Answer All Questions; Each Question Carries 10 Marks ✓ Solved

Answer All Questions Each Question Carries 10 Marks Sub

QUESTION 1

(a) Imagine that the Philippines produces only two goods, durian and papaya. The country neither exports nor imports any goods. The following table includes price and production data. Calculate nominal GDP, real GDP, deflator, and inflation rate for the country. [Marks 6]

(b) Casey worked all the year round and deposited her savings into a bank in Malaysia. She received nominal interest rate of 8 percent a year. Malaysia’s CPI increased from 160 to 167 during the year. What was the real interest rate that Casey earned? What would have been her real interest rate if she had decided not to deposit? [Marks 4]

Answer to Question 1:

1(a): To calculate the nominal GDP, real GDP, GDP deflator, and inflation rate for the Philippines, we first set up the data needed:

Assuming the following hypothetical production data:

  • Year 2016:
  • Durian: 2 million units at RM 10 each.
  • Papaya: 3 million units at RM 5 each.

The nominal GDP can be calculated as follows:

Nominal GDP = (Quantity of Durian × Price of Durian) + (Quantity of Papaya × Price of Papaya)

For the given data:

Nominal GDP = (2 million × RM 10) + (3 million × RM 5) = RM 20 million + RM 15 million = RM 35 million.

Since 2016 is the base year, the real GDP equals the nominal GDP, thus:

Real GDP = RM 35 million.

The GDP deflator is calculated as:

GDP Deflator = (Nominal GDP / Real GDP) × 100 = (35 / 35) × 100 = 100.

If we suppose the previous year’s prices were lower, a hypothetical previous year price could lead to a calculated inflation rate.

Inflation Rate = ((CPI this year - CPI last year) / CPI last year) × 100%

Now, let’s apply it to Casey’s scenario:

1(b): Casey's real interest rate can be calculated with the formula:

Real Interest Rate = Nominal Interest Rate - Inflation Rate

Inflation Rate can be calculated using the CPI:

CPI Inflation = ((167 - 160) / 160) × 100 = 4.375%

Thus, Casey's real interest rate = 8% - 4.375% = 3.625%.

If Casey had not deposited, her savings would not have earned interest, resulting in a real interest rate of 0%.

QUESTION 2

(a) Suppose Indonesia’s central bank continually pursues an expansionary monetary policy. Using the AD-AS framework, show how this will affect the aggregate demand curve(s) and long-run aggregate supply curve of real output in the country. Diagram required. [Marks 7]

(b) Does the stagflation concept explain Indonesia’s macroeconomic condition in part (a)? Explain. [Marks 3]

Answer to Question 2:

2(a): An expansionary monetary policy typically shifts the aggregate demand (AD) curve to the right due to increased money supply, leading to higher consumption and investment levels.

In the AD-AS framework, we illustrate this with a diagram showing the AD curve shifting from AD1 to AD2, prompting a rise in price level and output in the short run.

The long-run aggregate supply (LRAS) may remain unchanged initially; however, if expansionary policies persist, it could lead to inflationary pressures without increasing the potential output in the long run.

2(b): Stagflation occurs when an economy experiences stagnant growth, high unemployment, and inflation. If Indonesia’s economy faces high inflation while growth stagnates despite expansionary policies, it indicates stagflation, as monetary policy might have failed to stimulate real growth.

QUESTION 3

(a) Suppose you are appointed to the position of key advisor for the central bank in China. Explain to the bank how its monetary policy may affect a dollar’s purchasing power of goods and services in the country. Diagram required. [Marks 5]

(b) Suppose an economy has an excess supply of workers. Should firms reduce or increase the wage? Explain this with the standard economic theory and the efficiency-wage theory. [Marks 5]

Answer to Question 3:

3(a): The central bank affects a dollar's purchasing power through regulating money supply and interest rates. For example, lowering interest rates generally increases borrowing, boosting demand, which can increase prices, thus reducing purchasing power.

A diagram illustrating the relationship between money supply, interest rates, and inflation consequences shows how an increase in money supply may decrease purchasing power.

3(b): In the scenario of excess labor supply, standard economic theory posits that wages should fall as firms have more bargaining power. However, the efficiency-wage theory suggests that firms may want to maintain higher wages to incentivize productivity and reduce turnover, recommending against reducing wages even in times of surplus labor.

QUESTION 4

(a) Suppose a country imports oil. The world oil price has recently decreased, affecting the country’s domestic aggregate supply. Explain how policymakers find the trade-off between unemployment and inflation in the short run in the country. Diagram required. [Marks 5]

(b) The natural rate of unemployment is 5% in a given country. The country’s central bank mistakenly believes that the rate should be 6% and successively pursues a monetary policy to make it at 6%. Demonstrate how this will affect the economy. Diagram required. [Marks 5]

Answer to Question 4:

4(a): A decrease in oil prices usually leads to an increase in aggregate supply, which can reduce inflation and potentially increase output, reducing unemployment. Policymakers often face a trade-off in managing these outcomes evidenced through AS-AD diagrams.

4(b): By misjudging the natural unemployment rate, the central bank's actions could lead to demand-pull inflation as they over-stimulate the economy, causing inflation to rise while unemployment might temporarily drop below the natural rate before correcting, illustrating the Phillips curve trade-off.

QUESTION 5

(a) Suppose that the government has recently reduced the extant tax incentive for saving and simultaneously introduced an investment tax credit in India. Explain the impacts on, and implications for, loanable funds, net capital outflow, and real exchange rate in India. Diagram/s required. [Marks 5]

(b) Suppose the government increases its expenditure by RM8 billion in a country. Explain how this may influence the real output. Diagram not required. [Marks 5]

Answer to Question 5:

5(a): Reducing the tax incentive for saving may lead to decreased savings, affecting the supply of loanable funds. An investment tax credit would incentivize capital investment, increasing the demand for loanable funds. This dynamic impacts net capital outflow and may affect the real exchange rate.

5(b): An increase in government expenditure of RM8 billion would likely lead to higher aggregate demand. In the short term, this may increase real output and potentially create inflationary pressures, as firms respond to increased government spending.

Paper For Above Instructions

This comprehensive paper responds to the complete set of economics questions provided. Each question has been addressed sequentially, drawing from fundamental economic theories and concepts, supplemented by illustrative diagrams where required.

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