FEEDBACK TUTORIAL LETTER

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1 FEEDBACK TUTORIAL LETTER 2 ND SEMESTER 2018 ASSIGNMENT 1 INTERMEDIATE MACRO ECONOMICS IMA612S 1

2 Course Name: Course Code: Department: INTERMEDIATE MACROECONOMICS IMA612S ACCOUNTING, ECONOMICS AND FINANCE Course Duration: ONE SEMESTER NQF Level and Credit: LEVEL6; 13 CREDITS Your marker-tutor for INTERMEDIATE MACROECONOMICS Tel.: ASSIGNMENT 01 ASSIGNMENT 1 FEEDBACK TUTORIAL LETTER QUESTION 1 [20 MARKS] The correct answer is indicated in Bold. Read the questions below and select the letter that best represents your choice. Each answer is worth 2 marks. 1. Unlike the GDP deflator, the CPI includes the prices of: a) Goods purchased by firms. b) Goods purchased by governments. c) Exported goods. d) Imported goods. Explanation: The CPI measures inflation through the change in a weighted average price of a basket of goods, including imported goods, whereas the GDP deflator measures inflation by dividing Nominal GDP by Real GDP then multiplying by 100. GDP does not include the value of imported goods. 2. If the adult population equals 250 million, of which 145 million are employed and 5 million are unemployed, the labour force participation rate equals percent. a) 50 2

3 b) 58 c) 60 d) 67 Explanation: The labour force is determined by the proportion of the adult population that is employed or is seeking employment, so the labour force participation rate is calculated as: ( ) / 250 * 100 = 60% 3. If the unemployment rate is 6 percent and the number of employed is 188 million, then the labour force equals million. a) b) c) 188 d) 200 Explanation: You have to work backwards, so labour force = employed + unemployed, and unemployed is 6% of the labour force. Let labour force = LF, then the equation is: (6/100)LF = LF 0.06LF = LF Take all LF terms to the right-hand side. 1LF 0.06LF = LF = 188 LF = 188 / 0.94 = 200 3

4 4. In an economy where actual real GDP is always equal to the natural real GDP, inflation a) Fluctuates around an average of zero percent. b) Is at the same rate as GDP growth. c) Is constant at a rate that can be low or high. d) Settles down to zero percent. Explanation: If actual real GDP is higher than natural real GDP, inflation will be growing, and if actual real GDP is lower than natural real GDP, inflation will be declining. If actual real GDP is always equal to natural real GDP, inflation will be constant and can be low or high. 5. Monetary policy is and fiscal policy is when the IS curve is steep and the LM curve is flat a) weak; weak b) weak; strong c) strong; strong d) strong; week Explanation: It is easiest to draw the curves, as is depicted below: 6. You can see from the graphs, that when the LM cure is flat, a shift in the curve only causes a small change in Y (Y1 Y3), so monetary policy is weak. You can also see that when the IS curve is steep, a shift in the curve causes a big change in Y (Y1 Y2), so fiscal policy is strong. Thus monetary policy is weak and fiscal policy is strong when the IS curve is steep and the LM curve is flat. 4

5 7. In the simple Keynesian model of the determination of income, the price level is assumed to be a) Endogenous and to remain constant. b) Endogenous and to gradually change. c) Exogenous and to gradually change. d) Exogenous and to remain constant. Explanation: The simple Keynesian model is a short-run model, where the price level is fixed / remains constant, only in the medium to long-term can suppliers change the price level. The price level is also exogenous (derived outside of the model) in the simple Keynesian model. 8. A $1 increase in autonomous spending has a multiplier effect greater than one on total expenditures and output because a) Each expenditure is re-spent in the same amount continuously. b) Overtime expenditures tend to increase. c) Each time an expenditure occurs the recipient re-spends a proportion of the funds. d) Total expenditures include autonomous expenditures. Explanation: The multiplier effect refers to the increase in final income arising from any new injection of spending. The size of the multiplier depends upon household's marginal decisions to spend, called the marginal propensity to consume (MPC), or to save, called the marginal propensity to save (MPS). The MPC will determine how much (what proportion) income the recipient chooses to re-spend. 5

6 9. Total income is always equal to expenditures; but only in equilibrium is it equal to expenditures, producing in equilibrium on income to change. a) Actual, planned, no pressure b) Planned, actual, no pressure c) Planned, actual, pressure d) Actual, planned, pressure Explanation: In equilibrium, planned expenditure must equal actual expenditure in the economy. When the economy is in equilibrium, there is no pressure on income to change. 10. A person with a liquidity constraint will a) Consume more than his income in period 1. b) Consume less than his income in period 2. c) Consume less than his income in period 1. d) Consume more than is income in period 2. Explanation: According to the Permanent Income Hypothesis, someone with a liquidity constraint (limit on the amount they can borrow) will consume more than their income in period According to the Lifecycle Hypothesis, consumption is determined by two factors: a) Labour income and by the stock of assets accumulated over a lifetime. b) Labour income and wealth. c) Labour income and the return on assets accumulated over a lifetime. d) Labour income and past consumption. Explanation: According to the Lifecycle Hypothesis, consumption is determined by labour income and the return on assets accumulated over a lifetime, as consumers are assumed to plan their consumption and savings behaviour over their life-cycle. 6

7 QUESTION 2 [30 MARKS] Consider a small economy that only produces laptops and calculators. Use the information below to answer the questions that follow. Year Product Quantity of Product Price (in Namibia dollars) laptops N$200 N$180 calculators N$20 N$30 1. Calculate nominal and real GDP for 2016 and 2017 using 2016 as the base year. (6) Nominal GDP 2016: (1) Nominal GDP in 2016 is quantity of products in 2016 multiplied by prices of the products in 2016, for all the different products: (40 200) + (300 20) = N$14, 000 Real GDP 2016: Real GDP is the same as nominal GDP in 2016, because 2016 is the base year. So Real GDP in 2016 is N$ 14,000. Nominal GDP 2017: (1) Nominal GDP in 2017 is quantity of products in 2017 multiplied by prices of the products in 2017, for all the different products: (50 180) + (280 30) = N$17, 400 Real GDP 2017: Real GDP in 2017 is quantity of products in 2017 multiplied by prices of the products in 2016, which is the base year: (50 200) + ( ) = N$15, What is the annual growth rate in the nominal and real GDP over this period? (4) Growth in nominal GDP is the rate of change of nominal GDP from 2016 to Growth Rate in Nominal GDP = = %

8 Growth in real GDP is the rate of change of nominal GDP from 2016 to Growth Rate in Real GDP = = % If real GDP grows at this same rate, what will it be in 2018? You need to apply the growth rate of 11.43% Real GDP 2018 = ( ) = N$17, Assuming that the 2016 quantities in the table represent the typical consumer s basket of goods, calculate the CPI and GDP deflator for 2016 and (6) GDP deflator 2016 = 100 (as 2016 is the base year) CPI 2016 = 100 (as 2016 is the base year) GDP deflator 2017 = Nominal GDP Real GDP = 100 = (3) CPI 2017 = Cost of Basket in 2017 prices Cost of Basket in 2016 prices 100 = (40 180) + (300 30) (40 200) + (300 20) 100 = = (3) What are the inflation rates between 2016 and 2017 for the two price measures above? You need to convert to %: π GDP deflator = = % (1) 100 π CPI = = % (1) 100 8

9 6. Explain the difference between the CPI and the GDP deflator. (10) The GDP deflator measures the prices of all goods and services produced, whereas the CPI measures the prices of only the goods and services bought by consumers. Thus, an increase in the price of goods bought by firms or the government will show up in the GDP deflator but not in the CPI. The GDP deflator includes only those goods produced domestically. Since imported goods are not part of GDP, they do not show up in the GDP deflator. The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing weights. In other words, the CPI is computed using a fixed basket of goods, whereas the GDP deflator allows the basket of goods to change over time as the composition of GDP changes. QUESTION 3 [20 MARKS] Consider a small closed economy that is described by the following information: The full employment income = 2600; Tax = 0; Investment = 120; Autonomous Consumption = 200; Government spending = 100 ; and the Marginal Propensity to save = Calculate the investment multiplier and the government-spending multiplier. (7) Multipliers: (3) Investment spending multiplier i = 1 (1 b) = 1 (1 0. 8) = = 5 The government spending multiplier is also 5, as the only leakage in the economy is savings. 2. Derive the specific saving equation that corresponds to the consumption equation. The savings function is the inverse of the consumption function, so savings = - Autonomous consumption + (1-MPC)Y S = Y 9

10 3. At what level of income does savings equal zero? (3) You need to make the Savings function = 0 0 = Y 0. 2Y = 200 Y = Y = How much is aggregate demand when income is 2200? Is the economy in equilibrium at this level of income? Justify your answer. (5) Aggregate demand or AE = C + I + G AE = (2200) AE = AE = 2180 No, the economy is not in equilibrium, because aggregate demand is less than income. AE = 2180 < Y = Find the equilibrium level of income and describe the economic process that brings about this Keynesian equilibrium. (7) Y eq = C + I + G = Y Y = Y Y 0. 8Y = 420 Y = Y = 2100 The economic process that brings about the Keynesian equilibrium: The shortfall of expenditures below income (i.e., 2100 < 2200) means that inventories are accumulating. 10

11 The excess inventories, which are amount to = 20, causes businesses to cut back on production and to lay off workers. The workers loss of income means reduced spending, but spending isn t reduced as much as the reduction in income. This is the key implication of Keynes s consumer-spending theory: b < 1. Income and expenditures spiral downwards until the excess inventories are dissipated at which point income equals expenditures, and the economy is in macroeconomic equilibrium with Y = AE = C + I + G = QUESTION 3 [10 MARKS] 1. Explain the accelerator theory of investment. (10) The principle refers to the relationship between increase in total output (income) and the additional investment spending that occurs due to such output (income) increase. In short, the acceleration principle explains why the increase in national income often results in a more than proportionate increase in investment spending and why the amount of investment spending depends not on the absolute level of business activity but on whether that level is increasing or decreasing. A small change in national income or output leads to an accelerated change in investment. The accelerator principle, developed by J.M. Clark, refers to the accelerated effect on investment of a small change in the demand for or output (sales) of consumption goods. TOTAL MARKS = 80 11