Economics

Part A
This part comprises ten multiple choice questions each worth 2 marks. These questions are designed to test your knowledge of the course content. The questions in this section are typical of the kind of question that will be in part A of the examination paper.

Q. 1
A recession represents
an increase in the unemployment rate.
a reduction in stock prices.
a reduction in output.
a simultaneous reduction in economic activity and increase in inflation.
Ans C

Q. 2
During the mid-1980s, we observed a significant reduction in oil prices. In Australia, we would expect that this drop in oil prices would cause
a larger reduction in the CPI compared to the GDP deflator.
an equal reduction in the CPI and GDP deflator.
a larger reduction in the GDP deflator compared to the CPI.
no change in the CPI and a reduction in the GDP deflator.
Ans C

Q. 3
When disposable income is zero, we know that
consumption must be zero.
saving must be zero.
saving equals investment.
saving is negative.
the marginal propensity to consume must be zero.
Ans D

Q. 4
If C  100  .5YD, what increase in government spending would raise GDP by 1000
500
1000
1500
2000
2500
Ans D

Q. 5
Suppose there is an open market sale of bonds. Such an event will cause
an increase in bond prices and an increase in the interest rate (i).
a reduction in bond prices and an increase in i.
an increase in bond prices and a reduction in i.
a reduction in bond prices and a reduction in i.
none of the above
Ans B

Q. 6
Based on our understanding of the IS-LM model, we know that a tax cut
must cause investment spending to decrease.
must cause investment spending to increase.
will cause no change in investment spending.
may cause investment spending to increase or decrease.
a reduction in money demand and a reduction in the interest rate.
Ans D

Q. 7
Suppose there is a tax cut. Which of the following represents the complete list of variables that must increase in response to this tax cut
consumption
consumption and investment
consumption, investment and output
consumption and output
consumption, output and the interest rate
Ans E

Q. 8
Suppose there is a policy mix of contractionary monetary policy and contractionary fiscal policy. This combination of policies must cause
an increase in the interest rate (i).
a reduction in i.
an increase in output (Y).
a reduction in Y.
Ans C

Q. 9
Based on our understanding of the labour market model presented in Chapter 6, we know that an increase in the markup will cause
an increase in the equilibrium real wage.
a reduction in the equilibrium real wage.
a reduction in the natural rate of unemployment.
both B and C
Ans B

Q. 10
Which of the following represents the medium-run effect of an increase in the price target
a decline in output
an increase in the interest rate
a decrease in the price level
all of the above
none of the above
Ans D

Part B
Please answer each of the following questions using your own words. Use diagrams, tables or equations in your answer where appropriate.
As a guide, you should be able to answer questions 11, and 12 within 150 words (each question), questions 13 and 14 within 250 words (each question) and question15 within 300 words, plus diagrams if appropriate (except where a question requires only a list or calculation).
Note Each question in this part will be marked out of a maximum mark as indicated in parentheses.

Q. 11.
a.From the following list of newspaper headlines, identify those that concern macroeconomic variables
High oil prices threaten global growth
State government provides fuel subsidy for farmers
Government to provide more child care places
Federal government budget is in deficit
Migrant intake to be increased
Credit growth blowout
Government to increase expenditure on infrastructure.
Inflation expected to continue to increase
(2 marks)
Following items from above list concern Macroeconomic variables
High oil prices threaten global growth
State government provides fuel subsidy for farmers
Federal government budget is in deficit
Migrant intake to be increased
Government to increase expenditure on infrastructure.
Inflation expected to continue to increase

b.Explain why you identified the headlines in your list as concerning macroeconomic variables.
High oil prices threaten global growth  As oil is the one of the primary drivers of any economy, any increase in the oil prices means an increase in the prices of all commodities.
State government provides fuel subsidy for farmers  As the fuel subsidy is provided, the cost of production of grains is reduced and hence the cascading cost to the consumers is contained.
Federal government budget is in deficit  The GDP of the country is less and hence steps needs to be taken to increase it.

Migrant intake to be increased  This may result in the unemployment in the country.
Government to increase expenditure on infrastructure  Employment would increase as a result and hence the GDP would increase as well.

Inflation expected to continue to increase  Rise in inflation results in the economic growth.
(2 marks)Q. 12.

Define the following terms
a.Nominal variable Variables which do not have any numerical values are known  as nominal variables. As these variables do not have any numeric value, there is no specific order of sequence for these variables. The examples of nominal variable are occupation, gender.  b.Long run The duration in a macroeconomic analysis of the aggregate market, in which the prices and wages are flexible and are expected to achieve their equilibrium levels is known as the long run. This is one of two macroeconomic time designations the other is the short run. Long-run wage and price flexibility means that ALL markets, including resources markets and most notably labor markets, are in equilibrium, with neither surpluses nor shortages. Wage and price flexibility and the resulting resource market equilibrium are the reason for the vertical long-run aggregate supply curve.c.Fiscal policy The policy decisions by the Government of any country, usually in relation to the Government spending and taxation, with the goal of economic growth, full employment, and price stability.

The Government can change tax laws, to effectively modify the quantum of disposable income available to its taxpayers. The simple implication of increase in tax means less income available to the taxpayers and hence less spending. This difference in the disposable income goes to the Government instead to the consumers. The Government can redirect the additional revenues to the companies or may choose to increase the spending by purchasing services and goods from private companies. The idea of doing this is to increase the flow of money into the economy.   (6 marks each worth 2 marks)Q. 13.

a.Describe what is meant by the term economic fluctuations.
Economic fluctuation means -
1. The slight or dramatic changes into the prices of bonds, stocks or commodities. The changes could be up or down.

2. The peak and trough in the economic cycle
 INCLUDEPICTURE httpcorporatejourney2u.combusinessresourcesimagesbusiness-cycle-graphs.jpg  MERGEFORMATINET
Diagram 1 Economic Fluctuations

3. The economic cycle fluctuates over duration of time with the value of key macroeconomic variables going up and down. For example, movements in the inflation rate, interest rate, GDP are the example of economic fluctuations.(2 marks)b.Define equilibrium in the context of macroeconomics.
The concept of equilibrium is very important in the macroeconomics. The objective is to evaluate the outcome of the dependencies when the variables defined in the model have completed their maximized behavior. It is difficult to determine when certain agents in the process have completed the cycle in the short and long run. Economists over the generations have been thinking the strategies to come up with the approximate duration in which variables achieve the maximum value. However, in its simplest form, often, equilibrium denotes the point at which 2 or more lines intersect.

INCLUDEPICTURE httpimg.sparknotes.comfigures227494f43f8520c29bb39130541e7bb44Supply_and_Demand.jpg

MERGEFORMATINET
Diagram 2 Supply and demand equilibrium
For examples, supply and demand equilibrium.  Profit-maximizing firms show the quantity supplied at a given price by supply curve. On the other hand, demand curve is used to show the demand of quantity at a certain price. The point where both utility and profits maximize is the intersection of demand and supply curve. (3 marks)Q. 14.

a.Explain why macroeconomists do not always agree with one another.
Ans The foundation of Macro economy is based on the Keynesian models, which has deep conflicts with the monetarist model. The debates were centered around
The effectiveness of monetary policy versus fiscal policy,
The Phillips curve, and
The role of policy
The proponent of the fiscal policy argued that it could affect output faster and more reliably than the monetary policy. On the other hand, monetarists considered that monetary policy could explain the fluctuations in the output in a better way.

INCLUDEPICTURE httpwww.transtutors.comeconomics-homework-helpimagesecoKeynesian20Model1.JPG  MERGEFORMATINET
Diagram 3 Keynesian Model
Now, When rational expectations were introduced,
Keynesian models could not be used to determine policy

Keynesian models could not explain long-lasting deviations of output from the natural level of output
The theory of policy had to be redesigned, using the tools of game theory.(2 marks)b.Describe how government expenditure might be used to smooth out fluctuations in the level of economic activity.
Ans  Government expenditure is one of the important agents in smoothing out fluctuations in the level of Economic activity. As suggested by Keynes2 , Government should take active participation in managing the economy. Keynes suggested that Government can take countercyclical fiscal measures to act against the business tide by spending when the nation is suffering from recession. Similar measures can also be taken on the face of long delayed recovery and high rate of unemployment. As a countermeasure to inflation during boom times, Government can increase taxes and also reduce the spending from the Government. Keynes also suggested taking these actions in the short run as the long run wait for auto-correction may actually result in major loss of economic activity.

INCLUDEPICTURE httpimg236.imageshack.usimg236606282919697tc4.jpg  MERGEFORMATINET
Diagram 4 Government intervention can smooth out the peak and  trough

It is possible for the Government to trigger a amount of new production with a limited budget, if
1. The people receiving this money spend it in consuming goods and save the remaining.
2. The additional spending by the consumers gives opportunities to organizations for increasing the production, resulting in increased hiring and in turn increasing the consumer spending.

The above process continues until the cycle attains equilibrium. Thus, Government intervention in both recessionary and good times can make the high economic fluctuations smooth out.(3 marks)Q. 15.
Continuous unrest  war in the Middle East might affect the general level of prices and real output in an economy. Do you agree Explain.
(10 marks)

Ans Any unrest or War usually hits the economy negatively as the resources are directed towards winning it. The same resources which could have been used in the constructive purposes are used for destructive purpose in the war. It all starts with Government increasing the defense budget by redirecting the allocations from other areas. This decision of any Government severely impacts the real output as the money spent on War is not for any constructive purpose. For example, the same money could have been spent on developing a manufacturing establishment or a School which would have resulted in job creation and trained manpower. Instead, that money goes in purchase of weapons which are used in the war. It is a widely recognized fact that war estimates are not accurate as the cost involved is beyond the domain of battlefield. It also includes economic consequences and political reactions, among other things. The main objective of the war in the Middle East is understood to be stripping Iraq of its mass destruction weapons and un-seating the leaders who are un-friendly to the US. Often, cost estimates are not part of the agenda of debates on any war, though people do recognize that so long as the cost in terms of money and blood are low, the war is justified. Unless, the casualty numbers are thousands, or recession triggers as a result of war or Government implements high taxes, or the oil prices zoom up, or there are attacks on civilians, the Government considers war as low cost affair. As it is said, the cost of actual war may be low but the successful peace comes at a high cost. American taxpayers would be the ones paying for the reconstructions efforts at Middle East.