Section A: Short Answer Questions
Ans 1) A simple daily life activity like buying groceries adds to GDP growth. The transaction
involve an exchange of money, and hence increases GDP. The total consumer expenditure
across all supermarkets can be summed and GDP can be calculated using the expenditure
approach. One of the components of GDP using this approach, is consumer spending, and
since this will increase, it will lead to a subsequent increase in GDP.
Ans 2) Yes, a method certainly needs to be designed to calculate the monetary value of these
freely used natural resources. This is because breathing air does not have a monetary cost
attached to it, however it does increase our well-being and it is a vital component of natural
capital. Since GDP is defined to be a measure of economic or social well-being, and quality
of breathing air is a key aspect of economic welfare, it would be useful to use a method such
as the Human Development Index.
Ans 3) In my view, developing countries may benefit to a greater extent from the
technological developments than developed countries. This is because high developed
countries constantly face the problem of trying to invent new technologies whereas,
developing countries have to make use of that technology. As long as technology remains a
free good, available to all, developing countries will also benefit from it, owing to
convergence theory. Therefore, due to the existence of the phenomenon of ‘advantage of
backwardness’, the hypothesis is true.
Ans 4) Labor force participation rate is the proportion of the population ages 15 and older
that forms the labor supply. It is calculated by dividing the active workforce with the eligible
working population(15 and above). The number of employed people has
decreased(numerator), while number of people above 15 have increased(denominator),
therefore this will lead to an overall decrease in the overall labor force participation rate.
Ans 5) In order to reduce the inflation rate, the demand for labor needs to be low or the
unemployment rate needs to increase slowly. Lower demand for labor would mean a fall in the
overall wage rates. As wages are a significant component of company’s costs, lower wages will
lead to prices of products staying the same or decreasing, which will reduce inflation rate.
Therefore, as shown by Phillips Curve, an inverse relationship exists between the increase in
unemployment rate versus the decrease in inflation rate.
Ans 6) It should ideally include basic foods and beverages such as fruits, vegetables, milk. These
are everyday products used in almost every household. Secondly, housing costs such as rent
could be included in the CPI basket, since they change annually. Lastly, costs such as medical
and education expenses should be included in the CPI basket, since they reflect a significant
proportion of consumer spending habits.
Ans 7) Natural disaster may lead to a decrease in short run equilibrium output level. For example
a drought may destroy crops, which will act as negative supply shock, reducing production
whilst raising prices, and hence decrease the short run output level.
Ans 8) We can detect for example when there are shortages in the market. This helps show how
aggregate spending is greater than the equilibrium output level. Firms are most likely to increase
production, and equilibrium will be restored where planned aggregate spending is equal to the
short-run equilibrium output level.
Ans 9) High saving rate leads to a fall in consumption. If a high saving rate does not lead to an
increase in investment, this will further lower expenditure and lead to low aggregate demand and
output. According to the Keynesian view, this may lead to a recession in the short run and hurt
the economic system. In the long run, high saving rate will contribute to an increased
government spending on capital, which will increase output. Therefore, since in the long run
savings can be channeled into investment and lead to economic prosperity.
Ans 10) Bitcoin can be defined as money since it can be used as a store of value (a function of
money). Bitcoin cannot be used as a best medium of exchange, as it can only be used to
exchange a limited number of goods and not all companies accept payment in the form of
bitcoin. It can also not be used to measure the value of goods and services, since its huge price
fluctuations pose a problem for buyers and sellers. Therefore, bitcoin is unsuccessful as serving
as a unit of account. In conclusion , bitcoin does have certain characteristics that allow it to
function as money. However, the high volatility in its price fluctuations and the fact that it is not
a legal tender, unlike money, makes one conclude that it cannot really act as usual currencies and
can rather be classified as a financial investment.
Ans 11) Assuming same money base and fixed money demand, if people keep all money at
home, this will lead to a decrease in the bank reserves leading to a decrease in the money
multiplier, which will subsequently decrease the money supply and increase interest rates, since
less money is available for borrowing. Similarly, if they were to deposit the money into banks, it
would increase the money multiplier and result in an increase in money supply.
After the Euro became the major currency of European countries, individual countries like Greece, lost
their ability to control the money supply, that authority is taken by the European Central Bank. At the
height of Greek Crises in Europe, the European Central Bank refused to release more Euros to Greece,
which decreased the money supply of Greece to critical levels. Assuming demand remained the same,
show on a graph, how the decrease in the money supply would affect interest rate in Greece according
to the Liquidity Preference Model.
Ans 12) Graph
Ans 13) Assuming both negative demand shock and negative supply shock, as a result of corona
virus, due to a fall in demand, output and price level will fall. Fall in output, will lead to a
temporary negative supply shock, and supply shifts backwards till it returns to the long run
equilibrium, with inflation permanently lowered. As inflation would reduce, this would again
increase the power to spend, and prove to be a self-correcting mechanism.
Ans 14) Expansionary fiscal policy tools such as a decrease in taxes can be adopted to bring the
economy back to long-run equilibrium faster. Cutting taxes will increase the disposable income
of consumers, lead to an increase in spending, and higher economic growth. Due to increase in
spending, output levels will increase, which will restore the long run equilibrium level.
Ans 15) Deficit budget (government expenditure exceeds government revenue) is the best
approach for a government to undertake. This is due to several reasons, such as the ability to
boost demand in times of economic recession, by spending on reducing unemployment.
Furthermore, with higher expenditures, the government is also encouraged to spend on public
welfare. As long as a budget deficit does not lead to a serious debt trap, it is the most appropriate
approach.
Section B: Analytical Part
Ans 1a) Assumptions:
World GDP: 1 trillion dollars ( $1,000,000,000,000)
Contribution to GDP:
Agricultural sector: $300,000,000,000
a)
b)
c)
d)
Interest revenue: $30,000,000,000
Rent: $30,000,000,000
Labor: $150,000,000,000 (50%)
Capital: $90,000,000,000 (30%)
Industrial Sector: $500,000,000,000
a)
b)
c)
d)
Interest revenue: $50,000,000,000
Rent: $50,000,000,000
Labor: $150,000,000,000 (30%)
Capital: $250,000,000,000 (50%)
Service Sector: $200,000,000,000
a)
b)
c)
d)
Interest revenue: $20,000,000,000
Rent: $20,000,000,000
Labor: $120,000,000,000 (60%)
Capital: $40,000,000,000 (20%)
Final Answers Part a:
Value added
Aggregate wage
Aggregate profit
Aggregate interest
Aggregate rent
Agricultural
$300,000,000,000
$150,000,000,000
$90,000,000,000
$30,000,000,000
$30,000,000,000
Industrial
$500,000,000,000
$150,000,000,000
$250,000,000,000
$50,000,000,000
$50,000,000,000
Service
$200,000,000,000
$120,000,000,000
$40,000,000,000
$20,000,000,000
$20,000,000,000
Ans 1b) Aggregate wage for global economy: $420,000,000,000
Aggregate profit for global economy: $280,000,000,000
Share of labor: 60% (420/700*100)
Share of capital: 40%
Workforce = 70% * 5,000,000,000 = 3,500,000,000
Average wage = 420,000,000,000/ 3,500,000,000 = $120
Profit rate = 280,000,000,000/ 1,500,000,000,000 = 0.1867 or 18.67%
Ans 2a) Unemployment rate in 2019 = 4/32 * 100 = 12.5%
Unemployment rate in 2020 = 4/30*100 = 13.33%
Change in unemployment rate = 0.83%
Labor force participation rate in 2019 = 32 / 61 * 100 = 52.46%
Labor force participation rate in 2020 = 30 / 62 * 100 = 48.39%
Change in labor force participation rate = 4.07%
Number of employed people = 26 million
Population above 15 = 62 million
Labor force participation rate = 52.46%
Unemployed = 52.46(62)/100 – 26 = 6.525 million
Unemployment rate would be as high as 6.525/32.525*100 = 20.06%
2b) Target labor force participation rate = 75%
Increase in population above 15 = 5%
New population above 15 = 65.1 million
Increase in the labor force = 48.825- 30 = 18.825 million
Unemployment rate = 13.33%
Number of new jobs needed = (100-13.33)%*18.825 = 16.31 million
3a) MPC = 3/40 = 0.075
Multiplier = 1/(1-0.075) = 1.08
Assuming decrease of 10%
New planned investment level = 4.5 million
New mpc = 0.0675
Initial planned aggregate spending = 3+0.0675(40) +4.5 = $10.2 million
Unplanned investment level = $0.5 million
3b) New multiplier = 1/(1-0.0675) = 1.072
New short run equilibrium = AE planned = $10.2 million
Graph
Ans 4a) Money base = 4 million
Money supply = 20 million
Money multiplier = 5
Reserve ratio = 0.2
ASSETS
Reserves 800,000
Loans 3200000
Ans 4b) increase in money supply = 25%
Reserve ratio = 20%
New reserve ratio = 24% or 0.24
Money multiplier becomes 4.167
New money base = 5.9995
Increase in money base = Approx 2 million
LIABILITIES
Deposits 4,000,000