Question

Question 1: An economy with no government or foreign sector is represented below.

C = 800 +0 .5Y I = 200
Calculate the following:
(a) Equilibrium Gross domestic product (Y)
(b) Personal consumption expenditures
(c) Change in investment required to achieve increase in equilibrium GDP by 400.
Question 2: Describe the difference between structural and frictional unemployment. Which is
more serious, and why? Illustrate with goods examples
Question 3: Explain the factors that lead to shift in aggregate demand?
Question 4: What are the main causes of inflation in poor countries? (2

Answer 1

Ans1(a) In equilibrium, Y = C + I

Y= Gross domestic product

C= Consumption expenditure

I= Investment

putting values in the equation:

Y= 800 + 0.5 Y + 200

Y - 0.5Y = 1000

0. 5Y= 1000

Y = 1000/0.5

Y = 2000

Hence, at equilibrium GDP is 2000.

Ans1(b) Personal Consumption expenditure= 800 + 0.5Y

putting the value of Y in consumption expenditure:

= 800 + 0.5 *2000

=800 + 1000

= 1800

hence, personal consumption expenditure is 1800.

Ans1(c) To achieve increase in GDP by 400 , the investment must increase by 200.

So, now the new investment is 400.

Y = C+ I

Y = 800 + 0.5 Y + 400

Y - 0.5 Y = 1200

0. 5 Y = 1200

Y = 1200/0.5 = 2400

So now the increased GDP is 2400, which was earlier 2000. Hence, to increase the GDP by 400 we must increase the investment by 200.

Ans2-: Structural unemployment is an unemployment where a large number of persons do not get work because of limited job opportunities available. It arises from the shortage of capital equipments and other complementary resources.

Frictional unemployment occurs when there is a lack of adjustment between demand for and supply of labor force. People leave jobs for many reasons and it takes time to find new job because of lack of knowledge.

Structural unemployment is more serious than frictional unemployment because frictional unemployment occurs for a temporary period of time, whereas structural unemployment is not a temporary phenomena.

Frictional unemployment may take place because of change in demand.Here, people change their jobs due to economic progress when old industries contract and new industries come up. It can be reduced by improving the organization of the employment market. Whereas structural unemployment is deep rooted and chronic in nature. Capacity to create new jobs is limited because of lack of capital equipments.

Hence, structural unemployment is more serious problem than frictional unemployment.

Ans3-: Formula for Aggregate Demand:

AD = C + I + G + ( X - M)

C = cosmuer spending

I = investment spending

G = government spending

X = eports

M = imports

Factors that led to shift in aggregate demand are:-

1. Consumer spending -

An increase in consumer spending shifts the AD curve towards right and decrease in it shifts it towards left. Consumers may spend less because the cost of living is rising or the government may have increase the taxes whereas consumers may spend more when their is reduction in taxes by the government.

2. Government spending -

An expansionary monetary and fiscal policy shifts the AD curve towards right whereas contraction in monetary and fiscal policy shifts AD curve towards left.

Ans4:- Main causes of inflation in poor countries are:-

1. Increase in public expenditure-

Governments of poor countries are providing more facilities under public utilities and social services with the aim to provide welfare to it's people. So, this increase in government expenditure by the poor countries, increases the demand for goods and services and thereby results in increase in inflation.

2. Increase in consumer spending:-

The demand for goods and services increases when consumer expenditure increases. Poor countries provide cheap credit facilities in order to serve it's people, which resulted in increase in consumer expenditure and thereby causes inflation.

3. Increase in disposable income:-

When the disposable income of the people increases, it increases their demand for goods and services. Disposable income may increase because of reduction of taxes or reduction of savings.

4.Deficit financing:-

The government of poor countries resorts to deficit financing by borrowing from the public to meet their expenses. This raises the aggregate demand in relation to aggregate supply, thereby leading to inflationary rise in prices.