1. The following information is extracted from the National Income Accounts of an economy:

  Million units ofcurrency (MUC)

Factor incomes received by domestic residents from

 

Business sector 500Foreigners 20

Gross Investment 200Business Savings 25Net Investment 150Subsidies 10Corporate Profit taxes 15Personal Income taxes 100Net factor income from abroad –5Budget Deficit 10Net transfer to household sector 7Consumption Expenditure 319Indirect taxes 70

You are required to find:a. Gross Domestic Product at Market Prices.b. National Income.c. Current Account Balance.

Answer:

1. GDPMP = Factor income paid to domestic residents by the

production sector + Factor income paid to foreign residents by

the production sector + Business savings + corporate profit tax +

Depreciation + Indirect taxes – subsidies.

Depreciation =(Gross investment – Net investment) = 200

–150 = 50

Factor income paid abroad = Factor income received from

abroad - NFIA = 20 – (– 5) = 25

\ GDPMP = 500 + 25 + 25 + 15 + 50 + 70 – 10 = 675

b. NI = GDPMP – Indirect taxes + subsidies – Depreciation + NFIA

= 675 – 70 + 10 – 50 + (–5)= 560

c. CAB=Domestic savings (DS) – Domestic Investment (DI)

DS= Business savings + Government savings + Household savings.

Household savings = Personal Disposable income – Personal

consumption

PDI = NI – Business savings – corporate profit tax + net transfers –

Personal income tax

PDI = 560 – 25 – 15 + 7 – 100 = 427

\ PS = 427 – 319 = 108

\ CAB = (25 – 10 + 108) – 150 = – 27

\ Current account deficit = 27.

2. The following information is taken from Union Budget for the year 2006 – 07:

(Rs. crore)

Revenue Receipts  Tax Revenue (Net) 1,72,965Non-tax Revenue 72,140Capital Receipts  Recoveries of Loans 17,680Other Receipts 12,000Borrowings & Other Liabilities 1,35,524Non-plan Expenditure  On Revenue Account 2,70,169

(Of which, interest payments is Rs.1,17,390 crore)

 

On Capital Account 26,640Plan Expenditure  On Revenue Account 70,313On Capital Account 43,187

Required:a. Find the Fiscal Deficit, Revenue Deficit and Primary Deficitb. Comment on the significance of these deficits.c. For the economy money multiplier is estimated to be 3. If government

plans to monetize 10% of the fiscal deficit, what would be the impact on money supply?(12 points)

 

2. a. Fiscal Deficit = Borrowings and other liabilities =Rs.1,35,524 Cr

Revenue Deficit = Revenue expenditure – Revenue Receipts

Revenue Expenditure = Non-plan revenue expenditure + plan revenue

expenditure

=2,70,169 + 70313=Rs.3,40,482 Cr

\ Revenue Deficit = 3,40,482 – (1,72,965 + 72,140) = Rs.95,377 Cr.

Primary Deficit = Fiscal Deficit – Interest payments

= 135,524 – 117,390 = Rs.18,134 Cr.

 

b. Fiscal deficit signifies the net addition to the public debt for the current

year.

Revenue deficit signifies the amount of borrowings required to finance

current consumption expenditure of the government.

Primary deficit indicates the discretionary component of fiscal deficit. This is

because of committed nature of interest payments.

 

c. Fiscal Deficit = Rs.1,35,524 Cr.

10% of fiscal deficit = Rs.13552.4 Cr.

Monetization of deficit directly increase the high powered money in the

economy

\DH = Rs.13552.4 Cr.

DMs = m. DH = 3 ´ 13552.4 = Rs.40657.2

\ Monetization of 10% of the fiscal deficit would increase the money supply

by Rs.40657.2 Cr.

3. The consumption function estimated for an economy is

Ct = 80 + 0.6 dtY + 0.2 Ct – 1

If dtY increase by 100 and remains at that level,

find the change in steady state level of consumption.(4 points)

 Answer: 3. Ct = 80 + 0.6 Ydt + 0.2 Ct – 1

At steady state, tC = Ct – 1

\ Ct = 80 + 0.6 Ydt + 0.2Ct

0.8 Ct = 80 + 0.6 Ydt

Ct = 100 + 0.75 Ydt

DCt = 0.75 ´ D Ydt = 0.75 ´ 100 = 75

\ If Ydt increases by 100, steady state level of consumption

increases by 75.

 

4. The following relations are estimated for an economy:Savings function (S) = – 380 + 0.35 Yd + 10iTax function (T) = 0.30YInvestment function (I) = 300 + 0.15Y – 50iTransfer payments (R) = 200Government Expenditure (G) = 1200Exports (E) = 900Import function (M) = 50 + 0.105YMoney Supply (Ms) = 1000

Transaction Demand for Money (Mt) = 0.25YSpeculative Demand for Money (Ma) = 350 – 100i(All macroeconomic aggregates are in million units of currency (MUC) and the rate of interest is in percentage.)Required:a. Compute the equilibrium level of income and rate of interestb. The government desires to have an increase in the

equilibrium output by 10% in the next period and for this purpose, the following alternatives are under considerationi. Increase in government expenditure (G)ii. Increase in money supply (Ms)Compute the required increase in G and Ms to achieve the objective of the government.

c. Compute the impact of the two alternative measures in (b) above on private investment.

Answer: 4. a. S= – 380 + 0.35 Yd + 10i

C = 380 + 0.65Yd – 10i

Yd = (Y – tY + R) = (Y – 0.3Y + 200)

\ C = 380+ 0.65 (Y – 0.3Y + 200) – 10i = 510 + 0.455Y – 10i

IS functionY = C + I + G + (E – M)

=510 + 0.455Y – 10i + 300 + 0.15Y – 50i + 1200 + 900 – 50 – 0.105YY = 2860 + 0.5Y – 60i

Y = 5720 – 120i IS function.

LM function

Ms = Md

Md = Mt + Ma = 0.25Y + 350 – 100i

\ 1000 = 0.25Y + 350 – 100i

Y = 25.0

i100650

= 2600 + 400i LM function

At equilibrium LM = IS

2600 + 400i = 5720 – 120i

520i = 3120

i = 6%

Y = 5000.

 

b. If Y is to increase by 10% new equilibrium income is 5000 (1 + 0.10) = 5500

Option I: Increase in G

Y = 2600 + 400i LM function

If Y = 5500

400i = 5500 – 2600

i = 7.25%

IS function with G as a variable is

Y = (2860 – 1200 + G) + 0.5Y –60i

Y = 5.0

)i60G1660(

Y = 3320 + 2G – (120 ´ 7.25)

2G = 3050

G = 1525.

\ Increase in G = 1525 – 1200 = 325.

Option II: Increase in Money SupplyY = 5720 – 120i IS functionIf Y = 5500,120i = 5720 – 5500i = 1.83%Ms = 0.25Y + 350 – 100i LM functionIf Y = 5500 and i = 1.83%Ms = (0.25 ´ 5500) + 350 – (100 ´ 1.83)

= 1542Increase in G:

Change in Investment (DI) = I1 – I0

I1 = 300 + (0.15 ´ 5500) – (50 ´ 7.25)= 762.50

I0 = 300 + (0.15 ´ 5000) – (50 ´ 6.0)= 750

\DI= 762.50 –750= 12.50

Increase in Money SupplyDI = I1 – I0

I1 = 300 + (0.15 ´ 5500) – (50 ´ 1.83)= 1033.50

I0 = 750DI = 1033.50 –750

= 283.50

 

5. The following balances are taken from balance sheet of the Central Bank of a country.

ParticularsMillion units of currency

(MUC)Credit to Government 7,000Credit to Banks 4,000

Government Deposits 500Other non-monetary liabilities 25Net worth 1,000Credit to commercial sector 2,000Net foreign exchange assets 11,000Other assets 100Deposits of banks 6,000Other Deposits 600

The currency/deposit ratio has been ascertained as 0.24. Reserve ratio imposed by the central bank is 7%. The amount of Government money is 25 million units of currency.Required:a. Find the money supply in the economyb. Because of intervention in the foreign exchange market, net worth of the central bank is

expected to erode by 50% in the next period. If the Central bank desires to maintain the current level of money supply by changing the reserve ratio, what should be the new reserve ratio?

Answer: 5. a. High powered money = Monetary Liabilities of RBI + Government Money

Monetary liabilities of RBI =(Financial Assets + Other Assets – Non-monetary liabilities)

Financial Assets = (Credit to Government + Credit to Banks + Credit to commercial sector + Net

Foreign exchange assets) =7000 + 4000 + 2000 + 11000=24000.

Other Assets =100

Non-monetary liabilities = Government deposits + other non-monetary liabilities + Net worth

= 500 + 25 + 1000 = 1525

\ Monetary liabilities = 24000 + 100 – 1525 = 22575

Government money = 25

\ High powered money (H) = 22575 + 25 = 22600

Money Supply =H ´ m

Money multiplier (m) =(1+c)/(c+r)= 4

\ Money Supply in the economy = 22600 ´ 4 =90400 MUC

 

b. If net worth is eroded by 50%, Net worth = 500 MUC.

\ Monetary liabilities = 22575 + 500 = 23075

H = 23100.

If money supply is held constant,

90400 = 23100 /m. r is found out by the equation m=(1+c)/(c+r)

r = 0.0769 =7.69%

\ The central bank should increase the reserve ratio to 7.69%.