Investing in Africa s Future FACULTY OF MANAGEMENT AND ADMINISTRATION. Answer all questions in Section A and any TWO questions in section B

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1 Investing in Africa s Future FACULTY OF MANAGEMENT AND ADMINISTRATION COURSE TITLE: MEC102 ECONOMIC PRINCIPLES SEMESTER 1: FINAL EXAMINATION- MAY 2012 LECTURER: TIME: MR T. MASESE 3 HOURS INSTRUCTIONS Answer all questions in Section A and any TWO questions in section B Total possible mark is 100. Start each question on a new page in your answer Booklet. The marks allocated to each question are shown at the end of the section. Show all your workings. Credit will be awarded for logical, systematic and neat presentations.

2 Question One a. You are given the following simplified T account for a CBZ Bank: Assets Liabilities Reserves $1500 Deposits $4000 Loans $2500 Give that the required reserve is 10% i. How much is the bank required to hold as reserves given its deposits of $3500? (1 i How much are its excess reserves? (2 By how much can the bank increase its bank loans (2 Suppose a depositor comes to the bank and withdraws $200 in cash. Show the new bank balance sheet, assuming that the bank obtains the cash by drawing down its reserves. Does the bank now hold excess reserves? Is it meeting the required reserve ratio? If not what can it do? (4 b. What are the major functions played by the Central Bank? Explain each of the monetary policy tools used by the CB to control the money supply in the economy (8 c. Briefly explain the main types of unemployment clearly outlining the causes of each (8

3 Question Two a. Given the following information, answer the following questions: Using the following data for Austria calculate the following i. Gross private investment (2 i Net exports (2 Gross domestic product (3 Gross national product (3 v. Net national product (2 vi. v vi ix. National income (2 Personal Income (2 Disposable income (2 Explain why imports are subtracted in the expenditure approach to calculating GDP. (2 b. Suppose in producing a car, Quest Motors pays $100 to Dunlop for tires. Quest Motors uses these tires (among other parts) to assemble a car, which it then sells for $ What is the value added on this product and what amount is included in the calculation of GDP (5

4 SECTION B Question Three a. With the aid of diagrams, explain how each of the following affects the consumption function i. The threat of election violence leading to the public expecting a shortage of consumer goods (1 mark) i An increase in personal income tax (1 mark) An increase in the rate of population growth (1 mark) A sharp sustained decline in stock (securities) prices (1 mark) v. A decline in real interest rates (1 mark) b. Briefly explain the 4 main non-income determinants of consumption (4 c. With the aid of a diagram and a numerical example explain the paradox of thrift (4 d. Assume that GDP is $6000m, personal disposable income is $5100m and the government budget deficit is $200m. Consumption is $3800m and the trade deficit is $100m i. How large is the saving (S)? (2 i How large is the investment (I) (2 How large is the government spending (G) (2 b. With the aid of a circular flow diagram indicate the flow of goods and services and expenditures within a 4 sector economy. Clearly indicate the major players in the economy, expenditure components, injections and withdrawals (6 Question Four a. Briefly explain the main determinants of money demand (5 b. Explain the following concepts: i. Expansionary fiscal policy (2 i Expansionary monetary policy (2 Frictional unemployment (2 c. A simple distinction is made between demand pull and cost push inflation. Define inflation and briefly explain the causes of the mentioned forms of inflation (7

5 d. With the aid of diagrams illustrate the effect of an increase in each of determinants of household consumption expenditure (7 Question Five a. The demand for money in the economy in Zambia is given by the equation M d = r + Y Where M d is money demand in dollars, r is the interest rate and Y is national income. Assume that the initial Y is equal to i. Graph the amount of money demanded (on the horizontal axis) against interest rate (on the vertical axis (4 Suppose money supply (M s ) is set by the central bank at $ On the same graph in (i) above, add the money supply. What is the equilibrium rate of interest? Explain how you arrived at your answer (4 i Suppose that income rises from Y = 5000 to Y = $7500. What happens to the money demand curve you drew in (i)? Draw the new curve, if there is one. What happens to the equilibrium rate of interest if the Central Bank does not change money supply? (5 If the Central bank wants to keep the equilibrium interest rate at the same rate as it was in part (ii) above, by how much should it increase or decrease the supply of money given the new level of national income? (3 v. Suppose the shift in part (iii) above has occurred and the money supply remains at $10000 but there is no observed change in interest rate. What might have happened? Explain? (3 b. Illustrate each of the following situations using the IS/LM curves i. An increase in G with money supply held constant by the Central Bank An increase in G with Central bank accommodation designed to hold interest rates constant i The Minister of Finance cuts G and increases T while the Central Bank Governor expands money supply The Finance Minister increases G and holds T constant while the Central Bank Governor holds money supply constant during a period of inflation

6 Question SIX c. Illustrate the following using the supply and demand curves for money: i. The Central bank buys bond in the open market during a recession (1 During a period of rapid inflation the central bank increases its reserve requirement (2 i The Central bank holds interest rates constant during a period of high inflation (2 During a period of no growth in GDP and zero inflation, the central bank lowers the discount rate (1 v. During a period of rapid real growth of GDP, the Central Bank Acts to increase the reserve requirement (2 d. Briefly outline the main determinants of investment in the economy. What role is played by interest rates in determining the level of investment in the economy? (5 e. The following equations describe some macroeconomic variables for the Malawian economy. Assume that all the variables are in billions of dollars and interest is given as a percentage. C = 0.8 (1-T) Y, T = 0.25Y, I = r, G = 100, L = 0.25Y- 62.5r, M/P = 500 Where C = consumption, T = net taxes, I = investment, G = government, r = interest rate i. What is the equation that describes the IS curve? (2 i What is the general definition of the IS curve? (2 What is the equation that describes the LM curve? (2 What is the general definition of the LM curve? (2 v. What are the equilibrium levels of income and the interest rate (4