Answer to Question #318309 in Economics of Enterprise for PMN

Question

b) Explain why a little inflation is always necessary so as to grease the wheels of the

economy (4marks)

c) Discuss the key assumptions of the Mundell - Fleming model ( 5marks)

d) Explain five indicators of a developing country (5 marks)

e) Demonstrate your understanding of the concepts of inflationary gap and deflationary

gap and show how they can be corrected (6 marks)

Answer 1

b) Low inflation is said to encourage greater stability and encourage firms to take risks and invest.

c)

Spot and forward exchange rates are identical, and the existing exchange rates are expected to persist indefinitely. 

Fixed money wage rate, unemployed resources and constant returns to scale are assumed.

d)

• Growth rate of National Income:
• Per Capita Income (PCI):
• Per Capita Consumption (PCC):
• Physical Quality Life Index (PQLI) and Human Development Index (HDI):
• Industrial progress: ...
• Capital formation

e) Inflationary Gap is the amount by which actual aggregate demand exceeds the level of aggregate demand(anticipated) required to establish the full employment. Deflationary Gap is the amount by which actual aggregate demand falls short of aggregate supply at level of full employment.

Correction

Under the monetary policy, money supply is reduced and/or interest rates are increased. This gap, however, can be reduced either by reducing money income through reduction in government expenditure, or by increasing output of goods and services, or by increasing taxes.