ECS4864 ASSIGNMENT 2 2025 (Answer Guide) – Due 6th June 2025

ECS4864 ASSIGNMENT 2 2025 (Answer Guide) – Due 6th June 2025 Title: How the Financial Sector Interacts with the Real Economy Introduction In modern economies, the financial sector plays a central role in facilitating the functioning of the real economy. Its influence extends beyond the mere transfer of funds it actively shapes consumption, production, investment, and employment through complex monetary mechanisms. The real economy consists of all activities related to the production and exchange of tangible goods and services. By contrast, the financial sector deals with the circulation of money and credit, often through mechanisms such as banking, equity markets, and financial instruments. A proper understanding of the interaction between these two spheres is essential for analysing both economic stability and development. This essay explores this interaction with specific focus on: the conditions for macroeconomic and microeconomic equilibrium, the monetary logic behind injections and leakages in a fiat money system, and the broader implications for income, spending, and wealth effects within the economy. 1. The Nature and Logic of the Conditions for Macroeconomic and Microeconomic Equilibrium 1.1 Understanding Microeconomic Equilibrium Microeconomic equilibrium refers to the condition in which individual markets for specific goods clear that is, the quantity of a good supplied (Qi,S) equals the quantity demanded (Qi,D), and the price at which trade occurs falls within the reservation price limits of buyers and sellers. The buyer’s maximum price (Pi,D) must exceed or equal the seller’s minimum acceptable price (Pi,S), leading to voluntary exchange and market clearing. This condition assumes no coercion and that agents act in their own interest given prevai