North South University, Department of Economics, ECO104

Spring 2021 FINAL EXAMINATION , Marks: 40 , Submission due: 17th September, 9PM

Please follow the guidelines at the end very carefully. Total Marks: 40

Faculty: Humaira Husain

Name:____Naeem Ahmed _____ ID:____2011913630 _____ Sec:_____15 ___

Answer all following questions: Identify the correct answer (by highlighting with yellow color)
(1 times 10 = 10 Marks)

Q1. In the Keynesian model of national income, In case of G m(by highlighting with yellow
color) ultiplier if △G = 3.55 Million BDT , MPC = 0.75

△Y =

a) 12 Million BDT
b) 10 Million BDT
c) 14.2 Million BDT
d) 2 Million BDT

Q2. In the Keynesian model of national income, The smaller the value of MPC

a) The smaller the value of G multiplier c) The larger the value of G multiplier
b) The value of G multiplier is unaffected d) Value of G multiplier may increase or
decrease

Q3. In the Keynesian model of national income, the sign of ‘tax’ multiplier is negative because

a) Increase in equilibrium income is related to decrease in tax collection

b) Increase in equilibrium income is related to increase in tax collection
c) Increase in equilibrium income is not related to reduction in tax collection
d) Increase in equilibrium income is associated with increase in government purchase

Q4. In self-regulating economy if the current output is greater than natural level of output

a) Current unemployment rate = natural unemployment rate

b) Current unemployment rate > natural unemployment rate
c) Current unemployment rate < natural unemployment rate
d) Current unemployment rate may greater than natural unemployment rate

Q5. In Keynesian model of national income If MPC value falls the planned expenditure line
becomes

a) Flatter
b) Steeper
c) Neither steeper nor flatter
d) None of the above

Q6. In case of fractional reserve banking system

 a) Commercial Banks are indifferent to play roles in money creation
b) Commercial Banks do not contribute to money creation
c) Commercial Banks contribute to play roles in money creation
d) Commercial Banks do not have ability to play roles in money creation

Q7. In the model of money supply, if the money multiplier is constant, there is

a) Directly proportional relationship between money supply and monetary base

b) No relationship between liquidity preference of the public and money supply
c) Relationship between reserve requirement ratio and monetary base
d) Inversely proportional relationship between reserve requirement ratio & liquidity
preference of the public

Q8. In Neoclassical growth theory,

a) Capital deepening expedites economic growth

b) Technological upgradation promotes economic growth
c) Good governance promotes growth
d) Sound property right structure intensifies economic growth

Q9. In new growth theory

a) Skilled labor enhances economic growth

b) Research and development promote economic growth within economic system
c) Physical capital expedites growth process
d) Property right structure promotes growth within economic system.

Q10. If the base money is constant, greater the value of money multiplier

a) Greater the amount of money supply

b) Smaller the amount of money supply
c) Amount of money supply is unaffected
d) Amount of money supply may be affected

Q11. Answer any four of following questions (Add Picture in your answer if needed) (5 times
6= 30 Marks) (Maintain the order please) Do NOT elaborate your answer unnecessarily. To
answer all questions, USE at best 11 sentences.
a) Derive the expression for government purchase multiplier in Keynesian model. If the value
of G multiplier = 2.55, How do you interpret this?

Answer:

As we know, government has two fiscal policy instruments. One in either it can change the level
of its purchase and keep taxes constant. Another one is, it can change different tax rates and
keep its purchase level constant. we are assuming that all the taxes are constant, and increase in
Govt expenditure ΔG. This will lead to a new planned expenditure line reaching to a new
Keynesian cross point and ultimately increase the equilibrium output, ΔY

Actual & planned expenditure

Actual expenditure

B New PE line

ΔG A Original PE line

45o ΔY = increase in equilibrium output

0 Y1 Y2 Income/GDP/output

the graph depicts, the “actual & planned expenditure” is enacted in the vertical axis ,
“income/GDP/output” in the horizontal axis and the 45˚ angle is the actual expenditure.

Here, the original Keynesian cross point is A and when the government increased purchases
ΔG, the new Keynesian cross point changed to B.

Therefore, 0Y1 is the initial equilibrium level of income and 0Y2 is the new equilibrium level of
income. The difference between 0Y1 and 0Y2 is ΔY that indicates the increase in equilibrium
income.

Derivation:

Increase in income in 1st round = △G (Increase in purchase or planned

G) Increase in income in 2nd round = MPC × △G [ Multiply by MPC]

Increase in income in 3rd round = MPC (MPC × △G) = MPC2× △G

And the process continues………

Total change in Income = Summation of change in income in all rounds

△Y= △G + MPC × △G + MPC2×△G + MPC3× △G +………

 (△Y)/(△G) = [ 1+ MPC + MPC2+ MPC3+..............]

(△Y)/(△G) = 1/(1−𝑀𝑃) = 1/𝑀𝑃

Because, we know that

MPC + MPS=1

So, MPS = 1- MPC

(△Y)/(△G) = G multiplier = 1/(1−𝑀𝑃)

We also know that MPC, lies between 0 and 1. so MPC is a positive function.

Interpretation

The value of G multiplier = 2.55 refers that If Government increases its purchase by $1, the
equilibrium income rises by 2.55 dollars. We can also say that, G=2.55 means when government
expenditure increased by 1 unit, the equilibrium level of income increased by2.55 units.

B). Develop the following model of money supply: Money supply = Money multiplier ×
Monetary Base. If Base money = 5 million BDT and reserve requirement ratio = 10% and
currency deposit ratio = 15%, calculate Money supply of the economy.

Answer:

We know that,

Money Supply = money multiplier × monetary base

Again, the Money Supply, M = C + D ……. (I)

Where,
C = Currency;
D = Demand deposit of Banks

Monetary Base, B = C + R………II

Where,
C = Currency
R = Cash reserve held by banks.

After dividing I by II, we get Currency (C) as common in both the equations;

here, we have

M C+ D
=
B C+ R
Then dividing by D on the right. We have

𝑀/B= (C/D + 1)/ (C/D + R/D) [ here = C/D = cr and R/D = rr]
∴M / B = (cr + 1) / (cr + rr)
Or, M= (𝑐r+1) / (𝑐r+rr) × B……. III

Given that,

Base Money, B = 5 million BDT

Reserve requirement ratio, rr = 10%

Currency deposit ratio, cr = 15%

M= (𝑐r+1) / (𝑐r+rr) × B

= (0.15 + 1) / (0.15 + 0.10) × 5

= (1.15 / 0.25) × 5

= 23 million BDT

D). What are basic differences between neoclassical growth theory and New Growth Theory?

Answer:

Neoclassical Growth Theory: This growth theory developed by “Robert Solow” dominated the
literature in the ’60s and ’70s. The basic equation of Neoclassical Growth theory is Y/L = f (K/L)
= f (k).

New Growth Theory: the neoclassical growth failed to explain the cross-country income
differences of many economies that resulted in the brought up of New Growth Theory during
the early ’80s. A group of Economists, guided by Paul Romer, proposed this theory as an
alternative growth theory. the new growth theory is known as Endogenous Growth theory.

The basic differences between neoclassical growth theory and New Growth Theory are:

Neoclassical Growth Theory New Growth Theory

This emphasizes on labor and capital. This theory emphasizes the process of
discovering and formulating ideas.
focuses on Capital deepening i.e., giving However, this is driven by Research and
more physical capital to labor hour. development (R&D) activities.

Technological progress was said to be New Growth Theory suggest Technological

exogenous; outside the economic system progress to be within the economic system.

Finally, Neoclassical Growth Theory failed to Whereas, New Growth Theory is able to Explain
explain the cross-country income differences the cross-country income differences of many
 of many economies. economies.

E). How does adjustment in inventory investment by firm help reach equilibrium output in
Keynesian Model.

Answer: AE

A PE
Planned drop in inventory
B
E

F
Unplanned inventory
G accumulation = AB = positive
inventory investment. FG =
Negative inventory investment.
45˚

0 Y2 YE Y1 Y(Income/GDP/output)

Here, OYE in the equilibrium income and the Keynesian cross in at the point E. The larger level
of income in OY2. At OY2, level of income, PE equal to BY2, and AE equals to AY2. PE in
strictly less than AE.

At large level of income, Govt and households’ willingness to spend on goods and services in
low. The less people want to spend, the less goods and services firms can sell. Therefore, they
will choose to lay off home workers. Some goods will be unsold on firms. They will accumulate
those unsold goods to their stock of inventory. AB in positive inventory investment.

As a result of that, output will start Falling from OY2 to OYE. AT OY1, PE equals to FY, and AE
equals to GY, Govt. and households’ willingness to spend on goods and services in high. The
more people want to spend, the more goods and services firms can sell. Therefore, more
workers firm will choose to recruit. As a result, the firm will draw down the goods from
inventory. Output will start Rising from OY1 to OYE. As long as we reach Keynesian cross,
there will be no negative inventory investment.

Here, FG is the negative inventory investment. This is how adjustment in inventory investment
in helping the economy to convert toward the Keynesian cross. Therefore, the economy will
reach at the SR Of equilibrium level of GDP.

F) How does Property right structure promote Economic growth?

Answer:
Property rights mainly encourage individuals to direct their energies to practical economic
projects. Property rights of laws, rules, regulations that determines rights for the use and
transfer of resources. Let us consider two property rights structures.

First structure: People are allowed to hold the total monetary rewards of their labor.
Second structure: People are allowed to keep only half the monetary rewards of their labor.

Some economists would predict that the first property rights structure would stimulate more
economic development than the second property rights structure, ceteris Paribus. Countries
which have better legal system, financial system, and monetary system have better property
Rights structure means that the country is under good Governance. Property Rights Structure is
the important factor to boost the economic growth as individuals will be interested to invest
more and work harder when the property rights Structure allows them to hold more of the
monetary rewards. This in how structure in helping property Rights economic growth.

Thank you.