ECO401- Economics, 2011- 2010-2009 SUBJECTIVE SOLVED

Question No: 49 ( Marks: 3 )
What is meant by exchange rate? Also give example of exchange rate.
Answer:
EXCHANGE RATE:
Rate at which one currency may be converted into another. The exchange rate is
used when simply converting one currency to another (such as for the purposes
of travel to another country), or for engaging in speculation or trading in the
foreign exchange market. There are a wide variety of factors which influence the
exchange rate, such as interest rates, inflation, and the state of politics and the
economy in each country.also called rate of exchange or foreign exchange rate
or currency exchange rate.
EXAMPLE:
An exchange rate of 123 Japanese yen (JPY, ¥) to the United States dollar (USD, $) means that
JPY 123 is worth the same as USD 1.

Question No: 50 ( Marks: 3 )
What is the reason of poverty in developing countries according to
Prebisch-Singer
hypothesis?
ANSWER:
POVERTY means the state of being poor; lack of the means of providing material
needs or comforts.
According to Prebisch-Singer hypothesis following are the reason of poverty in
developing countries:
• One of the reson for poverty is increasing population.
• Another reason Lack of precious natural resources (like oil, gold, gas, iron, copper
etc.) was also cited by some as the reason for LICs’ continued poverty.

Question No: 51 ( Marks: 5 )
According to the values given in the following table, calculate the
injections at each level of output.
Output
(Y)
Saving
(S)
Gross
Imports
(M)
Gross
investment
(I)
Gross
exports
(X)
Govt.
Expenditures
(G)
Taxes
(T)
650 80 80 104 97 116 10
700 90 80 119 97 116 10
750 100 80 130 97 116 10
800 110 80 139 97 116 10
900 120 80 146 97 116 10
(Marks: 1 for each)
ANSWER:
We know:
INJECTION=I+X+G
SO,
the injections at each level of output=
1-317
2-332
3-343
4-352
5-359

Question No: 52 ( Marks: 5 )
What are the major weaknesses of exogenous growth theory? Which
theory was developed in against of exogenous growth theory?
ANSWER:
EXOGENOUS GROWTH THEORY:
The Exogenous growth model, also known as the Neo-classical growth model or Solow growth
model is
a term used to sum up the contributions of various authors to a model of long-run economic
growth
within the framework of neoclassical economics.
Exogenous growth theory suffered from three major weaknesses:
i. It could not explain why the gap between the poor and rich countries had widened (anticatch
up),
ii. It could not explain why some countries in East Asia had apparently grown consistently
on the back of higher saving rates, and
iii. It modeled technology as exogenous, and beyond the influence of policy.
PART B SOLUTION:
In economics, endogenous growth theory or new growth theory was developed in the 1980s as
a
response to criticism of the neo-classical growth model OR exogenous growth theory
Question No: 53 ( Marks: 5 )

Discuss the components on the assets and liabilities side of the balance
sheet of a central bank.
ANSWER:
Following are the components on the assets and liabilities side of the balance
sheet of a central bank
ASSET SIDE COMPONENTS:
• Loans to Govt Notes
• Forex reserves
• Loans to private sector
LIABILITY SIDE COMPONENTS:
• Notes, coins & currency in circulation
• Govt & commercial bank deposits
• Liquidity paper issued

Question No: 49 ( Marks: 3 )
Define balance of payment (BOP). How the BOP can be determined?
ANSWER:
THE BALANCE OF PAYMENTS (BOP):
BOP is an accounting record of a country’s transactions with the rest of the world.
The balance of payments (or BOP) measures the payments that flow between any individual
country
and all other countries. It is used to summarize all international economic transactions for that
country
during a specific time period, usually a year.
PART B SOLUTION:
How the BOP can be determined?
IT CAN BE DETERMINED IN THE FOLLOWING WAY:
The BOP is determined by the country's exports and
imports of goods, services, and financial capital, as well as financial transfers. It reflects all
payments
and liabilities to foreigners (debits) and all payments and obligations received from foreigners
(credits).
Balance of payments is one of the major indicators of a country's status in international trade,
with net
capital outflow.

Question No: 50 ( Marks: 3 )
Explain the shape of money demand curve with the help of diagram.
Answer:
PERFECT ANSWER ON THIS LINK IS AVAILABLE SEE THIS(PG 9
AND PG 10)
http://www.ssc.wisc.edu/~ldrozd/my_files/102files/slides_9.pdf

Question No: 51 ( Marks: 5 )
How can a current account, which is in deficit, be restored to balance
under fixed exchange rate regimes?
Answer:
There is solution for how can a current account which is in deficit be restored to
balance under fixed exchange rate regimes. The answer is “Economic
Deflation”
Economic Deflation says When a country’s national income rises, it spends
more; part of that spending falls on imported goods; higher imports cause the
current account to worsen.
The reverse is also true for this lower income must reduce import spending and
therefore improve the current account spending.
However, economic contraction is not a good idea to restore current account
equilibrium the other alternative solution presented by economist is to devaluate
or “devaluation”.
Devaluation is the phenomena related to exchange rate where exchange rate
faces depreciation but in the context of fixed exchange rates. The complement of
devaluation is revaluation.
A concept of devaluation is to bring the exchange rate in line with its long-run
equilibrium level, i.e. a level consistent with international competitiveness.

Question No: 52 ( Marks: 5 )
Identify which of the following are stock variables and which are flow
variables?
hese are the terms used to differentiate things like "wealth versus income" or
"debt versus deficit."
That is, a "stock variable" is a variable measurable at one particular time (wealth);
whereas, a "flow variable" is a variable measured after a prolonged amount of
time retrospecting spending in the past "x" amount of time (income).
a) Unemployment
b) Redundancies (job lay-offs)
c) Profits
d) A firm’s stock market valuation (share price)
e) The value of property after a period of inflation
(Marks: 1 for each)
ANSWER:
DEFINITION IS JST FOR CONCEPT NOT THE ANSWER.
These are the terms used to differentiate things like "wealth versus income" or
"debt versus deficit."
That is, a "stock variable" is a variable measurable at one particular time (wealth);
whereas, a "flow variable" is a variable measured after a prolonged amount of
time retrospecting spending in the past "x" amount of time (income).
REQUIRED ANSWER:
FOLLOWING ARE THE STOCK VARIABLES:
• Unemployment
• A firm’s stock market valuation (share price)
• The value of property after a period of inflation
•
FOLLOWING ARE THE FLOW VARIABLES:
• Redundancies (job lay-offs)
• Profits

Question No: 53 ( Marks: 5 )
World Bank suggests some structural reform policies for the poor
countries to grow. Discuss those policies briefly.
Ans:
World Bank has suggested following policies for the poor countries to
grow,
Governance and administrative reforms:
To reduce over employment in public sector, reduce wastes and to improve the
quality and reliability of public services. To strengthen the administration of taxes,
to eliminate the corruption. To decentralize the control of fiscal policy making. To
enrich the legal and regulator framework.
Privatization of state-owned enterprises:
Abbreviated as SOEs. These are influenced by political interference and it is one
of the reasons SOEs are considered inefficient. SOEs are also suffering form
lack of competition, cost awareness and fear of bankruptcy.
Financial liberalization:
It involves ending of financial repression policies including artificially low interest
rates, credit rationing, restrictions on banking competition and government
involvement in investment allocation
Deregulation involving dismantling of licensing systems and red-tape
Trade liberalization:
including tariffication of non-tariff-barriers, harmonization of tariffs and an
eventual reduction thereof
FDI liberalization:
To create a transparent, predictable environment for foreign investors to operate
in.
apital account liberalization:
To remove controls on capital flows
(These policies are suggested by world bank and the successful implementation
of these policies depend on the political and economic system of poor countries.
In general these policies are expected to provide the poor nation with better
understanding and help them to raise their growth.)

Question No: 50 ( Marks: 3 )
Differentiate between international trade and international finance.
ANSWER:
By international trade, we mean the exchange of goods and services between different countries.
International trade is the trade between two or more different countries. It is just the opposite of
the trade that takes place within a country i.e. national trade.
Whereas International finance is concerned with, among other thing, the mobility of financial
capital across
countries, and the problems and opportunities this mobility presents individual countries with. It
would
not be too inaccurate (in present day context) to say that while international trade deals with the
current
account, international finance deals with the capital account of the BOPs. That said, issues like
the
choice of exchange rate regime and of modern-day balance of payments crises also fall firmly
within the
purview of international finance.

Question No: 51 ( Marks: 5 )
Discuss the components on the assets and liabilities side of the balance
sheet of a central bank.
ANSWER:
Following are the components on the assets and liabilities side of the balance
sheet of a central bank
ASSET SIDE COMPONENTS:
• Loans to Govt Notes
• Forex reserves
• Loans to private sector
LIABILITY SIDE COMPONENTS:
• Notes, coins & currency in circulation
• Govt & commercial bank deposits
Liquidity paper issued

Question No: 53 ( Marks: 5 )
If y = Y / L, where, Y = Total GDP, L = Population, y = Per capita GDP then
prove that Growth rate of per capita income = Growth rate of total output Growth rate of population
ANSWER:
y = Y / L
Where,
• Y = Total GDP
• L = Population
• y = Per capita GDP
Taking log of both sides
• ln y = ln Y – ln L
Taking derivative w.r.t. time
• 1/y (dy/dt) = (dY/dt)/Y – (dL/dt)/L
gy = gY – gL
Growth rate of per capita income = Growth rate of total output - Growth rate of population
REFRENCE:
CHP NO 38 PAGE NO 168

Question No: 49 ( Marks: 3 )
Differentiate between inflation and deflation.
ANSWER:
Inflation is a situation in which there is a continuous rise in the general price level.
WHEREAS Deflation is the
opposite of inflation and occurs when the general level of prices falls.
Inflation is when the money supply increases by more than the real economy
does. This means that one unit of currency will buy less than it could in the past.
Deflation is when the money supply contracts, making a unit of currency able to
buy more than it could in the past. This is the exact opposite of inflation, but it is
also bad.

Question No: 50 ( Marks: 3 )
What are the reasons that poor countries remained poor?

Question No: 51 ( Marks: 5 )
Explain the difference between endogenous growth model and exogenous
growth model.

Question No: 52 ( Marks: 5 )
EXOGENOUS GROWTH THEORY
The Exogenous growth model, also known as the Neo-classical growth model or Solow growth
model is
a term used to sum up the contributions of various authors to a model of long-run economic
growth
within the framework of neoclassical economics
ENDOGENOUS GROWTH THEORY
In economics, endogenous growth theory or new growth theory was developed in the 1980s as
a
response to criticism of the neo-classical growth model.
In neoclassical growth models, the long-run rate of growth is exogenously determined by
assuming a
savings rate (the Solow model) or a rate of technical progress. This does not explain the origin of
growth, which makes the neo-classical model appear very unrealistic. Endogenous growth
theorists see
this as an over-simplification
Following table shows different stages of production of cloth. Calculate the
value added at each stage of production. What is GDP by this approach?
Stage of production Money value (Rs) Value added at each
stage (Rs)
Raw cotton 10.50 ?
Cotton yarn 25.68 ?
Coarse cloth 45.82 ?
Finished cloth 55.66 ?

ANSWER:
Stage of production Money value (Rs) Value added at each
stage (Rs)
Raw cotton 10.50 10.50
Cotton yarn 25.68 15.18
Coarse cloth 45.82 20.14
Finished cloth 55.66 9.84
REFERENCE
METHODS OF MEASURING GDP
There are three equivalent ways of measuring GDP:
i. The product or value added method which sums the value added by all the productive
entities in the economy;
ii. The expenditure method which sums up the value of all the “final goods” transactions
taking place in the economy;
iii. The factor income method which sums up all the incomes earned by all the factors of
production in the economy (rent for land, wages for labour, interest for capital, and equity
returns for entrepreneurship).
Value added is the difference between the value of goods produced and the cost of materials
and
supplies used in producing them. Value added consists of the wages, interest and profit
components
added to the output by a firm. Value added is the difference between inputs and outputs e-g if a
firm
spends Rs.500 making a good (inputs) and sells its product (output) for Rs.750, then value added
is
Rs.250.

Question No: 53 ( Marks: 5 )
Discuss the equilibrium condition in money market. Explain this
equilibrium condition with the help of diagram.
ANSWER= CHP NO 43

Question No: 49 ( Marks: 3 )
It is said that growth is an important macroeconomic issue. Why? Discuss.

ANSWER:
Why Growth is an Important Macroeconomic Issue:
It is obvious why growth is an important macroeconomic issue. Every government aspires to
deliver a
higher growth rate for the country. High growth rates means higher national income which means
better
living standards on average, which in democracies, means happier electorates and therefore
increased
chances of re-election for another term in office. However, while all countries might wish to
achieve
high growth rates, in practice, only a handful have been able to convert the wish into reality.

Question No: 50 ( Marks: 3 )
What are the different borrowing options available to the government for
reducing the fiscal deficit?
By borrowing locally (i.e. issuing bonds), foreign financing (including non-relpayable grants)
or printing
money (i.e. borrowing from the central bank). The first of these methods is least inflationary
while the last
one is most inflationary.
Question No: 52 ( Marks: 5 )
Differentiate between fixed exchange rate and floating exchange rate.
ANSWER:
Fixed exchange rate:
.A fixed exchange rate means the amount of currency received is set in advance.
A fixed exchange rate is based upon the government's view of the value of its currency as well as
the monetary policy. It has advantages. Stability is one. Another is predictability. Businesses and
individuals can plan their activities with the certainty of the value of money. A businessman
shipping goods overseas knows the value in advance. A tourist travelling in other countries can
budget knowing what his money will buy.
Floating exchange rates:
A floating exchange rate means that the rate is moving and the currency received depends
on the time of the exchange
.The floating exchange rate, in its true form, allows the marketplace to set the rate. The forces of
supply and demand determine the value of a currency. For example, when the US dollar is
considered strong it will take more euros, the currency of most European countries, to buy. When
the US dollar is considered weak or in decline the amount of euros needed to buy it will fall.

Question No: 53 ( Marks: 5 )
Some economists suggest “growth through trade strategy” to tackle the
problem of poverty of under developed countries.
a) What is the basic theme of this strategy?
b) Why this strategy is not so much successful?
c) What is the proposed soluteon presented to tackle the drawback of
this strategy?

Question No: 49 ( Marks: 3 )
Mention the transactions that cause the demand for dollars to increase in
the foreign exchange market.
Pakistani imports of US goods.
Pakistani travelers traveling to the US.
Pakistani students paying for study in US universities.
profits repatriated to
US by US firms operating in Pakistan.

Question No: 50 ( Marks: 3 )
Why countries have comparative advantage according to Ricardo?
ANSWER:
Comparative advantage according to Ricardo:
The law of comparative advantage refers to the ability of a party (an individual,
a firm, or a country) to produce a particular good or service at a lower opportunity
cost than another party. There is a source of comparative advantage can be
productivity differentials.Ricardo argued that there is mutual benefit from trade (or
exchange) even if one party (e.g. resource rich country, highly-skilled artisan)
is more productive in every possible area than its trading counterpart (e.g.
resource-poor country, unskilled laborer), as long as each concentrates on the
activities where it has a relative productivity advantage

Question No: 51 ( Marks: 5 )
A.
"Slope of the consumption function is less than 1".What is meant by
this statement?
ANSWER:
When we drawn in expenditure income space, the consumption function plots as a
straight line with positive intercept, and a positive but less than 1 slope. The slope is less
than 1 because not all the income is consumed some part of the income is saved.
B. What are the major macroeconomic variables involved in the
determination of national income?
(Marks: 2+3)
Following are the major macroeconomic variables involved in the
determination of national income :
C, I, G, X, M, T, S, prices, exchange rate, interest rate and money supply.

Question No: 52 ( Marks: 5 )
What are the conditions in which foreign exchange market exists? Also
give some examples of foreign exchange markets.
In a market there are buyers and sellers who negotiate and agree on the price for
the or
price for the commodity being exchanged. The foreign exchange market is no
different.
whatever, here the commodity being traded is foreign exchange and the price is
the foreign exchange rate. Specifically, a foreign currency is being traded for the
Pakistani Ruppee at a particular rate of exchange.
The sellers and buyers of foreign exchange are not mutually exclusive. The
sellers of today, may be the buyers of tomorrow, or even of today.
CONDITION:
Foreign exchange market exists when buyers and sellers exit and ready to sell
and buy.
The main driving force for foreign exchange market is the law of supply and
demand.
EXAMPLE:
US $-PAK RS Foregin exchange market
US $ - UK POUND Foregin exchange market

Question No: 53 ( Marks: 5 )
What thing determines comparative advantage among countries according
to Hechshcer-Ohlin? What is the criticism against their argument?
According to Hechshcer-Ohlin suppose we are given two countries one abundant
in labour and one abundant in capital and a labour-intensive good and a capital
intensive
good, the labour abundant country will have comparative advantage in the
production of the labour-intensive good while the capital abundant country will
have comparative advantage in the capital-intensive good.
So the determinants of comparative advantage among countries according to
Hechshcer-Ohlin is capital goods and labour intensive goods.
Critics argued that comparative advantage can and should be viewed in a
dynamic (time-varying) sense, and that it was not wise to rule out the possibility
of Pakistan developing comparative advantage in cars at some future point in
time.
Consequent:
The major criticism leveled against Hechscher-Ohlin type trade theories are that they
views
comparative advantage in an essentially static sense; i.e. if Pakistan is better at
producing
cotton and Japan better at producing, then this situation will always prevail.

Question No: 49 ( Marks: 3 )
Differentiate between inflation and deflation.
ANSWER:
Inflation is a situation in which there is a continuous rise in the general price level.
WHEREAS Deflation is the
opposite of inflation and occurs when the general level of prices falls.
Inflation is when the money supply increases by more than the real economy
does. This means that one unit of currency will buy less than it could in the past.
Deflation is when the money supply contracts, making a unit of currency able to
buy more than it could in the past. This is the exact opposite of inflation, but it is
also bad.
( Marks: 5 )

What is meant by Philips Curve? Explain the shape of this curve with the
help of diagram.
Philips Curve
W.A.Philips gave the idea of Keynes a formalized shape and draws the Philips curve stating
inverse
relationship between unemployment and inflation rate.
Philips’s views were consistent with the Keynesian views. The cost of reducing inflation is
unemployment and the cost of reducing unemployment is inflation
DIAGRAM
For diagram take a look on chp#34 page no 149.
(I DON,T HV MICROSOFT WORD IN MY PC THATS Y GRPAH
CAN,T BE DRAW HERE)

Question No: 53 ( Marks: 5 )
How crowding out of investment demand occur due to expansionary fiscal
policy?
ANSWER CAN BE:
In economics, crowding out is any reduction in private consumption or
investment that occurs because of an increase in government spending. If the
increase in government spending is financed by a tax increase, the tax increase
would tend to reduce private consumption. If instead the increase in government
spending is not accompanied by a tax increase, government borrowing to finance
the increased government spending would increase interest rates, leading to a
reduction in private investment, although there is no empirical evidence that
supports such interest rate effect on investment
1. Comments of current account in balance of payment 3 marks
ANSWER:
THE CURRENT ACCOUNT
The current account balance is essentially the trade balance (exports minus imports), but with net
factor
receipts from abroad added.
If the exchange rate is fixed, then changes in reserves must mirror the combined balance on the
current
and capital accounts in order to bring the overall BOPs to zero. If the exchange rate is floating,
then
changes to reserves can remain zero, as the adjustment burden is borne by the exchange rate
which
appreciates (depreciates) in response to a joint surplus (deficit) on the current and capital accounts.
REFRENCE FOR COMPLETE CONCEPT:
PARTS OF BOP
The BOPs can be divided into three parts:
i. Current account,
ii. Capital account and
iii. Changes to reserves
2. The reason of poverty in developing countries according PerbischSinger Hypothesis
( 3 marks)
ANSWER:
POVERTY means the state of being poor; lack of the means of providing material
needs or comforts.
According to Prebisch-Singer hypothesis following are the reason of poverty in
developing countries:
• One of the reson for poverty is increasing population.
• Another reason Lack of precious natural resources (like oil, gold, gas, iron, copper
etc.) was also cited by some as the reason for LICs’ continued poverty.
3. Pull demand inflation, cost push inflation ( 5 marks)
ANSWER:
DEMAND PULL INFLATION:
The inflation resulting from an increase in aggregate demand is called demandpull inflation. Such an inflation may arise from any individual factor that
increases aggregate demand, but the main ones that generate ongoing
increases in aggregate demand are :
Increases in the money supply
Increases in government purchases
Increases in the price level in the rest of the world
COST PUSH INFLATION:
Inflation can result from a decrease in aggregate supply. The two main sources
of decrease in aggregate supply are
• An increase in wage rates
• An increase in the prices of raw materials
These sources of a decrease in aggregate supply operate by increasing costs,
and the resulting inflation is called cost-push inflation.
4. What are the comparative advantages between countries according
Hechshcer-Ohlin? And criticisms against it.
ANSWER:
According to Hechshcer-Ohlin suppose we are given two countries one abundant
in labour and one abundant in capital and a labour-intensive good and a capital
intensive
good, the labour abundant country will have comparative advantage in the
production of the labour-intensive good while the capital abundant country will
have comparative advantage in the capital-intensive good.
So the determinants of comparative advantage among countries according to
Hechshcer-Ohlin is capital goods and labour intensive goods.
Critics argued that comparative advantage can and should be viewed in a
dynamic (time-varying) sense, and that it was not wise to rule out the possibility
of Pakistan developing comparative advantage in cars at some future point in
time.
Consequent:
The major criticism leveled against Hechscher-Ohlin type trade theories are that they
views
comparative advantage in an essentially static sense; i.e. if Pakistan is better at
producing
cotton and Japan better at producing, then this situation will always prevail
1.components of current account of BOPS:
ANSWER:
Following are the components:
1.GOODS
2.SERVICES
3.INCOME
4.CURRENT ACCOUNT.
(FOR COMPLETE UNDERSTANDING AND MORE COMPONANTS VISIT THIS
LINK)
http://www.investopedia.com/articles/03/061803.asp
:
1 . Difference between capital deepening and capital widening(5 MARKS)
ANSWER:
Capital deepening
is a term used in economics to describe an economy where capital per worker is increasing. It is
an increase in the
capital intensity. Capital deepening is often measured by the capital stock per labour hour.Overall,
the
economy will expand, and productivity per worker will increase. However, economic expansion
will not
continue indefinitely through capital deepening alone. This is partly due to diminishing returns
and wear
& tear
capital widening:
is a term used to describe the situation where capital stock is increasing at the
same rate as the labour force, thus capital per worker remains constant. The economy will expand
in
terms of aggregate output, but productivity per worker will remain constant

2 .Difference between GNP and NNP:(5 MARKS)
ANSWER:
Gross National Product (GNP):
Gross national product (GNP) is the value, at current market prices, of all final goods and services
produced during a year by the factors owned by the citizens of a country. Thus the income earned
by
Pakistani citizens working in the US would be included in Pakistan’s GNP but excluded from
Pakistan’s
GDP. Conversely, the income earned by a US citizen (individual or corporate) in Pakistan would
be
included in Pakistan’s GDP but excluded from Pakistan’s GNP. Generally, GNP = GDP + net
factor
income from abroad. The abbreviation for gross national product, which is the total market value
of all
goods and services produced by the citizens of an economy during a given period of time, usually
one
year. Gross national product often was once the federal government's official measure of how
much
output our economy produces.
GNP = GDP + Net factor incomes from abroad
Net National Product (NNP):
Mathematically, national income is net national product (NNP). It is GNP adjusted for
depreciation. In
words, it is the net output of commodities and services flowing during the year from the country’s
production system in the hands of ultimate consumers. The total market value of all final goods
and
services produced by citizens of an economy during a given period of time, usually a year, after
adjusting for the depreciation of capital. Net national product, abbreviated NNP, has the same
relation to
net domestic product (NDP) as gross national product (GNP) has to gross domestic product
(GDP). Net
national product also has the same relation to gross national product that net domestic product has
to
gross domestic product. Like NDP, NNP is a measure of the net production in the economy.
NNP = GNP – Depreciation allowance
3. Explain Comparative advantage among contries according to HechshcerOhlin. And criricism on it?
ANSWER:
According to Hechshcer-Ohlin suppose we are given two countries one abundant
in labour and one abundant in capital and a labour-intensive good and a capital
intensive
good, the labour abundant country will have comparative advantage in the
production of the labour-intensive good while the capital abundant country will
have comparative advantage in the capital-intensive good.
So the determinants of comparative advantage among countries according to
Hechshcer-Ohlin is capital goods and labour intensive goods.
Critics argued that comparative advantage can and should be viewed in a
dynamic (time-varying) sense, and that it was not wise to rule out the possibility
of Pakistan developing comparative advantage in cars at some future point in
time.
Consequent:
The major criticism leveled against Hechscher-Ohlin type trade theories are that they
views
comparative advantage in an essentially static sense; i.e. if Pakistan is better at
producing
cotton and Japan better at producing, then this situation will always prevail.
Q # 1 Difference between inflation and deflation? Marks 3
ANSWER:
Inflation is a situation in which there is a continuous rise in the general price level.
WHEREAS Deflation is the
opposite of inflation and occurs when the general level of prices falls.
Inflation is when the money supply increases by more than the real economy
does. This means that one unit of currency will buy less than it could in the past.
Deflation is when the money supply contracts, making a unit of currency able to
buy more than it could in the past. This is the exact opposite of inflation, but it is
also bad.

Q # 2 How the central banks plays its important role in order to control
the activities of commercial banks? Marks 3
central bank, reserve bank, or monetary authority is a banking institution
granted the exclusive privilege to lend a government its currency. Like a normal
commercial bank, a central bank charges interest on the loans made to
borrowers, primarily the government of whichever country the bank exists for,
and to other commercial banks, typically as a 'lender of last resort'. However, a
central bank is distinguished from a normal commercial bank because it has a
monopoly on creating the currency of that nation, which is loaned to the
government in the form of legal tender. It is a bank that can lend money to other
banks in times of need. Its primary function is to provide the nation's money
supply,

Q # 3 Difference between depreciation and appreciation of currency?
Marks 5
ANSWER:
Depreciation:
This is a more or less permanent decrease in value or price. "More or less permanent" doesn't
include
temporary, short-term drops in price that are common in many markets. It's only those price
declines
that reflect a reduction in consumer satisfaction.While all sorts of stuff can depreciate in value,
some of
the more common ones are capital, real estate, corporate stock, and money
APPRECIATION
This is a more or less permanent increase in value or price. "More or less permanent" doesn't
include
temporary, short-term jumps in price that are common in many markets. Appreciation is only
those
price increases that reflect greater consumer satisfaction and thus value. While all sorts of stuff
can appreciate in value, some of the more common ones are real estate, works of art, corporate stock,
and money.

Q # 4 what is meant by laffer curve? Also explain the shape of this curve?
Marks 5
ANSWER:
The graphical inverted-U relation between tax rates and total tax collections by government is
known as
Laffer curve. This curve is developed by economist Arthur Laffer; the Laffer curve formed a
key
theoretical foundation for supply-side economics of President Reagan during the 1980s. It is
based on
the notion that government collects zero revenue if the tax rate is 0% and if the tax rate is 100%.
At a
100% tax rate no one has the incentive to work, produce, and earn income, so there is no income
to tax.
As such, the optimum tax rate, in which government revenue is maximized, lies somewhere
between 0%
and 100%. This generates a curve shaped like an inverted U, rising from zero to a peak, and then
falling
back to zero. If the economy is operating to the right of the peak, then government revenue can be
increased by decreasing the tax rate.
(AGAIN FOR DIAGRAM VISIT PAGE NO 175 OF CHP # 40)

A slope of consumption function is less than 1." What is meant
by this statement?
ANSWER:
When we drawn in expenditure income space, the consumption function plots as a
straight line with positive intercept, and a positive but less than 1 slope. The slope is less
than 1 because not all the income is consumed some part of the income is saved.
Differentiate between Inflation and deflation. Marks3
ANSWER:
Inflation is a situation in which there is a continuous rise in the general price level.
WHEREAS Deflation is the
opposite of inflation and occurs when the general level of prices falls.
Inflation is when the money supply increases by more than the real economy
does. This means that one unit of currency will buy less than it could in the past.
Deflation is when the money supply contracts, making a unit of currency able to
buy more than it could in the past. This is the exact opposite of inflation, but it is
also bad

Question No: 50 ( Marks: 3 )
Why countries have comparative advantage according to Ricardo?
Comparative advantage according to Ricardo:
The law of comparative advantage refers to the ability of a party (an individual, a firm,
or a country) to produce a particular good or service at a lower opportunity cost than
another party. There is a source of comparative advantage can be productivity
differentials.Ricardo argued that there is mutual benefit from trade (or exchange) even if
one party (e.g. resource rich country, highly-skilled artisan) is more productive in
every possible area than its trading counterpart (e.g. resource-poor country, unskilled
laborer), as long as each concentrates on the activities where it has a relative productivity
advantage

Question No: 51 ( Marks: 5 )
A.
"Slope of the consumption function is less than 1".What is meant by
this statement?
When we drawn in expenditure income space, the consumption function plots as a straight line
with positive intercept, and a positive but less than 1 slope.
The slope is less than 1 because not all the income is consumed some part of the income is saved.
B. What are the major macroeconomic variables involved in the
determination of national income?
(Marks: 2+3)
C, I, G, X, M, T, S, prices, exchange rate, interest rate and money supply.

Question No: 52 ( Marks: 5 )
What are the conditions in which foreign exchange market exists? Also
give some examples of foreign exchange markets.
In a market there are buyers and sellers who negotiate and agree on the price for the or
price for the commodity being exchanged. The foreign exchange market is no different.
whatever, here the commodity being traded is foreign exchange and the price is the
foreign exchange rate. Specifically, a foreign currency is being traded for the Pakistani
Ruppee at a particular rate of exchange.
The sellers and buyers of foreign exchange are not mutually exclusive. The
sellers of today, may be the buyers of tomorrow, or even of today.
Foreign exchange market exists when buyers and sellers exit and ready to sell and buy.
The main driving force for foreign exchange market is the law of supply and demand.
Examples are US $-PAK RS Foregin exchange market
US $ - UK POUND Foregin exchange market

Question No: 53 ( Marks: 5 )
What thing determines comparative advantage among countries according
to Hechshcer-Ohlin? What is the criticism against their argument?
According to Hechshcer-Ohlin suppose we are given two countries one abundant
in labour and one abundant in capital and a labour-intensive good and a capital intensive
good, the labour abundant country will have comparative advantage in the production of
the labour-intensive good while the capital abundant country will have comparative
advantage in the capital-intensive good.
So the determinants of comparative advantage among countries according to HechshcerOhlin is capital goods and labour intensive goods.
Critics argued that comparative advantage can and should be viewed in a dynamic (timevarying) sense, and that it was not wise to rule out the possibility of Pakistan developing
comparative advantage in cars at some future point in time.
Consequent:
The major criticism leveled against Hechscher-Ohlin type trade theories are that they views
comparative advantage in an essentially static sense; i.e. if Pakistan is better at producing
cotton and Japan better at producing, then this situation will always prevail

Question No: 51 ( Marks: 5 )
Briefly discuss the private cost of advertising. How we can calculate the
marginal social cost?
ANSWER: Private Cost Of Advertising: The private cost of advertising is the
cost incurred by firm in making the advertisement i.e newspaper adds, tv
commercials etc. The firms do not take into account the nuisance faced by
people due to these advertisements otherwise the firms would do less
advertisement.
Marginal Social Cost: Marginal social cost is not a monetary based cost. It is
the cost borne by the society as a whole. It is the cost of consumption of one next
unit.

Question No: 52 ( Marks: 10 )
A.
What conclusions are derived from exogenous growth theory?
ANSWER: Exogenous Growth Theory: The major conclusions derived from
the exogenous growth are as follows:
• The steady growth rate of real GDP depends on exogenous rates of
growth of population (n) and technology (t). There are no policies for
government for how to affect the steady growth rate of a country. Higher
savings can only have a little effect on income it cannot cause long term
growth because savings cause diminishing returns to investment and
capital accumulation.
• If one country started with lower income and capital than another country,
the poorer country will grow faster to catch up the richer country and then
both the countries will grow together.

B. What is meant by convergence theory? Explain the convergence theory
in the given graph.
y
k
2
O
y = sAkα
nk
k
Convergence to
steady state
k
k0 1 k
Convergence theory
(Marks: 4+6)

Question No: 53 ( Marks: 10 )
Define fiscal policy. Differentiate between contractionary and
expansionary fiscal policy. In which situations, budget deficit and budget
surplus exist?
Answer: Fiscal Policy: Fiscal policy is the government’s about the
• expenditure in form of purchases, subsidies and interest payments on
debt etc.
• revenue in form of taxes etc.
Difference between Contractionary and Expansionary Fiscal Policy:
Contactionary Fiscal Policy Expansionary Fiscal Policy
In conactionary fiscal policy
government decreases its expenditure.
In expansionary fiscal policy
government increases its expenditure.
Budget Deficit and Budget Surplus: Budget deficit exists if government
expenditure increases the revenue earned. In this case government needs to
finance its expenditure through borrowing.
Budget surplus exists when revenue exceeds the government expenditure. In
this condition government can easily pay off its debt borrowings.
(Marks: 2+4+4)

Question No: 54 ( Marks: 10 )
Discuss the basic theories regarding IMF’s stabilization program. Are
these theories successful? If not, give reasons.
Answer: IMF’s Stabilization Theories:
• Tight Fiscal Policy: It works through higher revenues and reduced
government expenditure.
• Devaluation: Switching from imports to home produced goods. It
increases competitiveness, exports and increase investors confidence in
local currency.
• Tight Monetary Policy: Higher interest rates resulting in reduced private
sector consumption and investment demand. It reduces inflation and
increases savings. High interest rates also results in higher capital inflow.
Theses theories are generally not successful in lower income countries (LICs).
Because they caused the problems of:
• Devaluation: It raises the price of imports and also increased the inflation
while the real wage rate could not increase.
• Stabilization hurts poor: decrease in expenditure always badly effects
the poor which can then cause political instability.