut-18
What do you understand by ‘Consumer equilibrium’? (02 marks)
Answer;
The consumer is said to be in equilibrium when maximum possible satisfaction is obtained from the
individual’s purchases / when budget line and indifference curve are tangent, at the prices prevailing in
the market and given the amount of money the individual possesses for making purchases.
Examiner comment;
Although the overall performance in this question was very poor, the performance in this
part was relatively better. However, a number of students got confused between
consumer equilibrium and market equilibrium. Many candidates wrote about equimarginal
utility which was not required.
Marking plan;
Explanation of consumer equilibrium 2.0
Q.6; Aut-15
In the study of consumer equilibrium, price effect is the aggregate of substitution
effect and income effect. Explain it with the help of a diagram assuming that:
 goods are normal and substitute of each other.
 price of one good changes whereas consumer income and price of the other good
remain constant.
(08 marks)
6
Answer;
The initial equilibrium of the consumer is at E where indifference curve (IC1) is tangent to budget line AB.
The fall in price of good X (assuming consumer income and price of Y remain constant) would result in
new equilibrium at E' as consumer would buy more of good X and less of good Y. This price effect is an
aggregate of income effect and substitution effect.
The change in price would result in increase in real income of consumer. To determine the substitution
effect, the effect of increase in real income is eliminated so that consumer remains at original indifference
curve (IC1). To achieve this, a dotted line CD parallel to budget line AB1 is drawn. The new budget line is
tangent to IC1 at E''.
E to E'' represents the substitution effect and E'' to E' represents income effect. E to E' represents the price
effect which is the aggregate of substitution effect and the income effect.
Examiner comment;
This part was very poorly attempted though some students gave perfect answers as well.
Most of the diagrams were incomplete. In most cases the substitution effect was not
demonstrated. Moreover, instead of drawing one diagram showing income, price and
substitution effects, a number of students prepared separate diagrams showing income
effect and price effect. As is commonly observed, the explanation was quite poor and the
labeling was inadequate.
Marking plan;
 Preparation of labelled diagram 5.0
 Explanation of diagram 3.0
7
5
Q.7; Spr-19
What is an indifference curve? Briefly explain three main characteristics of
indifference curves. (06 marks)
Answer;
Indifference curve:
An indifference curve shows the total satisfaction derived by a consumer from the use of two commodities.
It is drawn on the assumption that for all possible points on an indifference curve, total satisfaction of the
consumer remains the same. Hence, the consumer is indifferent as to the combinations lying on an
indifference curve.
Characteristics of indifference curve:
Following are the characteristics of indifference curve:
(i) Negatively sloped
An indifference curve will slope from left to right. This is because if someone increases consumption of one
good, in order to maintain the same level of satisfaction, he must decrease his consumption of the other.
(ii) Higher indifference curve equals higher level of utility
An indifference curve that lies to the right of another represents a higher level of satisfaction than the
curve to the left.
(iii) Convex to the origin
In this instance, convexity means being bowed to the origin. The shape of the curve has to do with how
much of one good does a consumer want to exchange for another in order to maintain the same level of
utility. If the goods are not perfect substitutes, it would be represented by indifference curves which are
convex to the origin.
Examiner comment;
 Candidates correctly explained the characteristics of an indifference curve, however, they failed to
define the curve itself. Most of the answers were general in nature and lacked the concept of total
satisfaction derived by a consumer from the use of two commodities.
 Many candidates thought that indifference curve is related to the production of two goods.
 The curve was unnecessarily drawn which was not required at all.
Marking plan;
Definition of indifference curve 1.5
1.5 marks for explaining each characteristics of indifference curve 4.5
8
Q.8; Aut-19
Briefly describe the following diagram and the concept it depicts:
(08 marks)
Answer;
The above diagram depicts the concept of Law of Equi-Marginal Utility.

According to the law of Equi-Marginal Utility, a consumer maximizes his total utility with his limited income
when marginal utility of the last rupee spent on each commodity is equal. This is achieved at marginal rate
of substitution i.e. marginal utility of A divided by marginal utility of B is equal to price of A divided by price
of B.
In the above diagram, MN is the budget line representing the combination of two goods i.e. A and B that
the consumer can afford with limited income at his disposal. U, U1 and U2 are various indifference curves.
An indifference curve that lies to the right of another represents a higher value of satisfaction than the
other. Therefore, U1 is attainable, but inefficient whereas U2 is unattainable. The consumer maximizes his
total utility at point O on an indifference curve which is tangent to the budget line. Also, at point O,
marginal utility per rupee spent on good A equals the marginal utility per rupee spent on good B. At no
other point could the consumer have a higher utility given the constraints of the budget line.
9
Examiner comment;
 With the exception of few, none of the examinees were able to identify that the diagram was
related to the law of Equi-Marginal Utility.
 Majority of the answers were limited to only describing the indifference curves.
 Many examinees either could not identify the budget line or failed to acknowledge the concept
depicted by it.
Marking plan;
Identification of the concept that diagram depicts 1.0
Explanation of diagram 7.0
10
Chapter # 05
Costs, revenues and firms

Q.1; Aut-14
The following data refers to the revenue and costs (in million rupees) of a firm.
(a) Briefly explain the concept of fixed costs with reference to the above data
(02 marks)
(b) Determine the marginal revenue at each level of output and interpret the results
(04 marks)
(c) What level of output will the firm aim to produce and what would be the
amount of profit that the firm will make at this level? (04 marks)
Answer;
1
Examiner comment;
Q.2; Aut-14
State the main features of monopoly and name any one organisation which operates
under monopoly.
(03 marks)
Answer;
Examiner comment;
Q.3; Aut-14
Briefly explain the ‘monopolist’s equilibrium’ with the help of a schedule.
(04 marks)
2
Answer;
Examiner comment;
Q.4; Spr-15
What do you understand by “economies of scale”? Briefly discuss any four factors
that contribute towards achievement of economies of scale.
(07 marks)
Answer;
3
Examiner comment;
Q.5; Spr-15
Explain economies and diseconomies of scale with the help of long run average cost
curve. (04 marks)
Answer;
4
Examiner comment;
Q.6; Spr-15
Explain the term equilibrium of the firm. (02 marks)
Answer;
Examiner comment;
Q.7; Spr-15
Briefly describe the reasons on account of which a firm under perfect competition
acts as a ‘price taker’ rather than a ‘price maker’.
(05 marks)
Answer;
5
Examiner comment;
Q.8; Aut-15
Oligopoly is the situation where industry is dominated by a few large suppliers.
Briefly discuss any six features of oligopoly. (06 marks)
Answer;
Features of Oligopoly:
(i) Small number of large firms:
The oligopoly market is dominated by a small number of large firms with a high
concentration ratio. This characteristic gives each of the relatively large firm a
substantial market control.
(ii) Interdependence of firms:
It is the unique feature of oligopolistic market that the policies of every producer
directly affect others, because of less number of competitors and good substitute
products. Therefore pricing, output and other decisions of one firm generate prompt
response from the others.
(iii) Price rigidity:
Under oligopoly, firms avoid price competition for the fear of price war. They follow
the policy of price rigidity where prices tend to stay fixed irrespective of changes in
demand and supply conditions. No firm resorts to price-cut without making priceoutput
decision with other rival firms thus, leading to a monopoly under oligopoly.
6
(iv) Role of advertisement:

Due to non-price competition, oligopolistic firms employ various sales promotion
techniques to gain a greater market share. In view of this, firms have to spend
substantial amount on advertisement and other sales promotional activities.
(v) Indeterminate demand curve:
Under oligopoly the exact behavior pattern of a producer cannot be determined with
certainty. Any change in price by one firm may lead to change in price by the
competing firms, thus, demand curve keeps on shifting unlike monopoly and perfect
competition where demand curve is definite.
(vi) Barriers to entry:
Since oligopolistic market is dominated by small number of large firms, they may
create barriers for new entrants. Patents, economies of scale, control over essential
inputs, high capital requirements etc. may act as barriers for new firms.
(vii) Nature of product(s):
The firms under oligopoly may produce homogenous or differentiated product(s). If
firms produce homogenous products like cement or steel, they are known as perfect
oligopolies and if they produce differentiated products like automobiles, they are
known as imperfect oligopolies
Examiner comment;
Marking plan;
Q.9; Aut-15
When oligopolists fix prices by collusion among themselves, they are known as
cartel. Discuss the factors that are responsible for the success / failure of price cartel.
(04 marks)
7
Answer;
The failure or success of price cartels under oligopolistic market depends on following
factors:
(i) Control on supply:
For the successful price cartel, firms under oligopolistic market must hold all or
substantial market share.
(ii) Close substitutes:
Success of price cartel depends on non-availability of close substitutes of product
otherwise when higher price is set by oligopolists, the buyers will shift their demand
to close substitutes.
(iii) Price elasticity of demand:
Price cartel will be successful if price elasticity of demand for a product is inelastic.
Otherwise when oligopolists set higher price, buyers contract demand more
proportionately weakening the price cartel.
(iv) Agreement on individual share:
If all the firms in cartel agree on their allotted quota of supply, price cartels would be
successful. However, if firms secretly increase production and sale of the product,
price cartels would collapse because at increased supply, charging a higher agreed-on
price would not be possible.
(v) Competition law:
Price cartel would be affected by the presence / introduction of competition law. The
law prohibits firms to enter into an agreement that tend to lessen, distort or eliminate
competition within the market thus eliminating the price cartels.
Examiner comment;
Marking plan;
8
Q.10; Spr-16
Explain the law of variable proportions. Discuss the various stages of law of
variable proportions with the help of a diagram (schedule not required). Also
explain at which stage a rational producer would stop production.
(10 marks)
Answer;
9
Examiner comment;
Marking plan;
Q.11; Spr-16
One of the characteristics of a monopolist is the ability to engage in price
discrimination. Describe the term ‘Price Discrimination'. Briefly explain the
conditions which must exist to enable the monopolist to exercise the power of price
discrimination effectively. (04 marks)
Answer;
Examiner comment;
Marking plan;
10
9
Q.12; Spr-16
Monopolist will be in equilibrium at that price-output level at which his profits
are maximized. Explain the priceoutput equilibrium of a monopolist with the help
of a diagram. (08 marks)
Answer;
Examiner comment;
Marking plan;
11
9
Q.13; Aut-16
The following data refers to the total revenue and total costs of a firm at various
output levels:
(a) Calculate the firm’s fixed cost and the marginal cost at each level of output.
(03 marks)
(b) Determine the level of output at which the firm would optimise its profits. Also
determine the amount of profit that the firm will make at the desired level of
output. (05 marks)
Answer;
Examiner comment;
(a)
12
(b)
Marking plan;
Q.14; Aut-16
What do you understand by the term Perfect Competition? With the help of an
appropriate diagram, explain the Equilibrium of a Firm under perfect competition
in the long run. (08 marks)
Answer;
13
Examiner comment;
Marking plan;
_________________________________________________________________________________________________________________
Q.15; Spr-17
Define the term ‘Economies of scale’? Describe any four ways by which a firm May
achieve internal economies of scale. (06 marks)
Answer;
Examiner comment;
14
Marking plan;
__
__________________________________________________________________________________________
Q.16; Spr-17
What is meant by ‘Oligopoly’? List any four advantages and disadvantages of
Oligopolies. (05 marks)
Answer;
Examiner Comment
Marking plan
15
Q.17; Aut-17
Briefly describe the following diagram and the concept which it depicts.
(08 marks)
Answer;
16
14
Examiner Comment
Marking plan
Q.18; Spr-18
Describe the following diagram and the concept which it depicts.
(06 marks)
Answer;
17
14
The above diagram depicts the concept of long run equilibrium of a firm under perfect
competition.
In perfect competition every purchaser and seller is so small relative to the entire market
that he cannot influence the market price by increasing or decreasing his purchases or
output. Therefore, the market price remains the same regardless of firm’s output.
The demand curve is completely horizontal, which means that sale of each additional unit
produces the same revenue and therefore MR=AR=P(Price). MC is the marginal cost curve
which depicts the increase in cost on account of production of each additional unit. With
the sale of each additional unit the total profit of the firm would increase till such time that
the MC remains below the Marginal Revenue Curve i.e. PL. The profit will be maximum at
point R where MC curve cuts PL from below because above this point each additional unit
will cost more than the revenue it would generate. At this stage (i.e. point R) Marginal Cost
would be equal to Marginal Revenue and the firm would be producing OM units.
In the long run, the firms are able to increase /decrease their output by varying their
equipment. Therefore, in the long run no firm is in a position to earn super normal profits
and all firms earn normal profit which is depicted by the area OPRM where the total cost
and total revenue of the firm are the same.
Examiner Comment
A diagram was provided in this question and candidates were required to explain the diagram
and the concept depicted by it. The performance on this question remained below average.
However, the performance improved considerably from the last attempt when this type of
question was asked for the first time; as 18% of the candidates secured passing marks as
compared to only 4% in the previous attempt. About 2% of the successful candidates with good
conceptual understanding managed to score 80% or more marks on the question.
Replies of about 50% of the students were limited to the identification of the concept depicted by
the diagram which earned them only one or two marks. Some candidates only identified that the
diagram depicted a firm earning normal profit in the long-run but did not identify the type of
market structure such as perfect competition, imperfect competition, oligopoly or monopoly.
Some candidates erroneously stated that the diagram depicts a long-run equilibrium under
monopolistic competition.
Many candidates again wasted time in drawing the diagram which was already
provided in the question paper. Such wastage of time affects the candidate’s ability to
perform well in the other questions.
Marking plan
 Identification of the concept depicted by the diagram 1.0
 Describing the diagram and the underlying concept 5.0
18
14
Q.19; Spr-18
Briefly describe why the short-run average cost curve is U shaped.
(05 marks)
Answer;
Short-run average cost curve is U shaped:

The average cost is made up of an average fixed cost per unit plus an average variable cost per
unit.
Average fixed cost will fall as the level of output rises. Spreading fixed costs over a larger amount
of output is a major reason why (short-run) average costs per unit falls as output increases.
The standard assumption about the variable costs is that up to a certain level of output, the
variable cost per unit is more or less constant (e.g. wages and material costs per unit of output
remain unchanged).
Nevertheless, there is evidence that average variable costs rise when output increases beyond a
normal capacity level.
Average variable costs will therefore begin to rise at some point, even if there are no overtime
payments or use of more skilled labour.
As variable costs per unit rise, the average total cost per unit will rise too.
Hence the curve falls on account of spread of fixed costs and rises when the variable costs start
rising after a certain level, thus giving the curve a U shape.
Examiner Comment
This part required candidates to describe why the short-run average cost curve is U
shaped. Though the topic had been tested previously also, the candidates failed to
define the concept. Most of the answers were not only incomplete but also irrelevant
and somehow revolved around the concepts of economies and dis-economies of
scale. Some candidates thought that the U shape of the cost curve is due to the
operation of law of variable proportion whereas others attributed it to factors such as
production efficiency, inefficiency of labour force, breakdown of machinery, etc.
Marking plan
Up to 01 mark for each reason 5.0
Q.20; Spr-18
Describe the law of variable proportion. Also state the assumptions on which the
law of variable proportion is based. (03 marks)
Answer;
Law of variable proportion:
As the quantity of one factor is increased, with others remaining fixed, the marginal product of
that factor will decline.
19
14
Assumptions of the law of variable proportion:

The law is dependent on the following assumptions:
(i) Constant state of technology:
if technology improves, the marginal product could increase also.
(ii) Fixed amount of other factors / Factor proportions are variable:
they must stay constant to be able to test it. It operates in the short run because in the long run
fixed input becomes variable.
(iii) Possibility to combine factors:
the factors must be able to be combined to make a product.
Examiner Comment
This part asked candidates to describe the law of variable proportion and the
assumptions on which the law is based. Again, the performance was very poor.
Most of the candidates lacked conceptual understanding and related the law of
variable proportion to increase or decrease of cost and the return of the firm.
Marking plan
 Definition of the law of variable proportion 1.0
 Up to 0.5 mark for each assumption of the law of variable proportion 2.0
Q.21; Aut-18
Explain the concept of economies and diseconomies of scale with the help of long
run average cost curve. Also mention two factors that lead to economies and
diseconomies of scale. (07 marks)
Answer;
20
14
It can be seen from the above diagram that initially as the output of the firm
increases, the unit cost declines i.e. firm is achieving economies of scale due to large
scale of production and long run average cost curve goes down.
After certain level of output is reached, average cost curve remains constant. This
point is called minimum efficient scale as unit costs are minimized because of
maximization of economies of scale. In the above diagram, this level of output is
Qmes.
Any further increase in production level results in rising unit costs due to
inefficiencies generated by diseconomies of scale which in the above diagram is
depicted by the rise in long-run average cost curve.
Factors that lead to economies of scale include:

 Trading – ability to buy in bulk quantities at more optimal prices.
 Financial – larger firms are in a better position of borrowing at favorable
terms
 Technical – better efficiency through larger quantities of output
 Managerial – ability to employ specialist managers to increase efficiencies
 External – development of specialized labor force when firms cluster together
Factors that lead to diseconomies of scale:

 Control – too big firm may be difficult to manage and management may lose
control
 Local/firm’s infrastructure – there might be strains on local/firm’s
infrastructure as the scale of activities increases.
Examiner Comment:
The performance in this part of the question was below average as only about 20%
of the candidates secured passing marks. The requirement was to explain
economies and diseconomies of scale with the help of a long-run average cost
curve.
Generally the candidates were able to draw the U-shaped curve. However, the
economies and diseconomies were not correctly marked on the curve. The
explanation once again lacked content. Factors leading to economies of scale were
well described but only few could explain the factors leading to diseconomies of
scale.
21
14
Marking Plan;

 0.5 mark for mentioning each factor leading to economies and
diseconomies of scale 2.0
___________________________________________________________________________________________________
Q.22; Aut-18
One of the characteristics of a monopolist is the ability to engage in price
discrimination. Mention any three conditions required for price discrimination.
(03 marks)
Answer;
Three conditions that are required for price discrimination:

 Firm must have monopoly power in terms of setting prices.
 Each group of buyers must have a different elasticity of demand so that
consumer surplus can be extracted.
 Market is divided into sub-markets and each such sub-market is absolutely
separate i.e. it should not be possible to freely transfer units of the commodity
from one sub-market to another.
 It should not be possible for the buyers in the dearer market to freely sneak
into the cheaper market to take advantage of the low price.
Examiner Comment
This was a simple question requiring conditions required under which a monopolist
can resort to price discrimination. However, only about 50% of the candidates gave
the correct answer. Moreover, some candidates elaborated the conditions too much,
which was not required. They did not seem to understand that the requirement was
only to mention the condition, rather than explaining them. They even failed to
notice that it was just a 3 mark question.
Marking plan
01markforeachconditionrequiredforpricediscrimination 3.0
22
Q.23; Spr-19
Briefly describe the following diagram and the concept which it reflects.
(04 marks)
Answer;
The given diagram is of the kinked demand curve.

Theory of oligopoly suggests that once a price has been determined, it will not
change except to react to a competitor’s price change.
This means that members of a non-collusive oligopoly face a kinked (Bend) demand
curve as the reaction of competitors to a price change depends on whether price is
increased or decreased.
At the starting position the firm supplies Q0 at a price of P0.
Price increase
If the oligopolist raises price above P0 the rivals will maintain their price in order to
make the firm lose customers. Demand will move along the more elastic portion of
the demand curve to the left of Q0.
Price decrease
If the oligopolist cuts price below P0 then rivals will cut price too and hence there
will be little or no increase in demand. The firm will be forced on to the less elastic
portion of its demand curve to the right of Q0.
Examiner Comment
 Although candidates correctly identified the diagram, they could not explain the
impact of increase or decrease in price by the oligopolist on the quantity demand.
 The diagram was unnecessarily re-produced which resulted in loss of precious time.
23
Marking plan
Mark(s)
 Identification of the diagram 1.0
 Explanation of the diagram 3.0
Q.24; Spr-19
What is meant by ‘Costs of production’? Briefly describe implicit and explicit
costs and give two examples of each. (04 marks)
Answer;
Cost of production:
The overall costs incurred for producing a good or a service are called the costs of
production.
Explicit costs are the costs that have been incurred and have also been booked as
an expense. These are the expenses that are paid out costs and involve cash
outflows from the business.
Examples:
Examples include: salaries paid to the employees, prices of materials, overheads etc.
Implicit costs are the costs that have already been incurred but are not separately
shown as an expense while calculating the total cost of production.
Examples:
Examples include: salary of the entrepreneur, return on entrepreneur’s own
investment etc.
Examiner Comment
 The terms ‘Explicit or Implicit’ costs were either not properly defined or both concepts were
mixed up.
 Those who correctly defined the term ‘Implicit cost’ failed to give proper examples of it.
Marking plan
Mark(s)
 Definition of cost of production, implicit cost and explicit cost 3.0

 0.25 mark for each example of implicit cost and explicit cost 1.0
24
Q.25; Spr-19
What do you understand by the laws of increasing returns and diminishing
returns? List four basic assumptions underlying the law of diminishing
returns. (04 marks)
Answer;
The law of increasing returns:

When a variable factor of production is applied while other factors remain constant,
there is a more than proportional increase in the output.
The law of diminishing returns:
If additional units of a variable input factor are added to a given quantity of fixed
input factors, a situation would be eventually reached in which each additional unit
of the variable factor would add less to the total output than the previous unit.
Assumptions underlying the law of diminishing returns:
Following are the four basic assumptions underlying the law of diminishing returns
(increasing cost):
i. There is no change in the techniques of production or method of technology.
ii. The law is applicable in the short run as the supply of one or other factor cannot
be increased within the short span of time.
iii. All units of variable factors of production are assumed to be homogenous.
iv. The output is measured in physical units like tonnes, kilograms, etc.
Examiner Comment
 Candidates confused the concept of diminishing return with diminishing marginal utility.
Further, only one or two assumptions were listed.
 Some of the candidates opined that variable product instead of units of variable factors of
production should be homogeneous.
Marking plan
Defining the law of increasing returns 1.0
Defining the law of diminishing returns 1.0
0.5 mark for each basic assumption 2.0
25
Q.26; Spr-19
How does the law of increasing returns apply to the industrial sector?
(03 marks)
Answer;
Application of the law of increasing returns to the industrial sector:

The increasing return mainly arises due to the fact that large scale
production is able to secure certain economies of scale, both internal and
external.
These advantages may be on account of division of labour, specialized
machinery, commercial advantages of buying and selling wholesale,
utilization of by-products, use of extensive publicity and advertisement,
availability of cheap credit, etc.
The law of increasing return operates as long as the plant is producing
below capacity. The increase in the marginal return continues till the plant
begins to produce its full capacity
Examiner Comment
Candidates failed to answer this part of the question. Those who answered were only confined to
the statement that increasing returns arise due to economies of scale.
Marking plan
Explanation of the application of the law of increasing returns to the industrial sector
3.0
26
Q.27; Aut-19
Describe the concept of long-run equilibrium of a firm under monopolistic
competition with the help of a diagram. (08 marks)
Answer;
The above diagram depicts the concept of long run equilibrium of a firm under
monopolistic competition.
In the above diagram, AR = Average revenue curve, MR = Marginal revenue curve,
LAC = Long run average cost, LMC = Long run marginal cost.
In the long run the firms earns normal profit as new firms enter the industry and
starts production due to which supply increases and the price falls. The average
revenue curve is more elastic (i.e. flatter), since large number of substitutes are
available in the long-run.
AR is tangent to the LAC at P. The equilibrium output in the long-run is OM and the
corresponding price is MP (=OP’). Therefore, at this point the firm is in equilibrium
as both average revenue and average cost is at MP and the firm is earning normal
profits.
In the long-run, the following two conditions must hold. i.e.
Marginal Revenue = Marginal Cost and
Average Revenue = Average Cost
27
Examiner comment;
 Most of the answers were confined to the statements such as, marginal revenue is equal to marginal
cost and average revenue is equal to average cost.
 With regard to the type of profit which can be earned in long-run under the monopolistic
competition, examinees had divided opinions, some of them correctly discussed that only a normal
profit can be earned whereas in view of others it was either a supernormal or sub-normal profit or
even in some cases examinees discussed that a firm would sustain a loss in long-run.
 Many examinees also failed to draw a proper diagram. It lacked the basic concept that under a
long-run, LAC curve is always tangent to AR curve at a point which is vertical to the point where LMC
cuts MR curve from below.
Marking plan;
Labelled diagram of the long-run equilibrium of a firm under 2.5
monopolistic competition
Describing the concept with the help of the diagram 5.5
______________________________________________________________________________
Q.28; Aut-19
Show a graphical interaction of marginal cost, average variable cost, average fixed cost
and average total cost curves. (Explanation of the graph is not required)
(02 marks)
Answer;
Graphical representation of costs:
28
Examiner comment;
Most of the examinees were able to correctly draw only marginal cost or average total cost curves.
Majority of them were perplexed while drawing the average fixed cost curve and average variable cost
curves. Some examinees drew a horizontal straight line to depict average fixed cost curve.
Marking plan;
0.5 mark for drawing each correct curve 2.0
____________________________________________________________________________________________
Q.29; Spr-20
Identify and briefly discuss any four features which differentiate a market operating under
perfect competition from a monopoly.
(06 marks)
Answer;
The features which distinguish a market operating in an environment of perfect competition from a
market which operates as a monopoly are:
(i) Number of sellers - In conditions of perfect competition there are a large number of sellers in the
market. The individual sellers compete to sell their products in the market, but in a monopoly there is only
a single firm which sells the product.
(ii) Entry and exit of firms- In perfect competition, new firms can freely enter the industry and
inefficient firms can exit if they suffer losses. Under conditions of monopoly, there are several barriers
which are difficult to overcome for prospective new entrants.
(iii) Options available to buyers - In a market characterised by perfect competition, the buyers
have the option to purchase from any firm in the market. Under conditions of monopoly, the buyers must
purchase from the only seller who dominates the market.
(iv) Earning of normal and super-normal profits - In perfect competition, a firm may earn
super-normal profits in the short-run. In the long-run, the firm can earn only normal profits as new firms
would enter the market and force the prices to fall. Under conditions of monopoly, a firm can earn
super-normal profits in the short-run as well as in long-run due to the existence of barriers which prevent
entry of new firms.
29
Q.30; Spr-20
Briefly describe any four factors which are responsible for the success or failure of a price cartel
under oligopolistic market.
(04 marks)
Answer;
The failure or success of price cartels under oligopolistic market depends on following factors:
(i) Control on supply:
For the successful price cartel, firms under oligopolistic market must hold all or substantial market share.
(ii) Close substitutes:
Success of price cartel depends on non-availability of close substitutes of product otherwise when higher
price is set by oligopolists, the buyers will shift their demand to close substitutes.
(iii) Price elasticity of demand:
Price cartel will be successful if price elasticity of demand for a product is inelastic. Otherwise when
oligopolists set higher price, buyers contract demand more proportionately weakening the price cartel.
(iv) Agreement on individual share:
If all the firms in cartel agree on their allotted quota of supply, price cartels would be successful. However,
if firms secretly increase production and sale of the product, price cartels would collapse because at
increased supply, charging a higher agreed on price would not be possible.
30
Q.31; Spr-20
Discuss the concept and various stages depicted by the following diagram. Also identify the stage
in which rational decision is possible.
(08 marks)
Answer;
The above diagram shows the concept of law of variable proportion and its various stages.
According to the law of variable proportion:
As the quantity of one variable input in a production process is increased, with quantities of other
inputs remaining fixed, marginal product first increases, then after reaching a maximum, it starts
decreasing and finally becomes negative.
31
Three stages of the law:

Stage I:
In this stage, AP is maximum (R) whereas TP increases initially at increasing rate (L) and thereafter it
increases at diminishing rate (L to M). MP also increases initially and reaches its maximum (N) however,
later on it begins to diminish and becomes equal to AP (O). In this stage MP exceeds or is equal to AP.
Stage II:
In this stage, TP continues to increase at diminishing rate and reaches its maximum point (G).
Correspondingly MP diminishes rapidly and becomes zero (C). AP starts from its maximum (R) and
thereafter it begins to decrease. In this stage, MP is less than AP.
Stage III:
In this stage, TP starts diminishing, AP also continues to decline and MP turns negative thus law of variable
proportions firmly manifests itself.
A rational producer will not opt to stop production at Stage I because his fixed factor will remain
underutilized and he will be foregoing the opportunity of increasing production by increasing the quantity
of the variable factor whose average product continues to rise throughout in Stage I. He will also not
choose Stage III where not only average product is falling but also the total product is falling and marginal
product is negative. He would opt to produce in Stage II, where the marginal product continues to remain
positive.
32
Chapter # 06
Macroeconomics; An Introduction
Q.1; Aut-14
Draw a diagram of Circular Flow of Income? (04 marks)
Answer;
Examiner comment;
Q.2; Aut-14
List three types of ‘Withdrawals’ and ‘Injections’ from/into the Circular Flow of Income.
(03 marks)
Answer;
1
Examiner comment;
Q.3; Spr-15
Briefly describe three different approaches to measure National Income.
(06 marks)
Answer;
Examiner comment;
Q.4; Spr-15
Illustrate with the help of a diagram, the concept of deflationary gap in the
economy
(04 marks)
2
Answer;
Examiner comment;
Q.5; Spr-16
3
Answer;
Examiner comment;
Marking plan;
4
Q.6; Spr-16
Identify any six types of difficulties that are commonly faced in measuring
National Income. (03 marks)
Answer;
Examiner comment;
Marking plan;
Q.7; Spr-17
‘Income method measures the national income after it has been distributed and
appears as income earned or received by individuals of the country’.
List the items which are excluded from the computation of national income under
the income method.
(03 marks)
5
Answer;
Examiner comment;
Marking plan;
Q.8; Spr-17
Explain with the help of a diagram, the equilibrium of aggregate supply (AS) and
aggregate demand (AD) under neoclassical approach. (07 marks)
Answer;
6
Examiner comment;
Marking plan;
Q.9; Aut-17
Draw a diagram of the circular flow of national income. (04 marks)
Answer;
7
Examiner comment;
Marking plan;
Q.10; Spr-18
Answer;
(i) Equilibrium level of national income:

The equilibrium level of national income is given by:
Y=C+I+G+X-Z
OR Y = 0.4 Yd + 300 + 600 + 500 – 0.28Y
Y = 0.4×0.7Y + 1,400 – 0.28Y
Y = 0.28Y + 1,400 – 0.28Y = 1,400
8
(ii) Fiscal surplus / deficit:

The fiscal balance is given by:
T – G where T is the income from taxes and G is the government expenditure.
Therefore, T = 1,400 × 30% = 420 and
420 – 600 = 180 million (deficit)
Examiner comment;
In this part, the candidates were required to compute the equilibrium level of
national income and fiscal surplus/deficit from the given set of data. Majority of the
candidates who answered part (b) left this part unanswered. Many candidates who
attempted this part, only stated the formula for the computation of equilibrium level
of national income. Most of the students failed to adjust the disposable income while
computing the consumption expenditure. Further, very few students computed
surplus/deficit.
With regard to the computation of surplus/deficit, very few candidates attempted to
compute it.
Marking plan;
Q.11; Aut-18
The economy is in equilibrium at the point where short run aggregate supply (value of
output produced within an economy) is equal to aggregate demand (level of demand
for goods and services). Explain the equilibrium of economy with the help of a diagram
where a government has increased its spending and there is a rise in wage rates.
(07 marks)
9
Answer;
Illustration:
The existing equilibrium is at point A. An increase in government

spending would shift the aggregate demand curve outwards (i.e. from
AD1 to AD2) and now the equilibrium is determined at point B.
However, rise in wage rates would shift the short-run aggregate supply
curve inwards (i.e. from SRAS1 to SRAS2) and the new equilibrium is
determined at point C which would mean that increase in government
spending has been cancelled out by increase in wage rates and output
level returns to the same level as before.
Examiner comment;
Average performance was witnessed in this part of the question. About 60% of the
students drew the diagram correctly. Some students showed complete lack of
understanding as they drew upward sloping demand curve. Again many students could
not label the diagram correctly and lost easy marks. About 50% of those candidates who
drew the diagram correctly, explained the outward shift of the aggregate demand curve
but failed to properly explain the impact of increase in wages.
10
9
Marking plan;
______________________________________________________________________________________________________________
Q.12; Aut-18
List any three factors that may cause a shift in:
(i) aggregate demand curve (ii) short-run aggregate supply curve
(03 marks)
Answer;
(i)Aggregate demand curve
– Change in consumer income
– Change in government spending
– Imports or exports becoming more or less attractive
– Change in firms’ expectations of economy
(ii) Short-run aggregate supply curve
– Change in factor productivity (labor and capital)
– Change in size and quality of capital stock
– Change in size and quality of labor force
– Change in unit cost of labor
– Change in producer taxes or subsidies
– Change in inflationary expectations
Examiner comment;
Most of the candidates were able to identify the factors which cause shift in aggregate
demand curve but were unable to identify the factors which cause shift in short-run
aggregate supply curve.
Marking plan;
0.5 mark for identifying each factor causing a shift in aggregate demand
curve 1.5
0.5 mark for identifying each factor causing a shift in short-run aggregate
supply curve 1.5
______________________________________________________________________________________________________________
11
9
Q.13; Aut-18
Answer;
Examiner comment;
Average performance was witnessed in this part. Many students appeared confused
between GDP and GNP at market price. Moreover, only few could calculate or even
attempted to calculate GNP at factor cost. Further, many candidates did not show the
calculations and hence lost marks where their answers differed.
Marking plan;
0.5 mark for each component of GNP at market price 3.5
0.5 mark for each component of GNP at factor cost 1.5
____________________________________________________________________________________________
12
Q.14; Spr-19
State four types of difficulties which are usually associated with the measurement of
national income. (03 marks)
Answer;
Difficulties faced in measuring national income:
(i) Non-monetized transactions such as services of housewives and agricultural
products used by farmers for own consumption are generally not considered
while measuring the national income.
(ii) The barter transactions may either be totally ignored or included on the basis
of approximation.
(iii) Income of foreign firms creates complications i.e. whether to include it in
national income of the country of operation or country of origin.
(iv) Collection, compilation and analysis of statistical data is a highly technical and
difficult exercise and availability of sufficient trained staff is often difficult.
Examiner comment;
Candidates were only able to write the key words with regard to the difficulties
associated with the measurement of national income, such as double counting, non-
monetized transactions etc. without stating what they meant by these terms.
Marking plan;
0.75 mark for stating each difficulty 3.0

___________________________________________________________________________________________
Q.15; Aut-19
13
Answer;
Examiner comment;
 Some examinees made computational errors and included taxes on expenditures and subsidy as
component of GDP at market price.
 Few examinees also computed GDP, GNP and NNP at factor cost which was not required at all.
Marking plan;
Computation of GDP at market price 2.0
Computation of GNP at market price 1.0
Computation of NNP at market price 1.0

_________________________________________________________________________________________________________________
Q.16; Aut-19
Describe three different types of Injections and Withdrawals from the Circular Flow
of Income. (06 marks)
Answer;
INJECTIONS INTO THE CIRCULAR FLOW OF INCOME
Investments
Investments in capital goods are a form of spending on future output which is addition to
the expenditure and are therefore considered as injection of funds into the Circular Flow
of Income.
14
Government Spending
The funds spent by the government are injections in the Circular Flow of Income. The
funds may be raised by way of taxes or borrowings by the government.
Exports
The goods and services produced by the firms in the country and exported, result in
income from abroad and are therefore injections in the Circular Flow of Income.
WITHDRAWALS FROM THE CIRCULAR FLOW OF INCOME
Savings
Households do not spend all their income and save a certain portion. These savings are
withdrawals from the Circular Flow of Income.
Taxation
The amount of taxes paid to the government is not available for spending by the
households and is therefore considered as withdrawals from the Circular Flow of Income.
Imports
The expenditures incurred on the purchase of imported goods and services accrue to firms
in foreign countries and therefore constitute withdrawals from a country’s Circular Flow
of Income.
Examiner comment;
Some examinees mixed up the injections with withdrawals whereas few examinees only identified the
injections and withdrawals without any explanation.
Marking plan;
01 mark for describing each injection 3.0
01 mark for describing each withdrawal 3.0

___________________________________________________________________________________________
15
Q.17; Aut-19
Describe the concept of ‘Deflationary gap’ with the help of a diagram.
(04 marks)
Answer;
When the equilibrium in the economy is at less than its production potential, there exists a deflationary
gap.
The deflationary gap can be explained with the help of following diagram:
In the above diagram, short run aggregate supply is shown by the line SRAS and aggregate demand by
the line AD.
The actual level of national income is at the intersection of AD and SRAS i.e. at Ye whereas Yf is the
national income at full employment.
The gap between actual level of national income and national income at full employment i.e. Ye and Yf is
called a deflationary gap, as the price level is below of what it would be with full employment in the
economy.
16
Examiner comment;
 Many examinees plotted incomplete diagram. Those who drew the diagram correctly could
not explain it properly.
 Many examinees even failed to appreciate that actual level of national income lies at the
point where aggregate demand is equal to the short-run aggregate supply. Similarly many
examinees could not identify the production potential of the economy and as a result failed to
highlight deflationary gap on the diagram.
Marking plan;
Drawing a labelled diagram 2.0
Describing the concept of deflationary gap 2.0
_____________________________________________________________________________________________________
Q.18; Spr-20
Briefly describe any two methods used for measuring National Income.
(04 marks)
Answer;
(i) Expenditure approach:
This method arrives at national income by adding up all the expenditure incurred on goods and services
during the year.
(ii) Income approach:
This method measures the national income after it has been distributed and appears as income earned
or received by individuals of the country.
In this method, national income is calculated by adding up the rent of land, wages of employees, interest
on capital and profit earned by entrepreneurs/firms.
17
Q.19; Spr-20
Explain how equilibrium of aggregate demand (AD) and aggregate supply (AS) may
be achieved under neo-classical approach. Use diagram to illustrate your answer.
(07 marks)
Answer;
Equilibrium of AS and AD:
The equilibrium of aggregate supply (AS) and aggregate demand (AD) under neo-classical approach is
illustrated below:
In the above diagram, price level is measured on y-axis and real national output on x-axis. AD is the
aggregate demand curve whereas LRAS is the long run aggregate supply and SRAS is the short run
aggregate supply curves.
The macro economy is in equilibrium at the point where SRAS (value of output produced within an
economy) is equal to AD (level of demand for goods and services).
The reason why equilibrium does not arise at the intersection of LRAS and AD is that LRAS is the
productive potential in the economy. Whereas SRAS is what is actually being supplied in the macro
economy, and is therefore what equilibrium should be based upon.
If the general price level is above the equilibrium point, then firms will persistently find that their stocks
remain unsold. This then indicates that they should cut back on further production, to reduce the level of
inventory.
If, however, the general price level is below the equilibrium point, then demand will outstrip supply,
stocks will quickly become run down, thus signaling to producers that they should increase supply.
These mechanisms ensure that the macro economy is restored to equilibrium.
18
Chapter # 07
Consumption, Saving & Investment

Q.1; Aut-14
Explain the effect of an increase in household savings rate ? (03 marks)
Answer;
Examiner comment;
Q.2; Spr-15
Differentiate between Autonomous and Induced Investments. Give any two examples
of each. (04 marks)
Answer;
1
Examiner comment;
Q.3; Spr-15
Discuss the Keynes psychological Law of Consumption and the related
propositions? (04 marks)
Answer;
Examiner comment;
2
Q.4; Spr-15
Briefly describe the determinants of consumption in an economy? (06 marks)
Answer;
Examiner comment;
Q.5; Aut-15
The rate of interest and marginal efficiency of capital (MEC) determine the level of
investment in an economy. Explain the relationship between rate of interest and
MEC with the help of a diagram. (07 marks)
Answer;
There is an inverse relationship between the rate of interest and marginal efficiency of
capital (MEC) i.e. higher the rate of interest, lower the MEC and vice versa. As long as the
MEC is greater than interest rate, firms will continue to invest. When MEC = rate of
interest, equilibrium investment is determined. Thereafter, investment would only increase,
when either the rate of interest falls or MEC rises.
3
In above diagram, MEC curve represents the level of investment that will take place in the
economy at various levels of interest rate. At interest rate ro, investment Io is marginally
efficient i.e. has a net present value of 0 (or its internal rate of return equals rate of interest).
All points to the left of the MEC have a positive net present value. If the interest rate falls to
r1, then further investment would become feasible up to total investment I1 which is now
marginally efficient.
Examiner comment;
Marking plan;
Q.6; Aut-15
The MEC curve shifts outwards when expected rate of return increases. Briefly
discuss any three other factors that might cause an outward shift in MEC
curve. (03marks)
4
Answer;
The following other factors might cause an outward shift in MEC curve:
(i) Demand for product
If demand for particular product is expected to grow, it would induce the firms to
make investment thereby, shifting MEC curve to the right.
(ii) The state of confidence
If firms are optimistic about the favourable economic changes such as fall in costs,
they would expect the greater returns and be willing to make investments.
(iii) Technological development
Advances in technology and new inventions would make investment more
productive. Increase in productivity would cause the firms to invest more at a given
rate of interest thereby, MEC curve would shift outwards.
(iv) Government policy
The government policy as reflected by taxation or other regulations may affect
profitability of certain investments. Tax exemptions or subsidies may enhance the
profitability of firms which would shift the MEC outwards.
Examiner comment;
Marking plan;
Q.7; Spr-16
Briefly explain any four measures by which Govt. may influence the level of
private investment in an economy? (04 marks)
Answer;
5
Examiner comment;
Marking plan;
Q.8; Aut-17
Explain the concept of Marginal propensity to save and how it is calculated. Also
explain any four determinants of savings? (07 marks)
Answer;
6
Examiner comment;
Marking plan;
7
Q.9; Aut-17
Briefly describe the concepts of Autonomous and Induced Consumption? (03 marks)
Answer;
Examiner comment;
Marking plan;
Q.10; Spr-18
State Keynes Psychological Law of Consumption and the allied propositions?
(04 marks)
Answer;
Keynes’ Psychological Law of Consumption:
According to Keynes Psychological Law of Consumption, people increase their consumption as their
income increases, but not by as much as their income increases.
The law consists of three related propositions:
(i) Aggregate consumption can increase due to increased aggregate income, but the increase in aggregate
consumption will be less than the increase in income. This is because as basic necessities are fulfilled,
people begin to save additional income.
(ii) What is not spent on consumption is saved. (ΔY=ΔC+ΔS)
(iii) The increase in aggregate income will lead to increased consumption or savings. It is not possible for
savings and consumption to decrease when income increases.
8
Examiner comment;
This part required the candidates to state Keynes’ Psychological law of Consumption
and its allied propositions. The performance remained good as majority of the
candidates correctly defined the law and stated its three related propositions. The
most common error made by the students was that they only produced the law but
did not mention the three propositions.
Marking plan;
Definition of Keynes’ Psychological law of consumption 1.0

01 mark for stating each related proposition 3.0
Q.11; Spr-18
Briefly describe any four objectives which influence the consumption function in
an economy? (06 marks)
Answer;
Objective factors influencing the consumption function:

Following are the factors which influence consumption function in an economy:
(i) Real income:
Increase in real income would lead to increase in consumption and vice versa.
(ii) Distribution of income:
Change in pattern of income distribution would result in change of consumption. A more equal distribution of
wealth will raise the propensity to consume.
(iii) Expectations of price changes:
If prices are expected to rise, people will be motivated to spend more and accumulate goods, hence increase in
consumption.
(iv) Changes in fiscal policy:
Reduction in taxes would leave more post-tax incomes with the people and this will stimulate higher
expenditure on consumption.
(v) Changes in interest rates:
Decrease in interest rates would increase the amount of disposable income of people and thus encourage
consumption
Examiner comment;
This part asked candidates to describe any four objective factors which influence the
consumption function in an economy. The performance in this part was average.
9
Some candidates only provided the list of objective factors without any description.
Majority of the students mentioned two or three factors only.
Marking plan;
1.5 marksfordescribing eachobjective factor influencing consumptionfunction

in an economy 6.0
Q.12; Aut-18
What do you understand by Marginal efficiency of Capital (MEC) ? Explain the
relationship between rate of interest and the level of investment with reference to
MEC with the help of a diagram. (08 marks)
Answer;
MEC can be explained as the rate of discount that would make the present value of the prospective yields
from the capital asset equal to its supply price.
There is an inverse relationship between the rate of interest and the level of investment i.e. higher the rate
of interest, lower the level of investment and vice versa. This relationship in terms of MEC, can be explained
with the help of following diagram:
In the above diagram, MEC curve represents the level of investment that will take place in the economy at
various levels of interest rate. At interest rate ro, investment Io is marginally efficient i.e. has a net present
value of 0 (or its internal rate of return equals rate of interest). All points to the left of the MEC have a
positive net present value. If the interest rate falls to r1, then further investment would become feasible up
to total investment I1 which is now marginally efficient.
10
9
Examiner comment;
The performance in this part of the question was quite poor. A large number of students
ignored the requirement to define the term Marginal Efficiency of Capital. The diagram
was easily drawn, but the explanation focused more on relationship between interest rate
and marginal efficiency of capital rather than interest rate and investment. Many
candidates did not seem to understand that there is an inverse relationship between
interest rate and investment and not between investment and MEC. Some students
mentioned a direct relationship between rate of interest and investment instead of an
inverse relationship. Many students prepared schedules and calculations also, which were
not required. In many cases diagrams were not clearly labelled and in some cases even
diagrams were not labelled at all.
Marking plan;
Explanation of Marginal efficiency of capital (MEC) 1.0

Explanation of relationship between rate of interest and level of
investment 1.0
Explanation of diagram 3.5
Q.13; Aut-18
Explain the impact of decrease in interest rates on firms and individuals? (02 marks)
Answer;
A decrease in interest rate would impact firms and individuals as follows:
 Firms would be encouraged to invest more as it would be easier for firms to earn an adequate return on
project since cost of investment has reduced.
 Individuals would be discouraged to save more as their savings would give low return and they would
likely incline towards more consumption.
Examiner comment;
This question was generally well attempted. Still, there were many candidates who
thought that the impact of decrease in interest rates for the firm and the individuals would
be the same.
Marking plan;
Explanation of the impact of decrease in interest rates on firms 1.0
Explanation of the impact of decrease in interest rates on individuals 1.0
11
Q.14; Spr-19
Define Average propensity to consume and Marginal propensity to consume. How are
these calculated? (04 marks)
Answer;
Average propensity to consume:
The average propensity to consume is a relationship between total consumption and total income in a given
time period. It is the ratio of aggregate consumption to aggregate income.
Computation:
The formula for its computation is as under:
C
APC 
Y
Where, C stands for aggregate consumption and Y for aggregate income.
Marginal propensity to consume:
When income changes consumption also changes. Marginal propensity to consume is the ratio of change in
consumption to change in income.
Computation:
The formula for its computation is as under:
C
MPC 
Y
Where, ΔC stands for change in consumption and ΔY for change in income.
Examiner comment;
Both concepts were mixed up.
Formulas to compute APC and MPC were not provided.
Marking plan;
Definition of ‘Average propensity to consume’ 1.0
Definition of ‘Marginal propensity to consume’ 1.0
01 mark for each formula 2.0
___________________________________________________________________________________________________________________
Q.15; Spr-19
Briefly describe Autonomous Investment and Induced Investment. Who may
undertake such investments ? In respect of each of the above types of investment,
draw investment curve and give two examples.
(06 marks)
12
Answer;
Autonomous investment:
Investment which is independent of the level of income or profits is called autonomous investment.
Autonomous investment depends more on population growth and technical progress than on anything else and
is ordinarily undertaken by public bodies, or private organisations not pursuing profit.
Autonomous investment curve:
Examples:
Construction of highways
Street lighting
Other infrastructure projects
Induced investment:
Investment which varies with change in national income is called induced investment
This type of investment is usually undertaken by private enterprises in pursuit of maximising profit. The greater
the margin, the more will be invested until the economic gains no longer outweigh the costs.
Induced investment curve:
Examples:
Improvements to machinery
Human capital (i.e. staff training that will generate an economic return)
New assets
13
Examiner comment;
Candidates failed to identify who may undertake such investments.
A negative slope was drawn for induced investment curve instead of a positive slope.
Marking plan;
Describing autonomous investment 1.0
Describing induced investment 1.0
Identification of who may undertake such investments 1.0
01 mark for drawing each curve 2.0
0.5 mark for the examples of each type of investment 1.0
____________________________________________________________________________________________
Q.16; Aut-19
Briefly describe any four determinants of savings? (05 marks)
Answer;
Determinants of savings:
(i) Level of income
Saving is determined by the level of income. There is a direct relation between the two i.e., savings increase as
the level of income increases.
(ii) Net wealth
A household’s net wealth is the value of all assets owned by a household, less any liabilities or debt owed. A
decrease in net wealth would make consumers less inclined to spend and more inclined to save at each income
level.
(iii) Interest rate
Interest is the reward for increasing savings by reducing consumption and the amount paid by borrowers for
current spending power. An increase in interest rate, other things held constant, will lead to less spending and
thus higher savings.
(iv) Objective and institutional factors
Factors such as political stability and security of property encourage people to save more. Similarly, an
established system of banks and other financial institutions promotes savings by way of interest earning motives.
Examiner comment;
Some examinees identified the four determinants of savings however, they failed to describe them
properly.
Marking plan;
1.25 marks for describing each determinant of savings 5.0
14
Q.17; Aut-19
Describe any three short run factors which may affect marginal efficiency of capital
and investment? (03 marks)
Answer;
Factors that affect investment and MEC:
Short-run factors:
(i) Demand for product:
If demand for particular product is expected to grow, it would induce the firms to make investment thereby,
shifting MEC curve to the right.
(ii) The state of confidence:
If firms are optimistic about the favourable economic changes such as fall in costs, they would expect the greater
returns and be willing to make investments.
(iii) Liquid assets
If the assets an entrepreneur holds can easily be sold for cash then it may result in more investment.
Examiner comment;
 Majority of the examinees were not able to define all the three short-run factors.
 Many examinees wrongly defined current rate of investment, technological development, rate of
growth of population etc. as short-run factors where in fact these are the long-run factors.
Marking plan;
01 mark for the description of each short-run factor 3.0
____________________________________________________________________________________________
15
14
Q.18; Spr-20
What causes an upward or downward shift in the consumption function? Use diagram stating
two determinants of consumption function to support your answer.
(03 marks)
Answer;
An increase or decrease in the level of consumption at each level of disposable personal income
respectively shifts the consumption function upward or downward.
In the following diagram, the consumption function has shifted upward. (C1 to C2). This
means consumers are spending a larger percentage of their income. This could be due to:
 positive forecasts about economic prospects increasing consumer confidence; or
 reduction in price level increasing consumers’ real wealth. (wealth effect)
Similarly, the consumption function may shift downward (C1 to C3) with the increase in the price level
(decrease in real wealth) or increase in consumer pessimism with regard to future economic prospects.
(decrease in consumer confidence).
16
Chapter # 08
Multiplier and Accelerator
Q.1; Aut-15
Output is determined where savings of all of the households in an economy are equal to the
desired investment opportunities. Explain the equilibrium between savings and investments
with the help of diagram.
(10 marks)
Answer;
The equilibrium between savings and investments with the help of diagram is explained as
follows:
The curve II indicates the intended investment levels which for the purpose of simplicity
are assumed to remain same at each level of GDP and therefore a horizontal line. The
curve SS represents saving levels that are primarily dependent on disposable income. In
above diagram, saving and investment curves intersect at point E. This point corresponds
to a level of GDP given at point M and represents equilibrium level of output in an
economy. At this level of output, the desired saving of households equals the desired
investment of firms.
It is important to note that saving and investment would always tend to be in
equilibrium in the long-run. Whenever there is disequilibrium, the forces of demand and
supply would bring them back to an equilibrium position as explained below.
1
Consider point A, where desired saving of households is higher than the desired
investment of firms. Increase in savings mean decrease in consumption and consequent
reduction in demand. As a result, firms would cut back production and lay off workers
until investments and savings are in equilibrium and therefore, new output level would be
determined.
Similarly consider point B, where desired saving of households is lower than the desired
investment of firms. In response to increased demand, firms would continue to increase
production and employ more workers until investment and saving are in equilibrium and
therefore, new output level would be determined.
Examiner comment;
Marking plan;
Q.2; Spr-16
What do you understand by the term ‘Multiplier’? With the help of a diagram show the
multiplier effect of an increase in investment by Rs. 100 million on the equilibrium level of
income where marginal propensity to save is 1/3.
(06 marks)
Answer;
2
Examiner comment;
Marking plan;
Q.3; Aut-16
Discuss gross investment and explain its relevance to the accelerator principle.
(03 marks)
Answer;
Examiner comment;
Marking plan;
3
Q.4; Aut-16
Answer;
Examiner comment;
Marking plan;
Q.5; Spr-17
In an open economy, the marginal propensity to consume is 0.7 and the proportion of additional income that is
spent on imported goods is 20%. National income is Rs. 100,000,000 and the current account is in balance. What
would be the new equilibrium of national income if the government increases its expenditure by Rs. 50,000,000?
(02 marks)
4
Answer;
Examiner comment;
Marking plan;
Q.6; Aut-17
Describe the principle of accelerator. Also state the assumptions underlying the principle of
accelerator. (05 marks)
Answer;
Examiner comment;
Marking plan;
5
Q.7; Aut-17
Identify and explain any four limitations of ‘Multiplier’.
(05 marks)
Answer;
Examiner comment;
Marking plan;
Q.8; Spr-19
Compute the multiplier, if in an economy, out of every additional Rs. 100 of national
income, 8% is saved, 15% is paid in taxes and 17% is leaked from the economy in
imports. (02 marks)
6
Answer;
Computation of multiplier:
Calculation of the value of multiplier:
Multiplier = 1 ÷ (sum of the propensities to save + tax + import)
= 1÷ (0.08+0.15+0.17) = 1÷0.4 = 2.5
Examiner comment;
The effect of leakages from the economy while computing the value of multiplier was
ignored.
Marking plan;
Computation of multiplier 2.0
Q.9; Aut-19
Assume in a closed economy with no government intervention, Rs. 1 billion increase in
investment results in Rs. 5 billion increase in consumption. Compute the value of marginal
propensity to consume.
(03 marks)
Answer;
Examiner comment;
Except for writing the equation 1/1-MPC, majority of the examinees completely failed to compute the
MPC.
Marking plan;
Computation of marginal propensity to consume 3.0
7
Q.10; Spr-20
What would be the multiplier effect of an increase in investment by Rs. 50 million on the
equilibrium level of income where marginal propensity to consume is 0.8 and the proportion of
additional income that is spent on imported goods is 30%? Illustrate your answer with the
help of a diagram.
(06 marks)
Answer;
Multiplier effect:
In the above diagram, SS is the saving curve and II is the investment curve. These two curves intersect at
point E and hence, the equilibrium level of income is determined. If now there is an increase in
investment by Rs. 50 million, then II curve will shift upward to the position of I’I’ and the two curves I’I’
and SS will intersect at point E’ which would be the new equilibrium level of income. Hence, the diagram
shows that an increase in investment by Rs. 50 million would increase the national income by Rs. 100
million (1 ÷ (1-MPC + MPM) × change in investment) i.e. 1÷(1-0.8+0.3). Thus the value of multiplier is
equal to 2.
8
Chapter # 09
Growth and taxes
Q.1; Aut-14
Analyse the effect of imposition / increase of indirect taxes on producers and consumers
and its relationship with the elasticities of demand and supply.
(10 marks)
Answer;
An indirect tax increases the cost of products. Its effect on the market place depends upon the relative
elasticities of demand and supply and the extent of the tax charge.The market would either pass on the cost
to consumers or to bear the affect by way of a reduction in profit. At first consideration it might appear that a
simple solution of passing the entire amount of tax on to the consumer would be considered to be
appropriate.
The following diagram indicates the effects of indirect taxes on elasticity of demand and supply.
As the diagram shows, the effect of the tax increase is indicated by a leftward shift of the supply curve. This
signifies that the firms in the market have incurred an increase in costs, in this instance arising from the
government demand that tax should be raised on the sales of the goods in question. As can be seen, the
equilibrium price increases from P1 to P2 which results in a contraction in demand from Q1 to Q2. The
proportion of the tax paid by the consumers is the increase in price attributable to the tax change. Obviously,
this is the difference between P1 and P2.
1
However, the consumers do not bear the entire burden of the tax. As shown on the diagram the total tax increase is
indicated by the vertical distance between the two supply curves marked as ab. Thus, if the consumers are
contributing P2-P1 (or ac) the producers are contributing the rest, shown as cb.
The extent to which firms can pass on the tax increase depends upon the elasticity of demand in relation to the
elasticity of supply. Therefore,
 If the demand is inelastic or supply is elastic, the consumer would need to bear the major portion of the
burden of tax.
 If the demand is elastic or supply is inelastic, the producer would need to bear the major portion of the
burden of tax.
It may also note that the larger the elasticities of demand and supply for a good, the greater will be the reduction in
output following a rise in indirect taxation on that good. If the combined elasticities are high, not only the firm will
have to absorb most of the tax increase itself but output will also fall resulting in a fall in total revenue. This
represents an additional burden on the producer.
Examiner comment;
In this question the candidates were required to analyse the effect of imposition of indirect taxes on producers
and consumers and its relationship with the elasticities of demand and supply. This proved to be a difficult
question. In fact, only about 30% of the students attempted this question from Section B. Most of them could
only explain the impact on demand for the product and to some extent its linkage with elasticity of demand
but very few could explain the relationship with elasticity of supply.
Q.2; Aut-14
What is meant by the term ‘Recession’? What economic characteristics are commonly
observed during recessionary periods?
(06 marks)
Answer;
2
Examiner comment;
Q.3; Aut-15
Indirect taxes are usually unavoidable and broaden the tax base. Specify the probable
advantages and disadvantages of indirect taxes.
(07 marks)
Answer;
Advantages of indirect taxes:
 Indirect taxes can correct externalities. If a product causes direct external costs (e.g. unwanted
imports or products involve health costs associated with alcohol or cigarettes etc.), indirect taxes can
be used to mitigate them.
 Indirect taxes have wider coverage and are usually unavoidable. Being part of final price of
product, indirect taxes cannot be easily avoided.
 Unlike direct taxes which are charged against income, indirect taxes facilitate consumers to make
a choice by simply not consuming certain products.
Disadvantages of indirect taxes:
 Indirect taxes are regressive. Every consumer of the taxed commodity pays the same tax
regardless of his/her income which promotes unequal distribution of wealth.
 The incidence of indirect taxes is inevitably passed on the consumers in the form of increased
prices which causes cost-push inflation.
 Indirect taxes may be uneconomical to collect as several intermediaries are involved in the
collection and the process involves a very large number of transactions that may require close
monitoring of the activities.
 Indirect taxes may be uncertain as it is not always possible to anticipate the collection on account
of tax imposed on a particular commodity.
 As indirect taxes are incorporated in the price of commodity, it may not promote civic
consciousness among tax payers as they might not feel the burden of taxes.
Examiner comment;
3
Marking plan;
Q.4; Spr-16
Briefly describe any two features of each of the following:
(i) An economy in a period of downturn
(ii) Good taxation system
(04 marks)
Answer;
Examiner comment;
Marking plan;
Q.5; Aut-16
Identify and briefly explain the different phases of business cycle.
(06 marks)
4
Answer;
Examiner comment;
Marking plan;
Q.6; Aut-16
List any eight indicators which would confirm the stages of business cycle the economy is in.
(04 marks)
5
Answer;
Examiner comment;
Marking plan;
Q.7; Aut-16
What is meant by ‘direct taxation’ and ‘indirect taxation’? Give two examples of each type
of taxation.
(04 marks)
Answer;
6
Examiner comment;
Marking plan;
Q.8; Aut-16
State any three advantages and three disadvantages of direct and indirect taxation.
(06 marks)
Answer;
7
Examiner comment;
Marking plan;
Q.9; Spr-17
What is meant by ‘Economic growth’? Briefly describe the benefits of economic growth.
(08 marks)
Answer;
8
Examiner comment;
Marking plan;
Q.10; Spr-17
Explain any two limitations of fiscal policy.
(10 marks)
Answer;
9
Examiner comment;
Marking plan;
Q.11; Aut-17
What is meant by ‘Regressive’, ‘Proportional’ and ‘Progressive’ taxes? Give one example of
each of the above types of taxes in the context of Pakistan.
(06 marks)
Answer;
Examiner comment;
Marking plan;
10
9
Q.12; Aut-17
State any eight characteristics which are important for creating a good system of taxation.
(04 marks)
Answer;
Examiner comment;
Marking plan;
Q.13; Spr-18
Identify and describe the stage of business cycle which eventually takes the economy into
recession.
(04 marks)
Answer;
The stage of business cycle which takes the economy into recession:
Downturn is the stage where the economic activity begins to slow down.
When demand begins to decrease, firms begin to scale back their production and investment plans.
There is a steady decline in output, profits, prices and employment as demand falls, and firms respond by
reducing their output.
Banks reduce the credit they issue, firms reduce orders that they place, and people begin to lose their
jobs, which further decreases the level of aggregate demand. This eventually takes the economy into a
state of recession.
11
9
Examiner comment;
The overall performance was very poor. Majority of the candidates failed to identify ‘Downturn’ as the
stage of business cycle which eventually takes the economy into recession. Most of the candidates drew
a diagram and wasted considerable time explaining various stages in detail although the requirement
was just to explain the stage preceding Recession.
Marking plan;
Identification of the business cycle 1.0
Description of the identified business cycle 3.0
Q.14; Spr-18
Alongside the benefits of economic growth, certain costs are also associated with it.
Identify and discuss the costs associated with economic growth.
(06 marks)
Answer;
The costs associated with economic growth.
Following are some of the costs associated with economic growth.
(i) Inflation:
When economy grows too quickly, Aggregate Demand exceeds Aggregate Supply because of which
economic growth is not sustainable as it results in positive output gap which prompts the firms to push
up their prices.
(ii) Current account deficit:
Economic growth causes an increase in spending on imports which consequently causes a deficit on the
current account.
(iii) Inequality:
More often increase in the rate of economic growth results in an increased level of inequality because
the growth may benefit a small section of the society more than the others.
(iv) Negative externalities / Environmental costs:
Rapid growth can give rise to plenty of environmental concerns; which includes noise pollution, air
pollution, road congestion, household and industrial waste, deforestation, etc.
Examiner comment;
The performance in this part was better than that of part (a). Many candidates were able to
identify and define at least one or two costs associated with economic growth. However, some
candidates did not comprehend the requirement of the question and deliberated on the benefits
of economic growth which had not been asked.
12
Marking plan;
(b) 0.5 mark for identification and up to 01 mark for describing each cost 6.0
______________________________________________________________________________________________________
Q.15; Spr-18
Identify four main objectives of fiscal policy and briefly describe how these objectives may
be achieved.
(04 marks)
Answer;
Objectives of fiscal policy:
Following are the objectives of fiscal policy:
(i) High level of Employment: The state expenditure are directed towards public projects thereby
creating employment with productivity.
(ii) Resource Mobilization: Fiscal mechanism attempts at resource mobilization by creating a climate
conducive to savings and investments, by influencing their relative profitability.
(iii) Resource Allocation: A fair share of resources is allocated to different sectors and regions through
the budgetary mechanism.
(iv) Economic stability: Undesired pace of inflation or deflation is controlled by way of taxation and
government spending.
(v) Income Distribution: Fiscal policy is a combination of taxation and relief measures which are used
to correct imbalances resulting from the unequal distribution of ownership of income earning assets.
Examiner comment;
This part required candidates to identify four main objectives of fiscal policy and describe how these
objectives may be achieved. Majority of the candidates performed well on the question. Candidates
could not score full marks either due to their failure in identifying all the four objectives of fiscal policy or
due to incomplete description of how such objectives may be achieved. Moreover, some candidates
wrote the objectives of monetary policy instead of fiscal policy.
Marking plan;
0.5 mark for identification and 0.5 mark for describing each objective of fiscal policy
4.0
____________________________________________________________________________________________
13
Q.16; Aut-18
Explain four main canons of taxation as suggested by Adam Smith that are usually
considered by a government while designing the tax system of the country.
(08 marks)
Answer;
Four main canons of taxation as suggested by Adam Smith are explained below:
(i) Canon of Equality:
According to canon of equality, tax should be paid in proportion to the ability of the tax payer i.e. the
amount of revenue generated by (income of) tax payer. This requires progressive taxation where tax
payers have to pay higher rate of tax as their income increases.
(ii) Canon of Certainty:
According to this canon, there should be no ambiguity as to the timing, manner and amount of tax
payment expected from tax payer. Tax budgets are given publicity and transparency to make the tax
payers aware of as to why and when they are expected to pay a particular sum.
(iii) Canon of Convenience:
According to this canon, time and manner of tax payment should be convenient for the tax payers. For
example, consumers paying taxes at the time of purchase of goods or services or tax being deducted at
the time of payment of salaries.
(iv) Canon of Economy:
According to this canon, tax should be economical in terms of its collection. Tax policies should be as
such to ensure maximum tax is collected and in the most economical manner.
Examiner comments;
This part of the question was very well attempted and most of the candidates who
attempted it obtained high marks.
Marking plan
0.5 mark for identification of each canon of taxation 2.0
1.5 marks for explanation of each canon of taxation 6.0
14
Q.17; Aut-18
There is a series of events that occur throughout the business cycle but there are certain
indicators that can be identified and used to assess at what stage the economy is in. List
any two such indicators under the headings of:
(i) Leading economic indicators (ii) Lagging economic indicators
(02 marks)
Answer;
(i) Leading economic indicators:

 index of business confidence
 manufacturers’ orders
 building permits for private housing
 money supply
(ii) Lagging economic indicators:
 consumer price index (i.e. level of inflation)
 average duration of unemployment
 interest rates
 average income
Examiner comments;
This part was poorly attempted as most of the candidates were not familiar with the terms ‘Leading
indicators’ and ‘Lagging indicators’. Consequently, many candidates who did well in part (a), omitted
this part altogether. Many students used guesswork as they seemed to believe that leading means
important and lagging means relatively unimportant.
Marking plan
0.5 mark for listing each of the leading economic indicators 1.0
0.5 mark for listing each of the lagging economic indicators 1.0
15
14
Q.18; Spr-19
Describe four limitations of fiscal policy.
(06 marks)
Answer;
Limitations of fiscal policy:
Following are the limitations of fiscal policy:
(i) Forecasting
The fiscal policy is devised around predictions of various economic activities. For the fiscal policy to work
as desired, these predictions need to be reasonably accurate. However, making reasonably accurate
prediction is not easy.
(ii) Time lag
Time lag means the difference between the time the action is taken and the time when the fiscal
measure has its impact felt.
(iii) Crowding out
Increased government spending for stimulating aggregate demand might result in crowding out i.e.
decreasing the size of private sector due to increased government spending.
(iv) Tax
Raising taxes to reduce deficit reduces Aggregate Demand. Moreover, it may cause demotivation to
work. Consequently a fall in productivity might be observed and Aggregate Supply may fall.
Examiner comment;
 Candidates were able to correctly describe only two or three limitations of fiscal policy.
 Some candidates without comprehending the question, deliberated on monetary policy.
 With regard to the time lag, candidates were of the opinion that it is the difference between the time
when the policy is formulated and the time when it is implemented instead of the time when the
action is taken and the time when the fiscal measure has its impact felt.
Marking plan; Mark(s)

1.5marksfordescribingeachlimitation 6.0
____________________________________________________________________________________________________
14
16
Q.19; Spr-19
State two advantages and two disadvantages of indirect taxation.
(04 marks)
Answer;
Advantages of indirect taxation:
 Change the pattern of demand: the government can alter the demand for a product say
imported and luxury goods.
 Can correct externalities: if a product causes direct external costs (e.g. health costs associated
with alcohol or cigarettes), the tax can be used to lower down the consumption.
Disadvantages of indirect taxation:
 Increases inequality: regardless of their incomes, people are faced with the same tax on a
good.
 Causes cost-push inflation: increases the price of inputs for goods.
Examiner comments;
Good performance was observed in this part
Marking plan
 01 mark for each advantage of indirect taxation 2.0
 01 mark for each disadvantage of indirect taxation 2.0
Q.20; Spr-19
What is meant by the term ‘Coincident economic indicators’ in the context of assessment of
a country’s economic stage in a business cycle? Also identify the economic characteristics
which are usually observed during recessionary periods.
(05 marks)
Answer;
Coincident economic indicators:
These indicators are events and measures that indicate a peak or trough. These include:
 Number of people in employment
 Industrial production
 Personal incomes
 Size of manufacturing and trade
17
14
The economic characteristics which are most commonly observed during a recessionary period are:
(i) decline in demand for labour followed by layoffs and increase in unemployment rates.
(ii) fall in demand for capital goods, consumer durable goods and luxury items and downward trend in
their prices.
(iii) sharp drop in business profits.
(iv) decline in volume of shares traded on the stock exchanges and fall in their prices.
(v) decline in the demand for credit accompanied by drop in interest rates.
Examiner comments;
 Instead of defining the coincident economic indicators, candidates deliberated on different stages
in the business cycles.
 The economic characteristics of recession was not clearly identified and was mixed up with
recovery and depression.
Marking plan
Explanation of ‘Coincident economic indicators’ 2.0
Identification of economic characteristics observed during recessionary
periods 3.0
Q.21; Aut-19
State three advantages and three disadvantages of direct taxation.
(03 marks)
Answer;
Advantages of direct taxation:
 Equitable: people with higher incomes pay more to the society than those with less income,
creating a more equitable distribution of (net) wealth.
 Cost of collection is low: it is an economical way of raising revenues, saving expense.
 Relative certainty: the government can estimate how much it will receive allowing better
planning of projects.
Disadvantages of direct taxation:
 Possible to evade: it is possible to falsify tax claims meaning the correct amount is not always
paid.
 Unpopular: the end user will often try to find ways to avoid paying it.
 Discourage savings/ investment: if too high, then it would leave consumers and firms less
money to put to other causes and larger investor would explore investment outside the country.
18
14
Examiner comments;
Majority of the examinees’ correctly deliberated on the advantages and disadvantages of direct
taxation.
Marking plan;
0.5 mark for each advantage and each disadvantage of direct taxation 3.0
_____________________________________________________________________________________________________
Q.22; Aut-19
Describe any three benefits of economic growth.
(03 marks)
Answer;
Benefits of Economic Growth:
Following are benefits of economics growth:
(i) Higher Employment/lower unemployment
Real economic growth gives rise to higher employment. This is because with higher levels of output,
firms tend to employ more workers.
(ii) Increased tax revenues
Growth boosts the government finances by way of taxes that in turn help to reduce the budget deficit.
(iii) Enterprise confidence
Sustained economic development casts a positive impact on company profits and raises business
confidence.
Examiner comments;
Most of the examinees identified and described the benefits of economic growth, however, some of
them found it challenging to describe the benefits.
Marking plan;
01 mark for describing each benefit of economicgrowth 3.0
_______________________________________________________________________________________________________
19
14
Q.23; Spr-20
Briefly describe ‘Leading economic indicators’ and ‘Lagging economic indicators’. Give two
examples of each.
(04 marks)
Answer;
Leading economic indicators:
The nature of these indicators is that they are used to forecast at what stage the economy will be in, at
some time in the future.
These in particular give an indication for whether a peak or trough will be reached in the following 3-12
months.
(i) Index of business confidence
(ii) Manufacturers’ new orders
Lagging economic indicators:
These indicators are used to assess whether an economy has reached a peak or trough 3- 12 months
after it would have occurred.
(i) Consumer Price Index (i.e. level of inflation)
(ii) Average duration of unemployment
Q.24; Spr-20
State four main functions of taxation.
(04 marks)
Answer;
Functions of taxation:
Following are the four main functions of taxation:
(i) Fiscal:
Taxes play their role in the formation of the budget necessary for the realization of national and holistic
government programmes. It funds the government expenditures.
(ii) Allocation:
It acts as a means of distributing wealth among various groups of citizens: wealthy to poor, as a means
of maintaining a social stability.
(iii) Regulatory:
This function is aimed at achieving specific goals of the taxation policy through the taxation mechanism.
(iv) Incentive:
It stipulates special taxation arrangements for certain members of society as a result of past achievement.
This function has a social facet.
20
Q.25; Spr-20
What do you understand by the terms ‘Expansionary fiscal policy’ and ‘Contractionary fiscal
policy’? List two tools in respect of each of the above two policies which the government may
use for their implementation.
(03 marks)
Answer;
Expansionary fiscal policy:
A macroeconomic policy that seeks to increase the rate of economic growth.
Contractionary fiscal policy:
A macroeconomic policy that seeks to slow down the rate of economic growth.
List of tools which the government may use to implement expansionary or contractionary
fiscal policies.
Expansionary:
 Tax cuts
 Tax rebates
 Increased government spending
Contractionary:
 Increase taxes
 Reduce subsidies
 Wage freeze
21
Chapter # 10
Public Finance
Q.1; Spr-17
Briefly describe the main functions of ‘Public finance’ as stated by Musgrave.
(06 marks)
Answer;
Examiner comment;
Marking plan;
1
Q.2; Spr-18
In recent times, public expenditure has increased enormously. Briefly describe any four
principal causes of growing public expenditure of nations.
(06 marks)
Answer;
Principal causes of growing public expenditure:
Following are some of the reasons of continuous increase in public expenditure:
(i) Welfare state ideology:
the state is expected to promote the wellbeing of its citizens in every respect i.e. politically, economically
and socially. With increased number of functions and higher expectations, State needs more to spend on
public expenditure than before.
(ii) Size of population:
because of ever-increasing size of population the government has to cater to the structural and social
needs of the increased population.
(iii) Technological developments:
technological advancements play an integral role in the economic growth of the country but at the same
time also cost a lot. For instance, invention of combustion engine led to the manufacturing of
automobiles for which roads and highways were necessary to be built thus increasing the government
expenditure.
(iv) Ability to tax:
As the economies are growing, the government’s ability to generate revenues/taxes is increasing making
it possible to increase expenditure to provide better facilities to the public.
(v) Expansion in social services:
there has been a remarkable expansion in social services such as education and public health services
leading to the development of schools, colleges, educational institutes, hospitals and medical centres
that in turn require finances for establishment and stability.
(vi) Provision of public utility services:
Another significant increase in the public expenditure is due to an augmented provision of public utility
services such as electricity, water and transport services.
(vii) Political and social factors:
The government expenditure also increases due to various political and social factors.
For instance, ministers are pressurized to undertake more activities to bring about changes in their home
districts.
2
Examiner comment;
In this part, the candidates were required to state the reasons for continuously growing public
expenditure. The performance in this part was also good. However, those candidates lost marks who
gave incomplete description or who were confused between public and private expenditure.
Marking plan;
1.5 marks for describing each principal cause of growing public expenditure 6.0
Q.3; Aut-19
The importance of public finance can be easily understood by its functions. Describe any two
main functions of public finance as emphasized by Musgraves.
(04 marks)
Answer;
Functions of public finance:
According to Musgraves, the major functions of public finance are the following:
(i) Allocative function
The allocative function refers to the role of government that it plays in providing resources to extend
support to the public goods. The examples include expenditure on infrastructure, national defence, etc.
The budgetary policy divides the total resources among private and social goods by
which the mix of social goods is chosen.
(ii) Distributive function
The government plays the distributive role by way of deciding as to whom the resources should be
allocated. Practically it means setting the balance between free market outcomes and distribution
through taxes and other means with a view to reducing economic inequalities and yielding optimal
income distribution.
Examiner comment;
 Majority of the examinees identified the functions of public finance however, description in
most of the cases was either inadequate or incorrect.
 Many examinees thought that providing social welfare and building of infrastructure are the
only functions of public finance.
Marking plan;
02 marks for describing each function of publicfinance 4.0
3
Q.4; Spr-20
Explain two basic differences between public and private finance with reference to
‘Adjustment of income and expenditure’ and ‘Deficit financing’.
(03 marks)
Answer;
Basic difference between public and private finance:
(i) Adjustment of income and expenditure:
An individual determines his expenditure according to his revenue and the government adjusts its
revenue to its expenditure.
For instance; while an individual knows his fixed income and spends his money accordingly, the state first
estimates the total expenditure and then imposes the taxes accordingly.
(ii) Deficit financing:
In case of deficit financing, the government has an option to print currency notes and create money to
meet the expenditure.
On the other hand, individual cannot create money by printing currency notes or by such other means.
4
Chapter # 11
Money
Q.1; Aut-14
An increase in ‘GDP’ and ‘financial innovation’ are the two important factors that
influence the total demand for money in an economy.
Briefly explain with the help of suitable diagrams, how each of the above factors
affects the quantity of money demanded in an economy.
(06 marks)
Answer;
Money demanded and an increase in GDP
When economic growth increases in the economy, there is an increase in incomesas well as the number of
people employed in the economy. This causes an increasein the demand for money at each level of interest
rate.
Consequently there is an outward shift in the demand for money.
1
Money demanded and an increase in financial innovation

Financial innovation incorporates new means of spending money such as creditcards and debit cards, which
reduce the need to withdraw cash in order to purchasegoods and services.
Consequently there is an inward shift in the demand for money.
Examiner comment;
In this question the candidates were required to explain with the help of suitable diagrams how increase
in ‘GDP’ and ‘financial innovation’ influence the total demand for money in an economy. Most of the
students explained the impact of increase in GDP on demand for money correctly but seemed confused
while discussing the impact of financial innovation. Some of them discussed the impact of innovation on
GDP instead of demand for money. In either case, many students named the MD curve as MEC curve.
Further, many students failed to label the diagrams correctly.
___________________________________________________________________________________________________________
Q.2; Aut-14
What is Keynesian liquidity trap? Identify any three policies which can help to break out of
the liquidity trap.
(04 marks)
2
Answer;
Liquidity trap
Liquidity trap is a situation where savings rates are high despite very low interestrates, causing monetary
policy to be ineffective.
Policies that can help to break out of liquidity trap are as follows:
 Government through expansionary fiscal policy may raise the aggregate demand.
 Raising inflation expectations may convince the people to spend.
 Central bank may convince the people of lower interest rates in the future.
Examiner comment;
More than 80% of the students defined the concept of liquidity trap correctly but only half of them
identified that fiscal policy measures, raising inflationary expectations and expectations of low interest
rates can help in overcoming the situation of liquidity trap.
Q.3; Aut-14
Briefly describe ‘Demand deficient unemployment’ and ‘Structural unemployment’.
(04 marks)
Answer;
Examiner comment;
3
Q.4; Spr-15
Briefly explain the ‘Quantity Theory of Money’.
(03 marks)
Answer;
Examiner comment;
Q.5; Spr-15
Identify three reasons why people prefer to hold money in liquid form.
(03 marks)
Answer;
Examiner comment;
4
Q.6; Spr-15
Discuss how introduction of money has resulted in overcoming the shortcomings of barter
system.
(04 marks)
Answer;
Examiner comment;
Q.7; Aut-15
What do you understand by Demand-pull inflation and Cost-push inflation?
(04 marks)
Answer;
Demand-pull inflation:
In demand-pull inflation, the aggregate demand for goods persistently exceeds their supply.
As the demand for goods is more than the total supply of goods at current price, there is a tendency for
increase in prices. Demand-pull inflation is generally observed in a situation of full employment.
Cost-push inflation:
In cost-push inflation, the prices of goods rise due to persistent increase in the cost of production of
goods, while their demand remains consistent.
5
Examiner comment;
Marking plan;
Q.8; Aut-15
Briefly discuss the probable causes of Demand-pull inflation and Cost-push inflation.
(06 marks)
Answer;
Causes of Demand-pull inflation:
 Fiscal stimulus will increase aggregate demand in the economy. Given the effects of multiplier, an
increase in government spending would result in greater increase in demand which would lead to
demand-pull inflation.
 Monetary stimulus such as fall in interest rates, buying of government securities etc. would trigger
an increase in demand and may lead to a situation where ‘too much money chasing too few goods’.
The surplus demand would increase the price level and therefore, demand-pull inflation.
Causes of Cost-push inflation:
 When level of unemployment in an economy is low, skilled labor would be in a position to
demand higher wages which would give rise to cost-push inflation.
 When people in an economy anticipate higher inflation, they may demand higher wages to
protect their real income. Higher wages would increase the costs to a firm which would ultimately
fulfill the expectation of higher inflation. When higher inflation materializes, people expect it to be
higher in the following period as well and hence the chain of events continues. This is called the
wage-price spiral.
 An increase in the price of raw materials and other inputs would give rise to cost-push inflation.
For example, imposition of indirect taxes would cause the higher costs to firms which would
ultimately pass on to end consumers resulting in cost-push inflation.
 The exchange rate depreciation would make exports cheaper and imports more expensive. In an
economy where demand for imports is inelastic, exchange rate depreciation would lead to cost-push
inflation.
6
Examiner comment;
Marking plan;
Q.9; Spr-16
Define Phillips Curve. Explain the trade-off between unemployment and wage inflation with
the help of a Phillips Curve.
(08 marks)
Answer;
7
Examiner comment;
Marking plan;
Q.10; Spr-16
Describe the type of unemployment that is generally observed during a period of recession in
an economy.
(02 marks)
Answer;
Examiner comment;
Marking plan;
Q.11; Aut-16
Discuss the concept of Consumer Price Index (CPI). State any three limitations of CPI as a
measure of inflation.
(06 marks)
8
Answer;
Examiner comment;
Marking plan;
Q.12; Aut-16
Briefly discuss any two measures that may be adopted for controlling inflation if an economy
is facing:
 cost-push inflation
 demand-pull inflation
(04 marks)
Answer;
9
Examiner comment;
Marking plan;
Q.13; Spr-17
What is inflation? Briefly state any four harmful effects of inflation on the economy.
(05 marks)
Answer;
10
Examiner comment;
Marking plan;
Q.14; Spr-17
Explain the concept of ‘Natural rate of unemployment’ with the help of a diagram.
(05 marks)
Answer;
11
Examiner comment;
Marking plan;
_________________________________________________________________________________________________________________
Q.15; Spr-17
Identify and describe the functions of money.
(04 marks)
Answer;
Examiner comment;
Marking plan;
____________________________________________________________________________________________
12
Q.16; Spr-17
Compute the velocity of circulation of money in an economy using the Quantity Theory of
Money, where the average price level is 1.8, real GDP is Rs. 28,726 billion and the nominal
money supply is Rs. 12,926 billion.
(02 marks)
Answer;
Examiner Comment
Marking plan
Q.17; Aut-17
Briefly discuss any two causes each of ‘Cost-push inflation’ and ‘Demand-pull inflation’.
(06 marks)
Answer;
13
Examiner Comment
Marking plan
14
Q.18; Aut-17
Briefly explain ‘Liquidity preference theory’. Briefly describe the three motives, identified
by Keynes which determine an individual’s demand for holding money in liquid form.
(07 marks)
Answer;
Examiner Comment
Marking plan
18
15
Q.19; Aut-17
What is meant by ‘Keynesian liquidity trap’? Identify any two policies which may help in
breaking out of the liquidity trap.
(03 marks)
Answer;
Examiner Comment
Marking plan
Q.20; Spr-18
According to the monetary economist Milton Friedman, a trade-off exists between
unemployment and wage inflation but only in the short-run. In the long-run, no such trade-
off exists.
Explain, with the help of a diagram, the arguments put forward by Friedman in this regard.
(06 marks)
.
16
14
Answer;
With the help of a diagram, explanation of the arguments put forward by
Milton Friedman with regard to long run Phillips curve and a trade-off
between unemployment and inflation:
Milton Friedman’s argument was that each short-run Phillips curve (SRPC) is based upon a fixed
expectation of inflation.If there is an increase in the expectation of inflation,then this would cause the
SRPC to shift higher.
Diagrammatically it can be illustrated as follows:
In the above diagram, The economy begins in equilibrium at A.

When there is an increase in government spending to boost Aggregate Demand (AD), the
unemployment decreases from U1 to U2 and takes the equilibrium to point B where inflation is 6%.
At point B, firms’ costs and individuals’ wage demands increase, meaning output falls, unemployment
rises, and hence SRPC1 shifts to SRPC2.
Therefore, in the short run, a trade off may occur, however in the long run, it is not possible to expand
beyond the long-run Phillips curve (LRPC).
17
14
Examiner comments;
This part of the question required candidates to explain with the help of a diagram, the arguments put
forward by Milton Friedman with regard to non-existence of a trade-off, in the long-run, between
unemployment and wage inflation. The performance remained very poor. Most of the candidates who
attempted the question were only able to draw a partial diagram showing trade-off between
unemployment and wage inflation. Only a handful of candidates were able to explain that short-run
Phillips curve (SRPC) is based upon fixed expectation of inflation and that if there is an increase in the
expectation of inflation then this would cause the SRPC to shift higher. Hardly any candidate was able to
explain the reasons of shifting of SRPC1 curve to SRPC2 curve. Many candidates ended up explaining the
concept of Phillip curve.
Marking plan;
Preparation of diagram 3.0

Explanation with the help of the diagram that no trade-off exists between
unemployment and wage inflation in the long-run 3.0
___________________________________________________________________________________________________________
Q.21; Spr-19
What do you understand by ‘Consumer price index’ (CPI)? Also explain how it is calculated.
(04 marks)
Answer;
CPI:
Consumer price index (CPI) is a measure of the weighted average of prices of a basket of goods and
services. It is calculated by taking price changes for each item in the predetermined basket, averaging
them, and weighing them based on the importance of each and then determining the weighted average.
This average is compared with the base year to compute the CPI.
Examiner Comment:
Candidates failed to explain how CPI may be calculated.
Marking Plan;
Definition of consumer price index 1.0
Explanation of the method of calculation 3.0
_____________________________________________________________________________________
18
14
Q.22; Spr-19
Briefly describe four costs associated with high inflation.
(06 marks)
Answer;
Costs of inflation:
Following are the costs associated with high inflation:
(i) Income redistribution:
Higher inflation can have a regressive effect on lower income families. Especially if the price of food and
utilities increases drastically.
(ii) Fall in real incomes:
If wages are cut (to help tackle inflation) then this means that real incomes have reduced.
(iii) Negative real interest rates:
If the savings interest rate is lower than inflation, than those who rely on savings as their income will
become poorer with the passage of time.
(iv) Cost of borrowing:
In response to high inflation, governments may increase the interest rates. This will increase the cost of
businesses getting a loan, which may stifle investment.
Examiner Comments;
 Only one or two costs associated with high inflation were described.
 Types of inflation were explained instead of the costs associated with high inflation.
Marking plan
1.5 marksfor describingeach cost 6.0
Q.23; Spr-19
The problems of barter system led to the evolution of money in its current form. Discuss
how money resolved these problems.
(03 marks)
Answer;
Functions of money which resolved the problems of barter system:
Following are the four functions of money which resolved the problems of barter system:
(i) To act as medium of exchange:
Barter system lacks the ability to exchange. Finding someone with opposite needs is problematic in
complex society. Money acts as a medium which is acceptable to all.
19
(ii) To act as a unit of account:

Fixing a measure across different types of products was complicated under barter system. Money acts as
a unit of account allowing people to compare the relative prices of goods and services through a
common denomination.
(iii) To act as a store of value:
Barter system lacks the ability to store value, particularly when goods are perishable. Money acts as a
store of value allowing people to forgo immediate consumption if they have surplus resources, and to
retrieve it later.
(iv) To act as a standard of deferred payment:
Barter system lacks the ability to allow people to consume the goods now and pay for them in future.
Money as a standard of deferred payment solved this problem as it is easier to pay at a future date.
Examiner Comment
 Answers revolved round the functions of money and candidates could not differentiate between
the functions and the characteristics of money.
 Candidates were unable to explain how money solved the problem of barter system.
 Candidates also deliberated on the types of money which was not required at all.
.
Marking plan
0.75 mark for discussing each function of money which resolved the problems of
barter system 3.0
Q.24; Spr-19
Briefly describe the ‘Quantity theory of money’.
(03 marks)
Answer;
Quantity theory of money:
Quantity theory of money states that there is a direct relationship between changes in the money supply
and the rate of inflation. The theory is based on equation MV=PT.
MV is the value of total expenditure in a period which must be equal to the value of goods and services
sold in the same period which is PT. The equation is useful as an explanation of inflation when certain
assumptions are made and which, if accepted, means that the average price level (P) is solely determined
by changes in the money supply (M).
20
Examiner Comment
Except for writing the equation MV = PT or MV = PY, candidates completely failed to elaborate the
concept of quantity theory of money.
Marking plan;
Description of the quantity theory of money 3.0
____________________________________________________________________________________________
Q.25; Aut-19
What is ‘Demand-pull inflation’? Briefly describe how fiscal and monetary stimulus may cause
(05 marks)
Answer;
Demand-pull inflation:
In demand-pull inflation, the aggregate demand for goods persistently exceeds their supply. As the
demand for goods is more than the total supply of goods at current price, there is a tendency for
increase in prices. Demand-pull inflation is generally observed in a situation of full employment.
Fiscal and monetary stimulus causing demand-pull inflation.
Fiscal stimulus:
Fiscal stimulus will increase aggregate demand in the economy. Given the effects of multiplier, an
increase in government spending would result in greater increase in demand which would lead to
Monetary stimulus:
Monetary stimulus such as fall in interest rates, buying of government securities etc. would trigger an
increase in demand and may lead to a situation where ‘too much money chasing too few goods’. The
surplus demand would increase the price level and therefore, demand pull inflation.
Examiner Comment
 Many examinees failed to properly explain demand pull inflation. With the exception of
few, most of the answers were limited to the statement that in demand pull inflation, the
aggregate demand exceeds aggregate supply.
 While explaining how fiscal stimulus may cause demand pull inflation, many examinees
did not mention the effects of multiplier.
 Similarly while explaining monetary stimulus, many examinees failed to appreciate the
impact of fall in interest rates on increase in demand.
21
Marking plan;
Definition of demand-pull inflation 2.0
Describing how fiscal stimulus may cause demand-pull inflation 1.5
Describing how monetary stimulus may cause demand-pull inflation 1.5
______________________________________________________________________
Q.26; Aut-19
What do you understand by ‘Liquidity preference theory’? Describe the influence ofthe
motives identified by Keynes, on the liquidity preference of an individual.
(07 marks)
Answer;
Liquidity preference theory:
Liquidity preference theory states that all factors remaining the same, people prefer to hold cash
(liquidity) rather than assets that are illiquid. They will, however, be paid a premium to hold more illiquid
assets.
The three motives for holding money in liquid form are:
(i) Transactions motive:
Individuals need money to meet their day-to-day requirements of purchases of goods and services. The
need to hold money for transactions arises because the payments and receipts of individuals are not
exactly synchronized. The liquidity preference or transactions demand for money will increase either by
an increase in the real national income or an increase in the general price level or any combination of the
two.
(ii) Precautionary motive:
Individuals keep money in hand or with banks as a precautionary measure to meet any unforeseen
fluctuations in receipts and payments. The precautionary demand for money arises due to uncertainty
regarding the timing and size of payments and receipts. The higher the level of national income, the
larger amounts of money balances that would be needed for precautionary purposes, reflecting higher
liquidity preference.
(iii) Speculative motive:
The holding of money has an opportunity cost in the form of income foregone by not using the money
to purchase an income bearing asset e.g. a bond. When interest rates are high, individuals will hold lesser
amounts for speculative purposes and therefore have low liquidity preference. When the interest rates
tend to be low, individuals will retain large amounts in anticipation of increase in interest rates and would
have high liquidity preference.
22
Examiner Comment
Majority of the examinees were able to define the liquidity preference theory and two out of the
three motivesi.e. transactions and precautionary motives. However, they failed to explain speculative
motive and viewed it as a store of value.
Marking plan;
Definition of liquidity preference theory 1.0
02 marks for describing the influence of each motive on the liquidity
preference 6.0
______________________________________________________________________
Q.27; Aut-19
There are different types of financial instruments that can be classified as money. State
four types of money categorised by its liquidity.
(04 marks)
Answer;
Types of money categorised by its liquidity:
Following are the types of money categorised by its liquidity:
 Transactional money (M0): it is used to buy and sell things within an economy
 Checking accounts (M1): money that is in peoples’ accounts that they have immediate access to
 Savings deposits (M2): money that belongs to people, but which they cannot access
immediately
 Large time assets (M3): such as institutional money market funds
Examiner Comment
Majority of the examinees failed to identify the types of money categorised by its liquidity. They
mostly considered fiat money, paper money, plastic money, cheques etc. as types of money
categorised by its liquidity.
Marking plan;
(b) 01 mark for stating each type of money categorised by its liquidity 4.0
_______________________________________________________________________________________________________
23
Q.28; Spr-20
Describe any four unfavourable consequences of unemployment.
(06 marks)
Answer;
The unfavourable consequences of unemployment are:

(i) Loss of output – Unemployment results in the under-performance of the economy and low
levels of output of goods and services. Consequently, there is a decline in the level of national income.
(ii) Loss of human capital – Unemployment leads to gradual erosion of the work skills of the
unemployed workers and deterioration in their capacity to perform satisfactorily in future.
(iii) Increase in inequality in distribution of wealth – Unemployment results in loss of
incomes and decline in savings of unemployed persons. This leads to more inequitable distribution of
wealth among the citizens.
(iv) Social costs – Unemployment brings social problems of mental depressions, increase in crime
rates and causes personal suffering to the unemployed workers and their families.
Q.29; Spr-20
What do you understand by the term credit money?
Answer;
Credit money:
Any monetary claim against a physical or legal person that can be used for the purchase of goods and
services. For instance, IOU’s, bonds and money market accounts. Virtually any form of financial
instrument that is not repaid immediately is considered credit money
24
Chapter # 12
Monetary Policy
Q.1; Aut-14
Describe the four major objectives of a government’s economic policy.
(06 marks)
Answer;
Examiner comment;
Q.2; Aut-14
What role does monetary policy play in achievement of the above objectives?
(02 marks)
Answer;
1
Examiner comment;
Q.3; Aut-14
List any four tools that a central bank may use to implement its monetary policy.
(02 marks)
Answer;
Examiner comment;
Q.4; Spr-15
State the meaning of ‘Financial Intermediary’.
(02 marks)
Answer;
Examiner comment;
2
Q.5; Spr-15
Describe the measures that are available to a central bank for restricting credit creation
ability of commercial banks. How such measures affect the process of credit creation?
(08 marks)
Answer;
Examiner comment;
3
Q.6; Aut-15
There are various objectives of monetary policy but it is not possible to satisfy all of them
simultaneously. Briefly describe the conflicts that may exist between various objectives of
monetary policy.
(06 marks)
Answer;
The following conflicts may exist between various objectives of monetary policy:
(i) Price stability versus full employment
In order to increase employment, central bank takes various monetary policy measures such as reducing
interest rates. However, these measures could drive up inflation, putting more pressure on the price
stability target.
(ii) Economic growth versus exchange rate stability
In order to boost economic growth, a central bank may decide to depreciate local currency to increase
the likelihood of exports thus to achieve economic growth. However, such act would jeopardize stability
in exchange rates.
(iii) Economic growth versus credit control
A way to grow the economy might be through the expansion of credit, as it would spur investment and
spending. However, this comes with heightened economic risk of credit defaulting.
Examiner comment;
Marking plan;
4
Q.7; Aut-15
Monetary policy may bring about many advantages but in the real economy, there are certain
limitations to its effectiveness. Discuss any four such limitations.
(04 marks)
Answer;
Following are the limitations of monetary policy:

(i) Existence of non-monetary sector
The existence of large non-monetized sector particularly in developing countries hinders the operation
of effective monetary policy as people at that sector (such as rural areas) do not use money as medium
of exchange rather barter is practiced.
(ii) High liquidity in financial markets
Efforts of central bank to tighten the money supply would be adversely affected, if agents in the
economy have access to high liquid assets.
(iii) Time lags
The desired effects of a monetary policy often take time to occur. In order to be effective, central bank
would have to predict the circumstances in advance which are difficult when there is high uncertainty.
(iv) Lack of co-ordination between monetary and fiscal policies
Monetary policy is implemented by central bank whereas fiscal policy is implemented by the government.
In the absence of co-ordination among the objectives of these policies, the desired effectiveness would
not be achieved.
Examiner comment;
Marking plan;
5
Q.8; Aut-15
An important objective of a central bank is to reduce inflation. Briefly describe how the
central bank uses money market operations to achieve this objective.
(03 marks)
Answer;
Central bank can reduce inflation by contracting the money supply in an economy. Money supply can be
contracted by means of money market operations i.e. selling of government securities. Purchase of
securities by commercial banks would reduce the cash available with them which would lead to decrease
in investment and spending thus weakening the inflationary pressure.
Examiner comment;
Marking plan;
Q.9; Aut-15
What role does a central bank play for a government?
(07 marks)
Answer;
Central bank plays the following role for a government:

 Issuer of currency:
The central bank has monopoly of issuing currency which is done keeping in view the overall objectives
within an economy.
 Banker to the government:
The central bank offers advice and funding to the government for financing projects in the same way a
commercial bank would do to its customers.
 Regulator of the banks:
Central bank regulates the banks through banking laws and by means of monetary policy instruments.
6
 Exchange rate controls:

The central bank has a control over country’s foreign currency reserves. It uses them to overcome short-
term exchange rate volatilities and inefficiencies.
 Establishment of specialized banks:
In some cases, central bank allows the creation of banks to serve a particular purpose, usually not for
commercial means. For example, agricultural bank to provide funds to farmers at subsidized interest
rates.
 Economic stability:
Central bank undertakes to ensure economic stability in a country. For example in order to overcome
inflationary pressure, it controls the money supply in an economy by means of monetary policy.
Examiner comment;
Marking plan;
Q.10; Spr-16
Briefly describe any two features of Investment banks
(02 marks)
Answer;
Examiner comment;
Marking plan;
7
Q.11; Aut-16
List any four functions of a central bank.
(02 marks)
Answer;
Examiner comment;
Marking plan;
Q.12; Aut-16
Explain how the central banks are able to reduce the level of aggregate demand in an
economy by changing the reserve requirements of commercial banks?
(08 marks)
Answer;
8
9
Examiner comment;
Marking plan;
Q.13; Spr-17
Illustrate the concepts of ‘Nominal interest rate’ and ‘Real interest rate’.
(05 marks)
Answer;
Examiner comment;
Marking plan;
9
Q.14; Spr-17
Illustrate the process through which the central bank may reduce the level of aggregate
demand in the economy using open market operations.
(05 marks)
Answer;
Examiner comment;
Marking plan;
_________________________________________________________________________________________________________________
10
Q.15; Aut-17
‘Central bank uses monetary policy to achieve number of objectives in an economy. However,
due to conflicting situations, it is not possible to achieve all of these objectives at once’.
Briefly describe any two conflicts which may exist between these objectives.
(04 marks)
Answer;
Examiner comment;
Marking plan;
____________________________________________________________________________________________
11
Q.16; Spr-18
What do you understand by the term ‘Bank’? Briefly describe the following:
(i) Retail bank (ii) Specialized bank (iii) Investment bank
(06 marks)
Answer;
Bank:
A financial institute licensed by the government to receive deposits, which then invests these funds in a
number of securities.
(i) Retail bank:
A bank targeted at the mass-market in which individual customers can purchase/obtain mortgages,
checking accounts, personal loans, and other bank services.
(ii) Specialized bank:
A bank targeted to a specific section of the economy in which firms and customers can have access to
specialized forms of banking services.
(iii) Investment bank:
A financial intermediary that undertakes a number of financial services for clients such as raising capital,
underwriting securities and other assets, providing advice, etc.
The investment bank can also aid companies with acquiring funds, and facilitate a number of transactions
through utilising the financial markets.
An investment bank does not accept deposits.
Examiner Comments;
The performance remained average as most of the candidates correctly defined the terms ‘bank’ and
‘specialized bank’ but failed to define the terms ‘retail bank’ and ‘investment bank’. With regard to
investment bank majority of the answers were only confined to the statement that ‘it assists institutions in
raising capital or providing advice’.
Marking plan;
Definition of bank 1.0
Up to 02 marks for the definition of each term 5.0
__________________________________________________________________________________________
12
Q.17; Spr-18
Identify any eight functions of a central bank.
(04 marks)
Answer;
Functions of a central bank:
(i) issuing currency notes
(ii) banker to the state
(iii) banker to other banks
(iv) guardian of the money market through the control of credit
(v) lender of last resort
(vi) maintaining the external value of the domestic currency
(vii) custodian of foreign exchange reserves
(viii) ensures stability of the internal value of the currency i.e. price level
(ix) overall economic stability of the country
(x) clearing agent for commercial banks
Examiner comments;
The performance was good as most of the candidates scored passing marks. However, only few students
managed to identify more than six functions of central bank.
Marking plan
0.5 markforidentificationofeachfunction ofthe centralbank 4.0
13
14
Q.18; Aut-18
Monetary policy can play a vital role in influencing the use of money and credit within an
economy in order to achieve certain objectives.
Briefly discuss objectives of monetary policy and how these objectives can be achieved.
(05 marks)
Answer;
Objectives of monetary policy and the means to attain them:
(i) Price stability to keep the inflation low by managing the supply of money.
(ii) Economic growth by encouraging consumption and investments.
(iii) Exchange rate stability by effective utilization of policy instruments.
(iv) Full employment by encouraging consumption and investments by allowing resources to be fully
utilized.
(v) Credit control by regulating commercial banks through central bank (discount rate policy, reserve
requirements, open market operations, etc.).
Examiner Comments;
Most of the students correctly identified the objectives of monetary policy. However, many students
mentioned credit creation as one of the objective which was not correct. Further, in the latter part of the
question which required a discussion on how they can be achieved using monetary policy, the
candidates appeared confused and mixed up between fiscal and monetary policy.
Marking plan
0.5 mark for identification of each objective of monetary policy 2.5
0.5 mark for discussing how each objective can be achieved 2.5
18
14
Q.19; Spr-19
Briefly describe how the level of aggregate demand may reduce when a central bank changes
the reserve requirements for commercial banks.
(05 marks)
Answer;
The central banks are able to reduce the level of aggregate demand in an economy by changing the
reserve requirements, as described here under:
(i) When a central bank increases the level of reserves that the commercial banks must hold, the
commercial banks have to reduce the level of loans that they give out. A certain reduction in the level of
reserves that commercial banks must hold translates, through the multiplier effect, in a much bigger
contraction in the overall money that they loan out. This causes the money supply to decline.
(ii) As the money supply contracts, money becomes “tight” (i.e. less available and more expensive). This
reduced level of money in the economy raises the interest rate, and reduces the amount of credit
available in the economy. Consequently interest rates rise and firms/individuals looking for investment
are discouraged from borrowing, and spending more money.
(iii) As a result of the above aggregate demand reduces.
Examiner Comments;
 Answers were confined to the statement that increasing the reserve requirement would leave less money
with the commercial banks for lending.
 Candidates deliberated on both the consequences i.e. when reserve requirement is increased by the central
bank and when it is reduced by the central bank.
 The effect of multiplier in case of increase in the level of reserves that the commercial banks must hold,
was ignored.
Marking plan
Up to 02 marks fordescribing each process through which the level ofaggregate
demand may be reduced by the central bank by changing the reserve
requirements for commercial banks 5.0
15
14
Q.20; Aut-19
Briefly describe any three tools which are available to the Central bank for controlling
money supply in an economy.
(06 marks)
Answer;
The tools available to Central Bank to control money supply are as
follows:
The reserve ratio A change in the reserve ratio changes the amount of reserves the banks are required
to keep with the central bank. Consequently the funds available for lending i.e. money supply changes
with the change in reserve ratio.
Open market operation When the central bank buys securities in the open market from commercial
banks or general public, the funds available with them will increase and vice versa.
Discount rate it is the rate of interest which central bank charges on the loans it grants to the
commercial banks. The interest on such loans being discounted at the time the loan is negotiated rather
than collected at the time the loan is repaid.
A decline in the rate encourages commercial banks to borrow from the central bank, thereby enhancing
their ability to extend credit to the public and enhancing money supply. The position is reversed when
discount rate is increased.
Examiner Comments;
 In majority of the cases, only one or two tools for controlling the money supply were
identified. The answers were inconclusive and limited to the increase or decrease of interest
rates.
 Most of the examinees were unable to distinguish between the interest rate and discount rate.
 Some examinees wasted time in explaining exchange rate policy.
Marking plan
02 marks for describing each tool of controlling money supply 6.0
16
14
Q.21; Spr-20
Briefly describe the four primary forces behind the determination of interest rate.
(06 marks)
Answer;
Determinants of interest rate:
(i) Supply and demand
The interest rate depends upon the supply and demand of the credit. An increase in demand would lead
to an increase in the rate of interest whereas a decrease in demand would lead to a decrease in the rate
of interest.
On the contrary an increase in the supply of credit would decrease the rate of Interest and a decrease in
supply of credit would cause an increase in the rate of interest.
(ii) Inflation rate
Interest rate rises with the rise in actual or expected inflation rate.
(iii) Government
The government has a say in the determination of the interest rates by way of devising the monetary
policy.
(iv) Type of loan
The interest rate on different type of loans depends on multiple factors, such as credit risk, time, tax
considerations etc. Risk refers to the likelihood of loan being repaid.The higher the risk the more the
return. Time is also an important factor. Long term loans are riskier because of the time interval involved
and the inflation, making them more costly in terms of interest rates.
Q.22; Spr-20
Briefly describe the following:
(i) Retail bank (ii) Specialized bank
Answer;
(i) Retail bank: A bank targeted at the mass-market in which individual customers can
purchase/obtain mortgages, checking accounts, personal loans, and other bank services.
(ii) Specialized bank: A bank targeted to a specific section of the economy in which firms and
customers can have access to specialized forms of banking services.
17
14
Chapter # 13
Credit
Q.1; Spr-15
Various sources of short-term and long-term credit are available to the firms. Briefly
discuss any two sources in each case.
(06 marks)
Answer;
1
Examiner comment;
Q.2; Spr-16
Commercial banks play a vital role in creation of credit money in an economy. Describe the
process of credit creation by commercial banks by means of advancing loans, with the help
of an example.
(06 marks)
Answer;
Examiner comment;
Marking plan;
2
Q.3; Spr-16
Briefly discuss any four factors which might limit the commercial banks’ ability to create
credit money in an economy.
(04 marks)
Answer;
Examiner comment;
Marking plan;
Q.4; Aut-17
What is ‘Credit money’? Give two advantages and disadvantages of credit money.
(06 marks)
3
Answer;
Examiner comment;
Marking plan;
Q.5; Aut-18
Briefly discuss limitations of credit creation in achieving economic objectives.
(05 marks)
Answer;
Limitations of credit creation in achieving economic objectives:

(i) The initial size of money supply. If initial size of money supply is lower, less credit would be
created and vice versa.
(ii) Liquidity preference of people. In period of high inflation, people may not wish to hold their
money in banks that would mean less money is available to banks thereby less credit would be created.
(iii) Availability of quality securities. If high valued collateral assets are not available, less credit
would be created and vice versa.
(iv) Economic conditions of trade and business. In the period of depression, investors would be less
inclined to borrow thereby limiting the role of credit creation.
4
Examiner comment;
This part required a discussion of the limitations of credit creation in achieving economic objectives. The term
credit creation spurred a considerable number of candidates to explain credit creation in detail and they ignored
the requirement of the question completely.
Marking plan;
0.75 mark for identification of each factor limiting the credit creation 3.0
0.5 mark for discussing how each factor limits the credit creation 2.0
Q.6; Spr-19
State two advantages and two disadvantages of credit money.
(04 marks)
Answer;
Advantages and disadvantages of credit money:
Advantages of credit money:
 Allows immediate consumption of expensive goods, based on future earnings.
 Allows firms to invest, expand and generate future revenue, rather than use internally generated
funds.
Disadvantages of credit money:
 There is often an element of risk involved that the person issuing credit may not receive full
payment.
 It may lead to over spending.
Examiner comment;
Candidates limited their answer to the advantages and disadvantages of using credit cards.
Marking plan;
 01 mark for each advantage of credit money 2.0
 01 mark for each disadvantage of credit money 2.0
____________________________________________________________________________________________
5
Q.7; Spr-20
Describe three types of credit.
Answer;
Types of credit:
Following are the kinds of credit which are classified according to the type of users:
(i) Trade credit/Commercial credit/Mercantile credit
This exists between a customer and a seller, usually in the commercial sector. A purchaser can order a
good, receive the good, and then pay for it after a certain period of time. The credit terms will often
mean that the amount has to be paid after 30, 60 or 90 days.
(ii) Bank credit
This type of credit exists when an individual or firm goes to a bank, receives an amount of money upfront,
and then pays back the amount over a period of time. Bank credit can have varying terms of how much
needs to be paid back, and by what time.
(iii) Consumer credit/Retail credit
A consumer credit agreement often occurs between a retailer and a consumer. In exchange for store
credit (i.e. currency to spend at the establishment) a consumer can pay the amount back over a certain
period of time.
6
Chapter # 14
Balance of payments and trade
Q.1; Aut-14
What do you understand by the terms ‘floating exchange rate’ and ‘fixed exchange rate’?
List three advantages of each of the above types of exchange rates.
(07 marks)
Answer;
Floating exchange rate is the rate set by the unhindered forces of demand and supply of the currency.
Fixed exchange rate is the rate set at a fixed parity against one or more foreign currencies. In this case the
government agrees to buy or sell at this rate to stop fluctuations.
Advantages of floating exchange rates

 The need for government intervention in the foreign exchange markets is eliminated.
 It helps to correct balance of payments disequilibrium.
 Frees the policy instruments of government to concentrate on internal issues such as unemployment and
inflation.
 Acts as a shock absorber. Variations in the rates of exchange act as a check against invasion of the
inflationary and deflationary forces.
Advantages of fixed exchange rates

 Avoids damaging speculation effect against the local currency
 Promotes trade as importers and exporters are protected from exchange rate risks
 Government has to pursue responsible economic policies domestically because excess aggregate demand
and inflation would make it very difficult to support the currency in the long term.
Examiner comment;
This question required explanation of fixed and floating exchange rates and their advantages. It proved
to be the highest scoring question for majority of the students. However, many students also made
diagrams which weren’t required.
1
Q.2; Aut-14
Identify the reasons why a government may want to influence exchange rate.
(03 marks)
Answer;
A government may want to influence exchange rates in order to achieve the following objectives:
(i) Stabilise the domestic currency against the pressures of short-term speculation.
(ii) Stimulate demand for exports or to restrain imports.
Examiner comment;
This was a 3 mark question about why governments may want to influence exchange rates. Most of the
students gave correct answers and scored high marks.
Q.3; Aut-14
Explain what is meant by the term ‘balance of payments deficit’.
(03 marks)
Answer;
A balance of payments deficit:
The balance of payments account records all the transactions between residents of a country and residents of
the rest of the world over a period of time. The account is further bifurcated into current account and financial
account. The current account records all exports and imports of goods and services whereas the financial
account records inflows and outflows of capital.Generally, a deficit in balance of payments usually refers to a
current account deficit that means the country has spent more on imports than it has received from exports.
Examiner comment;
Most of the students were able to describe balance of payments deficit correctly and scored good marks.
However, many students confused it with balance of trade. Further, many students did not explain its
bifurcation into current account and financial account.
Q.4; Aut-14
Discuss the difference between ‘financing’ a balance of payments deficit and ‘correcting’ that
deficit.
(07 marks)
2
Answer;
Financing a balance of payments deficit
Financing a deficit involves the use of funds from the financial account to offset deficits in the current account.
These funds may be in the form of:
 gold and foreign currency reserves;
 borrowings from overseas banks or other international lenders like IMF and World Bank, etc.
Correcting the balance of payments deficit

A country’s borrowing power obviously is not infinite. Therefore, measures have to be taken to correct a
balance of payments deficit. These include:
 exchange rate depreciation
 deflation by bringing down the domestic price level. This can increase the attractiveness of goods on
the international market, thereby increasing exports.
 exchange control – e.g. a monetary authority may direct exporters to relinquish foreign exchange
reserves to the central bank.
 imposition of tariffs on import
 fixation of quotas on import of goods
 Helping the exporters to sell their goods and services by organizing exhibitions and trade fairs
 Curtailing the level of imports by producing the required goods domestically
In conclusion, financial measures are short term methods of dealing with balance of payments deficits.
Corrective measures must be applied to correct long-term deficit.
Examiner comment;
In this question it was quite evident that majority of the students had resorted to rote learning and
therefore were unable to perform well because the question was formatted in a different manner.
Otherwise, the two aspects tested in the question i.e. "financing" as against “correcting” balance of
payment deficits are topics in which the students usually perform well.
Q.5; Aut-15
Balance of payments is a combination of current account and capital/financial account.
Briefly discuss the components of:
current account
capital/financial account
(08 marks)
3
Answer;
Components of current account:

(i) Trade in goods
This component includes import and export of tangible items such as finished goods, semi-finished
goods and component parts for assembly etc.
(ii) Trade in services
It includes intangible items such as tourism, financial services and consultancy etc.
(iii) Income
It comprises of overseas activity that leads to a flow of money back to the country. For example, interest
received from direct investment, the activities of subsidiaries and dividends earned from owning shares in
foreign firms etc.
(iv) Unilateral transfers
It includes receipts and payments that take place without anything receiving in return. For example,
donations, personal remittances, aid and grants etc.
Components of capital / financial account:
(i) Real foreign direct investment
It involves stable investments where investors are unlikely to pull their money at short notice. For
example, returns received by a domestic firm from a factory setup in another country.
(ii) Portfolio investment
It involves acquiring interest such as shares in a business that has already been established abroad. Such
investors have little or no control over businesses.
(iii) Financial derivatives
It involves dealing in foreign financial instruments; the underlying values of which are based on other
assets.
(iv) Reserve assets
These are financial assets that can be bought and sold by central authority such as central bank and
include a country’s official reserves of foreign exchange. For example, central bank may use foreign
financial assets to cover deficits and imbalances.
Examiner comment;
4
Marking plan;
Q.6; Aut-15
List the ways through which government can promote the exports of a country in the short-
term.
(02 marks)
Answer;
The ways through which government can promote the exports of a country in the shortterm:
(i) Organization of exhibitions and trade fairs to create awareness among overseas importers.
(ii) Provision of tax rebates and other reforms to exporters.
(iii) Exchange rate control to ensure exports are not adversely affected by exchange rate fluctuations.
(iv) Provision of finance at subsidized interest rates to exporters.
Examiner comment;
Marking plan;
Q.7; Aut-15
Frequent exchange rate variations may not be desirable. However, an absolute rigidity of
exchange rates in face of drastic changes may be equally harmful. Give arguments in favour
of floating exchange rates.
(03 marks)
Answer;
Arguments in favor of floating exchange rates:
 The need for government intervention in the foreign exchange markets is eliminated allowing its
policy instruments to concentrate on internal issues such as unemployment and inflation.
 It helps to correct balance of payments disequilibrium by free forces of demand and supply of
currency.
 Acts as a shock observer. Variations in the rates of exchange act as a check against inflationary
and deflationary forces.
5
Examiner comment;
Marking plan;
Q.8; Spr-16
Governments often seek to achieve certain objectives by influencing the exchange rates.
Identify any three such objectives.
(03 marks)
Answer;
Examiner comment;
Marking plan;
Q.9; Spr-16
Governments often follow a policy of deliberately weakening the domestic currency by
reducing its parity value within a fixed rate system. Identify the purpose of following such
policy and also discuss the factors upon which effectiveness of such policy depends.
(07 marks)
6
Answer;
Examiner comment;
Marking plan;
Q.10; Spr-16
What do you understand by ‘Terms of Trade’? Briefly explain whether improved terms of
trade always mean a fall in the balance of payments deficit. (04 marks)
Answer;
7
Examiner comment;
Marking plan;
Q.11; Spr-16
Briefly explain various monetary and non-monetary measures which may be taken by the
government to correct balance of payments deficit.
(06 marks)
Answer;
Examiner comment;
8
9
Marking plan;
Q.12; Aut-16
Briefly discuss five main causes of disequilibrium in the balance of payments.
(05 marks)
Answer;
Examiner comment;
Marking plan;
9
Q.13; Aut-16
State and briefly describe the impact of any five measures that a government may take to
rectify the disequilibrium in the balance of payments.
(05 marks)
Answer;
Examiner comment;
Marking plan;
Q.14; Spr-17
What do you understand by ‘J curve’? Explain with the help of a ‘J curve’, how in the short-
run the current account deficit may get worse before improving.
(10 marks)
10
Answer;
Examiner comment;
Marking plan;
11
Q.15; Aut-17
Briefly explain ‘Balance of payment’, ‘Balance of trade’ and ‘Terms of trade’.
(06 marks)
Answer;
Examiner comment;
Marking plan;
___________________________________________________________________________________________
Q.16; Aut-17
Describe any four corrective measures which may be adopted to improve the balance of
payment position in Pakistan. (04 marks)
Answer;
12
Examiner Comment
Marking plan
Q.17; Spr-18
The current account, the capital account and the financial account make up country’s balance
of payments.
Briefly describe the components of the financial account.
(04 marks)
Answer;
Components of financial account:
Following are the components of financial account with brief description of each:
(i) Real foreign direct investment:
A firm setting up a factory in another country.
(ii) Portfolio investment:
a domestic investor buying shares in a business that is already established. Such investors have little or
no control over these companies.
(iii) Financial derivatives:
financial instruments where the underlying value is based on another asset.
(iv) Reserve assets:
these are foreign financial assets held by Central Bank which uses them to cover deficits and imbalances.
13
Examiner comment
This part required candidates to describe the components of financial account. The performance remained
average as most of the candidates who correctly listed the components such as, real foreign direct investment,
portfolio investment, financial derivatives and reserve assets failed to describe them correctly. Some
candidates listed current account and capital account as the components of financial account and also listed
the transactions posted to such accounts. Some candidates were of the view that total imports and exports as
well as total government expenditure and taxes are the components of financial account.
Marking plan
01 mark for describing each component of financial account 4.0
____________________________________________________________________________________________
Q.18; Spr-18
What is meant by ‘Exchange rate’? Briefly describe the impact of fall in exchange rate on a
country’s exports and imports.
(04 marks)
Answer;
Exchange rate:
The exchange rate is the price of one currency expressed in terms of another currency.
Impact of fall in exchange rate on country’s exports and imports:
As the exchange rate falls, the demand for country’s exports extends as depreciation makes exports
cheaper and increases the competitiveness of exporting firms.
As the exchange rate falls, imports look less attractive as imported goods become more expensive for
both the direct consumer and the domestic producer using them for further processing. Consequently,
country’s demand for imports contracts.
Examiner comment
The performance was average. Most of the candidates correctly defined exchange rate but could not
properly explain the impact of fall in exchange rate on a country’s exports and imports. Most of them
only stated that fall in exchange rate would make the imports expensive and exports cheaper but did not
specify whether exports and imports would increase or decrease as a result thereof. Some of the
candidates gave exactly the opposite answer i.e. fall in exchange rate would decrease exports and
increase imports.
Marking plan
 Definition of exchange rate 1.0

 1.5 marks each for describing the impact of fall in exchange rate on
country’s exports and imports 3.0
14
Q.19; Spr-18
Illustrate with the help of a diagram, how the government may stop exchange rate from
falling.
(06 marks)
Answer;
How the government may stop exchange rate from falling:
Suppose the government wishes the rate to be at Rt. Policy options are:
 Increase the domestic interest rate and hence shift the demand curve for rupees from D to D1.
 Purchase the surplus rupees (Qs-Qd) using foreign exchange reserves.
Deflate the economy to reduce the demand for imports. This will shift the supply curve of rupees from S
to S1.
Examiner comment
The performance in this part was very poor. Majority of the candidates who answered part (a) did not
attempt this part. Candidates who attempted this part were barely able to draw the diagram without
proper labelling and explanation. Few candidates, without understanding the requirement of the
question, deliberated on the concept of J curve.
Marking plan
Preparation of diagram 3.0
Explanation with the help of the diagram, how the government may stop
exchange rate from falling 3.0
15
14
Q.20; Aut-18
Sometimes the governments weaken the domestic currency deliberately with the objective of
reducing balance of payments deficits by making imports more expensive and exports less
expensive. Describe the factors upon which the effectiveness of such policy depends.
(05 marks)
Answer;
The effectiveness of policy of devaluing the domestic currency depends on:
Price elasticity of demand for imports
If price elasticity of demand for imports is inelastic, then making imports more expensive will not
significantly reduce the volume of demand for imported goods and services. It will more likely increase
total expenditure on imports thus further deepening the balance of payments deficit thus making such
policy ineffective.
Price elasticity of demand for exports
If price elasticity of demand for exports is inelastic, then making exports less expensive will not
significantly increase the volume of demand for exported goods and services. It will more likely reduce
total revenue from exports thus further deepening the balance of payments deficit thus making such
policy ineffective.
Examiner comments;
Governments sometimes devalue their currencies to reduce balance of payment deficit. The students were
supposed to describe the factors on which the effectiveness of such a policy depends.
Most of the candidates produced irrelevant answers. The majority only explained how devaluation affects imports,
exports and foreign direct investment rather than explaining the factors which contribute to the effectiveness of the
policy. Some candidates also discussed fixed and floating exchange rates which was totally irrelevant. Some
candidates discussed measures which the government should take to succeed in its efforts which was also not
relevant to the requirement of the question.
Marking plan
Discussion on factors upon which the effectiveness of the policy of devaluing
domestic currency for reducing imports dependence 2.5
Discussion on factors upon which the effectiveness of devaluing domestic
currency for increasing exports dependence 2.5
Q.21; Aut-18
Why do governments interfere to influence the foreign exchange rates? List the policy
instruments available to a government to influence the foreign exchange rates.
(05 marks)
16
14
Answer;
Governments often interfere to influence the foreign exchange rates because of the following reasons:
(i) To stabilize the currency against the pressures of short-term speculations.
(ii) To stimulate demand for exports or to reduce imports.
Policy instruments available to government to influence foreign exchange rates:

(i) Setting of domestic interest rate.
(ii) Central bank’s intervention in purchasing or selling of currency.
(iii) Structural adjustments to the behavior of the economy.
Examiner Comment:
The performance in this part also remained poor. Many students could not differentiate between influencing the
foreign exchange rate and devaluation and only mentioned the purpose of devaluation. As regards the policy
instruments most of the answers mentioned only one of them i.e. purchasing and selling of foreign currency. Many
candidates omitted this part altogether.
Marking Plan;
01 mark for each reason because of which governments interfere to
influence foreign exchange rates 2.0
01 mark for listing each policy instrument available to government to
influence the foreign exchange rates 3.0
___________________________________________________________________________________________________
Q.22; Aut-18
Discuss the non-monetary corrective measures which a country may take to overcome its
current account deficit.
(04 marks)
Answer;
A country may take any or combination of following non-monetary measures to overcome current
account deficit:
(i) Increasing import duties by means of tariff thereby, making the imports expensive.
(ii) Fixing the quantity of goods that may be imported by means of quotas to restrict the level of imports.
(iii) Helping exporters to promote locally manufactured goods in international market by organizing
exhibitions, trade fairs and striking diplomatic deals.
(iv) Encouraging manufacturing and consumption of locally produced goods and services / import
substitution by means of providing specialist training, subsidies and tax reliefs.
17
Examiner Comment:
This part of the question was also attempted well by most of the students. However, there were few who
mentioned monetary measures instead of non-monetary measures or mentioned both of them.
Marking plan
01 mark for discussing each non-monetary corrective measure to overcome current account deficit 4.0
Q.23; Aut-18
From the following data, compute the overall balance of payments of the country duly
segregated between current and capital accounts:
Net balance
Balance of payment item
(in billion)
Investment income (15)
Portfolio investment flows 10
Overseas transfers 25
Trade in goods (75)
Short-term banking flows (5)
Foreign direct investment flows 20
Trade in services 20
Changes to reserves of gold / foreign currency 15
(06 marks)
Answer;
18
Examiner Comment:
The performance in this part was also good. Most of the candidates were able to place the items under the correct
heads and calculated the current and capital account balances correctly. However, rarely was there a mention of
the errors and omissions figure and the overall balance of payments. Some candidates computed the overall
balance of payments without distinguishing between current and capital accounts.
Marking plan
0.5 mark for each correct component under current and capital accounts 4.5
Mentioning:
 net errors and omissions adjustment 1.0
 overall balance of payment as nil 0.5
Q.24; Spr-19
Exchange rate may either be fixed or floating. State three advantages of each of these
types of exchange rates.
(06 marks)
Answer;
Advantages of fixed exchange rate:
 Avoids damaging speculation effect against the local currency
 Promotes trade as importers and exporters are protected from exchange rate risks
 Government has to pursue responsible economic policies domestically because excess aggregate
demand and inflation would make it very difficult to support the currency in the long term.
Advantages of floating exchange rate:

 The need for government intervention in the foreign exchange markets is eliminated.
 It helps to correct balance of payments disequilibrium.
 Frees the policy instruments of government to concentrate on internal issues such as
unemployment and inflation.
 Variations in the rates of exchange act as a check against invasion of the inflationary and
deflationary forces.
Examiner Comment
 Only one or two advantages of fixed or floating exchange rates were stated.
 The advantages of two types of exchange rates were mixed up.
 Candidates wasted time in explaining what may be regarded as a fixed or a floating exchange rate.
Marking plan
01 mark for each advantage of fixed exchange rate 3.0
01 mark for each advantage of floating exchange rate 3.0
19
Q.25; Spr-19
Briefly describe the components of a current account.
(04 marks)
Answer;
Components of current account:
(i) Trade in goods
This component includes import and export of tangible items such as finished goods, semi-finished
goods and component parts for assembly etc.
(ii) Trade in services
It includes intangible items such as tourism, financial services and consultancy, etc.
(iii) Income
It refers to the overseas activity that leads to a flow of money back to the country. For example, interest
received from direct investment, the activities of subsidiaries and dividends earned from owning shares in
foreign firms, etc.
(iv) Unilateral transfers
It includes receipts and payments that take place without anything receiving in return. For example,
donations, personal remittances, aid and grants, etc.
Examiner Comment
Candidates while describing trade in goods and services misunderstood the concept and explained the sale and
purchase of goods and services locally instead of import and export of tangible and intangible goods and
services.
Marking plan
01 mark for describing each component of current account 4.0
Q.26; Spr-19
What do you understand by the term ‘Inverse J curve’? Explain the concept with the help of
a diagram.
(05 marks)
Answer;
The opposite of J-curve concept is inverse J-curve, where countries attempt to rebalance a current
account surplus by appreciating exchange rate.
The inverse J-curve shows how in the short run, the surplus may further increase before decreasing. This
concept is depicted below:
20
The inverse J curve effect is observed in trade balances because the stronger currency initially translates
into more cheaper imports and costlier exports,leading to a bigger initial trade surplus.
However, in long-run, because the affected country’s exports are now expensive in currency terms, they
start to fall as foreign demand for the high-priced option decreases. Local consumers also purchase
fewer of the locally produced expensive goods and substitute them with comparable imported goods
which have now become more affordable.As a result, the trade balance eventually deteriorates and the
surplus decreases to a lower level than it was at before the exchange rate appreciated.
The lag is caused by the fact that importers and exporters have to honor pre-existing contracts, so the
trade volumes initially remain unchanged even though the exchange rate and relative prices have
changed.
Therefore, in the above diagram, starting from Point B, the surplus first increases in the short-run and
goes down into a deficit as time goes on.
Examiner Comment
 Incomplete answers were produced and in some cases, the concept of J curve instead of inverse J curve
was explained.
 Candidates plotted a wrong diagram without showing any surplus or deficit.
 Diagram was plotted without offering any explanation in this regard.
Marking plan
Explanation of the concept of inverse J curve 3.0
21
Q.27; Aut-19
What is ‘Balance of payment’? Describe any five causes due to which a country may have a
deficit in balance of payments.
(07 marks)
Answer;
Balance of payment:
The Balance of Payments is a systematic and complete record of a county’s transactions with other
countries which takes place over a period of time. The Balance of Payments is in deficit when a country’s
outflows are more than the inflows.
Causes of deficit in balance of payment:
Following are some of the causes of deficit in balance of payment:
(i) Natural factors
Natural calamities like drought or flood may easily cause disequilibrium in balance of payments. These
natural calamities can adversely affect agricultural and industrial production. Exports may decline and
imports may go up, causing a deficit in the country’s balance of payment.
(ii) Trade cycles
Business fluctuations caused by the operation of trade cycles may also result in deficit in country’s
balance of payments. For instance, if there occurs a recession, it may induce a fall in the exports and
exchange earning of the country concerned resulting in a deficit in the balance of payments.
(iii) Political instability
Political instability results in disrupting the productive potential within the country, thereby causing a
decline in exports.
(iv) Relatively high rate of inflation
High rate of inflation as compared to other countries makes the goods produced by that country
relatively expensive. As a result, its exports decline and the balance of payment runs into a deficit.
(v) Trade restrictions by other countries
Sometimes other countries impose heavy custom duties or fix quotas or ban imports from a country. It
results in lower exports of that country.
Examiner Comment
 While explaining balance of payment, answers were restricted to the statement that it is the difference
between country’s imports and exports.
 Most of the examinees either did not state all the five required causes of deficit in balance of payment or
could not explain them properly. The only factors which they considered were; increase in import and decrease in
export.
22
Marking plan
Definition of balance of payment 2.0
01 mark for describing each cause of deficit in balance of payment 5.0
____________________________________________________________________________________________________
Q.28; Aut-19
Briefly describe the monetary measures which may be taken by the government to correct
balance of payments deficit.
(03 marks)
Answer;
Monetary measures
Following measures may be taken by the government to correct balance of payments deficit:
(i) Exchange rate depreciation
Reducing the rate of exchange of domestic currency in terms of foreign currency would make the
imports costlier and uncompetitive, whereas exports become more competitive.
(ii) Deflation
A decline in the price level domestically may increase the attractiveness of domestic goods on the
international market, thereby increasing exports.
(iii) Exchange control
In an extreme situation, by restricting access to foreign exchange, the central bank can control the level
of imports.
Examiner Comment
 Incomplete answers were produced.
 Many examinees discussed fiscal measures instead of monetary measures.
Marking plan
Up to 01 mark for each measure 3.0
23
Q.29; Spr-20
Explain the terms ‘Balance of trade’ and ‘Terms of trade’.
(04 marks)
Answer;
Balance of trade
Balance of trade is a record of a country’s international trade transactions (import and export of goods)
with other countries during a given period of time. The Balance of trade is in deficit when a country’s
imports exceeds its exports and vice versa.
Terms of trade
The quantity of domestic goods that a country must give up to obtain a unit of imported goods is called
the terms of trade.
Q.30; Spr-20
Describe any four measures which the government may adopt to correct the balance of
payment position in Pakistan.
(06 marks)
Answer;
Corrective measures for improving balance of payment position in
Pakistan:
(i) Establishment of labour intensive industries:
Since labour is cheaper in Pakistan therefore labour intensive industries can be set up and the products
from such industries could be exported.
(ii) Export tariffs:
Reducing export duties will help us make our exports competitive in the international market. Foreign
countries would prefer to buy our products because of reduced prices.
(iii) Joint ventures:
Establishing joint ventures with foreign investors can give a boost to our sales outside the country.
(iv) Controlled imports:
Imports of all luxury items should be discouraged and only the needed items should be imported.
24
Q.31; Spr-20
Briefly describe the Mutual funds.
Answer;
Mutual funds:
 Mutual funds are investment vehicles where many investors pool their resources together to be
invested in a variety of financial instruments.
 These are operated by professional money managers having specialist knowledge of money
markets and capital markets.
 These allow individual investors to diversify their investment which otherwise might not be
possible for investor with small amount of capital.
25
Chapter # 15
Financial Markets
Q.1; Spr-17
Define ‘Money market’. Briefly describe any two marketable instruments traded on money
markets.
(04 marks)
Answer;
Money market:
It is the financial market for raising short-term credit.
Instruments of money market:
(i) Treasury bills:
These are instruments issued by government to raise money from the public. T-bills have short maturities,
and the government will pay the holder the par value when this maturity is up. They are bought through
auction, and are one of the most popular instruments because they are considered almost risk-free
because they have the backing of the government.
(ii) Certificates of Deposits:
These are time deposit with a commercial bank, whereby after a fixed time a certain level of money will
be returned to the holder. This has a slightly higher yield because the default risk is higher with a bank,
than with the government.
Examiner comment;
The performance in this part remained satisfactory as majority of the candidates were able to define the
term ‘Money market’ and explain at least one of the marketable instruments traded on the money
markets out of the two required.
Marking plan;
Definition of the term ‘Money market’ 1.0
1.5 marks for describing each type of marketable instrument 3.0
Q.2; Spr-15
Distinguish between ‘Money Market’ and ‘Capital Market’. Identify any three institutions
which operate in each market.
(06 marks)
1
Answer;
Examiner comment;
Most of the students got the explanation of money and capital market right. However, instead of
mentioning the institutions which operate in each type of market, many students gave the name of the
instruments such as shares, bonds etc.
Q.3; Spr-15
Identify any two capital market instruments that are available to the government for
financing its expenditure. What factors the government should consider before raising
finances through these instruments?
(04 marks)
Answer;
2
Examiner comment;
Most of the students wrote about bonds and debentures being the capital market instruments but only
few students could write about the factors which a government should consider before raising finance
through capital market.
Q.4; Spr-15
What do you understand by the term ‘Derivative’? List different ways in which derivatives
are traded.
(07 marks)
Answer;
Examiner comment;
Only a small number of students chose to attempt this question in Section B. Those who attempted, were
mostly able to define the term ‘derivative’ correctly. However, most of them did not know that derivatives
are also traded over the counter (OTC).
Q.5; Spr-15
Explain the following financial instruments:
(i) Call and Put Options (04 marks)
(ii) Swaps (03 marks)
Answer;
3
Examiner comment;
(i)
This sub-part of the question contained four marks but many students explained the Call and Put options
in just one or at most two sentences as they only mentioned about an agreement to buy and sell at a
given price but did not fully explain the idea behind such agreements.
(ii)
Majority of the students could not explain SWAP correctly. Only few of them could explain how cash flow
is determined by a random or uncertain variable like interest rate etc. Almost no body discussed or even
mentioned the market outlook or risk appetite. Many students explained it merely as an exchange of
assets. Many students did not attempt it altogether.
Q.6; Spr-15
Various sources of short-term and long-term credit are available to the firms. Briefly
discuss any two sources in each case.
(06 marks)
Answer;
4
Examiner comment;
Q.7; Spr-16
Briefly describe any two features of of each of the following:
i. Derivative instruments
ii. Mutual funds
(04 marks)
Answer;
5
Examiner comment;
Marking plan;
Q.8; Aut-16
Define capital market and list any four types of organizations that operate in the capital
market.
(04 marks)
Answer;
Examiner comment;
Marking plan;
Q.9; Aut-16
If a government wishes to raise money through the capital market, explain the choice of
instruments that are available to it. Also state what matters it would consider while raising
the money through capital market.
(06 marks)
6
Answer;
Examiner comment;
Marking plan;
Q.10; Spr-18
What is a capital market? State its main objectives.
(03 marks)
Answer;
Capital market:
Capital market is the financial market which is largely used to raise long-term finance and capital.
8
7
Objectives of capital market:

Capital market plays a vital role in mobilizing the savings and making them available to the enterprising
investors.
It facilitates the buying and selling of capital instruments.
The capital market provides long-term debt and equity finance for the government and corporate sector.
Examiner comment;
This part required the candidates to explain ‘Capital market’ and also state its objectives. The
performance remained poor as most of the candidates did not have a clear idea of a capital market.
Many candidates wasted time by listing the instruments used by the capital market and the institutions
involved in the capital market.
Many candidates did not have any knowledge about the objectives of capital market. They tried
guesswork and stated objectives such as economic growth, decrease in inflation, increase of output, etc.
Marking plan;
Definition of capital market 1.0
Up to 01 mark for each objective 2.0
______________________________________________________________________________________________________
Q.11; Spr-18
What do you understand by the term ‘Derivatives’? State the main objective of exchange
traded derivatives.
(03 marks)
Answer;
Derivatives:
Derivative is an instrument whose price is dependent on one or more underlying asset(s). It is a contract
between two parties. The price of a derivative changes with the change in the underlying asset(s).
Objective of exchange traded derivatives (ETD):
The main objective of ETD is to reduce the level of counterparty risk, as trades are done by means of
regulated contracts through a clearing house.
Examiner comment;
This part required the candidates to explain the term ‘Derivatives’ and state the main objective of
exchange traded derivatives. Good performance was witnessed in this part of the question. Most of the
candidates correctly provided the definition. However, only about 50% could state the main objective of
exchange traded derivatives.
8
9
Marking plan;
Definition of the term ‘Derivatives’ 2.0
Stating the main objective of exchange traded derivatives 1.0
Q.12; Aut-18
Briefly discuss the main features of:
(i) mutual funds (ii) derivatives
(05 marks)
Answer;
Mutual Funds
possible for an investor with small amount of capital.
Derivatives
 Derivative is merely a contract between two parties.
 Its price is dependent on one or more underlying asset(s).
 They are traded over the counter (OTC) and/or on an exchange.
Examiner comment;
This question was attempted quite well. However, mutual funds part of the question was
better answered than the derivatives part.
Marking plan;
01 mark for each feature of mutual funds and 01 mark for each feature of
derivatives 5.0
___________________________________________________________________________________________________________
Q.13; Aut-19
Briefly describe the term ‘Derivatives’ and state the main objective of exchange traded
derivatives.
(03 marks)
9
Answer;
Derivatives:
Derivative is an instrument whose price is dependent on one or more underlying asset(s).
It is a contract between two parties. The price of a derivative changes with the change in
the underlying asset(s).
Objective of exchange traded derivatives (ETD):
The main objective of ETD is to reduce the level of counterparty risk, as trades are done by
means of regulated contracts through a clearing house.
Examiner comment;
Some examinees failed to properly describe the term derivatives. The answers were varied in nature and
generally seemed to be the product of guess work. With regard to the objective of exchange traded derivatives,
the most common one line answer was that ‘it reduces the risk’ where in fact it reduces the level of counterparty
risk as trades are done by means of regulated contracts through a clearing house.
Marking plan;
Definition of derivatives 2.0
Stating the objective of exchange traded derivatives 1.0
____________________________________________________________________________________________
Q.14; Spr-20
State the matters which the government may consider while raising money from capital
markets.
(04 marks)
Answer;
Following are the matters which the government may consider while raising money from
capital markets:
(i) Rate of interest that needs to be paid to investors
(ii) Length of time to pay back
(iii) The risk factor of them not returning money to investors
(iv) Alternative methods of raising capital (increasing taxes, etc.)
10
Q.15; Spr-20
Briefly describe the Mutual funds
Answer;
Mutual funds:
possible for investor with small amount of capital.
11

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2020

E C Chapter-wise ICAP past paper with

Shaan Rehman (SRTG)

(ii) Market economy:

(i) Allah is the sustainer:

Comment on whether the goods are substitute or complement

Factors which determine the price elasticity of demand of a commodity:

(i) The availability of substitutes

 Up to 0.5 mark for each factor 2.0

From the above schedule:

(b) Recommendation with justification 2.0

The above diagram depicts the concept of Law of Equi-Marginal Utility.

Costs, revenues and firms

(iv) Role of advertisement:

Short-run average cost curve is U shaped:

Assumptions of the law of variable proportion:

Factors that lead to economies of scale include:

Factors that lead to diseconomies of scale:

 Preparation of labelled diagram 3.0

Three conditions that are required for price discrimination:

The given diagram is of the kinked demand curve.

 Definition of cost of production, implicit cost and explicit cost 3.0

The law of increasing returns:

Application of the law of increasing returns to the industrial sector:

Three stages of the law:

(i) Equilibrium level of national income:

(ii) Fiscal surplus / deficit:

The existing equilibrium is at point A. An increase in government

0.75 mark for stating each difficulty 3.0

Computation of GDP at market price 2.0

Computation of GNP at market price 1.0

Computation of NNP at market price 1.0

WITHDRAWALS FROM THE CIRCULAR FLOW OF INCOME

01 mark for describing each injection 3.0

01 mark for describing each withdrawal 3.0

Consumption, Saving & Investment

Definition of Keynes’ Psychological law of consumption 1.0

Objective factors influencing the consumption function:

1.5 marksfordescribing eachobjective factor influencing consumptionfunction

Explanation of Marginal efficiency of capital (MEC) 1.0

Autonomous investment curve:

Computation of multiplier 2.0

Computation of marginal propensity to consume 3.0

(i) Leading economic indicators:

Marking plan; Mark(s)

02 marks for describing each function of publicfinance 4.0

Money demanded and an increase in financial innovation

In the above diagram, The economy begins in equilibrium at A.

Preparation of diagram 3.0

(ii) To act as a unit of account:

The unfavourable consequences of unemployment are:

Following are the limitations of monetary policy:

Central bank plays the following role for a government:

 Exchange rate controls:

Limitations of credit creation in achieving economic objectives:

Advantages of floating exchange rates

Advantages of fixed exchange rates

Correcting the balance of payments deficit

Components of current account:

 Definition of exchange rate 1.0

Policy instruments available to government to influence foreign exchange rates:

Advantages of floating exchange rate:

Objectives of capital market:

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