ECONOMICS (ECO415)

PAST YEAR QUESTION

JUNE 2014
CREATED BY:
SITI NURAZLINDA BINTI MOHD ZAKARIA

QUESTION 2
a) Define economic growth. How can economic growth be measured?
Economic growth is the increase in the market value of the goods and services produced by an
economy over time. The economic growth can be calculated using the following formula:
= Real GDP in Year 1- Real GDP in Year 0 x 100
Real GDP in Year 0
b) Based on the article, list three (3) challenges to achieve positive economic growth.
Weak commodity prices
Anemic global demand for electrical and electronic product
Reducing the strength of emerging economies such as China and India
c) What is the meaning of an open economy? Explain.
Open economy is define as economy that involve international trade with other country. It is include
import and export of goods, services and investments. It is consist of four sectors of the economics
which are households sector, firm sector, government sector and foreign sector.
d) Define inflation. Based on paragraph 4 list two (2) factors that can influence inflation.
Inflation is a situation where there is a persistent and rapid increase in the general price level
(consumer price index). Factors that can influence inflation are:
Increase in electricity tarif
Reduce in petroleum subsidy

e) How can inflation be measure? With aid of a diagram, briefly explain one
(1) type of inflation.
Inflation can be measure by using consumer price index (CPI) and inflation rate for a
year can be measure using following formula:
= CPI this year CPI previous year x 100
CPI previous year
FIGURE 1.1 illustrates cost- push inflation. The

General Price
Level

AS

AS2
P2
P1

AS1

AD
Y1

Y2

FIGURE
1.1

National
Output

original equilibrium occurs at point A, which

corresponds to a price level P1 and output
level Y2. An increase in the production cost
reduces the aggregate supply, thereby
shifting the aggregate supply curve from AS1
to AS2. As a result, the general price level
increases to P2. This inflation will remain
forever, unless the government undertakes
anti- inflationary measures to increase the
aggregate supply.

PART B
QUESTION 1

a) Explain basic economic concepts. Give examples.

Scarcity refers to the economic resources that are limited in supply compared to the
unlimited wants of individual, families and societies. Human beings have unlimited wants as they
never satisfied with what they have. For example, a person who has house would want a bigger
house and more. As resources to produce goods and services are limited, thus unlimited wants
and needs can not be satisfied. Therefore, it is important to use these resources efficiently in
order to maximize the output that can be produce from them. This resources are called factor of
production that consist of four type of resources, which are land, labor, capital and entrepreneur.
Choice means enjoying commodity and forgoing other commodities that can be produced by
the resources. Choice is inevitable because we have scarce or limited economic resources to fulfil
their unlimited wants. It is mean that we cannot acquire everything that we want using the
limited resources. So we have to choose among the many alternatives. For example, government
have vacant land. It has to decide what to do with the lands either built the hospital or school or
others.
Opportunity costs is anything that is forgone or sacrificed in order to enjoy commodities. In
other word, the next best alternative forgone or sacrificed when we make choice. Once one
alternative is chosen another alternative is given up. Since resources are limited, everyone has
to make a choice among alternative choices. As a result, an opportunity cost is incurred. For
example, government decide to built a hospital on the vacant land. In building the hospital, the
government has forgone the opportunity to build a school.

b) Using examples, explain four (4) determinants of demand.

Income is one of the determinant of demand. Change in income have a powerful
efect on demand of the goods and services. If an increase in income cause the demand
for a product to increase, the product must be a normal products. For example,
consumers will buy more furniture and clothes when their incomes increase. For inferior
good, increase in incomes will leads to the fall in demand. For example you might buy
less ordinary burger as your income increases and buy more McDonald burger instead.
Other example of inferior goods are salted fish and low- grade rice.
Besides, taste and preferences is another determinant of the demand. Tastes and
preferences of consumers are triggered by many factors, such as advertising, fad and
fashion, and development of the new product. When product become less preferable to
consumers, the demand curve of the product will shift to the left and when a product
become more preferable, the demand curve will shift to the right. For example, it is now
a trend among teenagers to wear sling bags, so demand for the slings bag will increase.
Afro hair cut is no longer in fashion, thus the demand for it falls. As for development of
new products, blue ray discs have replace compact discs (CDs) which mean that
increase in demand of blue ray discs and decrease in the demand of compact discs
(CDs).

Price of related goods is also a determinant of demand. Related good can either
be substitute or complementary goods. Substitute goods are two goods that serve
the same purpose. For example, butter and margarine, cofee and tea and so on. It is
mean that the more you buy of one, the less you buy the other. For example, if the
price of cofee increases, tea get relatively cheaper and therefore demand for tea
increases. Meanwhile, complementary goods are two goods that must be used
together in order to function. Example of complementary goods are printer and ink,
car and petrol and so on. When two goods are complements, the more you buy one
good, the more you will buy other good. For example, if the prices of the petrol
increases, consumers will reduce the quantity of petrol demanded, so the demand
for cars also falls.
Furthermore, number of buyers also is one of the determinant of demand. The
demand for a good will vary with the number of buyers. When the number of buyers
increases, the demands for most products will increase. For instance, the demand for
stationary increases in the beginning of school sessions because there is more
buyers of the stationary. The same things happen when there is new customer in the
market, which is influenced by population growth. For example, the demand for food
rises as population increases, because there are more people to consume food.

c) Explain two (2) determinants of price elasticity of demand.

Availability of substitutes is one of the determinant of price elasticity of
demand. Demand is elastic if the product has many substitutes and inelastic if it
few substitutes. For example, if the price of the particular brand of the detergent
increases, the quantity demand for it will fall by a larger percentage because
there are many other brands of substitute detergents. Therefore, the demand for
particular brand of detergent tends to be relatively price elastic. Another example
for no substitute products is electricity. As price increase, people would not have
any other substitute products but they only can reduce its quantity marginally.
Therefore, the demand for electricity is fairly price inelastic.
Besides, types of product also is the determinant of price elasticity of demand.
The demand will be elastic for luxurious products while inelastic for necessities or
essentials products. Necessities are things that we cannot go without or things
that we have. For example, insulin is necessary for diabetic patients. It is mean
that even if its prices increases, the patients will not reduce the quantity
demanded. Thus, its demand is inelastic. However, people can go without the
luxurious car. So, its demand tends to be elastic, which means consumer would
respond significantly to a fall in its price by demanding more of it.

QUESTION 3
a) Discuss four (4) macroeconomics objectives.
Macroeconomics objectives needs efort to achieve as its actually aimed at
solving certain problem in the economy. These economic objectives include full
employment, controlling inflation and external balance and better quality of life.
The first objective is full employment or reducing unemployment rate. Full
employment means those who willing and able to work are working and can
find a suitable job. The objective of high employment is the counterpart of low
unemployment. The unemployment rate is the percentage of people in the
labor force who are without jobs and are actively seeking jobs. It is important for
everyone to be working because unemployment creates a lots of problems like
social problems such as drug addiction and robbery. In some countries, a
minimum allowance is given to the unemployed. If many people are
unemployed, government have to spend a lot more money paying allowance to
these unemployment. Unemployment obviously also reduces the amount of
goods and services produced by the country (its GDP).

Second objective is controlling inflation or maintaining price stability. Prices stability exists
when prices remain largely stable and there is no rapid inflation or deflation or in other words it
is said to be steady levels of low- moderate inflation. The most common measure of the overall
price level is the consumer price index (CPI) which measures the cost of the fixed basket of
goods typically bought by average consumer. Deflation occur when there is a sustained general
fall in the average prices, which mean that the rate of inflation is negative. On the other hand,
an increase in price level denotes inflation. The government need to control inflation because it
is not good for majority of people in the society. Inflation, which is the continuous increase in
the prices of goods and services, will reduce the value of money or the purchasing power of
money. So inflation results in a rise in the cost of living and deterioration in the standard of
living for those whose incomes are fixed.
Third objective of the macroeconomic is external balance. Balance of payments is a record
of trade and financial transactions between a country and the rest of the world. It is necessary
to have a balance in the balance of payments in order to maintain the external value of the
countrys currency and its economic stability. Equilibrium in the balance of payment exist when
exports roughly equal imports over the long run. If there are more cash outflows than cash
flows, the balance of payments will go into deficit. A deficit was considered highly embarrassing
in these days. The government will have to borrow money from abroad, or draw on its own
foreign currency reserve to make up the shortfall of foreign currencies. Moreover, the exchange
rate, which is the rate at which one currency is exchanged for another will fall. A falling
exchange rate is a problem because it raises the price of imports and may lead to inflation.

Another objective of macroeconomic is a better quality of life. Better quality

of life is an increase in the amount of goods and services as well as a better
living environment, better health care and more leisure time. Other than that,
less poverty and more freedom also increase the quality of life. As for better
living environment, it exists when there is less pollution, more green, less
floods, less crimes and so on. Quality of life is difers from the standard of living
which is evaluated based primarily on income. Quality of life is hard to
measure as it involves more than just the monetary aspect. The most
commonly used measure for quality of life is the Human Development Index
( HDI ) and the Physical Quality of Life Index ( PQLI )

b) Explain four (4) monetary tools that can be used to overcome the
unemployment.
Monetary tools refer to actions taken by the central bank (BNM) to regulated money
supply in the economy to achieve a desired macroeconomic objective. An expansionary
or easy monetary policy is another measure that can be used to reduce the
unemployment rate. The objective of this policy is to increase the money supply and
the level of aggregate demand and spending. There are a few tools that can be used to
overcome the unemployment. They are reduction in the liquidity ratio, reduction in the
statutory reserve ratio, reduction in the bank rate and discount rate, and also through
the purchase of government securities in the open market operations.
Liquidity ratio refers as all depository institutions are required to hold a minimum
percentage of deposits as cash reserves and liquid assets to meet the demand of their
customers. The aim of this reserve is to control the excess reserves which become the
base for the banks to give loans or credits. A decrease in liquidity ratio allows bank to
have more excess reserves so that they can create more credits and deposits. By
making loans, banks create more deposits so that the money supply increases. This will
encourage more spending and an increase in aggregate demand. Thus, it is suitable for
reducing unemployment and recession or to achieve full employment.

As for statutory reserve ratio, all commercial bank are required to hold a minimum
percentage of their deposits liabilities as reserves with the central bank (BNM). This minimum
percentage is called required reserve ratio which mean that the legally mandated ratios of
reserves to deposits for banks. BNM can use the statutory reserve ratio as a monetary
measure to manipulate commercial banks ability to create credit and money. A decrease in
the statutory reserve ratio permits banks to have more excess reserves out of their total
deposit liabilities. Thus they can create more deposits by making loans in the form of demand
deposits, which in turn will increase the money supply of the economy. An increase in the
money supply encourages aggregate spending and aggregate demand which will stimulate
the economy and thus reduce the unemployment problem.
Bank rate and discount rate are the interest rate charged by the central bank and other
banks. In addition to providing loans to customers, banks themselves borrow funds when they
are in need. There are two sources for the banks to borrow funds. They can borrow from other
banks in the money market or from the central bank. In both places they have to pay an
interest. If the government wants to encourage an increase in the money supply to reduce
unemployment or recession, it will in turn reduce the bank rate and the discount rate, making
it cheaper for the banks to borrow from the central bank or the interbank money market. As
result, banks can extend more loans to members of the public.
Open market operation is the purchase or sale of the government securities such as
treasury bills and bonds in financial markets that afect the amount of excess reserves
available to banks. An open market purchase by the central bank will increase the money
supply and thus is suitable for reducing unemployment.