a) Elucidate how an economy's income must always equal its expenditure.

b) Assume a hypothetical economy that produces only one good - Peanut Butter. In year 1, the quantity produced is 4 packs and the price is Rs.400 per pack. In year 2, the quantity produced is 5 packs and the price is Rs.500 per pack. In year 3, the quantity produced is 6 packs and the price is Rs.600 per pack. Year 1 is the base year.

a. What is nominal GDP for each of these three years?

b. What is real GDP for each of these years?

c. What is the GDP deflator for each of these years?

d. What is the percentage growth rate of real GDP from year 2 to year 3?

e. What is the inflation rate as measured by the GDP deflator from year 2 to year 3?

f. In this one-good economy, how might you have answered parts (d) and (e) without first answering parts (b) and (c)?

Question 3

a) Discuss the problems with the Consumer Price Index.

b) Consider a nation obsessed with Coke Studio. All they produce and consume are DVDs and karaoke mics, in the following amounts:

Karaoke Mics DVDs

Quantity Price Quantity Price

2020 10 Rs.4,00030 Rs.1,000

2021 126,000 501,200

a. Using a method similar to the CPI, compute the percentage change in the overall price level. Use 2020 as the base year and fix the basket at 3 DVDs and 1 karaoke mic.

b. Using a method similar to the GDP deflator, compute the percentage change in the overall price level. Again, use 2020 as the base year.

c. Is the inflation rate in 2021 the same using the two methods? Explain why or why not.

Question 4

a) If you are given a choice to live in a country with high level of GDP and low growth rate or to live in a low level of GDP and a high growth rate, which option would you choose and why?

b) Assume a hypothetical society that decides to reduce consumption (production of consumption goods) and increase investment (production of capital goods).

i. How would this change affect economic growth?

ii. What groups in society would benefit from this change? What groups might be hurt?

Question 5

a) What is fiat money? What is commodity money? Which kind do we use?

b) Explain whether each of the following events increases or decreases the money supply.

i. The State Bank of Pakistan sells bonds in open-market operations.

ii. The State Bank of Pakistan increases the reserve requirement.

iii. The State Bank of Pakistan reduces the interest rate it pays on reserves.

iv. MCB Bank repays a loan it had previously taken from the State Bank of Pakistan.

v. After a rash of pickpocketing, people decide to hold less currency.

vi. Fearful of bank runs, bankers decide to hold more excess reserves.