Assignment

Q1. Discuss clearly macroeconomic equilibrium condition by using an appropriate graph and
both aggregate demand and aggregate supply equation?

ANSWER Q1

In economics, equilibrium is a state where economic forces (supply and demand) are balanced.
Without any external influences, price and quantity will remain at the equilibrium value.

Equilibrium: Similar to microeconomic equilibrium, the macroeconomic equilibrium is the point

at which the aggregate supply intersects the aggregate demand.

Q2. List and discuss three means of measuring the annual values of total output in a given
economy?

ANSWER Q2

GDP = consumption ( C ) + private investment ( I ) + government purchases ( G ) + net exports

( X n ), or GDP = C + I + G + X n

 Personal consumption is a flow variable that measures the value of goods and services
purchased by households during a time period. Purchases by households of groceries,
health-care services, clothing, and automobiles—all are counted as consumption.
 Gross private domestic investment is the value of all goods produced during a period for
use in the production of other goods and services. Like personal consumption, gross
private domestic investment is a flow variable.
 Government purchases are the sum of purchases of goods and services from firms by
government agencies plus the total value of output produced by government agencies
themselves during a time period.
 Net Exports: -Sales of a country’s goods and services to buyers in the rest of the world
during a particular time period represent its exports.
Exports (X) − imports (M) = net exports ( X n)

GNP = GDP + net income received from abroad by residents of a nation

Q3.

Expenditure categories Million in Birr

1 Personal Consumption 4500

Expenditure(C)

2 Gross private domestic 850

investment (I)

3 Gov. purchasing of goods and 1250

services (G)

4 Export(X) 750

5 Import(M) 1000

6 Net Factor Income received from 950

abroad (NFIRA)

7 Net Factor Income paid from 1050

abroad (NFIPA)

8 Indirect Business tax (IBT) 450

9 Depreciation(D) 525

Based on Above Information calculate

A, Gross Domestic Product
B, Gross National product
C, Net National Income
D, National Income
E, Trade Balance

ANSWER Q3

a. Gross domestic product

GDP = C+I+G+(X-M)
= 4500+850+1250+(750-1000)
= 4500+850+1250+(-250)
= 6350
b. GNP = GDP + NFIRA - NFIPA
= 6350 + 950 – 1050
= 6350 - 100
= 6250
 c. Net National Income
= GNI – Depreciation
= 7300 – 525
= 6775
C+I+G+(X-M)+NFFI - IT - D
4500 + 850 + 1250 + (750-1000) + 950 - (1050) - 450 – 525
6350 +100 - 450 – 525
6450
d. National Income

NI = C + I + GE + (X– M) + FPNR – DPBNR

= 4500+850+1250+(750-1000) + 950 – 1050
= 6250
e. Trade Balance
TB = Export (X)- Import (M)
= 750- 1000
= -250

Q4. A farmer grows a bushel of wheat and sell it to a miller for $1.00. The miller turns the
wheat into flour and then sells the flour to a baker for $3.00. The baker uses the flour to
make bread and sells the bread to an engineer for$6.00. The engineer eats the bread. What
is the value added by each person? What is GDP?

ANSWER Q4

The farmer: 1- 0 = 1

The miller: 3-1 = 2

The baker: 6 - 3 = 3

GDP = final product cost = 6 or GDP = amount of value added = 1 + 2 + 3 = 6

Q5. Based on Keynes consumption function C= a+bY an income rises average propensity to
consume (APC) raises. Answer true/False and explain briefly way true or false?

ANSWER Q5

False: -According to him, as the income increases, consumption increases but not in the same
proportion. The proportion of consumption to income is called average propensity to consume
(APC). Thus, Keynes argues that average propensity to consume (APC) falls as income
increases.

The Keynes’ consumption function can be expressed in

 the following form C = a + bYd, is the real disposable income which equals gross national
income minus taxes, a and b are constants, where a is the intercept term, that is, the amount of
consumption expenditure at zero level of income.

Thus, a is autonomous consumption. The parameter b is the marginal propensity to consume

(MPC) which measures the increase in consumption spending in response to per unit increase in
disposable income.

Thus, MPC = ΔC/ΔY Since the average propensity to consume falls as income increases, the
marginal propensity to consume (MPC) is less than the average propensity to consume (APC).

Q6. Suppose that, the gross national product of Ethiopia was 627,064.7 million birrs in 2015
and 691,025.4 million birr in 2016. Calculate annual growth rate of the economy?

ANSWER Q6

Growth rate = present – past / past*100

= 691,025.4 million birrs - 627,064.7 million birrs/ 627,064.7 million birrs*100

= 10.2% =

Q7. Assume the economy is closed and describe by the following equation

C=800+0.8yd
I= 500
G= 600
T= 800, where Yd disposable income, I gross investment and T net tax
A, Compute the equilibrium value of income
B, determine the value of the multiplier

ANSWER Q7

a, Compute the equilibrium value of income

Y = C0+ C1(Y-T) + G + I
= 800 + 0.8yd + 0.8(Y- 800) + 600 + 500

0.8Y = 800 + 600 + 500 – 640

0.8Y= 1260

Y = 1575

b. Determine the value of the multiplier

YD = Y – T

= 1575 – 800
 = 775

== C = 800 +0.8yd = 800+ 0.8(775) = 1420

Q8. List and discuss the three major reasons(motives) why peoples demand to hold money?

ANSWER Q8

1. Transaction Motive:- It refers to demand for money for conducting day-to-day

transactions. This motive can be looked at from the perspective of consumers, who want
income to meet their household expenditure (income motive) and from the perspective of
businessmen, who require money to carry on their business activities (business motive).
According to Keynes, transaction demand for money is positively associated with the
level of income, i.e. higher the level of income, larger would be the size of money
holdings for transactions.
2. Precautionary Motive:- It refers to the desire of people to hold cash balances for
unforeseen contingencies. People wish to hold some money to provide for the risk of
unforeseen events like sickness, accident, etc. The amount of money held under this
motive, depends on the nature of individual and on the conditions in which he lives. The
demand of money for precautionary balances is also closely related to the level of
income. Higher the level of income, more will be the cash balances for contingencies.
3. Speculative Motive: - It refers to desire of the holder to keep cash balance as an
alternative to financial assets like bonds. Under speculative motive, it is presumed that
people can hold their wealth either in the form of bonds or in the form of cash balances.
The decisions regarding holding of bonds or cash balances depend upon the expectations
about changes in the rate of interest or capital value of assets (bonds) in future.

Q9. Briefly explain the difference between IS and LM curve

ANSWER Q9

The LM curve represents the combinations of the interest rate and income such that money
supply and money demand are equal. The demand for money comes from households, firms, and
governments that use money as a means of exchange and a store of value.

The IS curve relates the level of real GDP and the real interest rate. It incorporates both the
dependence of spending on the real interest rate and the fact that, in the short run, real GDP
equals spending.

A shift in the IS curve along a relatively flat LM curve can increase output substantially with
little change in the interest rate.

The IS curve. This investment schedule shows what planned spending would be at various rates
of interest.
 The LM curve, or the money market equilibrium schedule (in contrast with the goods market in
IS). The LM curve shows the combinations of interest rates and output levels so that money
demand equals money supply.

Q10. List the four factors that determine money supply?

ANSWER Q10

1. The Required Reserve Ratio: The required reserve ratio (or the minimum cash reserve ratio
or the reserve deposit ratio) is an important determinant of the money supply. An increase in
the required reserve ratio reduces the supply of money with commercial banks and a decrease
in required reserve ratio increases the money supply.
2. The Level of Bank Reserves: The level of bank reserves is another determinant of the money
supply. Commercial bank reserves consist of reserves on deposits with the central bank and
currency in their tills or vaults. It is the central bank of the country that influences the reserves
of commercial banks in order to determine the supply of money.
3. Public’s Desire to Hold Currency and Deposits: People’s desire to hold currency (or cash)
relative to deposit in commercial banks also determines the money supply. If people are in the
habit of keeping less in cash and more in deposits with the commercial banks, the money
supply will be large
4. High Powered Money and the Money Multiplier: The current practice is to explain the
determinants of the money supply in terms of the monetary base or high-powered money.
High-powered money is the sum of commercial bank reserves and currency (notes and coins)
held by the public.

1. High-Powered Money (H): reserve money

2. Money Multiplier: Money multiplier is the degree to which money supply is expanded
as a result of the increase in high-powered money, Thus m = M/H
3.