The second document presents revenue and expenditure figures from the Union Budget of India for 2006-07 including tax revenue, capital receipts, non-plan expenditure, and plan expenditure. It asks to calculate: 1) Fiscal Deficit, Revenue Deficit, and Primary Deficit 2) Comment on the significance of these deficits 3) Impact on money supply if the government monetizes 10

1. 1. The following information is extracted from the National Income Accounts of an economy:
Million units of
currency
(MUC)
Factor incomes received by domestic residents
from
Business sector 500
Foreigners 20
Gross Investment 200
Business Savings 25
Net Investment 150
Subsidies 10
Corporate Profit taxes 15
Personal Income taxes 100
Net factor income from abroad –5
Budget Deficit 10
Net transfer to household sector 7
Consumption Expenditure 319
Indirect taxes 70
You are required to find:
a. Gross Domestic Product at Market Prices.
b. National Income.
c. Current Account Balance.
Answer:
1. GDPMP = Factor income paid to domestic residents by the
production sector + Factor income paid to foreign residents by
the production sector + Business savings + corporate profit tax +
Depreciation + Indirect taxes – subsidies.
Depreciation =(Gross investment – Net investment) = 200

2. –150 = 50
Factor income paid abroad = Factor income received from
abroad - NFIA = 20 – (– 5) = 25
GDPMP = 500 + 25 + 25 + 15 + 50 + 70 – 10 = 675
b. NI = GDPMP – Indirect taxes + subsidies – Depreciation + NFIA
= 675 – 70 + 10 – 50 + (–5)= 560
c. CAB=Domestic savings (DS) – Domestic Investment (DI)
DS= Business savings + Government savings + Household savings.
Household savings = Personal Disposable income – Personal
consumption
PDI = NI – Business savings – corporate profit tax + net transfers –
Personal income tax
PDI = 560 – 25 – 15 + 7 – 100 = 427
PS = 427 – 319 = 108
CAB = (25 – 10 + 108) – 150 = – 27
Current account deficit = 27.
2. The following information is taken from Union Budget for the year 2006 – 07:
(Rs. crore)

3. Revenue Receipts
Tax Revenue (Net) 1,72,965
Non-tax Revenue 72,140
Capital Receipts
Recoveries of Loans 17,680
Other Receipts 12,000
Borrowings & Other Liabilities 1,35,524
Non-plan Expenditure
On Revenue Account 2,70,169
(Of which, interest payments is
Rs.1,17,390 crore)
On Capital Account 26,640
Plan Expenditure
On Revenue Account 70,313
On Capital Account 43,187 Required:
a. Find the Fiscal Deficit, Revenue Deficit and Primary Deficit
b. Comment on the significance of these deficits.
c. For the economy money multiplier is estimated to be 3. If government
plans to monetize 10% of the fiscal deficit, what would be the impact on
money supply?(12 points)
2. a. Fiscal Deficit = Borrowings and other liabilities =Rs.1,35,524 Cr
Revenue Deficit = Revenue expenditure – Revenue Receipts
Revenue Expenditure = Non-plan revenue expenditure + plan revenue
expenditure
=2,70,169 + 70313=Rs.3,40,482 Cr
Revenue Deficit = 3,40,482 – (1,72,965 + 72,140) = Rs.95,377 Cr.
Primary Deficit = Fiscal Deficit – Interest payments
= 135,524 – 117,390 = Rs.18,134 Cr.

4. b. Fiscal deficit signifies the net addition to the public debt for the current
year.
Revenue deficit signifies the amount of borrowings required to finance
current consumption expenditure of the government.
Primary deficit indicates the discretionary component of fiscal deficit. This is
because of committed nature of interest payments.
c. Fiscal Deficit = Rs.1,35,524 Cr.
10% of fiscal deficit = Rs.13552.4 Cr.
Monetization of deficit directly increase the high powered money in the
economy
DH = Rs.13552.4 Cr.
DMs = m. DH = 3 ´ 13552.4 = Rs.40657.2
Monetization of 10% of the fiscal deficit would increase the money supply
by Rs.40657.2 Cr.
3. The consumption function estimated for an economy is
Ct = 80 + 0.6 + 0.2 Ct – 1
Ytd
If increase by 100 and remains at that level, find
Ytd
the change in steady state level of consumption.(4

5. points)
Answer: 3. Ct = 80 + 0.6 Y + 0.2 Ct – 1
d
t
At steady state, Ct
= Ct – 1
Ct = 80 + 0.6 Y + 0.2Ct
d
t
0.8 Ct = 80 + 0.6 Y
d
t
Ct = 100 + 0.75 Y
d
t
DCt = 0.75 ´ D Y = 0.75 ´ 100 = 75
d
t
If Y increases by 100, steady state level of consumption
d
t
increases by 75.
4. The following relations are estimated for an economy:
Savings function (S) = – 380 + 0.35 Yd + 10i
Tax function (T) = 0.30Y
Investment function (I) = 300 + 0.15Y – 50i
Transfer payments (R) = 200
Government Expenditure (G) = 1200
Exports (E) = 900
Import function (M) = 50 + 0.105Y
Money Supply (Ms) = 1000
Transaction Demand for Money (Mt) = 0.25Y
Speculative Demand for Money (Ma) = 350 – 100i

6. (All macroeconomic aggregates are in million units of currency
(MUC) and the rate of interest is in percentage.)
Required:
a. Compute the equilibrium level of income and rate of interest
b. The government desires to have an increase in the
equilibrium output by 10% in the next period and for this
purpose, the following alternatives are under consideration
i. Increase in government expenditure (G)
ii. Increase in money supply (Ms)
Compute the required increase in G and Ms to achieve the objective of the
government.
c.Compute the impact of the two alternative measures in (b) above on private
investment.
Answer: 4. a. S= – 380 + 0.35 Yd + 10i
C = 380 + 0.65Yd – 10i
Yd = (Y – tY + R) = (Y – 0.3Y + 200)
C = 380+ 0.65 (Y – 0.3Y + 200) – 10i = 510 + 0.455Y – 10i
IS function
Y = C + I + G + (E – M)
=510 + 0.455Y – 10i + 300 + 0.15Y – 50i + 1200 + 900 – 50 – 0.105Y
Y = 2860 + 0.5Y – 60i
Y = 5720 – 120i IS function.
LM function
Ms = Md
Md = Mt + M a = 0.25Y + 350 – 100i

7. 1000 = 0.25Y + 350 – 100i
650  100i
Y = 0.25 = 2600 + 400i LM function
At equilibrium LM = IS
2600 + 400i = 5720 – 120i
520i = 3120
i = 6%
Y = 5000.
b. If Y is to increase by 10% new equilibrium income is 5000 (1 + 0.10) = 5500
Option I: Increase in G
Y = 2600 + 400i LM function
If Y = 5500
400i = 5500 – 2600
i = 7.25%
IS function with G as a variable is
Y = (2860 – 1200 + G) + 0.5Y –60i
(1660  G  60i)
Y = 0.5
Y = 3320 + 2G – (120 ´ 7.25)
2G = 3050
G = 1525.
Increase in G = 1525 – 1200 = 325.
Option II: Increase in Money Supply

8. Y = 5720 – 120i IS function
If Y = 5500,
120i = 5720 – 5500
i = 1.83%
Ms = 0.25Y + 350 – 100i LM function
If Y = 5500 and i = 1.83%
Ms = (0.25 ´ 5500) + 350 – (100 ´ 1.83)
= 1542
Increase in G:
Change in Investment (DI) = I1 – I0
I1 = 300 + (0.15 ´ 5500) – (50 ´ 7.25)
= 762.50
I0 = 300 + (0.15 ´ 5000) – (50 ´ 6.0)
= 750
DI= 762.50 –750
= 12.50
Increase in Money Supply
DI = I1 – I0
I1 = 300 + (0.15 ´ 5500) – (50 ´ 1.83)
= 1033.50
I0 = 750
DI = 1033.50 –750
= 283.50
5. The following balances are taken from balance sheet of the Central Bank of a country.

9. Million units of currency
Particulars
(MUC)
Credit to Government 7,000
Credit to Banks 4,000
Government Deposits 500
Other non-monetary liabilities 25
Net worth 1,000
Credit to commercial sector 2,000
Net foreign exchange assets 11,000
Other assets 100
Deposits of banks 6,000
Other Deposits 600 The currency/deposit ratio has
been ascertained as 0.24. Reserve ratio imposed by the central bank is 7%. The amount of
Government money is 25 million units of currency.
Required:
a. Find the money supply in the economy
b. Because of intervention in the foreign exchange market, net worth of the central bank is
expected to erode by 50% in the next period. If the Central bank desires to maintain the current
level of money supply by changing the reserve ratio, what should be the new reserve ratio?
Answer: 5. a. High powered money = Monetary Liabilities of RBI + Government Money
Monetary liabilities of RBI =(Financial Assets + Other Assets – Non-monetary liabilities)
Financial Assets = (Credit to Government + Credit to Banks + Credit to commercial sector + Net
Foreign exchange assets) =7000 + 4000 + 2000 + 11000=24000.
Other Assets =100
Non-monetary liabilities = Government deposits + other non-monetary liabilities + Net worth
= 500 + 25 + 1000 = 1525
Monetary liabilities = 24000 + 100 – 1525 = 22575
Government money = 25
High powered money (H) = 22575 + 25 = 22600
Money Supply =H ´ m
Money multiplier (m) =(1+c)/(c+r)= 4
Money Supply in the economy = 22600 ´ 4 =90400 MUC

10. b. If net worth is eroded by 50%, Net worth = 500 MUC.
Monetary liabilities = 22575 + 500 = 23075
H = 23100.
If money supply is held constant,
90400 = 23100 /m. r is found out by the equation m=(1+c)/(c+r)
r = 0.0769 =7.69%
The central bank should increase the reserve ratio to 7.69%.