Last updated: February 28, 2019
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Macro economics Problem Sets

1.Prof Mitchell defines business cycle as a type of fluctuation found on aggregate economic activity of nations that organize their work mainly in business  enterprises .There are 4 phases of a typical business cycle via: expansion otherwise called prosperity or upswing  2.recession3.depression or contraction 4.revival or recovery.

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Expansion is when the demand, output, employment and income are at high level this tends to raise price. The increase in profit and prospect of its continuance, make the stock market value to rise. The economy is engulfed with optimism and profit expectation

Recession is the stage at which the forces that make for contraction finally wins over the forces of expansion .there is decline in price, investment and demand

Depression marks the situation where there is general decline in economic activity. There is reduction in the production of goods and services, employment, income and price

Revival sets in when depression has lasted for some times. The origin of this force may be internal or external. There is an increase in demand and these lead to gradual increase in investment, employment and output

2a.CPI {2005} =134.5———Y

CPI {2006} =140.5———-X

Rate of inflation=X-Y/Y*100


134.5 =0.0447*100=4.45%

2ba Cost of CPI basket in the base period= [quantity *price] olive+ {quantity *price} grape

= {10*8} + {5*10} =80+50=$130

b. % of average household budget=80*100/130


c. since 2005 is both the market basket and the base year. Then CPI in 2006=10*8+5*12=80+60


CPI 2005=100

CPI [2006] =140-100 *100



3a.mackenzie pipeline is purely investment goods because it is used in manufacturing industry to produce products. It cannot be consumed

b. A loaf of bread is consumption goods because its primary purpose is to serve as food material and it cannot be invested and since it not the whole bread

c. A taxi –cab is also an investment goods because it is used to meet the basic need of people i.e. transportation, and it yields profits

d. Tennis racquet is also an investment goods because it bring forth returns when employed in playing tennis game

4a.canada’s opportunity cost of producing 200 tones of wheat =90 tones of copper ingots, so if  to produce 200  tones of wheat Canada had to forfeit 90 tones of ingots then to produce a tonne of cupper Canada will forfeit

90/200=0.45 tonne of copper ingots

b. Chile’s opportunity cost of producing a tones of copper ingot=120/175=0.65tonne of wheat

c. calculating the Canada’s opportunity cost for producing a tonne of copper ingots=200/90=2.22 tonnes of  wheat

Chile has the comparative advantage over Canada in the production of copper ingot because it is cheaper to produce since the opportunity cost of producing it in Canada is 2.22 compare to Chile’s 0.65.

5a.since beef has been implicated, as one the prime source for heart disease ,people will be mindful of their health and this will reduce the demand for beef, reducing the supply this cause decrease in the equilibrium quantity but the equilibrium price remain the same

b. in this situation the demand for the old beef decrease but increase the supply of the processed beef

c. when consumers income increase it increase both the demand and the supply because people will have enough  money to buy it. This resulting in increase in equilibrium quantity but equilibrium price remain the same

d. when China an Japan start buying more beef, scarcity will ensue resulting in increase in demand but decrease in supply. The equilibrium quantity remain constant while the equilibrium price increases

e. when the available land is been used up, there will be decrease in supply of beef because there will be no place to rear the cattle but the demand will be constant .resulting in increase in equilibrium price but decrease in equilibrium quantity.

6. GDP using expenditure approach we add up the consumption expenditure, government expenditure, gross investment and net exports.


b.GDP using income approach we add up the interest and investment  income, profit of corporations and government enterprises, income from farm, wages, salary, and supplementary labour income, indirect taxes less subsidies and capital consumption allowance


C.Net domestic product at factor cost

NNP at market price =GDP-depreciation

=668-60           =$608

NNP at factor cost =608-75=$533 billion

7. Real GDP=nominal GDP/price index

Nominal GDP base year=real GDP base year=$577billion.P.I difference =104.5-100=4.5

Nominal GDP difference=577-559=$18billion

so real GDP in year 1=559+18/4.5  =559+4


GDP in year 2; using the same steps, nominal GDP difference=605-577=$28billion

Price index difference =108.3-100=8.3

Real GDP =563+28/8.3=$566.37billion

8. Real wage=nominal wage/price index

Nominal wages difference=19.50-18.00=$1.5per hour

GDP deflator in the base year is 100

Deflator difference=103.6-100=3.6

Then real wage {2004} =18+1.5/3.6=18+0.42=$18.42 per hour

b. real wage{2005} =18.42+1.5/6.7=18.42+0.22

=$18.64 per hour

c. Between year 2003 and 2005,the nominal wage  increases, the real wage also increase due to increase in GDP deflator

9. There are 4 sources of CPI bias namely: a. substitution bias .b new good bias. c. quality bias. d. outlet substitution bias. these are divided into two main groups viz;1st order bias { new good bias, quality bias and outlet substitution bias}.2nd order  bias{substitution bias}.outlet substitution bias describe a situation where by  a product purchase somewhere at high price is been sold at a lower price in a new outlet, and the BLS link the new lower price to the old higher price, so that no price change occur while substitution  bias is a bias resulting from the fixed weight price index assigning to much importance to high and rising price and less emphasis on declining prices of people unemployed in July 2004

=27.13-18.32 =8.81million

b. unemployment rate.=unemployed/labour force



c. labour force participation=labour force /working age  =19.65/27.13







E=Effective Demand






12{1}.the 4 basic tools of monetary policy are a]bank rate policy; when the central bank noticed that inflation have started in the economy, it raises the bank rate so that the commercial bank borrow less from the central bank, this in turn raises their lending rate  to business community. Also when price are low central bank lowers the bank rate, so that commercial banks can borrow.

[b]open market operation; this refers to the central bank buying and selling of securities in the money market. When prices are high the central banks sell off securities thereby decreasing reserve of the commercial banks.

[c].change in reserve ratios; every bank is expected to keep a certain percentage of its total deposits as reserve fund, when price are high, the central bank raises the reserve rate

[d].selective credit controls; is a measure used by the central bank on a particular sector when prices start to increase. It raises the margin for the requirement of credit, this result in less money as loan against specified securities

2].money supply M={b+1/b+x}*H

Where b=currency drain=desired reserve ratio and H=total cash in the economy

to calculate H=C+R where C=cash held by the public=0.35*50,000,000=$17,500,000 and R=reserve=0.07*50,000,000=3,500,000

so H=17500000+3500000=$21,000,000


=1.35/0.42*21000000 =$67,500,000

change in quantity of money=$67,500,000-$50,000,000


13a.concept of multiplier

Multiplier has been described by many author Keynes describe investment multiplier, Kahn describe is own in form of employment multiplier. The multiplier concept explain the effect of change in investment on income via its consumption expenditure Increase in investment leads to increased production which create more income and consumption expenditure  .when the marginal propensity to consume is high ,value of multiplier will also  be high according to this equation

k=1/1-c{M.L.Jhingan}               where c is the marginal propensity

to consume{MPC}

b. Marginal tax lowers the disposable income of the tax payer which reduces their consumption expenditure, this in turn lower the size of the multiplier

c. MPC =0.75

k=1/1-c       k=1/1-0.75=4

I.e. the slope of the AE curve is 4

If new MPC = 0.75-0.3=0.4.

Then new slope k=1/1-c=1/1-0.45=1.82

14a.This economy type is developing economy because the government has reduces income to it‘s people, thereby reducing the factor that causes inflation. Investment, consumers spending and employment are all reduced to check inflation

b. The fiscal policy automatically in operation is the built –in stabilizer in which change in budget are automatic, these are operate profit tax excise tax unemployment insurance and unemployment relief. The appropriate discretionary fiscal policy is that the government to increase its expenditure on goods and services keeping taxes constant

c. appropriate monetary policy is the expansionary monetary policy that will ease credit market condition and lead to increased in aggregate demand

15.the monetarists view about   is that monetary policy has a greater influence on the economy than the fiscal policy and that fiscal is only use unchanging supply of money, and that by following and sticking to a sound monetary policy, people’s expectations of inflation are reduced thus creating a stable environment for investment and growth while the Keynesians believe the both fiscal and monetary policy affect the economic but lay more emphasis on  expositional fiscal policy and uses deflationary fiscal policy with monetary policy to control boom and inflation

16 opportunity cost for 500 tons of fish by the Kiribati=the alternate forgone=1000tons of breadfruit.

So, opportunity cost for producing 1 unit of fish by Kiribati


b. opportunity cost for producing 1855 tons of fish by the Tuvalu=750 tons of breadfruit

Then the opportunity cost for I unit of fish in Tuvalu


c. Tuvalu has the highest comparative advantage to produce fish because the opportunity cost of producing 1 unit of fish is low

d. Kiribati will import fish from Tuvalu, since Tuvalu can produce more fish and has a comparative advantage over the Kiribati8

17.Government  made  trade restriction in form of taxes, import duties, tariffs etc these are increased so that people will have no choice than to buy their indigenous goods to make their currency valuable this will have a long term effect on the economy of such country.

Risk of specialization: countries might not want to take the risk of producing only a few products, of this risk is the technological advances which may render its major product obsolete. but the government can always do something by encouraging diversified economy

To create a strategic trade advantage: it has been argued that one of the reasons for trade restrictions is for the country to create a strategic advantage in producing or marketing some of its new product expected to yield profit’s if protection of domestic market can result in that one of the protected firm will be able to compete in the international market, then the protection may pay off.

Trade restriction is also practice to protect the labour and infant industries from undue competition from foreign manufacturer. It is also important in the social well being of the populace and this also create more employment for the citizen

18a.The Canadian exporters to US will run at loss because they will sell their good for a low amount of money when converted to their own currency

b. The Canadian firm will buy their machinery at a reduced price from US when converted to their own money

c. The cross boarder shoppers from Canada will also spend less on shopping

d. Retired Canadian will live large in us because the small money they take to US will be converted to a very big amount of money

19a .current account

Export of goods and services                 +411
Import of goods and services               -378
Net transfer            +3
Net interest payment  -34
Balance of current account=411+3+{-378-34}=+2

B .capital account



Foreign investment in Canada
Canadian investment abroad
Balance of capital account

C. official settlement account balance

=balance of payment of both current and savings+ statistical discrepancy

=2+ {-13} +10



M.L.Jhingan: Macroeconomic theory {11th revised edition 2004}

Lipsey and Chrystal: Principles of economics.9th edition {1999}

Briefing CIP Food and expenditure, CPI bias

Econ 304 Sonoma State University by Dr. Robert Eyler;