Macroeconomics Answers

Briefly explain the meaning of gross domestic product (GDP) and gross national product

(GNP). Decide and explain either GDP or GNP is better to measure the economic

performance of the country.

4. What would be the shape of:

(a) The IS curve if investment does not depend on the interest rate?

(b) The LM curve if the demand for money does not depend on interest rate?

(c) The LM curve if the demand for money does not depend on income?

5. Consider an economy with levels of aggregates as follows:

Consumption function: C = 0:8 (1 − t) Y

Tax rate: t = 0:25

Investment: I = 900 − 50r

Government expenditure: G¯ = 800

Demand for money: L = 0:25Y − 62:5r

Money supply: M = 1000

Price level: P = 2

(a) Derive the IS and LM equations.

(b) Determine the equilibrium levels of income and interest rate.

(c) Calculate the full government spending multiplier, αG.

(d) By how much income and interest change for a unit change in

government spending allowing the money and goods market to

interact?

(e) How do you account for the difference between the value of the

government spending multiplier in (b) and the change in income

in (d)? (Hint: What happens to investment?)

Differentiate between the classical and Keynesian approach to the macroeconomic issues

1. Explain the following terms.

(a) Liquidity trap

(b) Monetary accommodation

(c) The Marshall-Lerner condition

(d) Crowding out

(e) Monetary transmission mechanism

(f) Neutrality of money

(g) Sterilization

(h) Devaluation

1. In the traditional macroeconomic framework (under open or closed

economy), all macroeconomic variables can somehow be categorized as

part of the aggregate demand and aggregate supply with equilibrating

prices. List as many macroeconomic variables as possible and categorize them under sub-equilibrium and eventually under demand supply

framework. [Hint: Use the goods market, the money market, the labor

market equilibrium, and technology].

2. Transmission mechanism is the process by which changes in the monetary sector (money market) affects variables such as income in the real

sector (goods) market. Discuss.

3. Suppose a country targets an income level of Y ∗.

(a) Demonstrate, using graphs, that either fiscal or monetary policies

can be used to achieve the targeted level of income.

(b) What are the possible reasons for a country to opt for a particular

policy (fiscal or monetary) while both of them can yield similar

level of income?

4. A country faced an unexpected build-up of foreign exchange earning

following a positive price shock on the country’s main export in the international market. This gain was, however, accompanied by a soaring

inflation. How and under what conditions, if any, can the build-up of

the foreign exchange reserve trigger inflation?

5. Consider two authorities: the Ministry of Finance (MOF) of Ethiopia,

and the National Bank of Ethiopia (NBE). Suppose these authorities

have two major policy goals namely internal balance and external balance.

(a) What are the major targets under the goals of achieving internal

and external balances?

(b) To achieve the two goals, at least two policy instruments are required. Suggest two policy instruments of achieving the goals of

internal and external balances.

(c) The assignment problem: Using the Swan diagram, demonstrate

and discuss the conditions under which each authority is assigned

to the particular policy goal.

10. Distinguish between growth correlates and fundamental causes of growth.

11. Discuss how history, and aspiration failure explain differences in the

trajectory of economic growth of economies.

12. Consider two cultures X and Z. In culture X, parents live for their children and grandchildren where their current income is divided among

current consumption, saving for retirement, and investment in the education of their children. In culture Z, children are born as assets for

their parents so that the current generation expects to be taken care of by the future generation. Output produced by the younger generation is divided into proceed and bequest for parents, and investment

for future self-sufficiency.

(a) What is the direction of flow of resource of investment in the two

cultures?

9. Consider a production function of an economy:

Y = BKαT βL1-α-β (1)

where Y = output, K = capital stock, T = land, L = labor, B = index

of exogenous technological change, and α and β are elasticities.

(a) Show that growth in output along the balanced growth path is

gY = g + (1 - β¯)n and that growth in output per capita is given

by gy = g - βn ¯ where g = gB/(1 - α), and β¯ = /(1 - α). [Hint:

Assume that land is fixed and exploit the stylized fact that capitaloutput ratio (K/Y ) is constant at steady-state].

(b) What is the long-run growth a function of?

(c) Suppose there is little or no technological advancement in the

economy. What is the fate of the economy with fixed land and a

population growing at a rate of n?

(d) Discuss how the Malthusian checks would operate on this type of

hypothetical economy.

(e) Discuss the implication of this model on economies dependent on

non-renewable natural resources.

(f) How does technology help break the impasse in this model?