econimcs asignment 2. final

8/4/2019 Econimcs Asignment 2. Final

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Section A

1. F

2. F

3. T

4. T

5.

6.

7.

8. F

9. T

10. T


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Section B

Question 1

2005

Nominal GDP: Real GDP:Production x Price Production x Price100x2 100x 2200 200

2004Nominal GDP: Real GDP:Production x Price 600x 2100x3 3600 400

GDP Deflator 2003 GDP deflator 2004

Nominal GDP X 100 600x100Real GDP 400

200x100 = 150

200

= 100

Question 2

New classical macroeconomics, sometimes simply called new classical economics, is a school ofthought in macroeconomics that builds its analysis entirely on neoclassical framework. Specifically, it

emphasizes the importance of rigorous foundations, in which the macroeconomic model is built inanalogy to the actions of individual agents, whose behavior is modeled by microeconomics.

The hypothesis of rational expectations addresses this criticism by assuming that individuals take all

available information into account in forming expectations. Though expectations may turn out incorrect,

the deviations will not deviate systematically from the expected values.

Criticisms

The hypothesis is often criticized as an unrealistic model of how expectations are formed. First, truly

rational expectations would take into account the fact that information about the future is costly. The

"optimal forecast" may be the best not because it is accurate but because it is too expensive to attain

even close to accuracy.

Assumptions made by the New Classical School of Thought

Assumptions of Economic Agent are maximizers: Some of the information is accessible only to the

government and can affect their decision thus the need to be government intervention to make them

make optimal decisions.


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Assumptions of Expectations are rational: Only few people can understand some of the government

policies and expectations would not be rational even if they have information available. This assumption

is not realistic so there in need for government intervention.

Assumption for Market clear: Not realistic as there has to be government intervention to regulate on

wages and prices for both parties consumers and producers to be secure.

Section C

Question 1

Defining economic growth

Economic growth is best defined as a long-term expansion of the productive potential of theeconomy. Sustained economic growth should lead higher real living standards and rising employment.

Short term growth is measured by the annual percentage in real GDP.

Advantages of Economic Growth

Sustained economic growth is a major objective of government policy not least because of the benefitsthat flow from a growing economy.

Higher Living Standards for example measured by an increase in real national income perhead of population see the evidence shown in the chart below

Employment effects: Growth stimulates higher employment. The Botswana economy has beengrowing since 1999 and we have seen a large fall in unemployment and a rise in the number of

people employed.

Fiscal Dividend: Growth has a positive effect on government finances - boosting tax revenuesand providing the government with extra money to finance spending projects.

The Investment Accelerator Effect: Rising demand and output encourages investment in newcapital machinery this helps to sustain the growth in the economy by increasing long runaggregate supply.

Growth and Business Confidence: Economic growth normally has a positive impact oncompany profits & business confidence good news for the stock market and also for the growthof small and large businesses alike

Disadvantages of economic growth

There are some economic costs of a fast-growing economy. The two main concerns are firstly thatgrowth can lead to a pickup in inflation and secondly, that growth can have damaging effects on ourenvironment, with potentially long-lasting consequences for future generations.

Inflation risk: If the economy grows too quickly there is the danger of inflation as demand racesahead of aggregate supply. Producer then take advantage of this by raising prices for consumers


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Environmental concerns: Growth cannot be separated from its environmental impact. Fastgrowth of production and consumption can create negative externalities (for example, increasednoise and lower air quality arising from air pollution and road congestion, increased consumptionof de-merit goods, the rapid growth of household and industrial waste and the pollution thatcomes from increased output in the energy sector) These externalities reduce social welfare andcan lead to market failure. Growth that leads to environmental damage can have a negative effect

on peoples quality of life and may also impede a countrys sustainable rate of growth. Examplesinclude the destruction of rain forests, the over-exploitation of fish stocks and loss of naturalhabitat created through the construction of new roads, hotels, retail malls and industrial estates.

Economic Development: Economic development is the increase in the standard of living in a nation's

population with sustained growth from a simple, low-income economy to a modern, high-income

economy. Also, if the local quality of life could be improved, economic development would be enhanced.

Its scope includes the process and policies by which a nation improves the economic, political, and social

well-being of its people.

Factors influencing the economic development of a country

Population Growth: Large populations intend to act as a source of labour and also a market for

products of industries. Dependency theorists argue that poor countries have sometimes experienced

economic growth with little or no economic development; for instance, in cases where they have

functioned mainly as resource-providers to wealthy industrialized countries.

Natural resources: The natural resources are the principal factor which affects the development of an

economy. If a country is rich in natural resources, it is then able to make rapid progress in growth. In case

a country is deficient in forest wealth, mineral resources, water supply, fertility of land etc., it is then

normally not in a position to develop rapidly.

Capital Formation. Capital accumulation or capital formation is an important factor in the economicgrowth of a country. Capital formation refers to the process of adding to the stock of capital over time.The stock of capital can be built up and increased through three different resources which are as under:-

Sources of capital formation:

(a) An act of saving.

(b) Capital market.

(c) An act of investment.

(a) An act of saving. An act saving involves the postponing of consumption whether voluntarily orinvoluntarily so that funds thus made available be used for investment. In developing countries thesaving potential is low. A large majority of the people hardly keep their body and soul together withthe meager income at their disposal. Saving is a luxury and far beyond their reach.


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(b) Capital market. The capital market consists of financial institutions, like development banks, stockexchanges and investment banks. In low income countries, the capital market is less developed. Assuch it is not able to mobilize saving to the desired extent.

(c) An act of investment. In less developed countries, whatever meager saving are available withhouseholds and with the businessmen, is not all channelized for investment in capital goods. The

businessmen usually hesitate to invest their resources due to political and social instability in the country,fear of nationalization of industries, limited domestic market, poor roads, etc.


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Question 2

a) Consumption function

The consumption function never starts at zero, because we all have to spend some money to

survive even when we have no income. In this example the consumption function starts at

P5.40 and slopes upward, showing that the increase in amount of money we spend us we earnmore. The 45 line allows us to set points where expenditure equals income. In this case at

point X. to the right of X, we are spending less than we are earning, so we are saving.

The increase in price of fuel from P5.40 to P6.18 will lead to consumers using less fuel, thus

save the income they have, the price above P6.18 will mean consumers will save (the shaded

area).

b) AD-AS Model

Vertical axis price

Horizontal axis Level of income or GDP of the country

e- macroeconomics equilibrium

AS- positively economic sloping showing a positive relationship between price and GDP

AD- Negatively slope showing a negative relationship between price and GDP


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The AD-AS model shows the relationship between the incomes of the economy general price level

The decrease in demand will cause AD to shift to AD1 and this will cause income to decrease from Y2 to

Y1.

The increase in general prices from P5.40 to P6.08 causes a drop in the level of demand which lead to

the AD curve shifting to the left causing income to change from Liter to a new point of equilibrium liter.


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The expenditure income model shows the relationship between income and total expenditure of the

economy. The level of income Y1 is the same for the expenditure income model for the AD-AS

model illustrated above. Suppose the level of spending is A*(such as government expenditure orinvestment) decreasing, the AE curve will decrease to AE, as shown in the diagram below. This

will cause the Income to decrease from Y1 to Y0 changing the equilibrium from point Litreto

Litre1


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Question 3

The shortcoming of GDP calculations

GDP has several shortcomings when measuring the economy's performance. It does not take into

account nonmarket transactions. The labor of a homeowner repairing his own house is not

included in GDP, so GDP understates the total output.

Also, GDP fails to account for improved product quality. Personal computers have seen drastic

improvements in speed and storage capabilities since the 1990's, but their improvements are not

counted in GDP.

Black market economy- GDP covers only transactions in the official economy. But a significant

sector of economic activity goes unreported

The underground economy is, for obvious reasons, not included in GDP calculations. Gamblers,

smugglers, and drug dealers comprise a substantial amount of a nation's economic activity, buttheir "work" is disregarded.

The GDP per capita indicator emphasizes average income and neglects (changes in) the incomedistribution, even though an uneven distribution implies unequal opportunities for personaldevelopment and well-being. Furthermore, individuals or families with low incomes benefitrelatively much from an income rise, because of the diminishing marginal utility of income.GDP per capita does not capture these features. Related to distribution is the notion of relativeincome and context dependent preferences. This is characterized by comparing oneself withothers resulting in rivalry through the purchase of positional or status goods. As the GDPcompletely omits the relative income aspect of welfare, it tends to overestimate social welfare orprogress. Although an increase in relative income can improve the welfare of an individual, social

welfare is not being served by it. The reason is that status is a very scarce good, causing rises inrelative income and welfare to resemble a zero-sum game: what one individual gains, others lose


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Bibliography

1. Tony Buxton, Paul Chapman and Paul Temple, Britains Economic Performance, 2nd edition, 2001

2. David Begg, Economics, 7th edition, 2004

3. Oxford Dictionary of Economics by John Black

4. www.undp.ord/hdr2003/faq.html21- Human Development

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