Question 1

Part (a) Suppose your salary for this year remains the same as last year. Does that mean your real income remains the same? Explain.

Part (b) Suppose the people of an economy consume only two types of goods, namely food and clothing. In both Year 1 and Year 2, the production of goods and services in this economy consists of 50 units of food, 100 units of clothing and 40 units of machinery for production.

	Food	Clothing	Machinery for production
Year 1 price	$10	$5	$20
Year 2 price	$15	$10	$25

i Find the nominal GDP for the current year and base year. Show all your workings.

ii What is the percentage increase in the CPI?

iii What is the percentage increase in the GDP deflator?

Question 2

Use the loanable funds market model to analyse the effects of the following on national saving, investment and the real interest rate. Explain your reasoning and include diagrams in your answers.

Part (a) The government introduces an investment tax credit (offset by other types of taxes, so the total tax collections remain unchanged).

Part (b) Due to the pandemic, consumers become more future-oriented and thus decide to save more.

Part (c) A large number of accessible oil deposits are discovered, which increases the expected future marginal product of oil rigs and pipelines. It also causes an increase in expected future income.

Question 3

Part (a) 'The cost of inflation is zero if it is anticipated.' Explain whether this statement is true, false or uncertain.

Part (b) Explain why frictional and structural unemployment are unavoidable in an economy. Examine the measures that a government can use to try to reduce frictional and structural unemployment.

Question 4 Suppose the velocity of money grows at 1% and nominal GDP grows at 5% per annum. Answer the following questions based on the quantity theory of money (QTM).

a What is the annual money growth rate?

b What is the annual inflation rate if real GDP increases by 2% per annum?

Question 5

Part (a) Discuss two reasons why the GDP deflator gives a different rate of inflation than the CPI does. In calculating the real GDP of an economy, explain whether you would use the GDP deflator or the CPI.

Part (b) In view of the large adverse impact of COVID-19 on the world economy, many governments have implemented expansionary fiscal policy. Together with a decrease in tax revenues, the governments have suffered large deficits. How does a government deficit affect the interest rate, the quantity of loanable funds and economic growth? Explain your answers with a diagram.