Quiz Questions 13 January 2023 (Key)

Q1.Consider the following statements:

(1). Office of Economic Advisor (OEA), Department of Industrial Policy and Promotion.

(2). Ministry of Commerce and Industry calculates the Consumer Price Index (CPI).The Base Year of the CPI is 2012.

Which of the above statements is/are correct?

(a). 1 only

(b). 2 only

(c). Both 1 and 2

(d). None

Explanation:

Consumer Price Index (CPI) in India comprises multiple series classified based on different economic groups. There are four series, viz the CPI UNME (Urban Non-Manual Employee), CPI AL (Agricultural Labourer), CPI RL (Rural Labourer) and CPI IW (Industrial Worker). While the CPI UNME series is published by the Central Statistical Organisation, the others are published by the Department of Labour.The Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation has revisedthe Base Year of the Consumer Price Index (CPI) from 2010 to 2012 with effect from the month of January 2015.

Q2.High and volatile Inflation generally tends to:

1.Reduce value and demand of national currency.

2.Increase lending activities by financial institutions.

Which of the above is/are correct?

(a) 1 only

(b) 2 only

(d) None

Explanation:

Statement 1: Inflation erodes the value of currency. For e.g. if inflation in India is 1000%, then the very next year the value of Rs. 5000 in year 2016 will be near Rs. 500 in year 2017. It also leads to depreciation in the exchange rate of the currency. As a result, people lose confidence in the currency and holding it becomes a risky proposition.So, people switch to other forms of wealth like Gold, Foreign Currency,i.e. “inflation proof” assets. Statement 2: If inflation is high and volatile, the returns on lending are uncertain, volatile and low too. For e.g. if a bank has lent to a customer at an interest rate of 10% p.a., but inflation is hovering between 4-14%, the bank can make a profit of 6% (real interest rate) or bear a loss of 4% depending on whether the inflation is high or low. This discourages lending.

Q3.“Expectations augmented Phillips curve” is often used to predict. the short-term and long-term impact of macroeconomic management policies in an economy. The term “expectations” denotes expectations about

(a) GDP growth rate

(b) Inflation

(d) Environmental degradation

Explanation:

As per the Phillips curve there is a ‘trade off’ between inflation and unemployment i.e. an inverse relationship between them.The curve suggests that lower the inflation, higher the unemployment and higher the inflation, lower the unemployment.However, the economist Milton Friedman argued that in the long run, there was no trade-off between unemployment and inflation.Suppose if government increases aggregate demand (AD) by monetary expansion, this not only increases the AD but also increases the expectation that inflation will go up. As people expect inflation to go up, they demand higher wages and unemployment returns to the initial level.

Q4.The expectations-augmented Phillips curve thus introduces adaptive expectations into the Phillips curve and makes it more dynamic The “Base Effect”, when measuring inflation, refers to the impact of?

(a) Stock of domestic resources on inflation

(b) Technological breakthroughs on inflation

(d) Revision of consumption basket on inflation

Explanation:

The base effect refers to the impact of the rise in price level (i.e. last year’s inflation) in the previous year over the corresponding rise in price levels in the current year (i.e., current inflation).If the price index had risen at a high rate in the corresponding period of the previous year leading to a high inflation rate, some of the potential rise is already factored in, therefore a similar absolute increase in the Price index in the current year will lead to a relatively lower inflation rates.On the other hand, if the inflation rate was too low in the corresponding period of the previous year, even a relatively smaller rise in the Price Index will arithmetically give a high rate of current inflation.

Q5.What do you understand by the term “Core Inflation”?

(a) Headline inflation discounted for food and fuel inflation

(b) Core Industrial sector inflation discounted for raw material prices inflation

(d) CPI inflation discounted for WPI inflation

Explanation:

Core inflation represents the long run trend in the price level. In measuring long run inflation, transitory price changes should be excluded. • One way of accomplishing this is by excluding items frequently subject to volatile prices, like food and energy. • Therefore, a dynamic consumption basket is considered the basis to obtain core inflation. • Core inflation is calculated using the Consumer Price Index (CPI) by excluding such commodities. • If temporary price shocks are taken into account, they may affect the estimated overall inflation numbers in such a way that they are different from actual inflation.

Q6.What do you understand by a ‘deflationary Gap’ in the economy?

(a) Underproduction with respect to full employment GDP of the economy

(b) Consistent decline in inflation at an exponential rate

(d) Excess supply of goods and services with respect to the weak demand in the economy

Explanation:

Deflationary gap is the amount by which actual aggregate demand falls short of aggregate supply at level of full employment.It is a measure of amount of deficiency of aggregate demand. Deflationary gap causes a decline in output, income and employment along with persistent fall in prices.On the other hand, an inflationary gap is a signal that the economy is in the boom part of the trade cycle, resources are being used over their capacity, factories are operating with increasing average costs; wage rates increase because labour is used beyond normal hours at overtime pay rates.

Q7.Inflation generally results from:

1.An excess of supply over demand

2.An excess of demand over supply

3.If income increases faster than the increase in productive capacity of the economy

Select the correct answer using the codes below.

(a) 1 and 2 only

(b) 2 only

(c) 2 and 3 only

(d) 1 and 3 only

Explanation:

In simple terms, inflation is basically too much money chasing too few goods, or excess demand chasing limited supply. In both these cases, the prices of goods rises faster as individual consumers bid process higher in order to get the good.In simple terms, inflation is basically too much money chasing too few goods, or excess demand chasing limited supply. In both these cases, the prices of goods rises faster as individual consumers bid process higher in order to get the good. Statement 1: So, 1 is incorrect, as excess supply is likely to bring prices down, not high. Statement 2: 2 is explained by the above. Statement 3: If income rises faster, demand for goods and services will also rise. On the other hand, if the economy is unable to satisfy the increased demand, for e.g. due to poor infrastructure, lack of production etc, the higher income will spiral the prices upwards and lead to high inflation.

Q8.Consider the following statements. Assertion:

(A): Real interest rates have turned negative many times in India. Reason

(R): High inflation has been registered in many financial years.

In the context of the above, which of these is correct?

(a) A is correct, and R is an appropriate explanation of A.

(b) A is correct, but R is not an appropriate explanation of A.

(d) Both A and R are incorrect.

Explanation:

Nominal interest rates are what banks charge you on lending. But, this is not the actual interest rates received by banks, because inflation erodes earnings on interests.Real interest rate is the nominal rate adjusted for inflation. Suppose if nominal rate is 10% and inflation is 8%, real interest rates will be 2% only. But, if inflation exceeds 10% mark, real interest rate will turn negative. India has witnessed negative real interest rates since 2008, which has disincentivized savers, thereby triggering a sharp movement of household savings (70% of overall savings) from financial assets to physical assets. This is due to the double digit WPI and CPI inflation witnessed in these years.

Q9. Fiscal deficit will always cause inflation when:

1.It increases aggregate demand without addressing the supply side bottlenecks.

2.It promotes consumption spending by way of huge subsidies.

Which of the above is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) None

Explanation:

Statement 1: One of the main criticisms of deficits is that they are inflationary. This is because when government increases spending or cuts taxes, aggregate demand increases. If firms can’t match (supply) increased demand, inflation will occur.However, if there are unutilised resources, output is held back by lack of demand. A high fiscal deficit is accompanied by higher demand and greater output and, therefore, need not be inflationary.

Statement 2: Subsidies provide that additional income to households which are spent for consumption purposes.When persistently high fiscal deficit is run by the government, this excess money is not matched with any increase in the productive capacity of the economy. It also crowds out private sector investment, leads to inflation and slows down the economy.

Q10. Failure to account for which of the following leads to the notion of “Money illusion” among salaried workers?

(a) Growth in the level of employment in the overall economy

(b) Policies of the management towards social security of employees

(d) Inflation and decline in the real value of money

Explanation:

It is the belief that money has a fixed value in terms of its purchasing power.Therefore, it refers to the tendency of people to think of currency in nominal, rather than real terms.They believe their income and wealth does not decline over time, which actually does. For e.g. the value of Rs. 1,00,000 in 2007 and 2017 is different. It has declined over time.Real prices and income take into account the level of inflation in an economy.There are several reasons why the money illusion likely exists for many people, including a general lack of financial education, and the price stickiness seen in many goods and services.