MACROECONOMIC

Part (8)

Marginal Leakage Rate:

1 / [MPS + (1- R)]

1 / [0.4 + 0.88]

1/1.32 = 0.76

Marginal leakage rate refers to the portion of income that is taxed or saved instead of being used on consumption. In other words, it refers to the fraction of individual income that does not go into prompted consumption since it goes to prompted saving or falls under income tax revenue.

Part (9)

Expenditure multiplier = 1/ (1 –MPC) = 1 / (MPS)

Where MPC = marginal prosperity to consume and MPS = marginal prosperity to save

Expenditure multiplier = 1/ 0.4

= 2.5

Tax multiplier = -MPC /MPS

1/ (1 –MPC) = 2.5

1 = 2.5 – 2.5 MPC

2.5 MPC = 1.5

MPC = 0.6

Tax multiplier = -0.6 / 0.4

Tax multiplier = -1.5

Section B

Part (10)

The AE model indicates the classical aggregate expenditure (AE = C + I) where C = consumption expenditure and I = aggregate investment

For this case Aggregate Expenditure == C + I + G + NX

Where C = consumption, I = investment, G = government spending and NX = net exports

= 262619 + 86227 + 113601 + 99804

= 562251

AE Y= AE

B AE

$562251M A

GDP gap

$ 490, 000 M Real GDP

The economy is at equilibrium when AE is equal to aggregate supply. When supply is more than expenditure, the quantity of output or prices reduces, which in turn, lowers the GDP. When expenditure is more, the excess demand increases output or prices. This rise pushes the curve towards a high equilibrium and high GDP. From the above graph, a rise in expenditure will increase the equilibrium from point A to B. GDP will also shift to the right. Conversely, a fall in expenditure will shift equilibrium downwards to the left, which shifts GDP to the left (GDP reduces).

Part (11)

The economy has a GDP gap because the economy is spending more than it is earning. Changes in spending =

Aggregate expenditure – GDP

562251- 490000

A decrease of 72251 million USD on spending

Part (12)

Crowding out effects occurs when increased government spending affects the entire economy. It happens when increased expenditures or reduced spending by the government can either lead to a rise or fall in income and consumption, respectively. For this economy, the government has to cut its expenditure. When the government reduces spending, there will be job loss in some sectors of the economy. Initially, this reduced spending will lead to a fall in the national income. However, due to the higher rate of unemployment, the unemployed people will spend less, resulting in demand fall in other parts of the economy.

Part (13)

The GDP gap arises as a result of more spending in the economy when production is low. The central bank can decide to use interest rates instead of monetary policy to bridge this gap. It achieves it by increasing the interest rates to make it expensive to borrow. Through open market operations, the central bank selling treasury notes to commercial banks. This activity leaves the banks with reduced money to lend. The situation forces commercial banks to raise interest rates and reduce the number of borrowers. Reduced borrowing forces consumers to cut spending.

Part (14)

Exchange Rate Market Model

Currency priced

In terms of $

Supply for $

ER 2

ER 1

Demand for $

Q $

On the X-axis is the quantity of currency (Q $) being exchanged. On the Y-axis is the currency priced in terms of the other. The curve that indicates demand for $ slopes downwards from left to right while the curve that indicates the supply of $ slopes upward from left to right. ER1 represents the equilibrium exchange rate. The government increases interest rates by selling treasury notes. This will encourage savers in foreign nations to buy assets in the country. This will increase the demand for the local currency. Consequently, it will increase exchange rates from ER1 to ER 2.

Part (15)

I

LM

I 2 B

I 1 A

IS1 IS2

Y1 Y2 Y (GDP)

The above curve demonstrates the relationship between the assets market and interests rates. The intersection of the IS (investment-saving) and the LM (liquidity preference –money supply) shows the general equilibrium. On the Y-axis is the total investment. On the X-axis is the country’s GDP. The curve shows the equilibrium level, where total savings are equal to total investments. The intersection of IS –curve and LM-curve shows the point of balance between money markets and actual GDP. Changes in the exchange rate will affect investment, shifting the equilibrium from A to B and the GDP from Y1 to Y2.