QUESTION 1

i) List and explain the costs of expected and unexpected inflation

ii) Explain the 3 ways in which the central bank controls money supply

iii) Explain what is meant by fiat money, commodity money and Seigniorage

iv) What is meant by the natural rate of unemployment?

v) FNB Zambia decided to increase its workers' salaries so as to increase its profits.

Explain the economic intuition behind this decision.

QUESTION 2

Consider an economy with the following Phillip's curve:

= 1 0.5(u u

n),

While the natural rate of unemployment is given by an average of the past two years

unemployment

u

n = 0.5(u1 + u2).

a) Why might the natural rate of unemployment depend on recent unemployment (as is

assumed in the preceding equation)?

b) Suppose that the Fed follows a policy to re- duce permanently the inflation rate by 1 percentage point. What effect will that policy have on the unemployment rate over time?

c) What is the sacrifice ratio in this economy? Explain.

d) What do these equations imply about the short-run and long-run tradeoffs between

inflation and unemployment?

QUESTION 3

One argument postulated by some economists is that higher taxes cause people to want to work

less while lower taxes cause people to want to work more. These economists also believe thattaxes have an important effect on labour supply. Taking into account how this effect alters the

macroeconomic analysis of tax changes, answer the following questions:

a) If this view is correct, how does a tax cut affect the natural rate of output?

b) How does a tax cut affect the aggregate demand curve? The long-run aggregate supply

curve? The short-run aggregate supply curve?

c) What is the short-run impact of a tax cut on output and the price level? How does your

answer differ from the case without the labor supply effect?

d) What is the long-run impact of a tax cut on output and the price level? How does your

answer differ from the case without the labor supply effect?

QUESTION 4

a) What determines the amount of output an economy produces?

b) Explain the difference between government purchases and transfer payments. Give two

examples of each.

c) What makes the demand for the economy's out- put of goods and services equal the

supply?

d) Suppose that an increase in consumer confidence raises consumers' expectations of

future income and thus the amount they want to consume today. This might be

interpreted as an upward shift in the consumption function. How does this shift affect

investment and the interest rate?

e) Suppose that the government increases taxes and government purchases by equal

amounts. What happens to the interest rate and investment in response to this balancedbudget change? Does your answer depend on the marginal propensity to consume?