Question

d) Explain the effect of an expansionary monetary policy on real physical output, employment and inflation given that economy in Zambia is operating at potential output level. [6 Marks]

e) Use the aggregate demand and the 45-degree line to represent equilibrium in the goods market. Make sure to include intercept, and slope in your graph. Further assume that interest rates decrease, show the effect of decreased interest rates on equilibrium income. Explain the stage economy goes through in moving from one equilibrium to point to another. [10 marks

] f) Explain what determines consumption spending in Zambia. [6 marks] [Total 40 Marks

Answer 1

1. With the expansionary monetary policy, interest rate in the economy decrease, leading to an increase in the investment level, hence increasing the output and the price level. The increase in money supply is equal to the increase in the price level, hence causing no change in the real variables like output, employment, etc. This is known as NEUTRALITY OF MONEY. The phenomenon of causing no change in real variable is known as CLASSICAL DICHOTOMY.

Here Y shows the equilibrium level in the goods market. As the interest rate decrease, investment increases, leading to an upward shift in the AD=C+I+G+NX curve, as a result equilibrium level of Y increases.

3. Consumption spending is determined by the level of the disposable income, personal income left after paying taxes and miscellaneous from private income. It also depends on the purchasing power which is indirectly influenced by the level of money and prices in the economy.