ASSIGNMENT

DRIVE FALL 2013

SEMESTER III
BAC 303 MACRO ECONOMICS

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Q.No1 Explain the five macroeconomic factors that affect the economic growth of a country as
identified by Dr. Stephan Pfeffenzeller.
Answer: Dr. Stephan Pfeffenzeller, economics lecturer at the University of Liverpool, has identified the
following macroeconomic factors that affect the economic growth of a country:
1. Inflationary stability: Economic decision-making benefits from a stable general economic
environment. This means that a stable inflationary environment is incredibly important. Low rates of
predictable inflation are easily managed, whereas a substantial change in the rate of inflation will be more
problematic, not least because inflation is difficult to forecast in such a situation. In a modern, complex
economy, relative prices will act as a guide to production and investment decisions. Price signals like this
are useful if they reflect the scarcity of goods or demand pressures in product markets. However, if
relative price shifts come about because price signals are distorted due to inflationary pressures, they
become unreliable as a guide for production and investment decisions. Investment may then be directed
into less profitable activities. Over time these misallocations of resources will lead to a reduction in
growth when compared to what may have been achieved under an efficient resource allocation.

2. Openness to trade and investment: Openness to international trade and investment is also important
to promote economic growth. It has also long been recognized that specialization of labour makes for
increased productivity. Since a larger market allows for more specialization, productivity gains should be
expected from international trade as well. Some economists have moved beyond this basic principle and
argue that an economys most innovative and most productive sectors are also those which perform best
in export markets. To the extent that economic growth is driven by productivity gains, a higher export
share in GDP should then correspond to a better growth performance. This can be seen in the recent
resurgence of Germanys economic growth. Germany is the largest exporter of goods in the world.
3. Good governance: A stable, well-regulated macroeconomic environment depends on the quality of
governance. An appropriate degree of regulation will aim to ensure fairness, and protects the economic
system from potentially reckless business practices. This will enable the smooth running of business
transactions and thereby contribute to growth. There is a need for a balanced approach, as excess
government interference can in fact be detrimental to economic growth.
4. Unemployment: Some unemployment is likely to occur in any economy in the course of short-term
fluctuations around the long-run growth trend.
Where unemployment persists for long periods, not all available productive resources are being used.
Growth will therefore be slower than it could have been.
5. The housing market: Many of the above macroeconomic factors affect the housing market, although
most often in an indirect manner. The basic economic principles still hold true. House prices are likely to
rise in a rapidly growing economy. If the supply of new housing does not keep up with rising demand,
this trend will be particularly strong, as it has been in the UK where the supply of housing is strongly
limited by planning restrictions. The rise in house prices has, however, coincided with a decline in
personal savings to a point where household net savings rates are close to 0% of GDP. Personal debt, by
contrast, has increased in line with higher mortgages. There are indications that much of the UKs recent
growth has been driven by the house price boom, in combination with an increase in public debt.

2 Calculate (i) Net Domestic Product (NDP) (ii) Net National Product at market price (NNPmp) (iii)
Net National Product at factor cost (NNPfc) (iv) Gross National
Product (GNP) from the given data as under:

crores
(i) Depreciation 100
(ii) Net income from abroad 300
(iii) Gross Domestic Product (GDP) 15,000
(iv) Subsidies by Government 50
(v) Indirect taxes 75
NDP = GDP depreciation
Answer: (i) NDP = GDP depreciation
= 5,000 100 = 14,900 Crores
(ii) NNPMP = NDPMP + Net income from abroad
= 14,900 + 300 = 15,200 crores
(iii) NNPFC = NNPMP Net indirect taxes ( indirect + taxes + subsidies
= 15,200 75 + 50 = 15,175 crores
(iv) GNP = GDP + Net income from abroad
= 15,000 + 300 = 15,300 crores.

3 a)
If C = 100 + .5y
S = 100 + .5 y
T = `50 crore
I = `150 crore

G = `10 crore
Answer: We know that
Equilibrium = Aggregate output = Aggregate expenditure
C + S + T = C + I + G (4.2) on putting the values in equation (4.2) you get
(100 + .5 y) + (100 + .5y) + 50 = (100 + .5y) + 150 + 10
= 100 + .5 y 100 + .5 y + 50 = 100 + .5y + 150 + 10
y + 50 = 260 + .5y
y .5 y = 260 50
y .5 y = 210
y=
210
.5
y = `420 crore
Thus equilibrium level of income is `420 cr.

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B) Calculate the equilibrium level of national income.

What will be the level of equilibrium of national income in an open economy if
I = `1000 crore
C = 100 + .75 y
G = `50 crore

X = 200
M = 0.25 y
T = 100
Answer: In an open economy, the equilibrium of national income is written as follows:
y = C + I + G + (X M)
= 100 + .75 + 1000 + 50 + (200 0.25 y)
= 100 + .75 y + 1000 + 50 + 200 .25 y
= 1350 + .5 y
y .5y = 1350
.5 y = 1350
y=
1350
.5
= 2700 crore
y = `2700 cr.
Thus, the equilibrium level of income is `2700 cr.

4 Critically explain any five points regarding Says Law of Markets or classical theory of
employment.
Each point carries 2 marks. 2 x 5 = 10 Marks
Answer: The Law of Markets was propounded by J.B. Say, a French economist. According to this law,
Supply of a commodity creates its our demand. Say rejects the idea that overproduction and
underemployment are common occurrences. He believes that there can never be general overproduction
and hence general unemployment.
It is so because supply always creates its own demand. He further says that it is production which creates
market for goods.
The Law of markets may be summarized as follows:
1. Since there is automatic adjustment between production and consumption, there is no need for the
government to interfere in the working of the economic system. If at any time supply increases, the factor

income also increase which raises the demand and soon there will be equilibrium between demand and
supply.
2. Since there can never be general production, there is no general unemployment. If there is some
unemployment. It is purely of temporary nature and can be removed through money wage cuts. Such
money wage cuts would make labour relatively cheaper and would lead to more employment. Thus,
through money wage cuts, the economy can attain the stage of full employment.
3. As long as there are unemployed resources in the economy, it is useful to employ them. The
employment of these resources will increase production and so they will cover their own costs. Thus, the
economy will work at the full employment level.
4. Any imbalance between saving and investment could be corrected by changing the rate of interest.
5. Since every economy is self-adjusting, the government need not interfere in economic matters. This
will increase welfare of the economy.

5 Write short note on Investment Curve.

Answer: IS curve shows the combination of level of output and interest rate in such a manner so that the
desired expenditure equals to income.
There is an inverse relationship between rate of interest and the investment expenditure. Therefore, slope
of investment curve is negative. The higher the rate of interest the lower will be the investment
expenditure and vice-versa.
The position of investment demand and schedule depends on the slope and the level of autonomous
investment expenditure.
Any change in the autonomous investment shifts the investment schedule rightwards or leftwards. The
increase in the investment expenditure shifts the schedule rightwards.
It means firms are planning to spend more on different levels of income whereas any decrease in the
investment expenditure schedule will shift the schedule leftwards. As you know the IS curve shows the
equilibrium in the goods market whereas the LM curve shows the equilibrium in the money market. Thus,
the equilibrium in both goods and money market meets at that level where IS and
LM curve interest each other.
6 Explain the five major types of investments.
Answer: There are five major types of investments which are explained as follows:

1. Real and financial investments: The purchase of stocks, shares, debentures or bonds is known as
financial investment. Such investment shows the transfer of rights from one person or company to
another. It does not add to the stock of real capital of an economy. The creation of new assets or additional
productivity such as new factory or new plants is known as real investment.
2. Planned and unplanned investments: When a firm spends money to acquire capital goods and
inventories, it is known as planned investment.
It is also called intended or ex-ante investment. On the other hand, unexpected investment by a firm,
which tie up cash in slow moving or unsaleable inventory of finished goods or merchandise, is known as
unplanned investment. Unplanned investment can also be called increase in inventories. The sum total of
planned and unplanned investment is called actual investment.
Actual investment = Planned investment + Unplanned investment
(IA) = IP + IU
When unplanned investment is equal to zero, then actual investment will be equal to planned investment.
Let IU = 0
IA = IP + IU
IA = IP + 0
then IA = IP
3. Induced and autonomous investments: Investments that are made in order to generate profit are
known as induced investment. Private companies make this kind of investments when they see gap
between demand and supply. By filling this gap, they earn profits from this venture.
Investments that are made for the welfare of society are known as autonomous investments. Such
investments are made by governments in projects like construction of roads, dams and bridges. There is a
direct relation between induced investment and national income.
When national income increases, induced investment also increases. On the other hand, autonomous
investments are not influenced by change in national income.
4. Private and public investments: Private investment refers to the expenditure made by private sector
on the purchase of capital goods or inventories whereas public investment is made by the state and
managed by public authorities. Since, the private sector aims at earning profit therefore investment
activities are guided by profit motive. On the other hand, public investments are made with the motive to
provide services to the society such as opening schools and constructing airports.

5. Gross and net investments: Gross investment refers to the investment on real capital assets like
machines, plants, equipments, and construction mof factories and houses. A part of fixed capital like
machines and equipments depreciate due to wear and tear, accidents, fire or earthquakes.
Thus, depreciation refers to reduction in the value of fixed capital assets.
The stock of capital has to be maintained and renewed in order to keep the capital intact. Net investment
is obtained by deducting the depreciation cost from the gross investment.
Net Investment = Gross investment Depreciation Cost