MEC-002 : MACRO ECONOMIC ANALYSIS

(Assignment Code: MEC-002/AST/2011-12)

Section: A
Q.1

What is meant by steady state in the Solow Model? Explain how Golden Rule is different from
steady state.
Ans. The Steady State is a condition when the economy does not have to change its capital-labour
ratio.
Investment per unit of effective labour equals saving per unit of effective labour i.e
i = sy {since, y = f(k)}, then i = sf(k)
The rate of growth capital stock is equal to the rate of investment. In per effective labour term, written
as
= sf(k), where refers to growth rate in k.
Growth of Capital and Steady State
The Solow model assumes that existing capital depreciates at the rate . Thus each year K amount of
capital is depreciated.
Investment and depreciation act in opposite directions and the growth in capital stock is net of the two
quantities.
(t) = i(t) - k(t) {since i= sf(k(t)), then (t) = sf(k(t)) - k(t)
Capital stock rises when sf(k(t)) > k(t); falls when sf(k(t)) < k(t) and remain constant when sf(k(t)) =
k(t).
Population Growth and Steady State
Consider the case where population and the labour force grow at a constant rate n.
(t) = sf(k(t)) (n+)k(t)
For steady state the amount of investment required must not only cover depreciation (k) but also
provide new workers with capital (nk). Break-even investment now would be (n+)k. The steady state is
achieved at the point of intersection of investment and (n+)k curves. Capital Stock(K) and output (Y)
keeps on growing at the rate n to keep k and y constant. At steady state both k and y are constant.
Technological Progress and Steady State
The technological progress in the Solow model indicates the quantity of effective labour (AL). The rate
of technological progress is g. The change in k over time is now modified as (t) = sf(k(t))
(n+g+)k(t)

The analysis of steady state does not change with the inclusion of technological progress. But the
break-even investment now is (n+g+)k. Out of total investment sf(k), k is needed to cover
depreciation and nk to maintain capital per effective labour constant. However, as a result of
technological progress y grown at a rate of g.
The Golden Rule
In economics, we generally assume that the more people consume, the happier they are. So if we want
people to be as happy as possible, our aim is to maximize consumption per worker c. The steady state
associated with that particular outcome is called the Golden Rule (GR) steady state.
Steady State consumption is output net of investment. Thus
c* = y* - i* {since y* = f(k*) and investment (i*) = depreciation ((n+g+)k*) }
or c* = f(k*) - (n+g+)k*
As increase in steady state capital has contrasting effect on steady state consumption more capital
leads to more output which contributes positively to consumption, but it also means higher bread even
investment (n+g+)k.
Steady state consumption is the gap between the steady state output and steady state break-even
investment, which maximized at k* gold level of capital per effective labour.
While higher levels of capital mean higher levels of output, they also mean more capital is being
removed from the economy each year. If the capital stock is below the GR level, the slope of the
production function is greater than that of the capital stock curve, and an increase in capital per worker
has a greater impact on f(k) than on (n+g+)k giving us an increase in consumption. The opposite will
hold true when we are above the GR level. The GR steady state occurs when
MPK = (n+g+)
or
(MPK - ) = (n+g)
At the golden rule level of capital, the MPK net of depreciation is equal to the rate of growth of total
output (n+g).
A planner trying to maximize long-run consumption would then aim to get a savings rate that
corresponded with that particular steady state level of capital. Note that in the transition to the GR point,
there will be initial effects and long-run effects. Say were below the GR. As we increase savings,
there will be a temporary decrease in consumption, and then a long run increase. Why? Because an
increase in savings means less consumption right away (c = y - sy). However, as capital accumulates,
output increases, and thus so does consumption. This situation gives us a look into why its called the
Golden Rule . . . because we sacrifice consumption now for higher consumption for the people of the
future. As Mankiw puts it, the welfare of all generations is given equal weight, so sacrifice by this
generation is outweighed by the gains of future generations.

Q.2 Explain how the permanent income hypothesis reconciles the difference between longrun and short-run consumption functions?

Ans. According to the life cycle hypothesis the short-run consumption function shows a decline
average propensity to consume (APC) while the long-run consumption function exhibits constant
average propensity to consume due to increase in asset base. On the other hand permanent income
hypothesis explains the discrepancy in terms of permanent income and transitory income.
Friedmans permanent income hypothesis provides an alternative explanation to the apparent
discrepancy between cross-sectional and time series data on consumption. Unlike the life-cycle
hypothesis, Friedman does not postulate that incomes follow a regular pattern over the life cycle of an
individual; he instead argues that individuals experience random and temporary changes in their
income from time to time. Accordingly, Friedman views the current income in any period (Y t) as
consisting of two components: permanent income (Y tP) and transitory income (YtT). Permanent income
is that part of the income which prevails over the long run. Friedman interprets this as the long run
average income of the individual, i.e.
Y tP t)
Transitory income is any random deviation from this average, i.e
Y tT t)
A positive transitory income implies that the current income exceeds the permanent income; a negative
income implies that the current income is less than the permanent income. Since
Ct = A0/T + 1/T ( t) = A0/T + YtP , i.e current consumption of the household depends only on the
permanent income, any increase in the transitory part of the current income, which leaves the
permanent income unchanged, will have no impact on the level of current consumption.
Friedmans permanent income hypothesis solves the apparent puzzle in the consumption data.
According to Friedmans hypothesis, the average propensity to consume (C t / Yt) depends on the ratio
of permanent to current income YtP /Yt. Thus when current income temporarily rises above the
permanent income the average propensity to consume falls; the opposite happens when current
income temporarily falls below the permanent income. The high income group will contain some people
with a high transitory income, who will have a lower propensity to consume than the average. Similarly
the low income group will contain some people with a low transitory income, who will have a higher
propensity to consume that the average. Thus average propensity to consume will fall from lower to the
higher income group. Any increase in the long run reflects a permanent increase in the average income
level.

Section B
Q.3 Policy makers should stick to rules instead of pursuing discretionary policies. Do you
agree with the above statement? Substantiate your answer.
Ans
Yes, policy makers should stick to rules instead of pursuing discretionary policies. This is
because the greater the deviation from rules that a government displays in undertaking discretionary
action even in circumstances where intervention is unanimously demanded, the less will be the
credibility of policy rules announced by the government in the future. The credibility of an announced
policy rules depends not only on past experience regarding a governments ability to adhere to
commitments but also on a rational evaluation about the future possibility of a government adhering to

a policy rule. If the governments have the discretion to change policy at future points in time then an
announced policy rule will not be credible unless it is time-consistent, at some point in time it will not be
optimal for the government to follow the policy dictated by the rule. A problem might arise because the
policy rule which is optimal over the entire time horizon may not be time-consistent.
An obvious way by which the government can commit to a particular policy rule is to enact legislation
making it costly to deviate from the rule in the future. However, it might be difficult and time-consuming
to amend the legislation if there arises unanticipated eventualities which urgently require deviation from
the rule or if it is found that important assumptions make in faming the rule are erroneous. An
alternative way by which an optimal policy rule may be made credible without losing the flexibility for
using discretion in emergencies if for the government to delegate responsibility for this policy to some
autonomous agency which the public perceives as having a different objective function.
In practice policy formulation needs to be based on certain rules or procedures. However, there is a
need for revision of policy rules against unanticipated developments which may be time-taking and
costly. In order to tackle such eventualities the government can delegate the responsibility to some
autonomous body. The possibility of following a sub-optimal policy over time cannot be ruled out.
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Q.4 Explain in brief the salient features of real business cycle theory. In what respects is it
different from other theories of business cycle?
Ans. In real business cycle theory emphasis in given on real shocks such as technological change
which shifts the production function. A productivity shock changes the level of output produced by given
amount of inputs. The basic tenets of real business cycle theory are as follows:
(a)

An economy is considered as a sea with islands of local markets.

(b)
Buyers and sellers have perfect information about the prices of goods and services on their
islands but cannot sample the prices on other islands except by rowing there, a costly activity. But, they
form estimates of the general price level, the average of all prices. Thus, an increase in the general
price level will be misperceived as an increase in the price of goods on the island, a (small) subset and
therefore sub optimal decisions about consumption; production and investment will be taken.
(c)
Each household produces goods and sells them on one and only one of the arrays of these
markets.
(d)

Goods differ according to location, physical characteristics and so on.

(e)
Fluctuations in output by means of exogenous shocks. These shocks can originate on the
demand side as well as on the supply side.
(f)
A monetary shock leads to an increase in the general price level and a fall in the expected
interest rate.

(g)
The greater the uncertainty about money and the general price level, the fewer prices becomes
useful as the conveyor of information par excellence. Thus, the economy becomes less responsive to
changes in fundamentals, shifts in tastes and technology that require optimizing and efficient allocation
of resources.
The Real Business Theory emphasizes on relative prices rather than absolute price level, and
believes that money is neutral, and also because it lays emphasis on supply side forces. Real business
cycles are fluctuations generated by shock which might not reflect the rhythms of ebb and flow of
classical cycles. New Classical Business Cycle research is oriented towards explaining the familiar
pattern of boom and slump, one following the other in regular succession. The role of money and
finance in both approaches are distinguished. In the former, shocks referred to are changes in
technology and taster. Money is a veil. On the other hand, money and finance are part of the model of
expansion and contraction developed by New Classical Business Cycle theorists.

Q.5

Explain why firms may offer a higher wage to workers than the equilibrium wage rate.

Ans. The efficiency wage theories rationalize the existence of higher than market clearing real
wages. Firms pay higher than market-clearing real wages because the benefits accruing from higher
wages are more than the cost of paying higher wages. The higher benefits accrue for the following
reasons: (a)
The benefits come from increased efficiency of workers. The increased efficiency due to
increased physical efficiency of workers obtaining higher wages enables higher consumption including
higher nutrition.
(b)
A higher than market wage build loyalty and belonging among workers and induce higher effort.
Whereas in the context of the opposite situation of a lower wage, which is expected to have affects like
generating anger and a desire for revenge, thereby leading even to a sabotage by the workers.
(c)
A higher wage generates incentives for workers to avoid work shirking behaviour in situations
where the firms cannot monitor the work effort perfectly. Workers will have fear of losing high paying
jobs if caught shirking.
(d)
Higher wages get into the pool of workers with a higher reservation wage i.e. the minimum wage
that should be offered to a worker to induce him to supply his labour on the market. Workers with a
higher reservation wage are expected to have superior abilities along directions that cannot be directly
observed and duly compensated for on the market. These higher abilities in the pool o employed
workers are expected to benefit the firm.
The efficiency wage model not only rationalizes the existence of persistent unemployment, but
also produces a larger effect on employment in the short run. The shortcoming of an efficiency wage
model using a simple version of the effort function is that it implies that there is no increasing trend in
the real wage in the long run.

Q.6 Bring out the important issues on which Lucas criticizes Keynesian macroeconomics. To
what extent the New-Keynesian economists have accepted these criticisms?
Ans. One of the most influential economists since the 1970s, he challenged the foundations of
macroeconomic theory (previously dominated by the Keynesian economics approach), arguing that a
macroeconomic should be built as an aggregated version of microeconomic models (while noting that
aggregation in the theoretical sense may not be possible within a given model). He developed the
"Lucas critique" of economic policymaking, which holds that relationships that appear to hold in the
economy, such as an apparent relationship between inflation and unemployment, could change in
response to changes in economic policy. This led to the development of neoclassical and New
Keynesian economics and the drive towards microeconomic foundations for macroeconomic theory.
The development of macroeconomic theory since the 1970s was significantly influenced by the Lucas
critique. This critique implies that we cannot apply econometrics using macroeconomic models, which
directly assumed certain behavioural relations between macroeconomic variables, in order to check the
effects of alternative policies.
The Lucas critique, named for Robert Lucas work on macroeconomic policymaking, argues that it is
nave to try to predict the effects of a change in economic policy entirely on the basis of relationships
observed in historical data, especially highly aggregated historical data.
The Lucas critique suggests that if we want to predict the effect of a policy experiment, we should
model the "deep parameters" (relating to preferences, technology and resource constraints) that
govern individualbehavior. We can then predict what individuals will do, taking into account the change
in policy, and then aggregate the individual decisions to calculate the macroeconomic effects of the
policy change.
The Lucas critique was influential not only because it cast doubt on many existing models, but also
because it encouraged macroeconomists to build micro foundations for their models. Micro foundations
had always been thought to be desirable; Lucas convinced many economists they were essential.
One important application of the critique is its implication that the historical negative correlation
between inflation and unemployment, known as the Phillips Curve, could break down if the monetary
authorities attempted to exploit it. Permanently raising inflation in hopes that this would permanently
lower unemployment would eventually cause firms' inflation forecasts to rise, altering their employment
decisions.

Q.7

Write short notes on

(a)

Rational expectation and adaptive expectation

Ans
Expectations are said to be rational when they are formed on the basis of all available
information. Under this assumption, expectations are never biased.
Economic-behaviour observation according to which: (1) On average, people can quite
correctly predict future conditions and take actions accordingly, even if they do not fully understand the
cause-and-effect (causal) relationships underlying the events and their own thinking. Thus, while they
do not have perfect foresights, they construct their expectations in a rational manner that, more often
than not, turn out to be correct. Any error that creeps in is usually due to random (non-systemic) and
unforeseeable causes. (2) In efficient markets with perfect or near perfect information (such as in

modern open-market economies) people will anticipate government's actions to stimulate or restrain the
economy, and will adjust their response accordingly. For example, if the government attempts to
increase the money supply, people will raise their prices and wage demands to compensate for the
inflationary impact of the increase. Similarly, during periods of accelerating inflation, they will anticipate
stricter credit controls accompanied by high interest rates. Therefore they will attempt to borrow up to
their credit capability, thus largely nullifying the controls. This theory was proposed not as a
plausible explanation of human behaviour, but to serve as a model against which
extreme forms of behaviour could be compared. It was developed by the US economist Robert Lucas
(born 1937) who won the 1955 Nobel Prize for this insight.
Expectations are said to be adaptive when people form their expectations on the basis of past
behaviour.
Economic-behaviour observation that people form their expectations of economic trends solely
on the basis of what was the past magnitude and direction of those trends. If these expectations turn
out to be wrong then, depending on the degree of the error, people revise (adapt) their
future estimates accordingly.
(b)

Non-accelerating Inflation Rate of Unemployment (NAIRU).

Ans It is an unemployment rate that is consistent with a constant inflation rate. The NAIRU is the
unemployment rate at which the long-run Phillips curve is vertical. When unemployment is equal to
NAIRU there will be stability in the rate of inflation. When unemployment departs from NAIRU, there is
acceleration or deceleration in inflation rate. Thus if actual unemployment is less than u*, inflation will
continue to accelerate higher and higher in subsequent years. Unless unemployment returns to its
natural rate inflation spiral will keep on accelerating. When unemployment is more than u*, inflation will
tend to fall as long as unemployment is above u*.

MEC-003: Quantitative Techniques

Assignment
Course Code: MEC-003

Note: Answer all the questions. While questions in Section A carry 20 marks each, those of
Section B carry 12 marks each.
Section A
Long Answer Question

1.
How do you use differential equations in economics? What type of situations can be
helpfully depicted using differential equations? Discuss the role of initial condition in solving a
differential equation. If your objective is to examine the stability of equilibrium, with the help of
an example, show how a second-order differential equation helps in addressing your concern.
Ans. Differential Equation are equations involving the derivatives (or differentials) of unknown
functions. Solving differential equations in economics means finding a function that satisfies that
equation. If y = f(x) is a function for which derivatives of adequate order exist, the dy/dx = f(x).
or dy = f(x)dx
y = f(cx)dx,
Through differential equations, we solve the problems, which are related to change over time, i.e.
dynamic variables. For example, suppose that a hypothetical economys income (y) is related to time
(x). It is given in functional form: y(x) = 2x 1/2. If the income changes over time, we find the rate of
change as dy/dx = x - 1/2. To find the time path if the income change, we write y = y(x). The derivative of
this function will be same as that of y = y(x) + c, where c is any arbitrary constant. To determine a
unique time path of the income change, it is necessary to work out a definite value of c. Additional
information required for that purpose is to have the initial condition. The initial condition of the economy,
say, y(0), i.e value of y at x=0, then the value of the constant c can be determined,
Thus, from y(x) = 2 x1/2 + c, where x = 0,
We get y(0) = 2(0)1/2 + c = c
The differential equation that involves only the first derivative has a unique solution if it has one initial
condition. In addition, the differential equation that involves only the first and second derivatives has a
unique solution if it has two initial conditions.
In a differential equation, if the initial value has a solution that is a constant function and hence
independent of t, then the value of the constant is called an equilibrium state or stationary state of the
differential equation.
A second order ordinary differential equation consists of time as the independent variable with the
dependent variable y with its first and second derivatives. Consider for example an equation G(t, y(t),
y(t), y*(t)) = 0 for all t such that we can write it in the form

y*(t) = F(t, y(t), y(t)).

Equations of the form y(t) = F(t, y(t)
Take an equation of form
y*(t) = F (t, y(t)),
in which y(t) does not appear.
Stability of solutions of second order homogeneous equation
Consider the above homogeneous equation
y*(t) + ay(t) + by(t) = 0
If b 0, this equation has a single equilibrium, viz, 0. That is, the only constant function that is a
solution is equal to 0 for all t. Three possible forms of the general solution of the equation to evaluate
the stability of such equilibrium are as follows: Case I: Characteristics equation has two real roots. If r1 and r2, are the two roots of the
characteristics equation, then the general solution of the equation is y(t) = Ae r1t + Ber2t. The equilibrium
is stable if and only if r1 < 0 and r2 < 0.
Case I: Characteristics equation has single real roots. With a single root (say r), the characteristic
equation is in stable equilibrium if and only if this root is negative. Note that if r<0 then for any value of
k, tk ertconverges to 0 as t .
Case I: Characteristics equation has complex roots. When the characteristic equation has
complex roots, the form of the solution of the equation is Ae t cos(t + ), where = - a/2, the real part
of each root. The equilibrium will be stable if and only if the real part of each root is negative.

==================================================================
2.
Give examples of problems where you can make use of Poisson distribution. Does it
have a probability density function? Why or why not? Discuss your answer in the context of the
mean and variance of Poisson distribution.
Ans. The function f(x) is called the probability density function (p.d.f) provided it satisfies the following
two conditions

F(x) 0

If the range of the continuous random variable is (a,b) f(x) = 1

a
A random variable X is said to have a binomial distribution and is referred as a binomial random
variable, if and only if its probability distribution is given by
B (x;n,p) = nCx . px . (1-p)n-x for x = 0,1,2,..n

The probability of getting x success and n-x failures in n trials is given by px . (1-p)n-x.
The number of trials in the case of binomial distribution is very large and cumbersome. Then
the probability distribution used to approximate binomial possibilities. This limiting form of the binomial
distribution when n and p 0, while n.p remains constant. Let = n.p, therefore p = /n. The
binomial distribution written as
B(x,n,p) = nCx (/n)x (1-( /n))n-x = n (n-1) (n-2) (n-3)(n-x+1)/x! x (/n) x (1-( /n))n-x
= 1.(1-1/n)(1-2/n)(1-3/n)(1-(x-1)/n/x! x () x x [(1 - ( /n))n/] - x (1-(/n))-x .
When n while x and p are constants
(1-1/n) (1-2/n) (1-3/n) .(1-(x-1)/n) 1
(1 - ( /n)) -x 1
(1 - ( /n))-n/ e
Therefore, the limiting form of the binomial distribution becomes,
P (x,) = x e - / x! for x = 0,1,2,3,.
Thus, in the limit when n and p 0, n.p = remains constant; the number of success is a
random variable and will follow a poisson distribution with only parameter .
Thus Poisson distribution is a discrete probability distribution which is the limiting form of the binomial
distribution, provided
(a)
(b)

The number of trials is very large in fact tending to infinity.

The probability of success in each trial is very small; tending to zero.

The properties of the Poisson distribution are

(a)
Poisson distribution is a discrete probability distribution, where the random variable assumes
countably infinite number of values such as 0,1,2,3, to . The distribution is completely specified if
the parameter is known.
(b)

Mean and variance of poisson distribution are the same, both being .

(c)
Poisson distribution like the binomial distribution may have either one or two modes when is
not an integer, mode is the largest value contained in and when is an integer, there are two modes,
and (-1).
(d)
The poisson distribution used as an approximation to binomial distribution when n is large but np
is fixed.
Example: Let X be a random variable following poisson distribution. If P(X=1) = P(X=2), find P(X=0 or 1)
and E(X).
For poisson distribution, the probability mass function (p.m.f) is given by P (x,) = x e - / x!
Therefore,
(PX=1) = 1 e - / 1! = e -
(PX=2) = 2 e - / 2! = e -/2
As (PX=1) = P(X=2), from the equation e = 2 e - / 2! , we get = 2.
Therefore,
E(X) = = 2 and
It does not p.d.f
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Section B
Medium Answer questions
3.
Explain the relevant considerations of making choice between one-tailed and two-tailed
tests. How would you determine the level of significance in the above tests?
Ans. A test of any statistical hypothesis where the alternative hypothesis is one-tailed (right-tailed or
left-tailed) is called a one-tailed test. For example, a test for testing the mean of a population
H0 :
= 0against the alternative hypothesis H 1 : > 0 (right-tailed) or H1 : < 0 (left-tailed), is a single-tailed
test. In the right-tailed test (H 1 : > 0), the critical region lies entirely in the right tail of the sampling
distribution of x, while for the left-test (H 1 : < 0), the critical region is entirely in the left tail of the
distribution.
A test of any statistical hypothesis where the alternative hypothesis is two-tailed such as: H 0 : =
0, against the alternative hypothesis H 1 : 0 ( > 0 and < 0) is known as two-tailed test and in
such a case the critical region is given by the portion of the area lying in both the tails of the probability
curve of the test statistic.
In a particular problem, whether one-tailed or two-tailed test is to be applied depends entirely on the
nature of the alternative hypothesis. If the alternative hypothesis is two-tailed then apply the two-tailed
test and if alternative hypothesis is one-tailed, then apply one-tailed test.
The value of the test statistic, which separates the critical (or rejection) region and the acceptance
region, is called the critical value or significant value. It depends upon: (i) the level of significance
used, and (ii) the alternative hypothesis, whether it is two-tailed or single-tailed.
The critical value of test statistic at level of significance for a two-tailed test is given by z where z is
determined by the equation P[|Z| > z ] = i.e z is the value so that the total area of the critical region
on both tails is . Since normal probability curve is symmetrical curve, so P[|Z| > z ] = can be written
as,

P[Z > z] + P[Z < -z] =

P[Z > z] + P[Z < z] =
2P[Z > z] =
P[Z > z] = /2
i.e, the area of each tail is /2.
Thus, z is the value such that area to the right of z is /2 and to the left of -z is /2. Thus, the
significant or critical value of Z for a single-tailed test (left or right) at level of significance is the same
as the critical value of Z for two-tailed test at level of significance 2.

4.

A linear programming problem is given as

Find its optimal solution.

Ans
Simplex Table
50
y

0
S1

0
S2

(4)
1
1
0
30

(5)
1
2
0
50

(6)
1
0
0
0

(7)
0
1
0
0

Basic
Variable

(1)
0
0

(2)
S1
S2
zj
Cj - zj

Table 2

0
50

S1
x2
zj
Cj - zj

3
6
300
-

25
5

0
1
50
0

1
0
0
0

25
- 25

Table 3

30
50

x1
x2
zj
Cj - zj

6
3
330
-

1
0
30
0

0
1
50
0

2
-1
10
- 10

-1
1
20
- 20

Table 1

Values of
the Basic
Variables
(3)
9
12
0
-

30
x

Ratio

(8)
9/1 = 9
12/2 = 6

3/ = 6

In the
net evaluation row of the table all the elements are either zero or negative. This means the optimum
program has been attained and there is no scope for further improvement. Hence, the required
optimum solution is x1 = 6 and x2 = 3 and the corresponding value of z = 330.

5.
How would you determine linear dependence of a matrix? Define the rank of a matrix on
terms of its linear independence.
Ans. A number r is said to be the rank of matrix A, if
(i)
there is at least one (r x r) sub-matrix of A whose determinant is not equal to zero; and
(ii)
the determinant of every (r+1) rowed square sub-matrix of A is zero.
In other words, rank of a matrix is equal to the order of the highest order non-singular square matrix
contained in A. Moreover, rank of a matrix can also be defined as the maximum number of rows (or

columns) in a matrix. The rank of a matrix cannot exceed the number of its rows or columns
whichever is less.
The vector of rows (columns) of a matrix are said to be linearly dependent if and only if some linear
combination of them is a null vector or null row (column). The rows (columns), which are not linearly
dependent, are said to linearly independent.
Consider the matrix:
a21
a22
a23
a31

a32

a33

A linear combination of the rows 1, 2, and 3 are obtained by multiplying the 1 st, 2nd and 3rd rows by any
constants k1, k2 and k3 and adding them, where at least one constant is not zero. Thus, the new role will
be
[k1 a11 + k2 a21 + k3 a31
k1 a12 + k2 a22 + k3 a32
k1 a13 + k2 a23 + k3 a33] = [c1
c2 c3]
The rows are linearly dependent if all the three elements c 1, c2 and c3 are equal to zero for some values
of k1, k2, k3. Of course, k1, k2, k3 should all not be equal to zero, at least one of these must be non-zero.
With regard to the concept of linear dependence (independence), rank of a matrix is defined as follows:
The rank of matrix A (denoted by (A), is the maximum number of linearly independent rows (or
columns) in A.
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6.
The correlation coefficient between nasal length and stature for a group of 20 Indian
adult males was found to be 0.203. Test whether there is any correlation between the
characteristics in the population.
Ans.
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7.

Write short notes on the following:

(a)
Eigen-vectors and Eigen-values
(b)
Taylors expansion
(c)
Mixed strategy
(d)
Kuhn-Tucker condition
Ans.(a)
The eigen-vectors of a square matrix are the non-zero vectors that, after
being multiplied by the matrix, remain parallel to the original vector. For each eigenvector, the
corresponding eigen-value is the factor by which the eigen-vector is scaled when multiplied by the
matrix.
In abstract mathematics, a more general definition is given:
Let V be any vector space, let x be a vector in that vector space, and let T be a linear
transformation mapping Vinto V. Then x is an eigen-vector of T with eigen-value if the following
equation holds:
This equation is called the eigen-value equation. Note that Tx means T of x, the action of the
transformation Ton x, while x means the product of the number times the vector x. Most, but not all

authors also require x to be non-zero. The set of eigen-values of T is sometimes called

the spectrum of T.
Ans (b) The Taylor Expansion
Suppose to approximate a function f(x) at some arbitrary point x=a by a polynomial of the form, we may
be faced with a very complicated function f(x) whose behaviour in general may not interest us but we
may be interested in its properties at or near a point x=a. To extract this behaviour it is possible to write
f(x) = A0 + A1(x-a) + A2(x-a)2 + A3(x-a)3 + ... = An(x-a)n
(1.1)
n=0
If we are interested in the function near a then the quantities (x-a) n will become rapidly smaller and
smaller and ultimately vanishing after some value of n. Thus the function has now been approximated
by a polynomial. The catch however lies in obtaining the coefficients of the expansion. A trick catch
however lies in obtaining the coefficients of the expansion. A trick was provided by Taylor and proceeds
as follows:
(a) In eq (1.1) everywhere put x=a, then all terms vanish except A 0
\ A0 = f(a)
(1.2)
(b) differentiate eq. (1.1) once with respect to x
(x) / dx = A1 + 2A2(x-a) + 3A3(x-a)2 + ...
(1.3)
Now set, in eq. (1.3), x=a everywhere
df(x) / dx |x=a= A1 = 1!A1

(1.4)

(c) Differentiate eq. (1.1) twice or what amounts to differentiating eq. (1.3) once
d2f(x) / dx2 = 2A2 + 6A3(x-a) + ...
(1.5)

Now set x=a and

d2f(x) / dx2 |x=a= 2A2 = 2!A2
If you continue in this way you will soon discover that
dnf(x) / dxn |x=a= n!An
\ An = 1/n! (dnf(x)/ dxn) |x=a

(1.6)

(1.7)

Note the meaning of this: FIRST DIFFERENTIATE

n TIMES THEN TAKE x=a
Thus eq. (1.1) now becomes
f(x) = 1/n! [dnf(x)/dxn] x=a(x-a)n
n=0
This is called the Taylor expansion

(1.8)

Ans (c) In the theory of games a player is said to use a mixed strategy whenever he or she chooses to
randomize over the set of available actions. Formally, a mixed strategy is a probability distribution that
assigns to each available action a likelihood of being selected. If only one action has a positive
probability of being selected, the player is said to use a pure strategy.
A mixed strategy profile is a list of strategies, one for each player in the game. A mixed strategy profile
induces a probability distribution or lottery over the possible outcomes of the game. Nash equilibrium
(mixed strategy) is a strategy profile with the property that no single player can, by deviating unilaterally
to another strategy, induce a lottery that he or she finds strictly preferable.
Ans (d)The KuhnTucker conditions are necessary for a solution in nonlinear programming to
be optimal, provided that some regularity conditions are satisfied. Allowing inequality constraints, the
KKT approach to nonlinear programming generalizes the method of Lagrange multipliers, which allows
only equality constraints. The KKT conditions were originally named after Harold W. Kuhn, and Albert
W. Tucker, who first published the conditions
Suppose that the objective function and the constraint functions and are continuously differentiable at a
point x *. If x * is a local minimum that satisfies some regularity conditions (see below), then there exist
constants and , called KKT multipliers, such that
Stationary
Primal feasibility
Dual feasibility
Complementary slackness
In the particular case m = 0, i.e., when there are no inequality constraints, the KKT conditions turn into
the Lagrange conditions, and the KKT multipliers are called Lagrange multipliers.
==================================================================
The linear regression of Y on X and X on Y are:
Y = a + bX

and

X = a + bY

The two regression equations are

Yi Y = byx (Xi X)
and Xi X = bxy ( Yi Y)
Where byx and bxy are coefficients of regression
Mean of X = 30/5 = 6

and

Mean of Y = 40/5 = 8

Estimated value of Yi = (Xi X) + Y

= 26/5 x 1/8 (2-6) + 8 = 5.4
Similarly, estimated value of Xi = (Yi Y) + X
= 26/5 x 1/4 (5-8) + 6 = 2.1
The value of byx = 0.65 and bxy = 1.3

y = a + bX => y = 0.65x + a
Again x = a + bY => x = 1.3y + a

for y =5, x=2 we get a = 3.65 > 1 which is impossible

for y = 5, x = 2 we get a = -4.5 <1 which is possible

MEC-004; ECONOMICS OF GROWTH AND DEVELOPMENT

(Asst. Code: MEC-004/AST/2011-12)
Section A
Q.1

Critically examine the basic formulations of the Harrod-Domar model of economic growth. How
does the Harrod model explain the occurrence of trade cycles?
Ans. The basic formulations of the Harrod-Domar Model of economic growth are summarized as
follows: (i)
Investment is the central theme of the HDM. It plays a dual role. On the one hand it generates
income and on the other it creates productive capacity.
(ii)
The increased capacity results in greater output and greater employment, depending on the
behaviour of the income.
(iii)
Condition regarding the behaviour of income can be expressed in terms of growth-rates i.e , G,
Gw and Gn. The equality between these growth rates would ensure full employment of labour and full
utilization of capital stock.
(iv)
These conditions, however, designate only a steady-line of growth. The actual growth rate may
differ iron the warranted growth rate. If the actual growth rate is higher than the warranted rate of
growth, the economy will experience cumulative inflation. If the actual growth rate is lower than the
warranted growth rate, the economy will hurtle towards cumulative deflation.
(v)
The business-cycles are viewed as the deviations from the path of steady growth. These
deviations cannot go on indefinitely. There are constraints on upper and lower limits. The full
employment ceiling acts an upper limit and autonomous investment and consumption act as a lower
limit. The actual growth-rate fluctuates between these two limits.

Harrod has used his model to explain trade cycles. In the recovery phase, because of the
existence of unemployed resources, G>Gn. When full employment is reached G = Gn. If Gw exceeds
Gn at the full employment, slump is inevitable. Since G had to fall below Gw, it will, for the time being,
be driven progressively downwards. Further, G itself fluctuated during the course of the business cycle.
Savings as a fraction of income, though fairly steady in the long run, fluctuate in the short run. In the
short run, savings tend to be residual between the earning and normal consumption. Companies, also,
are likely to save large portion of their short-period increased in net receipts. Thus, even if Gw is
normally below Gn, it is likely to ride above Gn in the later stages of advance, and, if it so happens, a
vicious spiral of depression is inevitable when full employment is reached. If Gw does not ride above
Gn in the course of advance, there would be continued pressure to advance when full employment is
reached; this would lead to inflation and consequently, sooner or later, to a rise of Gw above Gn,
resulting ultimately into a vicious spiral of depression. Actually, G may be reduced before the
employment is reached because of immobility, frictions, and bottlenecks and, if it so happens,
depression may come before full employment is reached. If Gw is far above Gn, G may never rise far
above Gw during the revival and the depression may result long before full employment is reached.

Q.2

Discuss the concept of Golden Age Equilibrium in Joan Robinsons Model. What are its main
criticisms?
Ans The situation of smooth steady growth with full employment arising out of the equality of the
desired and possible rates of accumulation has been designated by Mrs. Robinson as the golden
age equilibrium.
Suppose Q is constant under the conditions of full employment, then from the equation K/N = Q, we get
K = QN
: . K = NQ
Or N = K/Q
Or N/N = K/Q/N = K/Q/K/Q (.: N = K/Q)
Or N/N = K/K
(i)
Eqn (i) implies that if Q is constant at the full employment level, their labour and capital grow at the
same rate. This is the situation of golden age equilibrium. The equality between the desired and
possible rates of accumulation coexists with full employment of labour and capital. Besides, both labour
and capital grow at the same rate. The economy is thus on a tranquil steady growth path a steady
rate of accumulation than rolls smoothly on its way.
Stability of Golden Age equilibrium: if certain forces operate so as to disturb the golden age
equilibrium of the economy, equilibrating mechanisms automatically comes into being to restore the
equilibrium.
The divergence from the golden age equilibrium path will take place if:

(a)
(b)

N/N > K/K

N/N < K/K

In case (a) the population will grow faster than the capital stock. This, signifies the situation of
underemployment with the prevalence of surplus labour, money wage rates get depressed.
In case (b) the rate of population growth falls short of the growth rate of capital-stock.
Limping golden age. Under this age, steady rate of accumulation coexists with unemployment.
Leaden Age.
It is a special case of a limping golden age in which the degree of unemployment is
increasing due to inadequate rate of accumulation.
Restrained golden age.
This is an age of full employment but the desired rate of accumulation
happens to exceed the possible rate determined by the rate of growth of labour force plus the rate of
technological progress.

Bastard golden age.

remain rigid downwards.

It denotes a situation where unemployment prevails but the real wages

Its main criticisms are as follows:

Only the various forms of Growth Process.

This model provides only a frame work for
studying the various forms of growth process. The different types of growth that have been analysed
are left as isolated islands in her model.

Mrs Robinson studies that the prime variable of her model, viz. the rate of capital accumulation gets
adjusted to the population growth via adjustments in wage rate, profit rate and labour productivity. This
tantamount to suggest redistribution of income through relative factor prices, but it would be more
practical and realistic to deploy fiscal and monetary measures for making adjustment in capital growth
with population growth.

Neglects Role of State.

In her model state has been completely left out of picture. It is indeed
unrealistic and precarious to rely solely on the private entrepreneurs for the achievement of a stable
growth of the economy in tune with the requirements of a growing population and rapidly changing
technology.

Wrong Assumption of constant technique. This model is carried out under the assumption of a
given and constant technological horizon, but is unrealistic.

It neglects the institutional factors as social cultural and institutional changes, on which the
development of the economy considerably depends.

Section - B
Q.3
(c)

Define any three of the following.

The Real Business Cycle Model

Ans There are two types of proposition of the Real Business Cycle (RBC) model. First, it says that
although we look at long term growth and short term fluctuations in economic activity separately, the
same reasons that give rise to long term growth also cause fluctuations in economic activity. The RBC
prefers fluctuations to cycles. The RBC model attempts to explain business fluctuations and play
down the role of monetary forces and believe that money is a veil. They insist that it is the real forces
like production, supply shocks etc that actually lead to fluctuations. They emphasis on relative prices
rather that the absolute price level, and believes that money is neutral as it lays stress on the supply
side of the economy. The RBC theorists focus on productivity shocks as well as on the propagation of
shocks to the rest of the economy. Productivity shocks can be of development of new techniques, new
management practices, crop failure and supply shocks coming from outside the economy and so on.
The basic structure of a prototype Real Business Cycle model is to maximize the following type
of utility function:
E Here c and l denote the representative households consumption and leisure
activities. is a discount factor that lies between 0 and 1. Leisure is time not devoted to labour. E is
the operator showing mathematical expectation, conditional upon information at time t.
Each firms has access to a production technology of the type y t = zt f(ntd, ktd). Here z is the
realization of a random variable depicting technology. The other variables n and k denote labour and
capital supplied during time t. The amount of labour supplied is 1-l where l is leisure. The budget
constraint of the firms likes the following
ct + kt+1 = zt f(ntd, ktd) + (1-) kt - w(ntd- nt) - r(ktd, ktd)
Here superscript d denotes the amount demanded of the variable, w is the wage rate, and r is
the rental for capital. The current consumption and the capital stock for the next period have a random
component and is used to pay wages and rental for capital.

(d)

Tragedy of the commons

Ans
The tragedy of the commons is a metaphor for the public goods problem that it is hard to
coordinate and pay for public goods. The term comes from Hardin (1968). The commons is a pasture
held by a group. Each individual owns sheep and has the incentive to put more and more sheep on the
pasture to gain, privately. The overall affect of many individuals do this overwhelms the carrying
capacity of the pasture and the sheep cannot all survive.

(e)

Vicious circle of poverty

Ans A vicious circle of poverty implies a circular constellation of forces tending to act and react upon
another in such a way as to keep a poor country in a state of poverty. Vicious circles are a set of

interlocking equilibrium circumstances that reinforce each other. Three such vicious circles are as
follows:(i)
In the underdeveloped countries, because of underdevelopment and backwardness, the total
output is low and that after consumption needs are fulfilled, little remains as a surplus for capital
accumulation. The capital deficiency leads to less investment and a resultant is low level of income.
(ii)
A low level of real income in economy presents little market opportunities for the entrepreneurs
and little demand for investment.
(iii)
A third vicious circle encompasses underdeveloped resources and the backward people.
Through illiteracy, lack of skills, deficient knowledge and factor mobility, the resources will remain
unutilized, causing underdevelopment to perpetuate itself.
The outward movement of the underdeveloped countries has been rendered impossible
because of the operation of vicious circle. If such an economy is to grow, it is necessary that concerned
efforts may be made to break these vicious circles.

Q.4 Explain the concept and implications of globalization. Also, discuss its advantages and
shortcomings.
Ans. Globalization means to make global, that is worldwide, or effecting or taking into consideration
the whole world or all people.
Globalization in its totality implies the following:
There is a spread of international trade.
People migrate from one country or region to another
Money or means of payment are exchanged on an increasing scale between countries or regions.
Capital flows from one country to another to help produce goods and services.
Finance-not necessarily linked to the production of goods and services flows between different
countries.
Traditional corporations arise which increasingly engage in the activities listed so far.
Technology is traded as between different countries.
Spread of print and electronic media.
Growing in trade and production of services of all kinds.
Advantages of Globalization are:
It helps improve the allocative efficiency of resources, reduce the capital output ratio and increase the
labour productivity, help to develop the export spheres and the export culture, increase the inflow of
capital and updated technology into the country, increase the degree of competition in the domestic
economy, reduce the relative prices of industrial and manufactured goods, improve the terms of trade in
agriculture and, in general, give a boost to the average growth rate of the economy in the years to
come.
It helps to restructure the production and trade pattern in a capital-scarce labour abundant economy
in favour of labour-intensive goods and labour-intensive techniques.
With the entry of foreign competition, the aggregate gross and net investment proportions to GDP will
go up.
Efficiency of banking and financial sectors will increase with the opening up of these areas of foreign
capital and foreign banks.

Shortcomings of globalization are:

The speed at which capital moves across borders, the rapid evolution of management and marketing
requirements increase the pressure for structural and conceptual restructuring to a breaking point.
Globalization process is in essence a tremendous redistribution of economic power at the world level
which will increasingly translate into a redistribution of political power.
In the globalization economics of the world are ironically moving away from one another more than
coming together.
Globalization process challenges some familiar assumptions. Technological changes have eliminated
more firms than they have created.

Q.5 Critically evaluate the theory of critical minimum effort. Also bring out its limitations.
Ans. The theory of critical minimum effort is associated with the name of Harvey Leibenstein. The
theory is based on the relationship between the three factors, viz. (i) per capital income, (ii) population
growth, and (iii) investment. Leibenstein identified population as an income-depressing factor (or a
shock), whereas investment is and income-generating (or a stimulant). Growth in an economy is
possible when the income-generating factors turnout to be more powerful than the income-depressing
factors. A small additional investment may generate a small income. The additional income would be
eaten up the additions to the populations which may come in the wake of the additional income, and
hence the effort may fail to generals a cumulative process of growth. An initial large volume of
investment may outweigh the growth of population problems. The theory is criticized on the following
grounds:
(i)
Leibenstein assumes that population increases as the income rises above the subsistence
level. Beyond a particular level of income, population declines. This assumption implies that rise in
income has a direct bearing on the growth of population. But, in reality, this relation is not so simple.
Growth of population is influenced by social attitudes, customs traditions of the people and not merely
by the per capital income.
(ii)
The functional relation between per capital income and income growth rate is not as simple as
assumes by Leibenstein. It is complex and has two stages. In the first state, the level of per capita
income influences the rate of saving and investment which, in turn, depends on the pattern of income
distribution and the effectiveness of financial institutions in mobilizing saving. In the second stage, the
relation between investment and resultant output depends upon the economic and social system of the
country. The relationship can be improved through innovations. The meaningful innovation is possible
when updated technology, skilled labour and necessary infrastructure in the country. However, there are
not available in the initial phase of development.
(iii)
In underdeveloped countries external forces play an important role in the initial stages of
development. This theory does not explain clearly the role of external forces like foreign capital, foreign
trade, international economic relations etc. These forces exert a vital impact on development and these
factors play an important role in the development process.

Q.6 Explain the meaning of planning as an instrument of resource allocation. Why is there a
need for planning in the development process?
Ans. Planning can be defined as a consciously directed activity with predetermined goals and
predetermined means to carry them out. It is an instrument or technique or mechanism whereby the
use pattern of resources is carried out. Two basic elements of planning are (i) the goals and (ii) the
means.
(i)
In a plan there may be one or more goals. In case there are many goals, they need to be placed
in order of their importance to the economy.

(ii)
The means are broadly constituted of two elements: policies and instruments.
The policies describe the outlines of actions for the fulfilment of plan goals.
The instruments may be defined as the qualitatively and quantitatively defined means of action by
which it is intended to achieve the plan goals. These instruments are the means by which planned
resources are matched with planned requirements.
The various economic factors that make it imperative that economic planning be adopted as an
instrument of resource allocation are as follows:
(i)
Since resources, whether natural, material, capital or human, are severely limited, planning
provides a method of rational and considered choice for securing the optimum combination of inputs.
(ii)
Planning help to identify those deficiencies in the economy and the social structure which
demand the largest attention.
(iii)
A plan for mobilizing resources and savings is a necessary counterpart of the scheme of
investment.
(iv)
The processes associated with planning and the implementation of plans enlarges the scope for
public participation and cooperation.
(v)
part.

A role for government planning is thus called for to ensure that potential free-riders play their

(vi)
As planning techniques improve and more precise statistical data become available, the interrelationship within the national economy can be seen more clearly and to that extent the effects of
different policies and measures can be traced systematically.
Q.7

Differentiate between
(a)

Embodied progress and Disembodied progress

Ans Embodied or Disembodied is an attribute of the way technological progress affects

productivity.
In any improvement in technology instantaneously affects the productivity of all factors of
production, we say productivity improvements are disembodied.
Disembodies technical progress does not depend on the nature of machines or shape of technology but
proceeds as though factors have just got augmented. Disembodied technology progress is exogenous.
If on the other hand, technical change is a property of only of new capital investment, we say
technologies are embodied in the new equipment.

(b)
Ans

Harrod neutrality and Hicks neutrality

A technological innovation is Harrod neutral if the technology is labour-augmenting.

A technological innovation is Hicks neutral if the ratio of capitals marginal product to labours
marginal product is unchanged for a given capital to labour ratio.
(c)

Capital augmenting and capital deepening.

Ans If effectiveness is multiplied by capital K but not by labour L, then we say the effectiveness
is capital-augmenting.
Capital deepening is an increase in capital intensity, measured by something analogous to the
capital stock available per labour hour spent, or the amount of capital available for a worker to use, but
this use is rare.

MEC-005: INDIAN ECONOMIC POLICY

Assignment (TMA)
Course Code: MEC-005
Assignment Code: MEC-005/AST/2011-12
Maximum Marks: 100
Note: Answer all the questions. While questions in Section A carry 20 marks each (to be
answered in about 500 words each) those in Section B carry 12 marks each (to be answered in
about 300 words each).
Section A

1. A number of steps can reduce the severity, spread and size of the black economy in
India Give the future directives on the parallel economy and cite the practical
obstacles faced on the way to fight the black economy.

Ans

The spread and size of the black incomes, especially, its growing concentration in the hands of the very
rich sections invades and corrupts the consumption sphere as well. The black-financed consumption
spree breaches all social norms and cultural barriers. It helps to create the mentality that fails to resist
the black related behaviour and recruits new entrants to the black circuit of activities.
The underground economy works under the wings of the informal and formal sectors. It enters the
consumption sphere and values and along with the economy also involves the executive, legislative
and judicial wings of the state. It concentrates social power and influence in the hands of the black
economy operators and, thus, becomes a powerful player in the policy arena. It was concentrated in the
hands of a few monopolistic industrial conglomerates with location largely in a few states and
metropolitan centres. The urge of hoard black wealth in the form of gold gave a double boost to
stashing away of black wealth worth thousands of crores of rupees. A huge, widespread black
economy, with active, indulgent, supporting and/or collaborative role of state processes and personnel,

expands itself by reinvesting the black incomes and savings into the black circuit to finance politics,
crime syndicates and some businesses on a growing scale. The protection and clandestine support
provided by the political-administrative structures to the black deals, extends over time to public
expenditure by forging a nexus between public works contractors, suppliers of goods and services to
public agencies, including the public enterprises, appointment authorities of public personnel, approver
of foreign collaboration deals, including for defence supplies, proposing schemes of incentives and
taxation to various industries, granting of industrial, imports, capital issue licences etc.

A number of steps can reduce the severity, spread and size of the black economy by means of a
number of policy, institutional, administrative and other policy and programmatic measures. An essential
precondition for effective intervention by the people is that they must have at least a minimum of
livelihood adequacy and security. This is essential for building up in a democratic society with robust
political and civil society institutions their capacity and willingness to work for a clean and just social
order. The existing order and its beneficiaries are the fountain head of the black economy and
perversion of policy processes. Hence, it is natural that beyond a point they would not like the policies
which strike at the very roots of the underground economy and their capacity to manipulate the policies
away from the general interest and towards their group, class and/or personal interests. Hence, a
political framework which guarantees the livelihood adequacy and security may be treated a positive
sign for strengthening the anti-black economy forces in the economy. Then, methods of checkmating
benami, that fictitious transactions, is also another major prerequisite for dealing some effective blows
against the black money phenomenon. The secrecy of public decision-making and totally unwarranted
protection available to Government functionaries against public scrutiny are also factors which must be
curbed in order to reduce corruption and increase public accountability and transparency in public
affairs. The prevailing bad money dominated politics and politicians are an active agency distorting the
policy processes from the declared lofty objectives and for amassing illegal wealth. Democratisation of
political parties and electoral reforms in order to break the unholy nexus between politicians, corrupt
business persons, bureaucrats and the criminal mafia gangs can go a long way in moving towards a
clean democratic society. Then a series of changes in our planning, policies, administration and
methods of policy and programme implementation are essential for effective and honest policies.
Democracy and peoples own efforts are the means which may be slow, difficult, at times frustrating, but
they do produce overtime desirable outcomes. There is every reason to hope that over time India would
move towards a genuine, honest pro-people state, economy and society. Then the black economy and
policy perversions would become marginal instances of deviant behaviour, unable to change the basic
course and character of system.
===============================================================
2.
In the wake of globalisation, in order to protect the vulnerable groups, different strategies of
employment need to be followed. Comment.
Ans. In the wake of globalisation, in order to protect the vulnerable groups, different strategies of employment
are as follows for various target groups: (a)
For those who are already unemployed, macroeconomic policy needs to be formulated and
implemented in such a way as to deploy national and local resources for creating large-scale

employment opportunities in the growth process. Three elements to a strategy to expand employment
can be considered:

Redistribution of income in favour of low income groups;

Creation of public investment; and
Provision of incentives to private investment.
Investment in agriculture and necessary infrastructure in terms of roads and electrification would play a
crucial role in employment generation. Efforts need to be made to create productive employment in
agriculture and not treating it as a residual sector for the surplus labour. Development of agriculture in
backward regions has very high potentiality for employment generation. The potential for indirect
employment in the form of agro-industries and other allied activities like food processing, dairy
development, etc have a high potential for employment. All these have a large export potential as well
as possibility of expanding domestic market. Concerted policy and action plan is needed to effectively
tape this potential. Adequate investment, suitable technological upgradation and proper marketing
arrangements are needed to develop them. Along with agriculture, the non-farm sector has potential for
employment generation in rural areas. Adequate credit facility, technology, marketing and other support
services need to be provided for developing various sub-sectors of non-farm sector in rural areas.
(b)
Increasing number of workers engaged as contract and temporary workers in the organized
sector. The Government enforcement machinery and trade unions have the responsibilities to
safeguard the interest of such vulnerable workers. There is a need to make minimum wages more
comprehensive for the organized sector workers. Training, skill development and vocationalisation of
education should be focused to take care of redundant and retrenched workers in the organized sector.
(c)
The role of direct poverty alleviation and employment generation programmes need to be
widened and strengthened for irregular wage workers.
(d)
Self-employed workers including home-based workers, street vendors etc. should be given
adequate access to inputs, services and marketing facilities. There is a need for creating more
supportive environment for self-employment both in rural as well as in urban areas.
(e)
Effective policies are needed to abolish the gender discrimination in the labour market. Gender
differentials in skill and expertise levels and gender biases operating in the labour market have to be
removed to enhance levels of utilization of the female labour force.
(f)
Independent producers/service providers, marginal farmers, forest dwellers, pavement dwellers
in the urban slums etc need to be provided with a proper mix of insurance scheme, measures to
provide them some capital, effective steps towards lessening the uncertainties of frequent loss of
income and measures towards providing supplementary sources of income and employment.

3.
Ans.

Section B
Discuss the instruments of monetary policy and throw light on the main features of monetary
policy from the late-1990s onwards.
Central Bank (eg RBI in India) seek to achieve its ultimate objective (of price stability, growth etc) though
some intermediate targets. These intermediate targets of exchange rate, money supply growth or a

level of interest rate etc could be achieved through operation of monetary policy instruments. These
instruments are of two types direct and indirect. The direct instruments include cash reserve ratio
(CRR), liquidity reserve ratios, directed credit and administered interest rates. CRR specifies the
amount of reserves, banks need to maintain as cash or with the central bank as percentage of their
liabilities (deposits). Liquidity reserves ratio, called Statutory Liquidity Ratio (SLR) in India, specifies the
amount of money banks must invest in Government securities (and bonds of PSUs) as proportion of
their deposits. Directed credit programme is used to channelize flow of credit to preferred/priority
sectors. Administered interest rates are used to control lending and deposit rates directly. The direct
instruments influence the financial system through changing the quantity of credit availability.
The direct instruments generally operate through price channel. That is, these instruments first cause
the rates (or prices) to change, which, in turn, causes flow of credit/liquidity to change. The indirect
instruments consist of the repos (repurchase agreement), Open Market Operations (OMOs), refinance
facility, and the discount window of RBI. The repos/reverse repos are used to mop up or inject liquidity
for a short duration. Both these instruments are operated by the RBI at its own discretion.
There has been gradual shift from direct to indirect instruments from the late-1990s onwards.
The main features of monetary policy from the late -1990s onwards are as follows: (a)
OMOs (including repos) were re-activated in 1992-93 in order to develop a market-based
mechanism to inject/absorb liquidity from the system.
(b) The Liquidity Adjustment Facility (LAF) was introduced in two phases in April 1999 and June
2000. The RBI is now able to control liquidity in the system on a daily basis through repos/reverse
repos under LAF.
(c)

The Bank Rate was re-activated in April 1997.

(d) In order to disentangle monetary policy from the clutch of fiscal policy, an auction system for the
Central Governments market borrowing programme was introduced in June 1992.
(e)
The interest rates were deregulated gradually with lending rates deregulated first followed by
deregulation of deposit rates.
(f)
Deposit rate deregulation started in April 1992 with removal of RBI prescribed multiple rates for
different maturities and replacing these with a single ceiling rate.

4.

In the light of the parameters for assessing economic reforms, critically examine its impact on
the Indian economy.

Ans.

The goals of economic development have been defined in the First and Second Five-Year Plan. They
alone become the parameters for assessing the impact of economic reforms. The major goals are:

A higher rate of growth of GDP 7-8 per cent per annum

Enlargement of the employment potential leading to full employment.

Reduction of the proportion of the population below the poverty line.

Promotion of equity or distributive justice

Reduction of regional disparities between the rich and the poor states of the India

Improvement in Human Development in terms of health and education of population.

While economic reforms may be justified on the basis that they have helped to improve rate of growth
of GDP, they cannot be justified in reducing unemployment and poverty to the desired extent. Their
record in terms of increasing unemployment rates is too glaring. As far as their impact on labour is
concerned, it is adverse. They pushed labour from secure to insecure employment, increasing
employers militancy and weakened trade unions. Economic reforms neglected the agricultural sectors,
more especially in terms of reducing investment in irrigation by the public sector. GDP in agriculture
which showed a growth rate of 3.7 per cent per annum during the pre-reform period (1981-91)
witnessed a decline in the 11-year post-reform period to 2.9 per cent. Economic reforms have also not
been successful in accelerating industrial growth, more especially in electricity generation and mining.
The failure was also manifest in basic and capital goods industries. The index of industrial production
which showed a growth rate of 7.8 per cent in the pre-reform period (1981-91) decelerated to 5.8 per
cent during the post-reform period (1993-94 to 2002-03). Regarding foreign trade, economic reforms
have helped foreigners to penetrate the Indian market to greater extent than Indians to penetrate
foreign markets. Economic reforms have not succeeded in improving growth rates of infrastructure in
electricity, coal and petroleum, though they have shown better record in saleable steel and cement.
Economic reforms have failed in reducing regional inequalities. Rather they held guilty for increasing
regional inequalities as data showed that the richer states recorded high growth rate of GDP than poor
states.

5.

Explain how Minimum support price (MSP), microfinance, easy access to credit and agricultural
marketing help in addressing the issues in the agricultural sector?

Ans

Minimum Support Price, microfinance, easy access to credit and agricultural marketing help in
addressing the issued in the agricultural sector. They are explained in following ways: Agricultural Marketing.
Marketing of agricultural produce is the most important activity for the
farming community as it is the means to getting a value for the produce. It is particularly important for
the small produces with small marketable surplus. Since crop output is a seasonal phenomenon, there
is every possibility of the crop price being low in the harvest season and the farmers being exploited for
their viability to hold the crop for a long period. To promote the interests of the farmers, Government has
organised marketing of agricultural commodities through a network of regulated markets. The gap
between the consumer prices of agricultural products and the producer prices received by farmers will
be reduced through direct purchase centres.

Minimum Support Prices (MSP). MSP system acts as an insurance against excessive price fall in
the years of boom in production. There are prices at which the Government is willing to buy any amount
of grain from the farmer. A very large number of crops are covered by the MSP system. MSP must fully
cover the cost of production but there is considerable debate on what constitutes true element of cost.
The MSP system has also been a factor contributing to the growing stocks of food grains.
Easy Access to Credit.
There was a need for credit not only for cropping but also for building
some capital base for long-term improvement at the farm level. There has also been a priority accorded
to credit to be given by commercial banks to agriculture. Subsidised interest rates for the agricultural
sector were also recommended. Access to credit will help the farmers for easily availability of high
yielding varieties of seeds, pesticides etc.
Microfinance.
Around 60 per cent of the credit requirement of the farmers are now being met by
institutional sources and the remaining 40 per cent by informal sources. The increase in total amount of
credit to small and marginal farmers will reduce the role of moneylenders who charges high rate of
interest.

6.

Policy-reform is an on-going process discuss the statement by making suggestions for

foreign capital policy.

Ans

The Industrial Policy Resolution 1948 emphasised the need for carefully regulating as well as inviting
private foreign capital. It laid special stress, inter-alia, on the need to ensure that in all cases of foreign
collaboration, the majority interest was always Indian. This was followed by the Fiscal Commission of
1949-50 which recommended that foreign investment may be permitted, first, in the public sector
projects needing imported capital good, and secondly, in new capital industries where no indigenous
capital or technical know-how was likely to be available. Foreign capital once admitted will be treated as
par with indigenous capital. Facilities for remittance of profits abroad will continue. The major interest in
ownership and effective control of an undertaking should be in Indians hands. If an enterprise is
acquired, compensation will be paid on a fair and equitable basis. The Government should not object to
foreign capital having control of a concern for a limited period and each individual case will be dealt with
on its merits.
The New Industrial Policy 1991 brings various changes in the Government policy towards
foreign investment and foreign agreements. They are classified into four categories as follows: (a)
Choice of Product: The number of products in which foreign investment is freely permitted
has been significantly increased.
(b)
Choice of Market:
the Indian market.

The foreign investors are free to compete with the domestic produces in

(c)
Choice of Ownership Structure:
majority share in equity.

In most cases, the foreign investor is free to own a

(d)
Simplification of Procedure:
India has opened two routes for Foreign Direct Investment
(FDI) inflows. First, the RBI route (or the Mumbai route). This is transparent in the sense that the
guidelines are clear. If projects satisfy the guidelines, the approvals are practically automatic.
The second route is the Foreign Investment Promotion Board (FIPB) route (or the Delhi route).
Foreigners are welcome to make proposals that don no fit into the first case. Such proposals are
considered case by case. The government has also set up Foreign Investment Implementation
Authority, independent of FIPB, to act as a single point interface between the investor and Government
agencies.
The economic reform of 1991 has laid the foundation for foreign investment in India by
Liberalisation of rules & regulation to attract FDI and FII in phases.

7.

Explain any three of the following.

b)
Ans.

Issues in union-state financial relations.

The issues in Union-state financial relations are

The unitary elements already embedded in the Indian Constitution have gained further strength over
the years with concentration of fiscal powers in the Centre and growing dependence of the States on
transfers from the Centre.
The institutions contemplated in the Constitution to safeguard the fiscal autonomy of the States have
not helped to correct the vertical imbalance.
In the distribution of responsibilities and powers delineated in the Indian Constitution, there is a
chronic imbalance with concentration of fiscal powers in the Centre. This is not uncommon in fiscal
federalism
About one-fifth of the transfers takes place at the discretion of the Centre.
The fact that the Planning Commission was a creature of the Centre and not a statutory body
continued to be a point of discord.
Union-State differences become sharp and cause anxiety in different ways and under different
conditions.

d)
Poverty Ratio and Working Poor
Ans Poverty ratio is a measure of poverty. It is also called Had Count Ration (HCR). It measures
incidence of poverty and is used for comparing the poverty situation in two areas or two regions or two
periods of time etc. It is expressed as a percentage and is defined as:
Number of people below poverty line
Incidence of Poverty = PR = HCR = ----------------------------------------------- x 100
Total population

Working Poor: Persons who are employed but who receive wages that are too low to enable him/her
and his dependents to raise their level of consumption to the minimum desired standard level specified
by the poverty line.

e)
Functions and Objective of the WTO
Ans. Functions of the WTO are: It administers through various councils and committees the 29 agreements contained in the final act
of the Uruguay Round of World talks, plus a number of plurilateral agreements, including those on Govt.
Procurement.
It oversees implementation of the significant tariff cuts and reduction of non-tariff barriers.
It examines the international trade
It provides conciliation mechanisms for arriving at amicable solutions to trade conflict among
members.
Trade disputes that cannot be solved through bilateral talks are adjudicated under the WTO dispute
settlement court.
Objectives of the WTO are:
Raising standards of living and incomes, ensuring full employment, expanding production and trade,
optimal use of worlds resources, at the same time extending the objectives of services and making
them more precise.
Introduces the idea of sustainable development in relation to the optimal use of worlds resources,
and the need to protect and preserve the environment in a manner consistent with the various levels of
national economic development.
Recognises the need for positive efforts designed to ensure that developing countries, especially the
least developed ones, secure a better share of growth in international trade.