Macroeconomics Tutorial Test Essay

Question 1. (i) Identify and briefly beg off the main features of the business cycle. (2 marks) Business cycles ar usually characterized by plosive speech sounds of transition from peak to trough and thence from trough to peak. The peak of a business cycle is the high point of GDP prior to a downturn whereas a Trough is the low point economic activity prior to a recovery. The close in which the frugality is moving from a peak to a trough is called a contraction and the halt in which the economy is moving from a trough to peak is an Expansion.(ii) Explain the concepts of (a) latent getup and (b) the proceeds gap. (3 marks) Potential Output (y*) or full practice issue is the level of GDP an economy bathroom produce when using its resources, such as labour and great(p), at normal rates. This is not the same as maximum create. Potential output grows over time with growth in labour and capital and with growths in technology. At any point in time, the difference between the economys potential output and echt output is called the output gap (y y*). A positive output gap, which occurs when actual output is higher than potential output and when resources are being utilised at preceding(prenominal)-normal rates, is called an expansionary gap. This is related to firms operating above normal capacity and can lead them to raise prices (inflationary). On the other hand, a negative output gap, which occurs when potential output exceeds actual output and when resources are not being utilised, is called a contractionary gap. This is related to capital and labour not being amply utilised (cost in terms of forgone output).(iii) Explain the concept of Okuns law. Discuss the implications of Okun law for constitutionmakers. (5 marks) Okuns law states that each extra percent point of cyclical unemployment is associated with close to a 1.6 percentage point (for Australia) outgrowth in the output gap, measured in sexual congress to potential output. The quantit ative relationship is (y-y*)/y* = -B(u-u*). This describes how an additional percentage point of cyclical unemployment is associated with a B percentage point decline in the output gap. The output losses associated sustained in recessions, calculated fit to Okuns law, can be quite significant. Calculations using this relationship depict that output gaps and cyclical unemployment whitethorn have major costs. Therefore, we can conclude with the fact that the public and policymakers have concern in relation to contractions and recessions.Question 2 (i) Discuss the role played by fixed (or sticky) prices in the Keynesian influence of income determination. Briefly explain what would happen if prices were fully flexible in the short run. (2 marks) New Keynesians assume prices and advantage are fixed or sticky, meaning that they do not swap easily or right away with alterations in supply and demand, so that quantity adjustment prevails. When prices are sticky, higher aggregate demand raises production, and this raises incomes. If prices were fully flexible in the short run, economys resources would be fully employed and thitherby the economy would return to the natural level of real GDP. Firms would stop producing when price is lower than production cost, so there would be less competition.(ii) Explain the concept of Planned Aggregate spend (PAE). How does PAE differ from Actual Expenditure? (2 marks) Planned Aggregate Expenditure is the total plotted spending on final goods and services. In equilibrium, planned uptake and actual expenditure must equal in the economy. The difference between planned and actual expenditure is unplanned inventory investment. When firms sell fewer products than planned, stocks of inventories increase. Because of this, actual expenditure can be above or down the stairs planned expenditure.(iii) Use the Keynesian aggregate expenditure model and appropriate diagrams to explain the followe The paradox of thrift The effect on equi librium GDP of an exogenous increase in exports. (6 marks)Question 3 (i) Explain what is meant by the multiplier? Why, in general, does a one dollar transfigure in exogenous expenditure produce a larger change in short output? (3 marks) The income-expenditure multiplier, or the multiplier for short, is the effect of a one-unit increase in exogenous expenditure on short-run equilibrium output. For example, a multiplier of 3 means that a 6-unit decrease in exogenous expenditure reduces short-run equilibrium output by 18 units. Therefore, a one dollar change in exogenous expenditure produce a larger change in short-run output as initial amount of expenditure leads to raised consumption spending resulting in an increase in home(a) income greater than the initial amount of spending.(ii) Explain the role played by the marginal zest to signification in determining the coat of the multiplier. Other things equal, how does an increase in the marginal propensity to import tint the size of the multiplier? (3 marks) The marginal propensity to import is the change in imports divided by the change in disposable income. It decides the slope of the aggregate expenditures line and is part to the multiplier process. Similar to taxes, the marginal propensity to import tends to lower the size of the multiplier as demand for domestically produced final goods and services falls. An increase in the marginal propensity to import increases the value of the denominator of the equation, which then decreases the overall value of the fraction and thereof the size of the multiplier.(iii) Use a diagram to illustrate the concept of short-run equilibrium in the Keynesian aggregate expenditure model. Suppose the economy is initially not in equilibrium, explain the process by which the economy adjusts to equilibrium. (4 marks)Question 4 (i) What are the main instruments of monetary policy? Explain how each skill be used to close an expansionary output gap. (4 marks) Main components of Fiscal Policy brass expenditure Government spending of goods and services, investment and infrastructure directly affects total spending. If too much or too small-scale total spending causes output gaps, the establishment can help to guide the economy toward full employment by changing its own level of spending. Taxes or transfer payments In contrast, changes in tax or transfers do not affect planned spending directly. When disposable income rises households should spend more. Thus tax inflict or increase in transfers should increase planned aggregate expenditure. Similarly, an increase in taxes or a cut in transfers, by lowering households disposable income, will tend to lower planned spending. This stimulates spending and eliminates contractionary gap.(ii) Explain what is meant by the judicature budget constraint. Indicate how it provides a link between fiscal policy and public debt. (3 marks) Government budget constraint is the term given to the concept that disposal spen ding in any period had to be financial either by raising taxes or by organisation borrowing.We can denote government expenditure undertaken by the government in period t by Gt and transfer payments by Qt. Therefore, the total spending activities of the government can be noted as Gt+ Qt. Also, the government has three means at its disposal to finance this expenditure 1. Taxes available to be spent by government it time t denoted by Tt. 2. Issued security when government borrows money This is a financial asset that obliges the government to repay the loan, and pay interest, over some designated time period. Bt-2 is the stock of securities that the government still has owing at the end of the last period. Any new borrowing that the government undertakes in period t will be denoted as Bt Bt-1. The stockpile of debt that accumulates when government continues borrowing money is called the public debt. 3. Interest require to pay on governments stock of debt in any time t the governm ent pays interest of rBt-1 where r is the real rate of interest. Government expenditures (purchases, transfer payments and interest payments) in any period need to be funded by taxes or by borrowing. This is the Government budget constraint summarized as below Gt+ Qt + rBt-1 = Tt + (Bt Bt-1).If we rearrange this so that gross taxes are on the left-hand side, the link between fiscal policy and the stock of public debt becomes readily apparent Gt+ Qt Tt + rBt-1 = (Bt Bt-1).(iii) Explain the difference between discretionary fiscal policy and automatic stabilisers. Which one of these will be the main influence on the size of the structural budget deficit? Explain. (3 marks) Discretionary fiscal policy refers to deliberate changes in the level of government spending, transfer payments or in tax rates. Automatic stabilizers refer to the tendency for a system of taxes and transfers, which are related to the level of income to automatically reduce the size of GDP fluctuations.