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ECO401 Economics Solved MCQs and Subjective Questions

(a) What were the Classical views about saving?

(b) What is the meaning of Paradox of thrift? Illustrate Paradox of thrift using a diagram.

                                                                                                                (Marks 10)


Classical views about saving

Classical economist considered saving as a big virtue of society. They said it is very important for the people to save because more they save, saving curve will shift towards right. This will lower interest rate and will increase investment. Due to more investment in the economy, higher will be the growth rate. So the saving was engine of growth for classical economists.

Meanings of Paradox of Thrift

The reverse multiplier effect can be illustrated in the context of Keynes’s paradox of thrift, which highlights the negative impact of higher saving in an economy in recession. Keynes said that such thrift (or conservative saving behavior) would accentuate the recession. As people save more, they will spend less. Firms will therefore produce less, and labor hiring will, as a result, fall, leading to a decline in incomes. This decline would also happen in a multiplied fashion, causing a huge decline in national income. The paradox lies in the fact that saving, while usually considered good for any one individual, can actually be harmful to the overall economy if everyone started saving.

Illustration of Paradox of Thrift using a diagram

Paradox of thrift can be illustrated using withdrawals and injections approach to output determination. Withdrawals and injections are taken on vertical axis and the output is taken on horizontal axis.

If people start saving more for a rainy day or something else, the withdrawal function will shift upwards because saving is a form of withdrawals. The withdrawal function will rise from w1to w2.However if the people save more, they will naturally be able to spend less. If the spending is less, the firms will be able to produce less. There will thus be a multiplied fall in income. The phenomenon of higher savings leading to lower national income is known as Paradox of Thrift i.e., the movement of point c to point a in this diagram that is from output level Ye1 to Ye2 shows the paradox of thrift that is the disadvantage of being overly  prudent.

But this is not all. Far from the extra saving encouraging more investment, the lower consumption will discourage firms from investing. So if investment falls, the J line will shift from J to J’. So there will again be a further multiplied fall in income from Ye2 to Ye3.So that was another dimension of Keynes argument. Through all these different arguments, Keynes was advocating the case of fiscal policy expansion in situation of recession.

Discuss the three core rules of elasticity.

(M - 05)

Rule # 01

If elasticity is between zero and one (0 < e < 1), it is said to be inelastic, if elasticity is greater than one (e > 1), it is said to be elastic, if elasticity is equal to zero (e = 0), it is said to be unitary elastic and if elasticity is equal to infinity (e = ∞), it is said to be infinitely elastic.

Rule # 02

If sign of income elasticity of demand is positive then good is normal and if sign is negative then good is inferior.

Rule # 03

If sign of cross price elasticity of demand is positive then goods are substitutes of each other and if the sign is negative then goods are compliments.

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Replies to This Discussion

Total Marks =10 

Highlight the correct option. 

1. Marginal utility measures: 

  1. The slope of the indifference curve.
  2. The additional satisfaction from consuming one more unit of a good.
  3. The slope of the budget line.
  4. The marginal rate of substitution.

2. Which of the following best expresses the law of diminishing marginal utility?

A.      The more a person consumes of a product, the smaller becomes the utility which he receives from its consumption.

B.      The more a person consumes of a product, the smaller becomes the additional utility which she receives as a result of consuming an additional unit of the product.

C.      The less a person consumes of a product, the smaller becomes the utility which she receives from its consumption.
D.      The less a person consumes of a product, the smaller becomes the additional utility which he receives as a result of consuming an additional unit of the product.


3. A curve that represents all combinations of market baskets that provide the same level of utility to a consumer is called:
A budget line.
An isoquant.
An indifference curve.
A demand curve.

4. The marginal rate of substitution:

A.      May rise or fall, depending on the slope of the budget line.

B.      Rises as you move downward along an indifference curve.

C.      Falls as you move downward along an indifference curve.

D.      Remains the same along a budget line.

5. Which of the following is a characteristic of the indifference curves?

A.      They are concave to the origin.

B.      They are convex to the origin.

C.      Curves closer to the origin have the highest level of total utility.

D.      Curves closer to the origin have the highest level of marginal utility.

6. In the diagram given below, the budget line is best represented by the line:

A.      AB

B.      AD

C.      FG

D.      DG

7. The endpoints (horizontal and vertical intercepts) of the budget line:

  1. Measure its slope.
  2. Measure the rate at which one good can be substituted for another.
  3. Measure the rate at which a consumer is willing to trade one good for another.
  4. Represent the quantity of each good that could be purchased if all of the budget were allocated to that good.

8. If prices and income in a two-good society double, what will happen to the budget line?

  1. The intercepts of the budget line will increase.
  2. The intercepts of the budget line will decrease.
  3. The slope of the budget line may either increase or decrease.
  4. There will be no effect on the budget line.

9. If Px = Py, then when the consumer maximizes utility,

  1. X must equal Y.
  2. MU(X) must equal MU(Y).
  3. MU(X) may equal MU(Y), but it is not necessarily so.
  4. X and Y must be substitutes.

10. The difference between what a consumer is willing to pay for a unit of a good and what must be paid when actually buying it is called:

  1. Producer surplus.
  2. Consumer surplus.
  3. Cost-benefit analysis.
  4. Net utility.

 Total Marks = 10

Highlight the correct option.

1. Which of following is a key assumption of a perfectly competitive market?

  1. Firms can influence market price.
  2. Commodities have few sellers.
  3. It is difficult for new sellers to enter the market.
  4. Each seller has a very small share of the market.

2. A firm maximizes profit by operating at the level of output where:

  1. Average revenue equals average cost.
  2. Average revenue equals average variable cost.
  3. Total costs are minimized.
  4. Marginal revenue equals marginal cost.

3. The demand curve facing a perfectly competitive firm is:

  1. Downward-sloping and less flat than the market demand curve.
  2. Downward-sloping and more flat than the market demand curve.
  3. Perfectly horizontal.
  4. Perfectly vertical.

 4. The monopolist has no supply curve because:

  1. The quantity supplied at any particular price depends on the monopolist's demand curve.
  2. The monopolist's marginal cost curve changes considerably over time.
  3. The relationship between price and quantity depends on both marginal cost and average cost.
  4. There is a single seller in the market.

5. A doctor sizes up patients' income and charges wealthy patients more than poorer ones.  This pricing scheme represents a form of:

  1. First-degree price discrimination.
  2. Second-degree price discrimination.
  3. Third-degree price discrimination.
  4. Pricing at each consumer’s reservation price.

6. For which of the following market structures is it assumed that there are barriers to entry?

  1. Perfect competition
  2. Monopolistic competition
  3. Monopoly
  4. All of the above

7. A market with few entry barriers and with many firms that sell differentiated products is:

  1. Purely competitive.  
  2. A monopoly.
  3. Monopolistically competitive.
  4. Oligopolistic.

8. Welfare economics is a branch of economics dealing with:

  1. Social issues.
  2. Normative issues.
  3. Political issues.
  4. None of the given options. 

9. ___________________ are goods that people must get a flavor of before they can consider buying them.

  1. Experience goods.
  2. Giffen goods.
  3. Normal goods.
  4. None of the given options.

10. Which of the following does not refer to macroeconomics?

  1. The study of aggregate level of economic activity.
  2. The study of causes of unemployment.
  3. The study of causes of inflation.
  4. The study of the economic behavior of individual decision-making units such as consumers, resource owners and business firms.

   Total Marks = 10


Fill in the blanks with appropriate words.

  1. The balance of payments (BOPs) is an accounting record of a country’s transactions with the rest of the world. 
  1. Any transaction which causes the supply curve of dollars to shift to the right is recorded with a positive sign on the BOPs. 
  1. A growth rate of between 2-3% is considered normal for mature developed countries.

 Fiscal deficits and debt are often reported as a ratio of GDP.

 There are two dimensions to the debate over taxation: equity and efficiency.  

  1. The relationship between tax rate and tax revenue collection can be summarized in the Laffer curve  diagram
  1. Disposable income is obtained by subtracting income tax from total income. 
  1. Money or paper currency serves at least three functions: it is a medium of exchange, a store of value and a unit of account
  1. Monetary policy can be defined as the central bank’s programme, often changing on a daily basis, regarding the direct or indirect control (through interest rates) of monetary conditions in the economy with a view to managing aggregate demand and inflation. 
  1. Any balance sheet has two sides: assets and liabilities.


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