UPSC Prelims Practice Questions — Why the debate between Keynesian and orthodox economics matters

Q1. With reference to Keynesian macroeconomics, consider the following statements: Which of the statements given above is/are correct?

  1. A fall in business investment can reduce national output by more than the amount of the initial fall in investment.
  2. In a liquidity trap, an increase in the money stock fails to lower interest rates and so does not boost output and employment.
  3. Since wages and prices adjust quickly enough to clear markets, a fall in any component of spending leaves output unchanged.
  • A. 1 and 3 only
  • B. 1, 2 and 3
  • C. 1 and 2 only
  • D. 2 only

Q2. Consider the following statements: Which of the following is correct in respect of the above statements?

  1. In the Keynesian view, higher government spending during a recession can raise output even though it adds nothing directly to the economy's productive capacity.
  2. Keynesian economics treats aggregate demand as the main driver of output in the short run, because prices and wages respond only slowly to changes in demand.
  • A. Both Statement-I and Statement-II are correct and Statement-II explains Statement-I
  • B. Both Statement-I and Statement-II are correct, but Statement-II does not explain Statement-I
  • C. Statement-I is correct, but Statement-II is incorrect
  • D. Statement-I is incorrect, but Statement-II is correct

Q3. A government cuts its spending on salaries and transfers to reduce its deficit at a time when private spending is already weak. An economist argues that the resulting fall in sales will lead firms to invest less, so the economy's long-run growth will also be lower. This argument is most consistent with which of the following?

  • A. The Keynes–Kalecki framework
  • B. The New Classical framework
  • C. The Monetarist framework
  • D. The Solow-type neoclassical growth framework

Q4. With reference to the flexible inflation targeting framework in India, consider the following statements: Which of the statements given above is/are correct?

  1. The inflation target is determined by the Central Government in consultation with the Reserve Bank of India.
  2. The framework operates only under an administrative arrangement between the Government and the RBI, without statutory backing.
  3. The Monetary Policy Committee that sets the policy rate includes members from outside the RBI who are appointed by the Central Government.
  • A. 1 only
  • B. 1 and 3 only
  • C. 1, 2 and 3
  • D. 2 and 3 only

Q5. Consider the following assertion: 'The shift from demand management to inflation targeting has moved the burden of macroeconomic adjustment towards workers.' Which of the following statements, if true, support the above assertion?

  1. An inflation-targeting central bank raises its policy rate to bring inflation back to target even when doing so increases unemployment.
  2. Over the period in which inflation targeting spread, the share of wages in national income fell.
  3. Inflation-targeting central banks use money supply aggregates, rather than a short-term interest rate, as their operating instrument.
  4. When disinflation is achieved through higher unemployment, workers' bargaining power over wages weakens.
  • A. 2, 3 and 4 only
  • B. 1, 2, 3 and 4
  • C. 1 and 2 only
  • D. 1, 2 and 4 only

Q6. Consider the following statements: Which of the following is correct in respect of the above statements?

  1. In New Keynesian models, a central bank can influence real output in the short run by changing its nominal policy rate.
  2. In New Keynesian models, a change in the policy rate permanently alters the economy's potential output.
  • A. Both Statement-I and Statement-II are correct and Statement-II explains Statement-I
  • B. Both Statement-I and Statement-II are correct, but Statement-II does not explain Statement-I
  • C. Statement-I is correct, but Statement-II is incorrect
  • D. Statement-I is incorrect, but Statement-II is correct

Q7. With reference to headline and core inflation, consider the following statements: Which of the statements given above is/are correct?

  1. Because food prices are volatile, food inflation in lower-income economies is typically short-lived and lower on average than non-food inflation.
  2. Exclusion-based measures of core inflation leave out components such as food and fuel whose prices are volatile.
  3. Headline inflation reflects price changes across the full consumption basket, including food and fuel.
  • A. 3 only
  • B. 1 and 2 only
  • C. 2 and 3 only
  • D. 1 and 3 only

Q8. With reference to the stagflation experienced by many advanced economies in the 1970s, consider the following statements: Which of the statements given above is/are correct?

  1. It combined high inflation with slow output growth.
  2. It strengthened the case that governments could permanently lower unemployment by tolerating somewhat higher inflation.
  3. It weakened Keynesian demand management, because stimulating demand to revive growth risked adding to inflation that was already high.
  • A. 2 and 3 only
  • B. 1 and 3 only
  • C. 1, 2 and 3
  • D. 1 only