SUGGESTED MEMO 2015 MAY/JUNE ECS2602
SECTION A
QUESTION 1
a) Multiplier Formula
1
Multiplier = (1−0.8)
= 5
b)
= 100 + 50 + 40 - 0.8(20) = 174
c) equilibrium ie AE = Y
DI = Y – T; AE = C + I + G + (X - M)
C = a + b(Y – T)
C = consumption spending, DI = disposable income, I = investment expenditure, G = government
spending, T = tax revenue, X = exports, M = imports, Y = real GDP, b = Mpc, a = autonomous
consumption
AE = 100 + 0.8(Y -20) + 50 + 40
AE = 100 + o.8Y – 16 + 90 AE =174 + 0.8Y
Since AE = Y therefore Y =174 +0.8Y Y – 0.8Y = 174
Y =870 million
Or
𝟏
Y = (𝟏−𝟎.𝟖 X (174) Y = 174 x 5 = 870
d) Full employment level of output and income – New equilibrium level of output and income
R980 million – 870 million = R110 million
e)
i. Effect of Government Spending to reach full employment
Output gap ÷ the multiplier
110/5 = R22 million upward shift
ii. Effect of Taxes to reach full employment
Taxes has to Decrease
Change in C which is mpc X Tax = R22 million
0,8 (T) = 22 T = .8 T = 27.5 million (twenty-seven million
five hundred thousand) upward shift
, f) Amounts are in millions
Z Z,
Z
196
22
174
110
450
870 980 Y
Increase government spending by R22 million or Decrease tax cT =0.8(27.5) = 22 million
Income gap 110, full equilibrium level of output and income 980, initial autonomous = 174, change
in autonomous increase by 22 ie 174 + 22 =196, current equilibrium level of output and income =
870
QUESTION 2
2.1 EXPANSIONARY MONETARY POLICY
, It is a policy used by the central bank to stimulate economic activities or correct the problems of
a business-cycle contraction by expanding or increase its money supply through open market
purchases of government bonds and leading to a reduction in interest rates
2.2
a) Refers when the governments’ expenditure is more than its revenue Or occurs when
a country's government spends more than it takes in from taxes or other forms of
revenue.
b) Restrictive/contraction fiscal policy reduces budget deficit (ie cut expenditure and increase tax)
QUESTION 3
3.1
a) Refers to an increase in the number of units of the domestic currency that can purchase a
unit of a given foreign currency.
b)
,OR
NB*** the demand for domestic goods (zz) is obtained by subtracting the value of imports from
domestic demand (DD), and then adding exports.
, The exports of a country will be cheaper and imports will become more expensive.
Domestic firms will benefit from increased sales therefore level of income, economic
growth (output level) will increase.
In addition this may also lead to job creation and lower unemployment, especially in
exporting industries.
The increase in X-M or NX will help increase Aggregate Demand (AD) and therefore lead
to higher economic growth and income in the economy.
Since there will be more exports (exports will be cheaper) and less imports (imports will
be expensive) this means that trade balance has improved or increased
NB** In short an increase in foreign demand for South African goods leads to an increase in domestic
output, income and an improvement in the trade balance
3.2
a) Possible solution(s)
Change in the money supply- a rise in the money supply will shift the LM curve
rightwards
• Autonomous Changes in Money - an autonomous decline in money demand would lead
to a rightward shift in the LM curve.
• A change in the overall price level (P) - if the price level declines, the LM curve shifts
right. This occurs because people need less money to pay the lower prices, and the lower
b)
i. When the money demand decreases, the LM curve shifts right for a given income (Y).
The rightward shift in the LM curve increase income and lowers the interest rate.
Or when the money demand falls, people buy bonds with excess money balances, price
of bond rises and interest rate falls
ii.
iii. Increase money supply causing domestic interest rate to temporarily falls as LM curve
shifts to the right (to LM'). Since foreign interest rate is higher, domestic investors
convert Rands into foreign currency causing a fall in exchange rate (Rand becomes weak
in the foreign currency market).
iv. Due lower interest rate and exchange rate this entice more exports (exports will be
cheaper) and less imports (imports will be expensive) and this lead increase trade
balance
v. The rightward shift in the LM curve result in increased level of output and income
because consumption and investment spending rises due to lower interest rates
QUESTION 4
4.1
, a) Possible causes of leftward shift or decrease in the aggregate demand curve are Decrease in
the following: government spending (G), in net exports (NX), a decrease in the willingness
of consumers (C) and businesses (I) to spend because they become less optimistic and also
due to increase in taxes (T) etc
b) Short run equilibrium is b; Medium run equilibrium is c and Long run equilibrium is a
c) Aggregate expenditures and price are inversely related for example a decrease in price level
will cause an increase in aggregate expenditures.
Movement from point a to point b
i. Interest rate (decrease) – As prices decreases, inducing a decrease in which triggers an
increase in borrowing used for consumption expenditures and investment expenditures
ii. Investment spending (uncertain) – When price level goes down leads to decrease in
demand for money causes interest to go down. This increase the demand for both
Consumption and Investment causing GDP to increase also.
iii. Nominal wage (decrease) – use of contraction monetary policy leading to reduction in
output causing a reduction in employment, an increase in unemployment, a reduction in
the nominal wage and a reduction in the price level.
d) Movements from point b to point c
i. Interest decrease - A lower price level will decrease the interest rate and increase
investment spending, thereby increasing the quantity of goods and services demanded
ii. Nominal wage decrease – Assume the economy is initially operating at the natural level
of output, increase in Taxes (contraction fiscal policy) will decrease nominal wages
iii. Real money supply increase – to stimulate economic activities, so with extra money in
circulation (expansion monetary policy), the purchasing power is in the economy is
enhanced and everyone is willing and able to buy more real production at the existing
price level resulting in an increase in aggregate demand.
SECTION B
1. 5
2. 3
3. 2
4. 3
5. 4
6. 3
7. 5
8. 4
9. 2
10. 4
11. 1
SECTION A
QUESTION 1
a) Multiplier Formula
1
Multiplier = (1−0.8)
= 5
b)
= 100 + 50 + 40 - 0.8(20) = 174
c) equilibrium ie AE = Y
DI = Y – T; AE = C + I + G + (X - M)
C = a + b(Y – T)
C = consumption spending, DI = disposable income, I = investment expenditure, G = government
spending, T = tax revenue, X = exports, M = imports, Y = real GDP, b = Mpc, a = autonomous
consumption
AE = 100 + 0.8(Y -20) + 50 + 40
AE = 100 + o.8Y – 16 + 90 AE =174 + 0.8Y
Since AE = Y therefore Y =174 +0.8Y Y – 0.8Y = 174
Y =870 million
Or
𝟏
Y = (𝟏−𝟎.𝟖 X (174) Y = 174 x 5 = 870
d) Full employment level of output and income – New equilibrium level of output and income
R980 million – 870 million = R110 million
e)
i. Effect of Government Spending to reach full employment
Output gap ÷ the multiplier
110/5 = R22 million upward shift
ii. Effect of Taxes to reach full employment
Taxes has to Decrease
Change in C which is mpc X Tax = R22 million
0,8 (T) = 22 T = .8 T = 27.5 million (twenty-seven million
five hundred thousand) upward shift
, f) Amounts are in millions
Z Z,
Z
196
22
174
110
450
870 980 Y
Increase government spending by R22 million or Decrease tax cT =0.8(27.5) = 22 million
Income gap 110, full equilibrium level of output and income 980, initial autonomous = 174, change
in autonomous increase by 22 ie 174 + 22 =196, current equilibrium level of output and income =
870
QUESTION 2
2.1 EXPANSIONARY MONETARY POLICY
, It is a policy used by the central bank to stimulate economic activities or correct the problems of
a business-cycle contraction by expanding or increase its money supply through open market
purchases of government bonds and leading to a reduction in interest rates
2.2
a) Refers when the governments’ expenditure is more than its revenue Or occurs when
a country's government spends more than it takes in from taxes or other forms of
revenue.
b) Restrictive/contraction fiscal policy reduces budget deficit (ie cut expenditure and increase tax)
QUESTION 3
3.1
a) Refers to an increase in the number of units of the domestic currency that can purchase a
unit of a given foreign currency.
b)
,OR
NB*** the demand for domestic goods (zz) is obtained by subtracting the value of imports from
domestic demand (DD), and then adding exports.
, The exports of a country will be cheaper and imports will become more expensive.
Domestic firms will benefit from increased sales therefore level of income, economic
growth (output level) will increase.
In addition this may also lead to job creation and lower unemployment, especially in
exporting industries.
The increase in X-M or NX will help increase Aggregate Demand (AD) and therefore lead
to higher economic growth and income in the economy.
Since there will be more exports (exports will be cheaper) and less imports (imports will
be expensive) this means that trade balance has improved or increased
NB** In short an increase in foreign demand for South African goods leads to an increase in domestic
output, income and an improvement in the trade balance
3.2
a) Possible solution(s)
Change in the money supply- a rise in the money supply will shift the LM curve
rightwards
• Autonomous Changes in Money - an autonomous decline in money demand would lead
to a rightward shift in the LM curve.
• A change in the overall price level (P) - if the price level declines, the LM curve shifts
right. This occurs because people need less money to pay the lower prices, and the lower
b)
i. When the money demand decreases, the LM curve shifts right for a given income (Y).
The rightward shift in the LM curve increase income and lowers the interest rate.
Or when the money demand falls, people buy bonds with excess money balances, price
of bond rises and interest rate falls
ii.
iii. Increase money supply causing domestic interest rate to temporarily falls as LM curve
shifts to the right (to LM'). Since foreign interest rate is higher, domestic investors
convert Rands into foreign currency causing a fall in exchange rate (Rand becomes weak
in the foreign currency market).
iv. Due lower interest rate and exchange rate this entice more exports (exports will be
cheaper) and less imports (imports will be expensive) and this lead increase trade
balance
v. The rightward shift in the LM curve result in increased level of output and income
because consumption and investment spending rises due to lower interest rates
QUESTION 4
4.1
, a) Possible causes of leftward shift or decrease in the aggregate demand curve are Decrease in
the following: government spending (G), in net exports (NX), a decrease in the willingness
of consumers (C) and businesses (I) to spend because they become less optimistic and also
due to increase in taxes (T) etc
b) Short run equilibrium is b; Medium run equilibrium is c and Long run equilibrium is a
c) Aggregate expenditures and price are inversely related for example a decrease in price level
will cause an increase in aggregate expenditures.
Movement from point a to point b
i. Interest rate (decrease) – As prices decreases, inducing a decrease in which triggers an
increase in borrowing used for consumption expenditures and investment expenditures
ii. Investment spending (uncertain) – When price level goes down leads to decrease in
demand for money causes interest to go down. This increase the demand for both
Consumption and Investment causing GDP to increase also.
iii. Nominal wage (decrease) – use of contraction monetary policy leading to reduction in
output causing a reduction in employment, an increase in unemployment, a reduction in
the nominal wage and a reduction in the price level.
d) Movements from point b to point c
i. Interest decrease - A lower price level will decrease the interest rate and increase
investment spending, thereby increasing the quantity of goods and services demanded
ii. Nominal wage decrease – Assume the economy is initially operating at the natural level
of output, increase in Taxes (contraction fiscal policy) will decrease nominal wages
iii. Real money supply increase – to stimulate economic activities, so with extra money in
circulation (expansion monetary policy), the purchasing power is in the economy is
enhanced and everyone is willing and able to buy more real production at the existing
price level resulting in an increase in aggregate demand.
SECTION B
1. 5
2. 3
3. 2
4. 3
5. 4
6. 3
7. 5
8. 4
9. 2
10. 4
11. 1
