2022

1(a). What is economics? Explain the integration between microeconomics and macroeconomics.

Economics is the social science that studies how individuals, businesses, and governments allocate
scarce resources to satisfy their unlimited wants and needs. It deals with the production,
distribution, and consumption of goods and services.

Microeconomics focuses on individual economic units such as households, businesses, and

specific markets. It studies factors like demand and supply, price determination, and consumer
behavior.

Macroeconomics examines the overall economy, analyzing aggregate indicators such as GDP,
inflation, unemployment, and government policies.

Integration between Microeconomics and Macroeconomics:

Microeconomic decisions, such as household consumption and business investment, collectively

shape macroeconomic outcomes like national income and economic growth.

Changes in macroeconomic variables (e.g., inflation or interest rates) influence microeconomic

behaviors, affecting firms' pricing strategies and consumers' purchasing power.

Government policies aimed at macroeconomic stability, such as fiscal and monetary policies,
directly impact individual markets and businesses.
Thus, microeconomics and macroeconomics are interconnected, as individual economic decisions
collectively determine national economic performance.

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1(b). Explain the alternative economic systems to solve the basic economic problems of society.

Every society faces basic economic problems like resource scarcity, production decisions, and
income distribution. To address these issues, different economic systems have evolved:

1. Capitalist Economy (Market Economy):

Private individuals and businesses own resources and make economic decisions.

Prices are determined by supply and demand.

Government intervention is minimal.

Example: The United States, United Kingdom.

2. Socialist Economy (Planned Economy):

The government owns and controls all major industries.

Economic planning determines production, distribution, and pricing.

Focuses on equality and welfare over profit.

Example: Former Soviet Union, Cuba.

3. Mixed Economy:

Combines elements of both capitalism and socialism.

Private businesses operate alongside government intervention.

The government regulates essential services while the market controls most economic activities.

Example: India, Bangladesh.

4. Islamic Economy:

Based on Islamic principles, such as prohibition of interest (riba).

Encourages ethical business practices and wealth distribution.

Example: Islamic banking systems in Malaysia, Saudi Arabia.

Each system has its advantages and challenges, and many countries adopt a mixed approach to
balance efficiency with social welfare.

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1(c). Explain the circular flow of economic activities.

The circular flow of economic activities describes how money, goods, and services move through
an economy between different sectors. This model helps in understanding how different economic
agents interact.

There are two primary models:

1. Two-Sector Model:

Involves two main participants:

Households: Supply labor and consume goods/services.

Firms (Businesses): Produce goods/services and pay wages.

Households earn wages by providing labor and use that income to buy goods/services from firms.

Firms use household spending as revenue to produce more goods, creating a continuous cycle.

2. Multi-Sector Model:

Expands on the two-sector model by adding:

Government: Collects taxes and spends on public services.

Financial Institutions: Facilitate savings and investments.

Foreign Sector: Engages in exports and imports, affecting national income.

This model shows how money flows through different sectors, maintaining economic stability.

If any part of this flow is disrupted, such as decreased household spending or reduced business
investment, the economy may experience slow growth or recession.

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Conclusion:

These three concepts—economics, economic systems, and circular flow—are fundamental to

understanding how an economy functions. They illustrate how individual and national-level
economic activities are interconnected, and how different systems attempt to address
economic challenges.

2(a). What do you mean by fiscal policy? Should the government rely on fiscal or monetary policy?
Definition of Fiscal Policy:

Fiscal policy refers to the government's use of taxation and government spending to influence the
economy. It is mainly used to achieve economic stability, control inflation, reduce unemployment,
and promote economic growth.

Types of Fiscal Policy:

1. Expansionary Fiscal Policy:

Used during economic slowdowns or recessions.

Involves increasing government spending and/or reducing taxes to stimulate demand and boost
growth.

Example: Stimulus packages and infrastructure investments.

2. Contractionary Fiscal Policy:

Used to control inflation and reduce budget deficits.

Involves reducing government spending and/or increasing taxes to slow down excessive economic
activity.
Example: Increasing corporate taxes to reduce excessive consumption.

Should the Government Rely on Fiscal or Monetary Policy?

Both fiscal and monetary policies play crucial roles in economic management, but the choice
depends on the economic situation:

Fiscal Policy: More effective in dealing with unemployment and boosting economic growth,
especially during recessions. However, it can lead to budget deficits and long-term debt.

Monetary Policy: Controlled by the central bank, it regulates the money supply and interest rates.
It is more effective in controlling inflation but may not directly address unemployment.

Conclusion: A balanced approach is best. The government should use fiscal policy for long-term
economic growth and employment generation while using monetary policy to maintain price
stability and control inflation.

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2(b). Explain the relationship between fiscal policy and monetary policy.
Fiscal Policy vs. Monetary Policy:

How Fiscal and Monetary Policy Work Together:

1. During a Recession:

Fiscal Policy: The government increases spending and cuts taxes to boost demand.

Monetary Policy: The central bank lowers interest rates to encourage borrowing and investment.

2. During High Inflation:

Fiscal Policy: The government reduces spending and increases taxes to slow down excess demand.

Monetary Policy: The central bank raises interest rates to control excessive borrowing and
spending.

Conflicts Between Fiscal and Monetary Policy:

If the government follows an expansionary fiscal policy (increasing spending), but the central bank
tightens monetary policy (raising interest rates), their effects may cancel each other out.

A well-coordinated approach ensures stability and balanced economic growth.

Conclusion: Fiscal and monetary policies are interrelated and must be used together for effective
economic management. While fiscal policy affects demand through government spending,
monetary policy influences demand through credit and money supply control.

3(a). How can we measure the supply of money in the economy?

Money supply refers to the total amount of money available in an economy at a given time. It
includes cash, bank deposits, and other liquid assets. Central banks, like the Federal Reserve or
Bangladesh Bank, control the money supply to ensure economic stability.

Measures of Money Supply:

Economists use different measures to calculate the money supply, commonly categorized as
monetary aggregates (M0, M1, M2, M3, etc.):

1. M0 (Narrow Money):

The most liquid form of money, including coins, paper currency, and central bank reserves.
Represents money in circulation and cash held by commercial banks.

2. M1 (Money in Circulation + Demand Deposits):

Includes all physical currency (M0) + demand deposits (checking accounts) and other highly liquid
deposits.

Used for daily transactions.

3. M2 (Broad Money):

Includes M1 + savings accounts, fixed deposits, and money market funds.

Represents money that is easily convertible but not as liquid as M1.

4. M3 (Total Money Supply):

Includes M2 + large time deposits, institutional money market funds, and other long-term financial
assets.

Provides a broader picture of money available in the economy.

Methods of Measuring Money Supply:

1. Monetary Aggregates Approach: Used by central banks to classify money into M0, M1, M2,
and M3.

2. Credit Creation by Banks: Commercial banks increase the money supply through lending and
deposits.

3. Velocity of Money Calculation: Measures how quickly money circulates in the economy,
influencing inflation and GDP growth.

Why Measuring Money Supply is Important?

Helps central banks control inflation and stabilize the economy.

Supports policymakers in making monetary policy decisions.

Affects interest rates, investment, and economic growth.

Conclusion: The money supply is measured using different monetary aggregates (M0, M1, M2,
M3), and central banks regulate it to ensure economic stability and growth.

4(a). Why is the world not concerned about deflation?

Definition of Deflation:

Deflation refers to a general decline in the price level of goods and services over time, often caused
by reduced demand, lower production costs, or decreased money supply. While inflation is a major
economic concern, deflation is not always seen as a major threat in many economies.

Reasons Why the World is Not Concerned About Deflation:

1. Deflation is Rare in Modern Economies:

Most economies experience inflation rather than deflation due to continuous economic growth and
central bank policies.

Governments and central banks actively manage monetary policies to prevent deflation.

2. Mild Deflation Can Be Beneficial:

If deflation occurs due to technological advancements and improved efficiency, it can lead to lower
production costs and consumer benefits.

Example: The fall in electronic gadget prices due to improved manufacturing.

3. Strong Monetary and Fiscal Policies:

Central banks control the money supply and interest rates to prevent prolonged deflation.

Governments use stimulus packages and tax cuts to boost demand if deflation occurs.
4. Global Trade and Demand Maintain Price Stability:

The modern global economy relies on continuous demand and consumption, reducing the chances
of long-term deflation.

5. Deflation is a Short-Term Issue in Most Cases:

Temporary deflation due to supply shocks or increased productivity is not a major concern, as
prices adjust over time.

However, Deflation Can Be a Concern in Some Cases:

If demand falls sharply, leading to lower wages and reduced business profits.

If consumers delay spending, expecting further price drops, causing an economic slowdown.

If debt burdens rise, as the real value of debt increases during deflation.
Conclusion:

While severe deflation can harm an economy, the world is not overly concerned because it is rare,
short-term, and manageable through economic policies. Most governments and central banks focus
more on controlling inflation rather than preventing deflation.

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4(b). Explain the Phillips Curve. Can you explain the present situation of inflation and
unemployment in Bangladesh by the Phillips Curve?

Definition of the Phillips Curve:

The Phillips Curve represents the inverse relationship between inflation and unemployment. It
suggests that:

When inflation is high, unemployment is low (because companies hire more workers to meet
demand).

When inflation is low, unemployment is high (because businesses cut costs by reducing jobs).

Graphical Representation:

The curve is downward-sloping, showing that a trade-off exists between inflation and
unemployment. However, in the long run, this relationship may weaken due to factors like
expectations and supply shocks.
Application to Bangladesh’s Present Economic Situation:

Inflation Rate in Bangladesh:

Bangladesh has been experiencing high inflation, mainly due to rising food and fuel prices.

Supply chain disruptions and global economic factors have contributed to this inflation.

Unemployment Rate in Bangladesh:

Despite high inflation, unemployment remains a concern, particularly among the youth.

Economic recovery after the COVID-19 pandemic has not fully reduced joblessness.

Does the Phillips Curve Hold for Bangladesh?

According to the traditional Phillips Curve, Bangladesh should have low unemployment due to
high inflation.
However, in reality, high inflation has not significantly reduced unemployment, suggesting that
other structural issues (such as skill gaps, automation, and global trade conditions) affect the labor
market.

The presence of stagflation (high inflation + high unemployment) indicates that the Phillips Curve
may not always hold in the long run.

Conclusion:

The Phillips Curve is useful in the short run but may not fully explain Bangladesh’s current
economic condition, where inflation remains high without a corresponding decrease in
unemployment. Structural economic reforms are necessary to improve job creation and
price stability.

5(a). Why does the long-run aggregate supply (LRAS) curve shift?

Definition of Long-Run Aggregate Supply (LRAS):

The LRAS curve represents the total quantity of goods and services an economy can produce when
all resources (labor, capital, technology) are fully utilized. It is typically vertical because, in the
long run, an economy’s output depends on supply-side factors rather than price levels.

Factors That Shift the LRAS Curve:

1. Technological Advancements:

New technologies improve production efficiency, shifting LRAS to the right.

Example: Automation in industries increases output capacity.

2. Increase in Labor Force or Human Capital:

A larger, more skilled workforce enhances productivity.

Example: Education reforms or immigration of skilled workers.

3. Capital Investment Growth:

More factories, machinery, and infrastructure expand production capacity.

Example: Government or private sector investments in industries.

4. Natural Resource Availability:

Discovery of new resources (oil, minerals) can boost long-term production.

Example: Oil discoveries increasing energy supply.

5. Government Policies and Institutional Changes:

Supportive policies (tax incentives, property rights protection) encourage investment and business
growth.

Example: Reducing corporate tax rates to boost entrepreneurship.

6. Improvements in Productivity and Efficiency:

Better management, innovation, and streamlined production processes increase output.

Example: Lean manufacturing techniques reducing waste and increasing output.

When Does the LRAS Curve Shift Left?

Natural disasters, wars, or economic crises that destroy resources or disrupt production.

Decline in workforce participation due to aging populations or emigration.

Conclusion: The LRAS curve shifts due to long-term structural changes like technology,
workforce, investment, and policy decisions, determining an economy’s growth potential.

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5(b). Why does the aggregate demand (AD) curve shift?

Definition of Aggregate Demand (AD):

The AD curve represents the total demand for goods and services in an economy at different price
levels. It slopes downward, meaning that as price levels fall, demand increases.

Factors That Shift the AD Curve:

1. Changes in Consumer Spending (C):

Increase in income, confidence, or wealth shifts AD to the right.

Example: Stock market booms make people feel richer and spend more.

2. Changes in Business Investment (I):

Higher investments in capital goods shift AD to the right.

Example: Businesses buying new equipment or expanding factories.

3. Government Fiscal Policy (G):

Increased government spending on infrastructure or welfare shifts AD to the right.

Tax increases reduce disposable income, shifting AD left.

Example: A government stimulus package boosts demand.

4. Net Exports (X - M):

Higher exports (X) or lower imports (M) increase AD.

Example: A weaker domestic currency makes exports cheaper and boosts foreign demand.

5. Monetary Policy (Interest Rates & Money Supply):

Lower interest rates encourage borrowing and spending, shifting AD right.

Higher interest rates reduce spending and investment, shifting AD left.

Example: A central bank cutting interest rates increases business investment.

6. Consumer and Business Expectations:

Optimism about the economy leads to more spending and investment, shifting AD right.

Fear of a recession reduces spending, shifting AD left.

Conclusion: The AD curve shifts due to factors influencing consumption, investment, government
policies, and global trade. Governments and central banks use fiscal and monetary policies to
manage these shifts.

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5(c). Explain the key facts about economic fluctuations.

Definition of Economic Fluctuations:

Economic fluctuations, also called business cycles, refer to short-term changes in economic
activity, moving between periods of growth (expansion) and decline (recession).

Key Facts About Economic Fluctuations:

1. Business Cycles Have Four Phases:

Expansion: GDP rises, employment grows, demand increases.

Peak: Economy reaches maximum growth before slowing down.

Recession: GDP declines, unemployment rises, consumer spending falls.

Trough: The lowest point before recovery begins.

2. Caused by Demand and Supply Shocks:

Demand shocks (e.g., financial crises, pandemics) reduce spending.

Supply shocks (e.g., oil price spikes, wars) increase costs and reduce output.

3. Government Policies Influence Fluctuations:

Fiscal policy (government spending, taxation) and monetary policy (interest rates, money supply)
help stabilize economic cycles.
4. Inflation and Unemployment Are Key Indicators:

During expansions, inflation tends to rise.

During recessions, unemployment increases as businesses cut costs.

5. Fluctuations Impact Investment and Trade:

Investors react to economic cycles, influencing stock markets and global trade.

Businesses adjust production and hiring based on economic conditions.

6. Recessions Can Have Long-Term Effects:

High unemployment can lead to skill loss.

Bankruptcies and debt crises can slow future growth.

Conclusion: Economic fluctuations are natural and influenced by demand, supply, and government
policies. While short-term cycles occur, economies generally trend toward long-term growth
through innovation, investment, and policy adjustments.

6 (a).what is the difference between GDP nd GNP? Is one a better of income /output than the
other? Why?

GDP (Gross Domestic Product) and GNP (Gross National Product) are both measures of economic
output, but they differ in what they account for:

1. GDP (Gross Domestic Product) measures the total value of all goods and services produced
within a country's borders, regardless of whether the producers are domestic or foreign. It focuses
on the location of production.

2. GNP (Gross National Product) measures the total value of goods and services produced by the
residents of a country, regardless of where they are located in the world. It includes income earned
by citizens and businesses from overseas investments but excludes income earned by foreigners
within the country.

Which is a better measure of income/output?

GDP is often considered a better measure of a country's economic activity because it focuses on
domestic production, which is more directly related to the economic health of the country. It's
particularly useful for understanding the size and performance of an economy.

GNP can be a better measure of income for a country's residents because it includes the income
from abroad. For example, a country with many international businesses or citizens working
overseas may have a higher GNP than GDP.

Ultimately, the choice between GDP and GNP depends on what you're trying to measure. For
understanding domestic economic health, GDP is generally preferred. However, if you're
interested in the total income of a country's residents, GNP might offer a clearer picture.

6(b).Why cost of unemployment is greater than cost of inflation?Explain.

The cost of unemployment is often considered greater than the cost of inflation for several reasons:

1. Long-Term Economic Harm: Unemployment can have long-lasting effects on individuals and
the economy. People who are unemployed for extended periods may experience skill degradation,
reduced future earning potential, and even permanent exit from the labor market, which can affect
overall productivity. High unemployment also reduces consumption and demand, leading to
slower economic growth.

2. Social and Psychological Impact: The social and psychological effects of unemployment are
significant. Unemployment often leads to increased stress, mental health issues, and social
instability. Families face financial hardship, and communities can become economically and
socially fractured.
3. Welfare Costs: High unemployment increases government spending on social welfare programs,
such as unemployment benefits and public assistance. This can strain public budgets and lead to
higher taxes or government borrowing.

4. Inflation is Temporary: While inflation can reduce purchasing power in the short term, it often
has less long-term negative impact compared to unemployment. Central banks can adjust monetary
policy to control inflation, whereas unemployment may require long-term structural solutions to
reduce.

5. Unemployment and Potential Output: When people are unemployed, the economy operates
below its potential capacity. High unemployment means resources (labor) are underutilized, which
leads to lower overall output, a less efficient economy, and fewer opportunities for growth.

6. Social Safety Nets: Inflation, though problematic, can often be mitigated through wage
adjustments or fiscal policies, while unemployment does not have an easy solution and can be
more challenging to reverse once it becomes entrenched.

Thus, while both inflation and unemployment have their costs, the far-reaching effects of
unemployment, especially in terms of economic, social, and personal costs, are why it is often
viewed as more detrimental.

6(c).what in NDP ? is it a better of worse measure of output than GDP? Explain.

NDP (Net Domestic Product) is a measure of a country's economic output that takes into account
the depreciation of capital goods. It is calculated as:

\text{NDP} = \text{GDP} - \text{Depreciation}

Where GDP (Gross Domestic Product) is the total market value of all goods and services produced
within a country in a specific period, without considering depreciation (the loss of value of capital
assets like machinery, buildings, and infrastructure due to wear and tear over time).

Is NDP a better or worse measure of output than GDP?

NDP can be considered a better measure of a country’s sustainable economic output than GDP for
the following reasons:

1. Incorporates Depreciation: NDP accounts for the depreciation of capital goods, which GDP does
not. Depreciation is the reduction in value of assets over time due to usage, aging, or obsolescence.
By subtracting depreciation from GDP, NDP provides a clearer picture of how much of the
produced output is available for future production and consumption, which is more sustainable in
the long term.

2. Indicates Long-Term Sustainability: While GDP reflects the total output of an economy, it
doesn’t tell us how much of that output is being used to maintain or replace capital. If a country is
over-consuming its capital (e.g., through rapid depletion of natural resources or not investing in
infrastructure), GDP may overstate the country’s actual economic health and growth. NDP,
however, adjusts for this, making it a more accurate reflection of sustainable economic activity.
3. Better Measure for Economic Well-being: NDP helps to assess whether the economy is growing
in a way that ensures long-term wealth creation and well-being. If a country’s GDP is high but it
is losing capital at a fast rate (high depreciation), the economy may not be in a strong or sustainable
position. NDP provides a more nuanced view by accounting for the depreciation of assets.

However, there are limitations:

NDP may understate short-term economic growth: GDP can be a better indicator when you're
interested in the total economic activity or output in the short term, without worrying about
depreciation. For instance, if a country is heavily investing in new infrastructure, GDP might look
better, but NDP will show a more cautious outlook.

NDP requires accurate measurement of depreciation: Estimating depreciation can be difficult,

especially when it involves physical capital, such as machinery or buildings, and natural capital,
like forests and minerals. Inaccuracies in estimating depreciation could lead to skewed NDP
figures.

Conclusion:

NDP is generally a more accurate measure of economic output in terms of long-term sustainability
because it accounts for the loss of capital (depreciation). However, GDP is still valuable for
understanding total economic activity in the short term. Therefore, NDP is a better measure of
output than GDP in terms of sustainability, but GDP is often preferred for understanding the overall
size of an economy at any given moment.
 2023

Here are the solutions to Question 1 (a), (b), and (c):

1(a) Distinguish between microeconomics and macroeconomics.

Microeconomics and macroeconomics are two branches of economics that focus on different
aspects of the economy:

1(b) Explain the three big questions that macroeconomics addresses.

Macroeconomics addresses three fundamental questions:

What to produce?

This question deals with resource allocation. Since resources are limited, societies must decide
what goods and services should be produced, such as food, healthcare, or defense.
How to produce?

This question focuses on the methods of production, including the choice between labor-intensive
and capital-intensive techniques. It also considers efficiency and sustainability.

For whom to produce?

This question determines the distribution of goods and services among people. It involves income
distribution, economic inequality, and government policies to ensure fair access.

1(c) Which of the macroeconomic goals do you consider most relevant for Bangladesh? Why?

Bangladesh, as a developing country, faces several economic challenges. Among the key
macroeconomic goals, the most relevant ones are:

Economic Growth

Bangladesh needs a high and sustainable GDP growth rate to improve living standards, create jobs,
and reduce poverty. The country has been growing steadily, but sustaining this growth is crucial.

Inflation Control

High inflation reduces purchasing power, affecting low-income households the most. Stable prices
are essential to maintain economic stability and investment confidence.
Employment Generation

Unemployment and underemployment remain major issues. Increasing job opportunities,

especially for the youth, is critical to economic progress.

Income Equality and Poverty Reduction

Economic development should be inclusive. Reducing income inequality and poverty through
social policies and economic reforms is essential for Bangladesh’s long-term stability.

Conclusion: Among these, economic growth and employment generation are the most critical for
Bangladesh because they directly impact poverty reduction and overall development.

Here are the solutions to Question 2 (a), (b), and (c):

2(a) What are the differences between GDP and GNP?

Gross Domestic Product (GDP) and Gross National Product (GNP) are both measures of economic
performance, but they differ in scope:

2(b) Explain different approaches to measuring the national income of an economy.

National income can be measured using three main approaches:

Product (Output) Method

Measures the total value of goods and services produced within a country.

Formula:

GDP = \sum (\text{Value of Output} - \text{Intermediate Goods})

Income Method

Measures the total income earned by individuals and businesses.

Formula:

National\ Income = Wages + Rent + Interest + Profits

Expenditure Method

Measures total spending on the economy’s output.

Formula:
GDP = C + I + G + (X - M) - *C* = Consumption - *I* = Investment - *G* = Government Spending
- *X* = Exports - *M* = Imports

2(c) What are the problems in measuring national income?

Measuring national income accurately is challenging due to several issues:

Informal Economy

Many transactions, especially in developing countries, are not recorded officially (e.g., street
vendors, home-based businesses).

Non-Market Activities

Household work, volunteer services, and black-market activities are not included in official
calculations.

Double Counting

If intermediate goods are counted along with final goods, it inflates GDP.

Price Fluctuations

Inflation affects nominal GDP, making it difficult to compare income across years.
Data Collection Issues

Inaccurate or incomplete data collection can lead to errors in national income estimates.

Exchange Rate Variations

Comparing GDP across countries can be misleading due to exchange rate fluctuations.

Conclusion: Despite these challenges, national income measurement is crucial for economic
planning, policy-making, and international comparisons.

Here are the solutions to Question 3 (a), (b), and (c):

3(a) What do you mean by the consumption function? Show the differences between short-run and
long-run consumption functions.

Consumption Function

The consumption function represents the relationship between total consumption and total income
in an economy. It shows how much households consume at different levels of income.

Mathematically, it is expressed as:

C = a + bY
C = Total consumption

a = Autonomous consumption (minimum consumption even when income is zero)

b = Marginal Propensity to Consume (MPC)

Y = Disposable income

Differences between Short-Run and Long-Run Consumption Functions

3(b) Put forward the main idea of Duesenberry’s relative income hypothesis. In this context,
explain the concept of the demonstration effect and the ratchet effect.

Duesenberry’s Relative Income Hypothesis

James Duesenberry proposed that a person’s consumption is influenced not only by their absolute
income but also by their relative income compared to others. People tend to compare their
consumption with those around them, leading to a tendency to maintain a higher standard of living
even when income falls.

Concepts in the Relative Income Hypothesis

Demonstration Effect

People imitate the consumption patterns of wealthier individuals.

It leads to increased spending even at lower income levels.

Example: If a middle-class person sees their wealthy neighbor buying a new car, they may feel
pressured to do the same.

Ratchet Effect

Consumption does not decrease proportionally when income falls.

Once people get used to a higher standard of living, they resist lowering their consumption even if
their income declines.

Example: A family used to dining at expensive restaurants continues to do so even after a financial
downturn.

Duesenberry’s theory suggests that consumption is "sticky" and adjusts slowly downward, leading
to persistent high spending levels in society.

3(c) Calculate real GDP in 2010 expressed in base year prices.

The problem provides a table of prices and quantities of goods (apples and oranges) for 2009 (base
year) and 2010. The formula to calculate real GDP using base year prices is:

\text{Real GDP} = \sum (\text{Quantity in 2010} \times \text{Price in 2009})

From the table:

\text{Real GDP (2010)} = 225 + 220 = 445

Thus, the real GDP in 2010 at base year (2009) prices is $445.

Here are the solutions to Question 4 (a), (b), and (c):

4(a) What is an investment? Graphically explain the two ideas of autonomous and induced
investment.

Definition of Investment

Investment refers to the expenditure made by firms and businesses on capital goods such as
machinery, buildings, and infrastructure to generate future production. It plays a crucial role in
economic growth by increasing productive capacity.

Types of Investment

Autonomous Investment

Investment that does not depend on income or economic conditions.

It remains constant regardless of GDP changes.

Examples: Government infrastructure projects, basic healthcare facilities.

Graphically, it is represented as a horizontal line since it does not change with income.

Induced Investment

Investment that depends on the level of income and economic growth.

It increases when GDP rises and decreases during economic downturns.

Examples: Business expansion in response to higher demand.

Graphically, it has an upward-sloping curve because investment rises with national income.

Graphical Representation:

Autonomous investment is shown as a horizontal line.

Induced investment is an upward-sloping curve, showing its positive relationship with income.

4(b) Elucidate the marginal efficiency of capital (MEC).

Definition of Marginal Efficiency of Capital (MEC)

The Marginal Efficiency of Capital (MEC) refers to the expected rate of return on an additional
unit of capital investment. It helps businesses decide whether to invest in new capital goods.
Formula for MEC:

MEC = \frac{\text{Net Expected Return from Capital}}{\text{Cost of Capital}}

Key Concepts:

Investment Decision: Firms invest in capital as long as MEC is higher than the interest rate.

Diminishing MEC: As more capital is accumulated, its efficiency decreases due to diminishing
returns.

Role in Economic Growth: Higher MEC leads to increased investment and economic expansion.

Example:

If a factory invests $1,000 in new machines and expects an annual return of $150, the MEC is:

MEC = \frac{150}{1000} \times 100 = 15\%

4(c) Define the savings function. Derive a savings function from the consumption function for a
closed economy.

Definition of Savings Function

The savings function represents the relationship between savings and income in an economy. It
shows how much households save at different levels of income.
Mathematical Form:

S=Y-C

S = Savings

Y = National income

C = Consumption

Deriving the Savings Function from the Consumption Function

The consumption function is:

C = a + bY

a = Autonomous consumption (consumption when income is zero).

b = Marginal Propensity to Consume (MPC), which represents the proportion of additional income
spent on consumption.

Since Savings (S) = Income (Y) - Consumption (C), we substitute the consumption function:

S = Y - (a + bY)

S = Y - a - bY ]
S = -a + (1 - b)Y

Interpretation:

(-a) represents autonomous dissaving, meaning savings are negative when income is zero.

(1 - b) represents the Marginal Propensity to Save (MPS), the fraction of additional income that is
saved.

Example:

If the consumption function is C = 50 + 0.8Y, the savings function would be:

S = -50 + (1 - 0.8)Y

S = -50 + 0.2Y ]

This shows that when income increases, savings increase by 20% of the additional income.

Here are the solutions to Question 5 (a), (b), and (c):

5(a) What do you understand by money? State the functions of money.

Definition of Money

Money is any asset that is widely accepted as a medium of exchange for goods and services. It
serves as a standard measure of value and a store of wealth in an economy.
Functions of Money

Medium of Exchange

Money facilitates transactions by eliminating the need for a barter system.

Example: Buying goods using cash instead of exchanging items.

Unit of Account

Money provides a common standard for measuring and comparing the value of goods and services.

Example: The price of a car is expressed in dollars rather than in terms of other goods.

Store of Value

Money retains its value over time, allowing people to save and spend later.

Example: Holding cash in a bank account for future use.

Standard of Deferred Payment

Money allows for borrowing and lending, enabling future payments.

Example: Taking a loan and repaying it with interest over time.

5(b) What are the motives of demand for money? Explain.

The demand for money refers to the desire to hold cash rather than investing in other assets.
According to Keynesian economics, there are three main motives for holding money:

Transaction Motive

People hold money for everyday purchases and business transactions.

Example: Salaried employees keep cash for monthly expenses.

Precautionary Motive

People keep extra money for unforeseen emergencies.

Example: Saving money for medical emergencies or unexpected travel.

Speculative Motive

Money is held to take advantage of investment opportunities when interest rates fluctuate.
Example: Investors may hold cash to buy stocks when prices drop.

5(c) Briefly explain the quantity theory of money.

Definition

The Quantity Theory of Money (QTM) states that the general price level of goods and services is
directly proportional to the amount of money in circulation.

Equation (Fisher’s Equation of Exchange):

MV = PY

M = Money supply

V = Velocity of money (how often money circulates)

P = Price level

Y = Real output (GDP)

Implications of QTM:
If money supply (M) increases, prices (P) rise, leading to inflation.

If money supply remains constant while output (Y) increases, prices (P) fall, leading to deflation.

Velocity (V) is assumed constant in the short run, meaning changes in money supply directly
impact prices.

Criticism of QTM:

Assumes velocity (V) is constant, which may not be true in real economies.

Ignores the role of interest rates and credit creation in influencing money demand.

Conclusion

Money plays a crucial role in facilitating trade and economic stability.

The demand for money depends on transactions, precautionary needs, and speculative
opportunities.

The quantity theory of money explains how money supply affects inflation and economic activity.

Here are the solutions to Question 6 (a), (b), and (c):

6(a) Define inflation. Distinguish between demand-pull inflation and cost-push inflation.

Definition of Inflation

Inflation is the rate at which the general price level of goods and services rises over time, reducing
the purchasing power of money. It is measured using indices like the Consumer Price Index (CPI)
and the Producer Price Index (PPI).

Types of Inflation

Demand-Pull Inflation

Occurs when the demand for goods and services exceeds supply.

Caused by factors such as increased consumer spending, government expenditure, or easy credit.

Example: If people have more money to spend, demand for products rises, causing prices to
increase.

Cost-Push Inflation

Occurs when production costs increase, leading to higher prices.

Caused by rising wages, raw material costs, or supply chain disruptions.

Example: If oil prices rise, transportation costs increase, leading to higher prices for goods.

Key Differences

6(b) What is unemployment? How does voluntary unemployment differ from involuntary
unemployment?

Definition of Unemployment

Unemployment occurs when people who are actively seeking jobs are unable to find work. It is
measured as the unemployment rate, which is the percentage of the labor force that is unemployed.

Types of Unemployment

Voluntary Unemployment

Occurs when individuals choose not to work despite job availability.

Reasons include higher wage expectations, preference for leisure, or waiting for a better
opportunity.

Example: A person rejects a job offer because they expect a higher salary elsewhere.

Involuntary Unemployment
Occurs when individuals are willing to work at prevailing wage rates but cannot find jobs.

Causes include economic downturns, automation, or company closures.

Example: A factory worker loses their job due to company downsizing.

Key Differences

6(c) Explain the different types of inflation.

There are several types of inflation based on its causes and impact:

Demand-Pull Inflation

Caused by increased demand exceeding supply.

Example: When consumer spending increases due to wage hikes.

Cost-Push Inflation

Caused by rising production costs, leading to higher prices.

Example: Increase in fuel prices raising transportation costs.

Built-In Inflation (Wage-Price Spiral)

Occurs when wages rise, leading to increased production costs, which further push prices up.

Example: Workers demand higher wages due to rising prices, causing businesses to increase prices
further.

Hyperinflation

Extremely high and out-of-control inflation, often exceeding 50% per month.

Example: Post-World War I Germany, where prices doubled every few days.

Stagflation

A situation where high inflation occurs alongside high unemployment and stagnant economic
growth.

Example: The 1970s oil crisis led to stagflation in the U.S.

Creeping Inflation
Mild inflation (1-3% annually), considered normal in a growing economy.

Example: The U.S. Federal Reserve targets 2% inflation annually.

Galloping Inflation

Rapid inflation (10% or more annually), leading to economic instability.

Example: Some Latin American countries have experienced galloping inflation.

Conclusion

Inflation reduces purchasing power and affects economic stability.

Unemployment can be voluntary (personal choice) or involuntary (lack of jobs).

Different types of inflation have distinct causes and economic effects.

Let me know if you need further clarification!

 3rd Ct

Here are the solutions to the given questions:

(a) When does the paradox of thrift arise?

The paradox of thrift arises when an increase in savings leads to a decrease in overall demand,
which in turn reduces total income and output in the economy. This paradox occurs in a situation
where people collectively save more, leading to reduced consumption. As a result, businesses earn
less revenue, causing lower production and higher unemployment, ultimately reducing total
savings instead of increasing them.

(b) Define demonstration effect and ratchet effect.

1. Demonstration Effect: This refers to the tendency of individuals to imitate the consumption
patterns of others, especially those in higher-income groups. People change their spending habits
by observing and trying to match the lifestyles of wealthier individuals, often leading to increased
consumption and reduced savings.

2. Ratchet Effect: This concept suggests that once people become accustomed to a higher level of
consumption, they find it difficult to reduce their spending even if their income declines.
Essentially, consumption levels "ratchet up" over time and do not easily decrease even during
economic downturns.
(c) Suppose C = 0.4 + 0.9Y. Derive autonomous consumption and MPC. What does the MPC
value mean?

The given consumption function is:

C = 0.4 + 0.9Y

Autonomous consumption (C₀) is the part of consumption that does not depend on income. It is
the constant term in the equation, which is 0.4.

Marginal Propensity to Consume (MPC) is the change in consumption due to a change in income.
It is the coefficient of in the equation, which is 0.9.

Meaning of MPC (0.9):

MPC represents the proportion of additional income that is spent on consumption. An MPC of 0.9
means that for every additional 1 unit of income earned, 0.9 units are spent on consumption, and
the remaining 0.1 units are saved.

Let me know if you need further explanations!

 2nd Ct

Here are the answers to your questions:

1. What are the functions of money?

Money has four primary functions in an economy:

Medium of exchange: It is used to buy and sell goods and services.

Unit of account: It provides a standard measure for valuing goods and services.

Store of value: It retains value over time, allowing people to save and use it later.

Standard of deferred payment: It is used for borrowing and lending transactions.

2. Which fiscal policy will be most effective to combat inflationary pressure?

The most effective fiscal policy to combat inflation is contractionary fiscal policy, which includes:

Reducing government spending: This decreases overall demand in the economy, helping to lower
inflation.
Increasing taxes: Higher taxes reduce consumer and business spending, slowing down demand-
pull inflation.

3. Why is the long-run Phillips curve vertical?

The long-run Phillips curve is vertical because, in the long run, there is no trade-off between
inflation and unemployment. This is based on the natural rate hypothesis, which states that:

In the short run, policies may reduce unemployment at the cost of higher inflation.

In the long run, wages and expectations adjust, bringing unemployment back to its natural rate,
regardless of inflation levels.

This means that monetary or fiscal policies cannot permanently reduce unemployment below the
natural rate, leading to a vertical long-run Phillips curve.