Download Final Exam Review Questions and Answers: Lecture W8 (Aggregate

Final Exam Review Questions and Answers:
Lecture W8
(Aggregate Demand)
1. What does reflect by Aggregate Demand (AD) curve? Explain briefly.
AD shows the inverse relationship between price levels and quantity of real GDP
demanded when other things are constant. It means
The higher the price level , the smaller is the quantity of real GDP demanded
because
a. As prices rise (increase), the buying power of your money _drops_ and the quantity of
real GDP demanded decrease.
b. As prices rise (increase), the interest rate rise and the quantity of real GDP demanded
decrease.
c. As prices rise (increase), export buyers will tend to buy less and local buyers will buy
more imports, so the quantity of real GDP demanded decrease.
The lower the price level, the greater is the quantity of real GDP demanded
because
a. As prices fall (decrease), the buying power of your money rise (increase) and the
quantity of real GDP demanded increase.
b. As prices fall (decrease), the interest rate fall and the quantity of real GDP demanded
increase.
c. As prices fall (decrease), export buyers will tend to buy more and local buyers will buy
less imports, so the quantity of real GDP demanded increase.
2. What are the factors that causes Aggregate Demand (AD) curve shifts?
There are 4 factors that changes aggregate demand (AD)
A) Expectations about the future:
Expected higher future income-larger aggregate demand and AD curve
shifts Rightward and Expected lower future income-lower aggregate demand
and AD curve shifts Leftward.
Expected higher future inflation-larger aggregate demand and AD curve
shifts Rightward and Expected lower future inflation-lower aggregate
demand and AD curve shifts Leftward.
Expected higher future profits-larger aggregate demand and AD curve shifts
Rightward and Expected lower future profits-lower aggregate demand and
AD curve shifts Leftward.
B) Government Economic Policies:
When government expenditure, investment, and consumption expenditure,
or net exports increases or taxes decrease, aggregate demand increase and
AD curve shifts rightward.
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When government expenditure, investment, and consumption expenditure,
or net exports decreases or taxes increase, aggregate demand decrease and
AD curve shifts leftward.
C) The state of the world economy:
If world economy become better, aggregate demand increase and AD shifts
to Rightward
If world economy become worse, aggregate demand decrease and AD shifts
to Leftward
D) Exchange Rate:
Due to lower exchange rate, aggregate demand increase and AD shifts to
Rightward
Due to higher exchange rate, aggregate demand decrease and AD shifts to
Leftward.
3. What is macroeconomic equilibrium?
Macroeconomic equilibrium occurs when the quantity of real GDP demanded
equals the quantity of real GDP supplied at the point of intersection of the AD
curve and the AS(SAS) curve.
4. What will happen in market equilibrium price and real GDP if new technology
discover?
If new technology discover, total products will increase and aggregate supply will
increase. AS curve will shift rightward. The market equilibrium price will decrease
and equilibrium real GDP will increase.
AS
AS1
AD
5. What will happen in market equilibrium price and real GDP if the consumers’
confidence increase?
If consumer’s confidence increase, aggregate demand will increase. AD curve will
shift rightward. The market equilibrium price will increase as well as equilibrium
real GDP will increase.
AS
AD
2
AD1
Lecture W9
(Expenditure multipliers: The
Keynesian model)
6. What is consumption function?
Consumption function is the relationship between consumption expenditure and
disposable income when other things remaining the same.
7. What is disposable income (DI)?
Disposable income is aggregate income (GDP) minus net taxes.
8. What is Marginal propensity to consume (MPC)? How to calculate it?
Marginal propensity to consume (MPC) is the fraction of a change in disposable
income that is spent on consumption.
C
MPC = --------DI
9. What are the factors that shifts consumption function curve?
If anyone of the following occurred, the consumption expenditure increases and
the consumption function curve shifts upward
• The real interest rate falls
• Wealth increases
• Expected future income increases
Consumption
If anyone of the following occurred, the consumption expenditure decreases and
the consumption function curve shifts downward
• The real interest rate rises
450
• Wealth decreases
• Expected future income decreases
C1
C
C2
Disposable Income
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10. What is equilibrium expenditure?
Equilibrium expenditure is the level of aggregate expenditure when aggregate
planned expenditure equals real GDP.
11. Fill in the gaps of the table. Find what point is the equilibrium point and how
much the equilibrium expenditure in the following table?
Points
A
B
C
D
E
F
Y (Real GDP)
0
100
150
200
220
250
C
5
10
30
40
?
60
I
10
30
40
?
40
60
Planned Expenditures
G
X
M
AE (C+I+G+X-M)
15
20
18
?
30
?
10
90
60
40
?
160
60
70
30
170
70
80
10
220
?
60
20
260
I
10
30
40
30
40
60
Planned Expenditures
G
X
M
AE (C+I+G+X-M)
15
20
18
32
30
30
10
90
60
40
10
160
60
70
30
170
70
80
10
220
100 60
20
260
Answer:
Points
A
B
C
D
E
F
Y (Real GDP)
0
100
150
200
220
250
C
5
10
30
40
40
60
The equilibrium point is E because at this point the planned aggregate
expenditures (AE) is equal to real GDP. So the equilibrium expenditure is $220.
12. What is expenditure multiplier?
The expenditure multiplier is the ratio of the change in the equilibrium
expenditure to the change in the autonomous expenditure.
 AEequilibrium
Expenditure Multiplier = ------------------------------------------------------------------------------------- autonomous expenditure (change in C or I or G or X or M)
OR = 1/MPS (MPS means marginal propensity to savings)
OR = 1/(1-MPC) (MPC means marginal propensity to consume)
(Because MPC+MPS = 1)
13. What would be the value of expenditure multiplier? And why?
The value of expenditure multiplier always be more than 1. Because an increase
in autonomous expenditure (C or I or G or NX) causes further increases in
aggregate expenditure.
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14. What are the inflationary and recessionary gaps? What policy should take to
eliminate these gaps?
a. The amount by which real GDP exceeds potential GDP is called a
inflationary gap.
To eliminate inflationary gap, government usually takes contractionary
fiscal policies such as decrease government expenditure (G), increase tax
(T), and decrease transfer payment (TP).
There is no more gap between real GDP and potential GDP at point C
where real GDP and potential GDP are equal 13 trillions.
b. The amount by which real GDP is less than potential GDP is called a
recessionary gap.
To eliminate recessionary gap, government usually takes expantinnary
(stimulus) fiscal policies such as increase government expenditure (G),
decrease tax (T), and increase transfer payment (TP).
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There is no more gap between real GDP and potential GDP at point C
where real GDP and potential GDP are equal 13 trillions.
15. If due to increased of G (government expenditure) by 0.5 trillion Riyals, AE
(equilibrium aggregate expenditures) increased by 2 trillion Riyals. What is
the expenditure multiplier?
We can calculate expenditure multiplier as folows:
Changed in equilibrium aggregate expenditures AE
Expenditure Multiplier = --------------------------------------------------------------------- = ----Change in Government expenditure
G
2
= ---------- = 4
0.5
16. If consumption expenditures increased by 50 million Riyals when MPC is
given equal 0.8, How much the real GDP will be increased?
 GDP =  C x multiplier
Here,  C = 50 millions,
Multiplier =
1
1
1
------------- = ---------- = -------------- = 5
(1-MPC)
(1 - 0.8)
0.2
So  GDP = 50 x 5 = 250 millions.
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Lecture W10
(Fiscal Policy)
17. What is fiscal policy? What are the tools of fiscal policy?
Fiscal policy is the policy that use by the government for revenue collection
(taxation) and expenditure (spending) to achieve the macroeconomic goals
namely sustained economic growth and full employment.
The tools of fiscal policy are as follows
a) Changing the government expenditure (G).
b) Changing the transfer payment (government benefits).
c) Changing the tax rate.
d) Combination of all three.
18. What is budget?
The budget is an annual statement of the revenues, outlays (expenses), and
surplus or deficit.
19. What is expansionary fiscal policy? When government can apply this
policy?
Expansionary fiscal policy is increasing government expenditures (G), increasing
transfer payment (government benefits), and decreasing tax (T) or combining all
together.
If real GDP is below potential GDP that means when there is recessionary gap
exist in the economy then the government might practice the expansionary fiscal
policy.
20. What is contractionary fiscal policy? When government can apply this
policy?
Contractionary fiscal policy is decreasing government expenditures (G),
decreasing transfer payment (government benefits), and increasing tax (T) or
combining all together.
If real GDP is above potential GDP that means when there is inflationary gap
exist in the economy then the government might practice the contractionary fiscal
policy.
21. What is government expenditure multiplier, tax multiplier and transfer
payment multiplier?
Government expenditure multiplier shows the effect of a change in government
expenditure (G)
on aggregate demand (AD). The value of government
expenditure multiplier is always positive and more than 1.
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Tax multiplier shows the effect of a change in taxes (T) on aggregate demand
(AD). The value of tax multiplier is always negative and smaller than government
expenditure multiplier.
Transfer payment multiplier shows the effect of a change in transfer payment
(TP) on aggregate demand (AD). The value of transfer payment multiplier is
always positive and smaller than government expenditure multiplier.
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