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IAS Prelims Exam 2016: GS Economy Questions: Inflation and Business Cycle

Jun 30, 2016 16:00 IST

    From UPSC IAS Examination point of view, the Questions based on Indian Economy are very important. The UPSC IAS Exam aspirants must be aware of the every perspective of Indian Economy either it is historical perspective or current perspective.


    For the Civil Services aspirants, here, we have developed Multiple Choice Questions for the UPSC IAS Prelims Exam based on Ramesh Singh’s Indian Economy book, one of the most important books available for UPSC IAS Exam.

    1.    Consider the following statements regarding the concept of inflation:
    I.    A rise in the general level of prices; a sustained rise in the general level of prices; persistent increases in the general level of prices ; an increase in the general level of prices in an economy that is sustained over time; rising prices across the board —is inflation.
    II.    If the price of one good has gone up, it is not inflation; it is inflation only if the prices of most goods have gone up.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    Only II
    c.    Both I and II
    d.    Neither I nor II

    Answer: c

    Explanation:


    A rise in the general level of prices; a sustained rise in the general level of prices; persistent increases in the general level of prices ; an increase in the general level of prices in an economy that is sustained over time; rising prices across the board —is inflation.

    These are some of the most common academic definitions of inflation. If the price of one good has gone up, it is not inflation; it is inflation only if the prices of most goods have gone up.

    2.    The opposite situation of inflation is known as:
    a.    Deflation
    b.    Stagflation
    c.    Hyperinflation
    d.    All of the above

    Answer: a

    Explanation:

    When the general level of prices is falling over a period of time this is deflation, the opposite situation of inflation. It is also known as disinflation. But in contemporary economics, deflation or disinflation not used to indicate fall in prices. Instead, a price rise is termed a ‘rise in inflation’ and a price fall is termed a ‘fall in inflation’.

    The terms deflation or disinflation have become part of the macroeconomic policy of modern governments. In policy terms, the terms show a reduction in the level of national income and output, usually accompanied by a fall in the general price level.

    Such a policy is often deliberately brought about by the governments with the objective of reducing, inflation and improving the balance of payments (BoP) by reducing import demand. As instruments of deflation, any policy includes fiscal measures (as for example, tax increase) and monetary measures (as for example, increase in interest rate).

    3.    Consider the following statements regarding the measurement of rate of inflation:
    I.    The rate of inflation is measured on the basis of price indices which are of two kinds—Wholesale Price Index (WPI) and Consumer Price Index (CPI).
    II.    A price index is a measure of the average level of prices.
    III.    Price index shows the exact price rise or fall of a single good.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    I and II
    c.    II and III
    d.    All of the above

    Answer: b

    Explanation:



    The rate of inflation is measured on the basis of price indices which are of two kinds—Wholesale Price Index (WPI) and Consumer Price Index (CPI). A price index is a measure of the average level of prices, which means that it does not show the exact price rise or fall of a single good.

    The rate of inflation is the rate of change of general price level which is measured as follows:
    Rate of inflation (year x) = Price level (year x) –Price level (year x-1) / Price level (year x-1) ×100. This rate shows up in percentage form (%), though inflation is also shown in numbers i.e. digits.

    4.    Consider the following statements regarding Demand-Pull inflation:
    I.    A mis-match between demand and supply pulls up prices.
    II.    Either the demand increases over the same level of supply, or the supply decreases with the same level of demand and thus the situation of demand-pull inflation arise.
    III.    The idea of demand-pull inflation belongs to Keynesian school.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    I and II
    c.    II and III
    d.    All of the above

    Answer: d

    Explanation:


    A mis-match between demand and supply pulls up prices. Either the demand increases over the same level of supply, or the supply decreases with the same level of demand and thus the situation of demand-pull inflation arise. This was a Keynesian idea. The Keynesian School suggests cuts in spending as the way of tackling excess demand mainly by increasing taxes and reducing government expenditure.

    In practice, the governments keep tracking the demand-supply matrix to check such inflation. At times, the goods in short supply are imported, interest on loans increased, wages revised, depending upon the situation.

    5.    Consider the following statements regarding Cost-Push inflation:
    I.    An increase in factor input costs (i.e. wages and raw materials) pushes up prices.
    II.    The price rise which is the result of increase in the production cost is cost-push inflation.
    III.    The Keynesian school suggested controls on prices and incomes as direct ways of checking such inflation and ‘moral suasions’ and measures to reduce the monopoly power of trade unions as the indirect measures.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    I and II
    c.    II and III
    d.    All of the above

    Answer: d

    Explanation:

    An increase in factor input costs (i.e. wages and raw materials) pushes up prices. The price rise which is the result of increase in the production cost is cost-push inflation. The Keynesian school suggested controls on prices and incomes as direct ways of checking such inflation and ‘moral suasions’ and measures to reduce the monopoly power of trade unions as the indirect measures (basically, cost-push inflations chiefly used to happen due to higher wage demanded by the trade unions during the era).

    Today, the governments of the world use many tools to check such inflations—reducing excise and custom duties on raw materials, wage revisions, etc.

    6.    Which of the following are used to measure inflation?
    I.    Wholesale Price Index
    II.    Consumer Price Index
    III.    Purchasing Power of individuals

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    I and II
    c.    II and III
    d.    All of the above

    Answer: d

    Explanation:

    Purchasing power parity (PPP) is a theory in economics that approximates the total adjustment that must be made on the currency exchange rate between countries that allows the exchange to be equal to the purchasing power of each country's currency.

    7.    Consider the following statements regarding the monetarist view of Demand-Pull inflation:
    I.    For the monetarists a demand-pull inflation is creation of extra purchasing power to the consumer over the same level of production.
    II.    This is the typical case of creating extra money without equivalent creation in production/supply.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    Only II
    c.    Both I and II
    d.    Neither I nor II

    Answer: c

    Explanation:

    For the monetarists a demand-pull inflation is creation of extra purchasing power to the consumer over the same level of production (which happens due to wage revisions at micro level and deficit financing at the macro level).

    This is the typical case of creating extra money (either by printing or public borrowing) without equivalent creation in production/supply i.e., ‘too much money chasing too little output’—the ultimate source of demand-pull inflation.

    8.    Consider the following statements regarding the monetarist view of Cost-Push inflation:
    I.    For monetarists, ‘cost-push’ is not a truly independent theory of inflation—it has to be financed by some extra money.
    II.    The extra money is created by the government via wage revision, public borrowing, printing of currency, etc.
    III.    A price rise does not get automatically reciprocated by consumers’ purchasing.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    Only II
    c.    Both I and II
    d.    Neither I nor II

    Answer: c

    Explanation:

    For monetarists, ‘cost-push’ is not a truly independent theory of inflation—it has to be financed by some extra money (which is created by the government via wage revision, public borrowing, printing of currency, etc.). A price rise does not get automatically reciprocated by consumers’ purchasing.

    Basically, people must have got some extra purchasing power created that’s why they start purchasing at higher prices also. If this has not been the reason, people would have cut-down their consumption (i.e. overall demand) to the level of their purchasing capacity and the aggregate demand of goods would have gone down. But this does not happen. It means the every cost-push inflation is a result of excessive creation of money—increasing money flow or money supply.

    9.    With reference to the monetarist view of inflation which of the following statements is/are correct?
    a.    For monetarists, a particular level of money supply for a particular level of production is healthy for an economy.
    b.    According to monetarists extra creation of money over the same level of production causes inflation.
    c.    The monetarists suggested proper monetary policy to check the situations of inflationary pressure on the economy.
    d.    All of the above

    Answer: d

    Explanation:

    For monetarists, a particular level of money supply for a particular level of production is healthy for an economy. Extra creation of money over the same level of production causes inflation. They suggested proper monetary policy (money supply, interest rates, printing of currencies, public borrowing, etc.) to check the situations of inflationary pressure on the economy. Monetarists cancelled the Keynesian theory of inflation.

    10.    Which of the following measures could be taken to check existing inflation in an economy:
    a.    The government may go for the import of goods which are in shortsupply— as a short-term measure.
    b.    As a long-term measure, governments go on to increase the production to matching the level of demand.
    c.    The governments may try to cool down the price by cutting down the production cost of the goods showing price rise with the help of tax breaks—cuts in the excise and custom duties.
    d.    All of the above

    Answer: d

    Explanation:

    The governments around the world distanced themselves from this debate and have been taking recourse to all possible options while controlling inflation. The governments resort to following options to check rising inflation:

    As a supply side measure, the government may go for the import of goods which are in short supply— as a short-term measure (as happened in India in the case of ‘onion’7 and meeting the buffer stock norm of wheat). As a long-term measure, governments go on to increase the production to matching the level of demand. Storage, transportation, distribution, hoarding are the other aspects of price management of this category.

    As a cost side measure, governments may try to cool down the price by cutting down the production cost of the goods showing price rise with the help of tax breaks—cuts in the excise and custom duties (as happened in June 2003 in India in the case of crude oil and steel8). This helps as a short-term measure. In the long-term, better production process, technological innovations, etc. are helpful. Increasing income of the people is the monetary measure to avoid the heat of such inflation.

    Click here for GS Economy Study Material

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