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Subject CB2
Revision Notes
For the 2019 exams

Macroeconomic models and

economic thought
Booklet 3

covering

Module 2 Main strands of economic thinking

Module 11 The macroeconomic environment
Module 16 Classical and Keynesian theory
Module 17 Monetarist and new classical schools, and
Keynesian responses
Module 23 Summary of debates on theory and policy

The Actuarial Education Company

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CONTENTS

Contents Page
Links to the Course Notes and Syllabus 2
Overview 4
Past Exam Questions 6
Solutions to Past Exam Questions 45
Final comments 78
Checklist 80
Exam Preparation Checklist 100

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These conditions remain in force after you have finished using the course.

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LINKS TO THE COURSE NOTES AND SYLLABUS

Material covered in this booklet

Module 2 Main strands of economic thinking

Module 11 The macroeconomic environment
Module 16 Classical and Keynesian theory
Module 17 Monetarist and new classical schools, and Keynesian
responses
Module 23 Summary of debates on theory and policy

The module number refers to the 2019 edition of the ActEd Course Notes.

Syllabus objectives covered in this booklet

1.2 Assess the main strands of economic thinking:

 classical
 Marxian socialism
 neoclassical, Keynesian, neo-Keynesian and post-Keynesian
 monetarist
 Austrian.

1.3 Analyse the recent macroeconomic history.

4. Discuss the aftershocks in Europe following the 2008 financial crisis.

5. Assess the stimulus-austerity debate and regulatory action after the
2008 crisis.

3.5 Discuss the macroeconomic environment of the business.

1. Describe the main macroeconomic variables that governments seek

to control.
2. Explain what determines the level of economic activity and hence
the overall business climate.
3. Describe the effect on business output if a stimulus is given to the
economy.
9. Discuss the determination of the price level in the economy by the
interaction between aggregate supply and aggregate demand in a
simple AD-AS model.

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11. Explain what is meant by GDP and describe how it is measured.

12. Discuss the representation of the economy as a simple model of the
circular flow of income.

3.9 Discuss what determines the level of business activity and how it affects
unemployment and inflation.

1. Discuss how the equilibrium level of income is determined within a

simple aggregate demand-expenditure model.
2. Describe the concept of the multiplier and calculate its value.
4. Describe the relationship between unemployment and inflation and
whether the relationship is stable.
5. Discuss how business and consumer expectations affect the
relationship between unemployment and inflation and explain how
such expectations are formed.
6. Describe how a policy of targeting inflation affects the relationship
between unemployment and inflation.
7. Describe what determines the course of a business cycle and its
turning points.
8. Discuss whether the business cycle is caused by changes in
aggregate demand or changes in aggregate supply (or both).

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OVERVIEW

In Booklets 1 and 2, we have concentrated on microeconomics. We now

move on to macroeconomics. Recall from Module 1 of the Course Notes
that macroeconomics is concerned with the economy as a whole and studies
economic aggregates, such as national income, unemployment and inflation.
It forms the basis of the material in Modules 11 to 23 of the Course Notes,
which is covered in Booklets 3 to 6.

This booklet focuses on the measurement of national income and some of

the main macroeconomic models that help us to understand how the
economy works. This will prepare us for:
 Booklet 4, in which we consider the role of money in the economy
 Booklet 5, in which we consider international trade, the balance of
payments and exchange rates
 Booklet 6, in which we consider the main sources of failure in the
market(s), both in a microeconomic and macroeconomic context, and
the main policies used to deal with these failures.

More specifically, this booklet:

 introduces the main macroeconomic objectives, which are then
discussed in more detail in Booklet 6
 revisits the circular flow model of the economy (which was first
mentioned in Module 1 of the Course Notes)
 examines how national income (or output) is measured
 introduces the AD-AS model of the economy, which is useful for
exploring the effects of changes in variables on the average price level
and national income (GDP). This model can also be used to help
explain the effects of the different policies that are covered in Booklet 6.
 discusses alternative shapes for the AS curve in the short run and in the
long run
 introduces the Phillips curve, which explores the relationship between
inflation and unemployment
 discusses alternative shapes for the Phillips curve, including the vertical
and expectations-augmented Phillips curves, and examines the related
accelerationist theory of inflation
 considers the business cycle and the real business cycle.

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Economics is an evolving subject. Theories and economic models are

suggested by economists and are used to explain and predict outcomes.
They are tested in the real world and if they fail to explain or predict outcomes
reasonably accurately they might be abandoned or amended. Interestingly,
some theories might make accurate predictions in some societies and not in
others; or might make accurate predictions for a certain period of time but then
seem to fail. This is because theories have to make assumptions about how
individuals and groups behave in certain situations. Human behaviour
depends on the environment in which individuals live, which can and does
change over time.

This booklet also covers the different schools of economic thought on major
macroeconomic issues and models. In particular:
 classical theory, which developed in the 18th century and was still widely
accepted in the 1930s
 Keynesian theory (developed by John Maynard Keynes), which
recommended new policies to reduce the mass unemployment of the
1920s and 1930s. Keynesian demand-management policies were
pursued by many governments from 1945 to the mid-1970s when they
came under increased criticism.
 monetarism (led by Milton Friedman), which challenged the Keynesian
orthodoxy in the 1970s and argued that governments should keep tight
control of the money supply in order to control inflation. Monetarists
believed that the market economy would automatically correct any
deviation from the ‘natural’ level of employment in the long run.
 new classical theory, which suggested that price and wage flexibility
allows markets to adjust continuously, so that the economy operates at its
natural level of employment in both the short run and the long run
 the neo-Keynesian, new Keynesian and post-Keynesian schools. These
built on Keynesian theory and formed responses to the criticisms that
were made of it, for example, that market imperfections, such as price-
stickiness, mean that output and employment (rather than prices) often
change in response to new conditions
 the ‘emerging consensus’ up until the financial crisis of 2008, the
financial crisis itself, and the search for a new consensus.

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PAST EXAM QUESTIONS

This section contains all the past exam questions from 2008 to 2017 that are
related to the topics covered in this booklet. These questions are taken from
the exam papers for Subject CT7. The questions are divided into three
sections: multiple-choice questions, short-answer questions and
long-answer questions.

Solutions are given later in this booklet. Answers only are provided for
multiple-choice questions. Other solutions give enough information for you
to check your answer, including working, and also show you what an
adequate examination answer should look like. Further information may be
available in the Examiners’ Report, ASET or Course Notes.

We first provide you with a checklist of all exam questions split by

module. You can use this, if you wish, to select the questions that relate
just to those aspects that you may be particularly interested in reviewing.
Alternatively you can choose to ignore the checklist, and instead attempt the
questions without having any clues as to their content.

Exam question checklist by module and subject area

Module Multiple-choice Short- Long-

answer answer

2
11 1, 5, 8, 9, 12, 14-17, 22, 27, 29-32, 1, 4, 5, 7, 4
34-38, 41, 45, 46, 48, 50-54, 58-62, 9, 15, 19
64, 67-70, 73, 75-78, 80-85, 87
16 2-4, 6, 7, 10, 11, 13, 18, 19, 21, 2, 3, 8, 1-3
23-26, 28, 33, 39, 40, 42-44, 47, 49, 10-14,
55, 57, 63, 65, 66, 71, 72, 74, 79 16-18, 20,
21
17 20, 56, 86 6
23

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Multiple-choice questions

1 Subject CT7, April 2008, Question 17

Within the circular flow of income, which of the following statements is

CORRECT?

A Taxes, investment and consumption are leakages.

B Imports, exports and savings are injections.
C Exports, investment and savings are injections.
D Savings, imports and taxation are leakages.

2 Subject CT7, April 2008, Question 18 (amended)

Given the following information:

Consumption = £210m
Taxes on income = £100m
National income = £330m

What is the level of savings?

A £80m
B £20m
C –£60m
D £100m

3 Subject CT7, April 2008, Question 19 (amended)

An injection of £50m is known to lead to a final increase in national income

of £125m. Which of the following is the marginal propensity to withdraw?

A 0.4
B 0.6
C 1.4
D 1.6

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4 Subject CT7, April 2008, Question 23

The level of economic activity is known to be £100m, the average price

level 2 and the nominal money supply £50m. The velocity of circulation is:

A 2
B 1
C 8
D 4

5 Subject CT7, September 2008, Question 13 (amended)

Given the following data for Country A, what is the value of injections into the
circular flow of income?

(£ billions)
Consumption expenditure 600
Savings 200
Government expenditure 250
Tax revenue 200
Investment expenditure 300
Imports 200
Exports 50

A £1,200 billion
B £750 billion
C £600 billion
D £1,000 billion

6 Subject CT7, September 2008, Question 14 (amended)

If consumption on domestic goods increases from £18,000 to £19,500 when

income increases from £20,000 to £26,000 then:

A the marginal propensity to consume domestic goods is 0.25 and the

multiplier is 1.33.
B the marginal propensity to consume domestic goods is 0.25 and the
multiplier is 4.
C the marginal propensity to consume domestic goods is 0.75 and the
multiplier is 4.
D the marginal propensity to consume domestic goods is 0.75 and the
multiplier is 1.33.

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7 Subject CT7, September 2008, Question 15 (amended)

The accelerator theory states that:

A investment is increased when interest rates fall.

B an increase in investment will lead to a more than proportionate
increase in output.
C the level of investment expenditure is determined by the rate of change
of national income.
D investment is increased when interest rates rise.

8 Subject CT7, September 2008, Question 17 (amended)

If a country has a negative net income from abroad then:

A gross domestic product is greater than gross national income.

B gross domestic product is less than gross national income.
C gross domestic product is the same as gross national income.
D we cannot say whether gross domestic product differs from gross
national income from this information.

9 Subject CT7, September 2008, Question 18

In 2000 the nominal gross domestic product (GDP) per capita is £20,000
and the GDP deflator is 100. In 2007 the nominal GDP per capita is £30,000
and the GDP deflator is 120. Real GDP per capita for 2007 at 2000 prices
is:

A £24,000.
B £25,000.
C £36,000.
D none of the above.

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10 Subject CT7, September 2008, Question 20

An increase in the marginal propensity to import:

A increases the multiplier at all levels of national income.

B increases the multiplier at low levels of national income and reduces it at
high levels of national income.
C decreases the multiplier at all levels of national income.
D has no effect on the multiplier.

11 Subject CT7, September 2008, Question 24

If the nominal money supply is 800, output (the real level of economic
activity) is 2,000 and the average price level is 12, then the velocity of
circulation is:

A 0.4
B 4.8
C 30
D 133,333.3

12 Subject CT7, April 2009, Question 16 (amended)

Gross national income is equal to:

A gross domestic product – depreciation.

B net domestic product + net income from abroad.
C gross domestic product + net income from abroad.
D net national income + depreciation.

13 Subject CT7, April 2009, Question 19

If the marginal propensity to consume domestic goods is 0.8 and there are
no taxes or trade, what is the simple autonomous expenditure multiplier?

A 1.25
B 0.8
C 5
D 0.2

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14 Subject CT7, April 2009, Question 20

A country with a population of 38 million has 32 million in employment and

2 million unemployed. What is the unemployment rate?

A 5.9%
B 5.3%
C 5.0%
D 6.3%

15 Subject CT7, September 2009, Question 15 (amended)

Given the following data for an economy, what is the value of its gross
national income?

Consumption expenditure £140 million

Investment £40 million
Government expenditure £80 million
Exports £20 million
Imports £60 million
Net income from abroad £20 million

A £180 million
B £200 million
C £220 million
D £240 million

16 Subject CT7, September 2009, Question 16

In the circular flow of income model which of the following is TRUE?

A Savings, taxes and investment are withdrawals.

B Exports, imports and government expenditure are withdrawals.
C Investment, government expenditure and exports are injections.
D Investment, exports and consumption are injections.

17 Subject CT7, September 2009, Question 17 (amended)

Which one of the following is NOT part of the gross national income?

A wages from self employment

B property rental income
C transfer payments
D net income from abroad

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18 Subject CT7, September 2009, Question 20 (amended)

An economy has the following characteristics:

Consumption expenditure = 0.3Y

Investment expenditure = £200 million
Government expenditure = £500 million
Exports = £300 million
Imports = 0.3Y

Determine the value of Y.

A £500 million
B £700 million
C £1,000 million
D £1,300 million

19 Subject CT7, September 2009, Question 24 (amended)

The accelerator theory implies that:

A investment is increased when interest rates fall.

B an increase in investment will lead to a proportionate increase in output.
C the rate of change of investment is directly proportional to the rate of
change of output.
D small fluctuations in national income can lead to large fluctuations in
investment demand.

20 Subject CT7, April 2010, Question 2

An increase in the natural rate of unemployment will cause:

A the long-run and short-run Phillips curves to shift to the right.

B the long-run and short-run Phillips curves to shift to the left.
C the long-run Phillips curve to shift to the right and the short-run Phillips
curves to shift to the left.
D the long-run Phillips curve to shift to the left and the short-run Phillips
curves to shift to the right.

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21 Subject CT7, April 2010, Question 5

In Country A, government expenditure is £350 billion, tax revenue is £275

billion, aggregate saving is £300 billion and aggregate investment is £250
billion. The net exports of Country A are equal to a:

A surplus of £125 billion.

B deficit of £125 billion.
C surplus of £25 billion.
D deficit of £25 billion.

22 Subject CT7, April 2010, Question 6

If a country has a current account deficit then:

A gross domestic product is greater than gross national product.

B gross domestic product is less than gross national product.
C gross domestic product is the same as gross national product.
D we cannot say whether gross domestic product differs from gross
national product from this information.

23 Subject CT7, September 2010, Question 1 (amended)

According to the accelerator theory, investment expenditure will:

A fluctuate more than consumer expenditure.

B rise when the long-term rate of interest falls.
C accelerate if business confidence picks up.
D accelerate if the government increases its capital expenditure.

24 Subject CT7, September 2010, Question 11

In an economy, economic agents have a marginal propensity to save of

0.25, an income of £200 million and an autonomous expenditure of £15
million. The level of consumption will be:

A £215 million.
B £165 million.
C £65 million.
D £100 million.

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25 Subject CT7, September 2010, Question 12

In a closed economy with no government sector, the marginal propensity to

save is 0.1, investment is £500 million, and autonomous consumption is
£200 million. Which of the following statements is TRUE at the equilibrium
level of national income?

A Planned savings are £300 million.

B The marginal propensity to consume is higher than the average
propensity to consume.
C Consumption expenditure is equal to £6,500 million.
D The gross domestic product is £6,800 million.

26 Subject CT7, September 2010, Question 13

In an open economy with a government sector, the marginal propensity to

consume is 0.75 and the marginal propensity to import is 0.25. The open
economy multiplier will equal:

A 4
B 2
C 1
D 1.33

27 Subject CT7, April 2011, Question 17

Which of the following could explain why a country’s aggregate demand

curve might shift inwards to the left?

A a decrease in interest rates

B a rise in exchange rates
C a rise in government expenditure
D an increase in business confidence

28 Subject CT7, April 2011, Question 18

If planned injections are less than planned withdrawals:

A unemployment will fall.

B the balance of trade will tend to improve.
C inflation will tend to rise.
D national income will rise.

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29 Subject CT7, April 2011, Question 20

Given the following macroeconomic data:

£ millions
Consumer expenditure 70
Investment expenditure 20
Government expenditure 40
Exports 20
Imports 30
Net income from abroad 10

What is the value of the gross domestic product?

A £150 million
B £130 million
C £120 million
D £110 million

30 Subject CT7, September 2011, Question 16

In the circular flow of income model:

A savings, taxes and investment are withdrawals.

B savings, imports and taxes are withdrawals.
C investment, government expenditure and imports are injections.
D investment, exports and consumption are injections.

31 Subject CT7, September 2011, Question 17

Which of the following does NOT form part of a country’s gross domestic
product?

A salaries of school teachers

B net income from abroad
C company profits
D investment expenditure

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32 Subject CT7, September 2011, Question 18

Which one of the following statements about real variables in the economy is
FALSE?

A If nominal gross domestic product (GDP) rises by 5 per cent then the
real GDP may have risen, fallen or remained unchanged.
B A nominal depreciation of a country’s exchange rate represents a real
depreciation if the domestic inflation rate is less than the foreign inflation
rate.
C An increase in real income will lead to a rise in the demand for real
money balances.
D Real interest rates are positive if the expected rate of inflation is greater
than the nominal rate of interest.

33 Subject CT7, September 2011, Question 19

In a simple economy, consumption is given by the relationship:

C = 0.75Y

where: C is consumption expenditure

Y is gross domestic product.

If government expenditure is £150 million, investment is £50 million and there is

no taxation or international trade, what will be the equilibrium value of gross
domestic product of the economy?

A £200 million
B £312.5 million
C £1,000 million
D £800 million

34 Subject CT7, September 2011, Question 20

The aggregate demand schedule slopes downwards because at higher price

levels the real money supply:

A decreases and national income is lower.

B decreases and national income is higher.
C increases and national income is lower.
D increases and national income is higher.

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35 Subject CT7, September 2011, Question 21

To obtain a measure of net national income from gross domestic product it is

necessary to:

A add net income from abroad and deduct transfer payments.

B deduct net income from abroad and add capital depreciation.
C add net income from abroad.
D add net income from abroad and deduct capital depreciation.

36 Subject CT7, September 2011, Question 24

You are given the following data for an economy:

£ millions

Consumer expenditure (including indirect taxes) 120

Investment 60
Government expenditure (including transfer payments) 70
Exports 40
Imports 30
Net income from abroad 20
Indirect taxes 10
Capital depreciation 20
Transfer payments 10

The value of the economy’s gross national income at market prices is:

A £250 million
B £260 million
C £270 million
D £280 million

37 Subject CT7, April 2012, Question 19

Which of the following is a possible explanation for an increase in the

average price level and a decrease in real national income?

A an increase in short-run aggregate supply

B a decrease in short-run aggregate supply
C an increase in aggregate demand
D a decrease in aggregate demand

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38 Subject CT7, April 2012, Question 24

In a country with a population of 25 million people there are 16 million in the

total workforce and 2 million unemployed. What is the rate of
unemployment?

A 8%
B 11.1%
C 12.5%
D 44%

39 Subject CT7, October 2012, Question 14 (amended)

In a closed economy with no taxation, the marginal propensity to save is

0.25 and the level of income is €800m. What is the likely level of
consumption expenditure resulting from a rise in government expenditure of
€100 million?

A €700 million
B €800 million
C €900 million
D €1,000 million

40 Subject CT7, October 2012, Question 15 (amended)

The accelerator theory states that:

A investment is increased when interest rates fall.

B an increase in consumer demand leads to a more than proportionate
increase in the level of investment.
C an increase in investment will lead to a more than proportionate
increase in output.
D the rate of change of investment affects the rate of change of output.

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41 Subject CT7, October 2012, Question 16

If a country has a negative net income from abroad then:

A gross domestic product is greater than gross national income.

B gross domestic product is less than gross national income.
C gross domestic product is the same as gross national income.
D we cannot say whether gross domestic product differs from gross
national income from this information.

42 Subject CT7, October 2012, Question 18

Which of the following will increase the size of the multiplier?

A an increase in government expenditure

B a decrease in the marginal propensity to save
C an increase in the marginal propensity to save
D an increase in autonomous investment

43 Subject CT7, October 2012, Question 19

In a closed economy with no government sector, if the amount people plan

to save exceeds the amount they plan to invest then there will be:

A a rise in national income.

B an unplanned rise in stocks.
C inflationary pressures.
D a rise in the amount people plan to invest.

44 Subject CT7, October 2012, Question 23

The quantity theory of money in its simplest form assumes that the:

A velocity of circulation and nominal output are both fixed.

B ratio of the velocity of circulation to the price level is fixed.
C ratio of the money supply to the velocity of circulation is fixed.
D velocity of circulation and real output are both fixed.

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45 Subject CT7, April 2013, Question 12

Which of the following are the three injections into the circular flow of
income?

A investment, government expenditure and exports

B consumption, government expenditure and investment
C consumption, investment and exports
D investment, government expenditure and imports

46 Subject CT7, April 2013, Question 17 (amended)

Which of the following will result in a decrease in aggregate demand, other

things being equal?

A a rise in imports
B a fall in savings
C a fall in interest rates
D a fall in economic and business uncertainty

47 Subject CT7, April 2013, Question 18

In the Keynesian 45 line diagram showing the equilibrium level of GDP in a
country, the marginal propensity to consume domestically produced goods
is:

A the intercept of the line representing the part of income spent on goods
produced in the country.
B the proportion of any rise in GDP withdrawn from the circular flow of
income.
C the slope of the aggregate expenditure line.
D the slope of the line representing the part of income spent on goods
produced in the country.

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48 Subject CT7, April 2013, Question 19

The unemployment rate is given by:

A the number of unemployed divided by the population expressed as a

percentage.
B the number of unemployed divided by the total labour force expressed
as a percentage.
C the number of unemployed divided by the number of employed
expressed as a percentage.
D the number of unemployed divided by all in the population of working
age expressed as a percentage.

49 Subject CT7, April 2013, Question 22

According to the accelerator theory the level of investment depends on the:

A level of national income.

B rate of change of national income.
C rate of change of the level of investment.
D level of the interest rate.

50 Subject CT7, April 2013, Question 24

Which ONE of the following is NOT part of the calculation for the gross
national income?

A net income from abroad

B gross capital formation
C capital depreciation
D imports of goods and services

51 Subject CT7, September 2013, Question 15

The short-run aggregate supply curves tell us that an increase in the

average price level will encourage firms to:

A reduce output and increase employment.

B reduce output and employment.
C increase output and reduce employment.
D increase output and employment.

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52 Subject CT7, September 2013, Question 19

In the circular flow of income model of an economy with no government and

no international trade, the flow of money is from:

A firms to households in return for goods and services provided and from
households to firms in return for the factor services provided.
B households to firms in return for the factor services provided.
C firms to households in return for the factor services provided and from
households to firms in return for the goods and services provided.
D firms to households in return for goods and services provided.

53 Subject CT7, September 2013, Question 20

In Country A the level of government expenditure is £275 billion, tax revenue

is £310 billion, aggregate investment is £180 billion and aggregate savings is
£150 billion. The level of net exports in Country A is a:

A deficit of £5 billion.
B surplus of £5 billion.
C deficit of £35 billion.
D surplus of £35 billion.

54 Subject CT7, September 2013, Question 25

Which one of the following would count as investment in the national income
accounts for Country X?

A The purchase of a £1,000 Country X Government bond.

B A museum purchases an 18th century work of art.
C A firm increases the quantity of cars it holds as stock.
D A firm places £1 million of its surplus funds with a Country X bank in a
high interest account.

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55 Subject CT7, April 2014, Question 14

In a simple closed economy, consumption is given by the relationship

C = 0.75Y

where C is consumption expenditure and Y is gross domestic product.

If government expenditure is £150 million and investment is £50 million,

what will be the equilibrium value of the gross domestic product of the
economy?

A £200 million
B £312.5 million
C £1,000 million
D £800 million

56 Subject CT7, April 2014, Question 17

Assume that the actual rate of unemployment is above the natural rate of
unemployment because the expected rate of inflation is above the actual
rate of inflation. If the expected rate of inflation falls to equal the actual rate
of inflation then real wage growth will:

A fall and real output will rise.

B fall and real output will fall.
C rise and real output will rise.
D rise and real output will fall.

57 Subject CT7, April 2014, Question 23

According to the equation of exchange, an increase in the money supply is

most likely to lead to inflation if the:

A velocity of circulation decreases.

B real national income increases.
C velocity of circulation and nominal national income are constant.
D velocity of circulation and the real national income are constant.

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58 Subject CT7, September 2014, Question 17

Which of the following could explain why a country’s aggregate demand

curve might shift inwards to the left?

A a decrease in interest rates

B a rise in exchange rates
C a rise in government expenditure
D an increase in business confidence

59 Subject CT7, September 2014, Question 18

Which of the following statements about real variables in the economy is

FALSE?

A If nominal gross domestic product (GDP) rises by 5 per cent with no

inflation then the real GDP will have risen by 5 per cent.
B A nominal depreciation of a country’s exchange rate represents a real
depreciation if the domestic inflation rate is less than the foreign inflation
rate.
C An increase in real income will lead to a rise in the demand for real
money balances.
D Real interest rates are positive if the expected rate of inflation is greater
than the nominal rate of interest.

60 Subject CT7, April 2015, Question 13

In the circular flow of income model:

A savings, taxes and investment are withdrawals.

B savings, imports and taxes are withdrawals.
C investment, government expenditure and imports are injections.
D investment, exports and consumption are injections.

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61 Subject CT7, April 2015, Question 14

If a country has a positive balance of net income from abroad then:

A gross domestic product is greater than gross national income.

B gross domestic product is less than gross national income.
C gross domestic product is the same as gross national income.
D we cannot say whether gross domestic product differs from gross
national income from this information.

62 Subject CT7, April 2015, Question 15

To obtain a measure of net national income from gross domestic product it is

necessary to:

A add net income from abroad and deduct transfer payments.

B deduct net income from abroad and add capital depreciation.
C add net income from abroad.
D add net income from abroad and deduct capital depreciation.

63 Subject CT7, April 2015, Question 16

If private savings exceed private investment by £300 million and government

expenditure on goods and services exceeds government tax revenue by
£200 million then net exports will be:

A zero.
B £100 million.
C –£100 million.
D £500 million.

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64 Subject CT7, April 2015, Question 17

You are given the following information for an economy:

Consumer expenditure £80 million

Investment expenditure £20 million
Government expenditure £40 million
Exports £20 million
Imports £30 million
Net income from abroad £10 million

What is the value of this economy’s gross domestic product?

A £130 million
B £140 million
C £150 million
D £160 million

65 Subject CT7, April 2015, Question 23

The following data on an economy is provided for 2005 and 2013:

2005 2013
Money supply 400 600
Real output 100 150
Price level 10 ?

According to the equation of exchange, what would be the value of the price
level in 2013 assuming that the velocity of circulation remains unchanged?

A 50
B 15
C 10
D none of the above

66 Subject CT7, April 2015, Question 24

In the model of the circular flow of income if injections are greater than
withdrawals:

A national income will tend to increase.

B national income will tend to decrease.
C unemployment and production will tend to fall.
D the general level of prices will tend to fall.

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67 Subject CT7, October 2015, Question 17

A country with a population of 38 million has 32 million in employment and

2 million unemployed. What is the unemployment rate?

A 5.0%
B 5.3%
C 5.9%
D 6.3%

68 Subject CT7, October 2015, Question 19

Assuming all other variables remain constant, a decrease in the average

price level will result in a:

A rise in the real wage rate.

B fall in the real interest rate.
C rise in the nominal wage rate.
D rise in the nominal interest rate.

69 Subject CT7, April 2016, Question 14

Which one of the following will have net exports directly measured in the
method used to calculate gross domestic product (GDP)?

A the income method

B the expenditure method
C the product method
D the investment method

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70 Subject CT7, April 2016, Question 15

You are given the following data for an economy:

£ millions

Consumer expenditure (including taxes on products) 120

Investment 60
Government expenditure (including transfer payments) 70
Exports 40
Imports 20
Taxes on products (Indirect taxes) 10
Capital depreciation 20
Transfer payments 10
Net income from abroad 10

The value of the economy’s gross national income at market prices is:

A £250 million.
B £260 million.
C £270 million.
D £280 million.

71 Subject CT7, April 2016, Question 16

Assume that the marginal propensity to consume domestically produced

goods is 0.7 and there are no taxes. The government decides to increase
public spending by £100 million. According to simple Keynesian multiplier
analysis, what is likely to be the total change in national income resulting
from this increase in government expenditure (to the nearest million)?

A £70 million
B £143 million
C £170 million
D £333 million

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72 Subject CT7, April 2016, Question 18

In a simple economy, consumption is given by the relationship

C = 0.75Y

where C is consumption expenditure and Y is gross domestic product.

Government expenditure is £150 million, investment is £50 million and there

is no taxation or international trade. What will be the equilibrium value of
gross domestic product of the economy?

A £200 million
B £312.5 million
C £1,000 million
D £800 million

73 Subject CT7, April 2016, Question 19

To obtain a measure of net national income from gross domestic product it is

necessary to:

A add net income from abroad and add capital depreciation.

B add net income from abroad and deduct capital depreciation.
C deduct net income from abroad and add capital depreciation.
D deduct net income from abroad and deduct capital depreciation.

74 Subject CT7, April 2016, Question 22

In Country A, government expenditure is £250 billion, tax revenue is £275

billion, aggregate saving is £300 billion and aggregate investment is £250
billion. The net exports of Country A are equal to a:

A surplus of £25 billion.

B deficit of £75 billion.
C surplus of £75 billion.
D deficit of £25 billion.

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75 Subject CT7, April 2016, Question 23

If the gross domestic product (GDP) in an economy rises and the

unemployment rate falls then:

A the GDP per capita must rise.

B the GDP per capita must fall.
C the GDP per capita remains constant.
D there is insufficient information to determine what has happened to GDP
per capita.

76 Subject CT7, September 2016, Question 17

Which of the following could explain why a country’s aggregate demand

curve might shift inwards to the left?

A an appreciation of the domestic currency

B a decrease in interest rates
C a rise in government expenditure
D an increase in business confidence

77 Subject CT7, September 2016, Question 18

The short-run aggregate supply curves show that an increase in the average
price level will encourage firms to:

A reduce both output and employment.

B increase both output and employment.
C increase output and reduce employment.
D reduce output and increase employment.

78 Subject CT7, September 2016, Question 21

Which of the following does NOT form part of a country’s gross domestic
product?

A company profits
B investment expenditure
C net income from abroad
D salaries of school teachers

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79 Subject CT7, September 2016, Question 22

If private savings exceeds private investment by £300 million and

government expenditure on goods and services exceeds government tax
revenue by £200 million then net exports will be:

A zero.
B +£100 million.
C £100 million.
D +£500 million.

80 Subject CT7, April 2017, Question 15

The aggregate demand curve slopes downwards because at higher price

levels the real money supply:

A decreases and national income is lower.

B decreases and national income is higher.
C increases and national income is lower.
D increases and national income is higher.

81 Subject CT7, April 2017, Question 18

If the total output of goods and services increases and the price index falls
then the nominal gross domestic product (GDP):

A may rise or fall and real GDP will fall.

B will stay the same and real GDP will rise.
C will rise and real GDP will rise.
D may rise or fall and real GDP will rise.

82 Subject CT7, April 2017, Question 19

If a country has a current account deficit then:

A gross domestic product is greater than gross national income.

B gross domestic product is less than gross national income.
C gross domestic product is the same as gross national income.
D we cannot say whether gross domestic product differs from gross
national income.

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83 Subject CT7, April 2017, Question 24

The nominal rate of interest is 2% and the rate of inflation is negative at

3%. Which one of the following is TRUE?

A The real rate of interest is greater than the nominal rate of interest.
B The real rate of interest is negative.
C The rate of inflation is greater than the real rate of interest.
D The real rate of interest is 1%.

84 Subject CT7, October 2017, Question 20

The nominal rate of interest is 2% and the expected rate of inflation is

positive at 3%. Which one of the following is TRUE?

A The real rate of interest is positive.

B The expected rate of inflation is less than the real rate of interest.
C The real rate of interest is greater than the nominal rate of interest.
D The real rate of interest is –1%.

85 Subject CT7, October 2017, Question 23

The unemployment rate, expressed as a percentage, is given by the number

of unemployed divided by:

A the total population.

B the total labour force.
C the number of employed.
D the number in the population who are of working age.

86 Subject CT7, October 2017, Question 24

If unemployment is above the natural level, the long-run Phillips curve would
suggest that, other things remaining the same, real wages would:

A fall and unemployment would rise.

B fall and unemployment would fall.
C rise and unemployment would fall.
D rise and unemployment would rise.

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87 Subject CT7, October 2017, Question 26

Which of the following does NOT form part of a country’s gross domestic
product (GDP)?

A salaries of school teachers

B net income from abroad
C company profits
D investment expenditure

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Short-answer questions

1 Subject CT7, April 2008, Question 32 (amended)

The following information is available on the component parts of a country

with an open economy:

Investment £250m
Government spending £320m
Transfer payments £65m
Consumption £710m
Exports £180m
Imports £190m
Net income from abroad –£25m

(i) Calculate the country’s gross domestic product. [1]

(ii) Calculate the country’s gross national income. [1]

(iii) Explain the difference between basic and market prices. [2]
[Total 4]

2 Subject CT7, April 2008, Question 33 (amended)

Detail why the accelerator theory can be used to explain the presence of
economic cycles. [4]

3 Subject CT7, September 2008, Question 32

In an open economy: the marginal propensity to save is 0.3, the marginal

propensity to import is 0.2, national income is £100 million and the current
account is in balance. The government increases its expenditure by
£20 million.

(i) Calculate the new equilibrium level of national income. [1]

(ii) Calculate the new current account balance. [1]

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For parts (iii) and (iv) assume government expenditure is unchanged, so that
national income is at £100 million and the current account is in balance. If
exports increase by £20 million:

(iii) Calculate the new equilibrium level of national income. [1]

(iv) Calculate the new current account balance. [1]

[Total 4]

4 Subject CT7, September 2008, Question 33 (amended)

You are given the following data on an economy:

Consumer expenditure (inclusive of indirect taxes) £90m

Investment £20m
Government expenditure (inclusive of transfer payments) £50m
Exports £20m
Imports £30m
Net income from abroad £10m
Transfer payments £20m
Taxes on products £15m

Population 0.5 million

(i) Calculate the gross domestic product at market prices. [1]

(ii) Calculate the gross national income at market prices. [1]

(iii) Calculate the gross domestic product at basic prices. [1]

(iv) Calculate the per capita gross national income at basic prices. [1]
[Total 4]

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5 Subject CT7, April 2009, Question 27 (amended)

Calculate the nominal GDP (at basic prices) of an economy, using the
information contained in the table below. [2]

Item £m
Wages and salaries 900,000
Consumption expenditure 640,000
Mixed income 90,000
Government transfer payments 50,000
Investment 400,000
Government purchases of goods and services 240,000
Export earnings 300,000
Depreciation 240,000
Import payments 220,000
Taxes on products (net of subsidies) 210,000

6 Subject CT7, September 2009, Question 35 (amended)

(i) Describe the Phillips curve. [2]

(ii) Explain why the accelerationist theory of inflation predicts a vertical

long-run Phillips curve. [3]
[Total 5]

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7 Subject CT7, April 2010, Question 33

The following information is extracted from a country’s National Statistical

Bureau:

€ billions
Wages and salaries 350
Mixed incomes 38
Net income from abroad 15
Gross profit/rent and interest of firms,
government and other institutions 150
Taxes on products 71
Subsidies on products 3
Depreciation 65

(i) Calculate the gross domestic product at market prices. [1]

(ii) Calculate gross national income at market prices. [1]

(iii) Calculate the net national income at market prices. [1]

[Total 3]

8 Subject CT7, April 2010, Question 35

(i) (a) List three categories of withdrawals from the circular flow of income.
(b) List three categories of injections of expenditure into the circular
flow of income. [3]

In a closed economy with no taxes, assume that government expenditure is

increased by £50m and that firms increase investment by £100m. The
marginal propensity to consume domestically produced goods is 2/3.

(ii) Calculate the increase in the equilibrium level of GDP. [2]

[Total 5]

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9 Subject CT7, April 2011, Question 32

State the adjustments needed to:

(i) obtain gross value added at basic prices from gross domestic product at
market prices [1]

(ii) obtain gross national income at market prices from gross domestic
product at market prices [1]

(iii) obtain net national income at market prices from gross national income
at market prices [1]

(iv) obtain households’ disposable income from gross national income at

market prices. [2]
[Total 5]

10 Subject CT7, April 2011, Question 36

In an economy, an increase in aggregate expenditure of £120 million will

cause an increase in the equilibrium level of gross domestic product of
£360 million.

(i) Calculate the multiplier and the marginal propensity to consume

domestically produced goods. [2]

(ii) Explain the effect on the multiplier of:

(a) a rise in consumer confidence
(b) an increase in income tax rate. [2]
[Total 4]

11 Subject CT7, April 2012, Question 32

The following table shows the consumption schedule for a closed economy.
Investment is currently £40bn and the marginal propensity to consume is
0.67.

National
income (Y) 30 60 90 120 150 180 210 240 270 300
(£bn)
Consumption
20 40 60 80 100 120 140 160 180 200
(C) (£bn)

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(i) Calculate the equilibrium level of national income assuming that the
government is currently spending £20bn. [1]

(ii) Calculate the level of savings in this economy if the government has a
budget deficit of £5bn at the equilibrium level of national income. [2]

Now assume that full employment is achieved at a national income level of

£240bn.

(iii) Assuming no change in tax rates, determine the increase in the

government expenditure required to achieve full employment. [1]

(iv) Assume that as an alternative measure to changing government

expenditure, the amount of taxes levied is changed in order to raise the
national income to its full equilibrium level. Determine the change in
taxes in this case. [1]
[Total 5]

12 Subject CT7, October 2012, Question 33 (amended)

The following data refers to a simple closed economy.

Money supply = 200

Price index = 10
Real output (ie real income) = 100 units
Liquidity ratio = 20%

Use the equation of exchange to determine the following with the above
figures as your starting point in each of your calculations:

(i) the numerical value of the velocity of circulation. [1]

(ii) the value of the price index if the money supply were to increase to 300.
[1]

(iii) the likely change in the money supply if there is an initial increase in
bank deposits of 15. [1]
[Total 3]

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13 Subject CT7, October 2012, Question 36

The following data relates to a closed economy with no government sector:

Income level Planned Planned

consumption investment
Y C I

80 64 22
100 78 22
120 92 22
140 106 22
where:
 C = 8 + 0.7Y

 planned consumption is the amount of consumption expenditure

households plan to undertake
 planned investment is the amount of investment firms plan to carry out

 planned savings is the amount that households plan to save.

(i) Determine the equilibrium level of national income. [1]

(ii) If the national income were £140 million calculate the rise or fall in
unplanned stocks. [1]

(iii) Determine the level of planned savings that will yield a level of income
at which there will be no rise or fall in unplanned stocks. [1]

(iv) Calculate the amount by which planned savings exceed planned

investment at an income level of £120 million. [1]

(v) Determine the increase in the level of national income if planned

investment rose from £22 million to £28 million. [1]
[Total 5]

14 Subject CT7, April 2013, Question 33

(i) The data below refers to a closed economy with no government

expenditure or taxes. Investment expenditure is assumed to be
constant at all levels of national income at £20 billion. For each of the
levels of income in the table, state the associated levels of injections,
withdrawals and aggregate expenditure. [3]

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Income (Y) (£ billions) 40 80 120 160 200 240 280

Consumption (£ billions) 40 70 100 130 160 190 220

(ii) Determine the marginal propensity to consume domestically produced

goods. [1]

(iii) State the equilibrium level of national income in the economy. [1]
[Total 5]

15 Subject CT7, April 2014, Question 32

Explain, with the use of a diagram, the circular flow of income in an open
economy with a government, financial/banking and a foreign sector, making
clear which are the withdrawals and which are the injections in the system.
[5]

16 Subject CT7, April 2014, Question 34

The government in a closed economy undertakes expenditure on goods and

services of £200 million. Investment expenditure is £100 million and the rate
of direct taxation is 25 per cent of all income. The consumption function is
given by the equation:

C = 0.8Yd

where C is planned consumption and Yd is disposable income (ie after

deduction of income tax).

(i) Calculate the level of national income at which the government has a
balanced budget. [1]

(ii) Calculate the government budget deficit/surplus if national income were

£600 million. [1]

(iii) Calculate the increase in the national income if government expenditure

is increased from £200 million to £300 million. [1]

(iv) Calculate the level of government expenditure required to achieve the

full-employment level of income of £900 million. [2]
[Total 5]

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17 Subject CT7, September 2014, Question 36

The following data is provided on a simple closed economy:

C = 10 + 0.75Y
I = 20
G = 40

where C is consumer expenditure, Y is national income, G is government

expenditure on goods and services and I is investment expenditure. All
amounts are in € million.

Calculate the following:

(a) the equilibrium level of national income

(b) consumer savings at the equilibrium level of national income if direct

taxation is 10% of all income

(c) the value of withdrawals at the equilibrium level of national income

(d) the new level of national income if government expenditure were to

increase by €10 million. [4]

18 Subject CT7, April 2015, Question 33 (part)

In Europa, a country which has no trade with other countries, consumption is

represented by C = 0.6Y where C and Y are consumption expenditure and
national income in billions of euros respectively. Assume that investment is
€20bn and the government expenditure is €80bn.

(i) Calculate the equilibrium level of national income. [1]

(ii) If the government has a budget deficit of €17.5bn, calculate the

government’s tax revenue and the level of savings in the economy,
assuming that the rate of direct taxation is a fixed percentage of all
income. [1]

(iii) Calculate the proportion of national income that is invested. [1]

[Total 3]

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19 Subject CT7, September 2016, Question 34

Define, in relation to the national income accounting framework, the

following terms:
(a) gross national income
(b) depreciation (or capital consumption)
(c) net national income. [3]

20 Subject CT7, April 2017, Question 35

You are given the following data on a simple closed economy:

C = £10 million + 0.75Y
I = £20 million
G = £40 million

where C is consumer expenditure, Y is national income, G is government

expenditure on goods and services and I is investment expenditure. There
are no taxes so all government expenditure is financed by borrowing.

(a) Calculate the equilibrium level of national income.

(b) Calculate savings at the equilibrium level of national income.
(c) Calculate the value of injections at the equilibrium level of national
income.
(d) Calculate the new level of national income if government expenditure
increases by £10 million. [4]

21 Subject CT7, October 2017, Question 32

(i) Determine the value of the multiplier if government expenditure

increases by £50 million and GDP rises by £120 million. [1]

(ii) (a) Calculate the marginal propensity to consume ( mpcd ) if the change
in domestic consumption is £85 million and the increase in GDP is
£106 million.

(b) Calculate the size of the multiplier given the mpcd calculated in
part (ii)(a). [3]
[Total 4]

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Long-answer questions

1 Subject CT7, September 2010, Question 37

(i) Describe the Keynesian explanation of the business cycle. [5]

(ii) Explain the fluctuations in the level of the gross domestic product with
reference to the interaction of the multiplier and accelerator. [5]
[Total 10]

2 Subject CT7, September 2013, Question 38 (amended)

(i) Explain, using a diagram, the impact on aggregate expenditure and

GDP in an economy with no public sector and no international trade,
following each of the events below (treat the two events separately):

(a) an increase in business confidence

(b) an increase in the marginal propensity to consume. [8]

(ii) Draw two new diagrams to show an inflationary gap and a deflationary
gap at the new level of aggregate expenditure. [2]
[Total 10]

3 Subject CT7, October 2015, Question 38

(i) Describe, with the aid of a Keynesian 45° line diagram, the multiplier
within the Keynesian model of aggregate expenditure. [5]

(ii) Explain why some countries have a smaller multiplier than others. [5]
[Total 10]

4 Subject CT7, October 2017, Question 38

Assess, using aggregate demand/aggregate supply (AD-AS) diagrams, the

likely impact on real GDP, employment and the price level given the
following events which should be treated separately:
(a) a decrease in government expenditure on healthcare
(b) a rise in the price of oil. [8]

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SOLUTIONS TO PAST EXAM QUESTIONS

Multiple-choice questions

1 D 11 C 21 D 31 B 41 A
2 B 12 C or D 22 D 32 D 42 B
3 A 13 C 23 A 33 D 43 B
4 D 14 A 24 B 34 A 44 D
5 C 15 D 25 C 35 D 45 A
6 A 16 C 26 B 36 C 46 A
7 C 17 C 27 B 37 B 47 C or D
8 A 18 C 28 B 38 C 48 B
9 B 19 D 29 C 39 C 49 B
10 C 20 A 30 B 40 B 50 C

51 D 61 B 71 D 81 D
52 C 62 D 72 D 82 D
53 B 63 B 73 B 83 A
54 C 64 A 74 C 84 D
55 D 65 C 75 D 85 B
56 A 66 A 76 A 86 B
57 D 67 C 77 B 87 B
58 B 68 A 78 C
59 D 69 B 79 B
60 B 70 C 80 A

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Short-answer questions

1 Subject CT7, April 2008, Question 32 (amended)

(i) Gross domestic product

GDP is calculated as follows:

GDP = C + I + G + X - M
= 710 + 250 + 320 + 180 - 190
= 1,270

(ii) Gross national income

GNY is calculated as follows:

GNY = GDP + net income from abroad

= 1,270 - 25
= 1,245

(iii) Basic prices vs market prices

Figures calculated at basic prices do not include taxes on products (net of

subsidies). Figures calculated at market prices do include taxes on products
(net of subsidies). To get from GDP at market prices to GDP at basic prices,
it is necessary to subtract taxes on products (net of subsidies).

2 Subject CT7, April 2008, Question 33 (amended)

The accelerator theory states that investment is determined by the rate of

change of national income. Thus, the percentage changes in investment
tend to be much greater than the percentage changes in income.

When national income rises, consumer spending rises and therefore firms
will buy new equipment to provide additional capacity to cope with the rise in
demand, ie new investment increases.

By combining the accelerator theory with the multiplier effect it is possible to

explain how business cycles can arise as the result of a one-off shock to
aggregate demand:
 A small percentage increase in national income can produce a large
percentage change in investment (accelerator effect).

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 This increase in investment increases national income further (multiplier

effect).
 Eventually, the rate of increase in national income will slow down (due
to capacity constraints), and as a result, new investment will fall and
firms may not even replace old equipment (accelerator effect).
 This fall in investment decreases national income (multiplier effect) and
thus investment falls further.
 At some point, the rate of decrease of national income will stabilise, and
investment will stop falling and eventually start to rise, as the
depreciating capital stock requires replacement (accelerator). This then
produces an increase in national income (multiplier), and so on …

3 Subject CT7, September 2008, Question 32

(i) New equilibrium level of national income

1
k=
mpw

In the absence of taxes, mpw = 0.3 + 0.2 = 0.5 , and so:

1
k= =2
0.5

Therefore:

DY = k ¥ DJ = 2 ¥ 20 = 40

So, the new equilibrium level of national income must be:

100 + 40 = £140 million

(ii) New current account balance

Exports are assumed to be independent of domestic national income and so

will not change in response to the increase in national income.

The increase in imports due to the increase in national income is equal to:

0.2 ¥ DY = 0.2 ¥ 40 = 8

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So, since the current account was originally in balance, it will now be –£8
million, ie a deficit of £8 million.

(iii) New equilibrium level of national income

As in part (i):

DY = k ¥ DJ = 2 ¥ 20 = 40

So, the new equilibrium level of national income is £140 million.

(iv) New current account balance

The increase in exports is £20 million.

The increase in imports resulting from the increase in equilibrium national

income is £8 million.

So, the new current account balance is +£12 million.

4 Subject CT7, September 2008, Question 33 (amended)

(i) Gross domestic product at market prices

= 90 + 20 + (50 – 20) + 20 – 30 = £130 million

(ii) Gross national income at market prices

= GDP at market prices + net income from abroad

= 130 + 10 = £140 million

(iii) Gross domestic product at basic prices

= GDP at market prices – taxes on products

= 130 – 15 = £115 million

(iv) Per capita gross national income at basic prices

= GNY at market prices – taxes on products

= 140 – 15 = £125 million

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So, per capita gross national income at basic prices is:

£125m
 £250
0.5m

5 Subject CT7, April 2009, Question 27 (amended)

Using the expenditure method and assuming that the figures in the question
are given in terms of market prices, GDP (gross domestic product) at market
prices is given by:

GDPmarket = C + I + G + X - M
= 640 + 400 + 240 + 300 - 220
= 1,360

GDP at basic prices is:

GDPbasic = 1,360 - 210

= 1,150

ie £1,150 billion.

6 Subject CT7, September 2009, Question 35 (amended)

(i) The Phillips curve

The Phillips curve shows an inverse relationship between unemployment

and inflation.

The original Phillips curve seemed to suggest that there was a trade-off
between unemployment and inflation. To reduce unemployment, the
economy would have to suffer higher inflation. Similarly, to reduce inflation,
the economy would have to suffer higher unemployment.

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(ii) The accelerationist theory of inflation

The following diagram shows a series of expectations-augmented Phillips

curves, for different rates of expected inflation. The actual inflation rate ( p )
is inversely related to unemployment ( U ) and positively related to the
expected rate of inflation (p e ) .

inflation rate, p
LRPC

9%

6%
p e= 6%
3%
p e= 3%

U1 U* e U
p = 0%

U * is the equilibrium rate of unemployment or the natural rate of

unemployment or the non-accelerating-inflation rate of unemployment
(NAIRU).

According to the accelerationist theory, attempts to maintain unemployment

below its natural rate will cause inflation to accelerate each year.

For example, if the government expanded aggregate demand to reduce

unemployment from U * to U1 , this would result in inflation of 3%. People
would then revise their expectations of inflation upwards from 0% to 3%,
and, if the government is committed to keeping unemployment down to U1
and expands nominal aggregate demand by 3% more than it did originally,
then actual inflation would increase to 6%. This process would continue with
ever-accelerating inflation.

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The government would have to allow the economy to return to its natural
rate of unemployment to avoid accelerating inflation. Hence, ultimately,
there is no trade-off between unemployment and inflation. The theory
instead suggests that the long-run Phillips curve (LRPC) is vertical at U * .

7 Subject CT7, April 2010, Question 33

(i) Gross domestic product at market prices

GDP at basic prices is:

= wages and salaries + mixed incomes + gross profit, rent and interest

= 350 + 38 + 150 = 538

GDP at market prices is:

= GDP at basic prices + taxes on products - subsidies on products

= 538 + 71 - 3 = 606

Therefore, GDP at market prices is €606 billion.

(ii) Gross national income at market prices

GNY at market prices is:

= GDP at market prices + net income from abroad

= 606 + 15 = 621

Therefore, GNY at market prices is €621 billion.

(iii) Net national income at market prices

NNY at market prices is:

= GNY at market prices - depreciation

= 621 - 65 = 556

Therefore, NNY at market prices is €556 billion.

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8 Subject CT7, April 2010, Question 35

(i)(a) Withdrawals from the circular flow of income

The three categories of withdrawals from the circular flow of income are:
1. net savings
2. net taxes
3. expenditure on imports.

(i)(b) Injections into the circular flow of income

The three categories of injections into the circular flow of income are:
1. investment
2. government spending
3. export expenditure.

(ii) Increase in the equilibrium level of income

The multiplier is:

1
k= =3
1- 23

Therefore:

DY = k ¥ DJ
= 3 ¥ (100 + 50)
= 450

The increase in the equilibrium level of GDP is £450 million.

9 Subject CT7, April 2011, Question 32

(i) GVA at basic prices from GDP at market prices

GVA at basic prices = GDP at market prices

– taxes on products
+ subsidies

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(ii) GNY at market prices from GDP at market prices

GNY at market prices = GDP at market prices

+ net income from abroad

(iii) NNY at market prices from GNY at market prices

NNY at market prices = GNY at market prices

– depreciation

(iv) Households’ disposable income from GNY at market prices

Households’ disposable income = GNY at market prices

– taxes paid by firms
+ subsidies received by firms
– depreciation
– undistributed profit
– personal taxes
+ benefits

10 Subject CT7, April 2011, Question 36

(i) Multiplier and marginal propensity to consume domestically

produced goods

The injections multiplier, k, is defined as:

DGDP
k=
DE

So, here:

360
k= =3
120

The multiplier is also equal to:

1
k=
1 - mpcd

So, here:

1
k =3=
1 - mpcd

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2
ie mpcd =
3

(ii)(a) Effect on the multiplier of a rise in consumer confidence

A rise in consumer confidence is likely to lead to an increase in consumption

as a proportion of income and hence to an increase in the marginal
propensity to consume domestically produced goods. This, in turn, will lead
to an increase in the value of the multiplier.

(ii)(b) Effect on the multiplier of an increase in the income tax rate

An increase in the income tax rate will reduce the disposable income
households have available to spend, eg on domestically produced goods. It
is therefore likely that the marginal propensity to consume domestically
produced goods will fall, leading to a decrease in the value of the multiplier.

11 Subject CT7, April 2012, Question 32

(i) Equilibrium national income

In a closed economy, there is no international trade, therefore:

AD = C + I + G
= C + 40 + 20
= C + 60

In equilibrium, Y = AD , therefore:

Y = C + 60
Y - C = 60

From the schedule given, the difference between Y and C is 60 when

Y = 180 and C = 120 , therefore the equilibrium level of national income is
£180bn.

(ii) Level of savings

In equilibrium:

S +T = I + G

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Therefore:

S = I + (G - T )
= 40 + 5
= 45

(iii) Increase in government expenditure required

From the schedule given, Y = 240 , C = 160 and so aggregate demand is:

AD = C + I + G
= 160 + 40 + G
= 200 + G

To restore equilibrium, we must have Y = AD , therefore:

Y = AD
= 200 + G

and so:

G = 40

Since G was 20, it must have increased by 20, therefore the answer is an
increase of £20bn.

(iv) Change in tax required

In equilibrium:

S +T = I + G

And since I = 40 and G = 20 (at the original equilibrium in part (i)), it must
be true that in the equilibrium state:

S + T = 40 + 20 = 60

Method 1 – all taxes are proportional taxes, and both the tax and the savings
rates are constant

Since S = 1
4Y , when Y = 240 , we have S = 60 .

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Therefore, T = 0 , so the tax rate falls to zero, and hence taxes must fall
from 15 to 0 in order to reach a full equilibrium level of 240.

Method 2 – assuming there is a lump sum tax (which doesn’t vary with
income)

If T is a lump sum tax, then T = 15 for all income levels and we can find
S as:

S = Y -C -T
= Y - 2 3 Y - 15
= 1 Y
3 - 15

Now, we want to find the new tax, T ' , for which S + T ' = 60 when Y = 240 :

S + T ' = 60
3 ¥ Y - 15 + T ' = 60
1

1 ¥ 240 - 15 + T ' = 60
3
T ' = -5

Therefore the lump sum tax must fall from 15 to -5 , ie a fall of 20.

12 Subject CT7, October 2012, Question 33 (amended)

(i) Velocity of circulation

The velocity of circulation can be calculated as:

PY 10 ¥ 100
V = = =5
M 200

(ii) Price index

Assuming V is fixed, the new value of the price index can be calculated as:

MV 300 ¥ 5
P= = = 15
Y 100

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(iii) Likely change in the money supply

Assuming the liquidity ratio (L) is 20%, the bank deposits multiplier (b) can
be calculated as:

1 1
b= = =5
L 0.2

Therefore, the likely change in the money supply following an initial increase
in bank deposits of 15 is:

15 ¥ 5 = 75

13 Subject CT7, October 2012, Question 36

(i) Equilibrium level of national income

As there is no government sector nor any trade, so both G and X are equal
to zero, and C refers to consumption of domestically produced goods.
Hence equilibrium national income is given by:

Y = AD = C + I

So, as:
 C = 8 + 0.7Y
 I = 22

Equilibrium occurs where:

Y = C +I
= 8 + 0.7Y + 22
= 30 + 0.7Y
Y = 100

ie the equilibrium level of national income is £100 million.

Alternatively, equilibrium national income is found by equating injections and

withdrawals, which here means:

I =S

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I = 22 and the net savings function is given by:

S = Y -C
= Y - (8 + 0.7Y )
= 0.3Y - 8

So:

22 = 0.3Y - 8

ie Y = 100

(ii) Unplanned change in stocks if Y = 140

If Y = 140, aggregate demand would be:

AD = C + I
= 8 + 0.7Y + 22
= 30 + 0.7 ¥ 140
= 128

Since Y > AD , there will be an unplanned increase in stocks of £12 million.

(iii) Level of planned savings at which there will be no unplanned

change in stocks

There will be no unplanned change in stocks if the economy is in equilibrium.

This is the case when injections equals withdrawals, ie when:

S = I = 22

Therefore, the required level of planned savings is £22 million.

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(iv) Amount by which planned savings exceed planned investment

when Y =120

if Y = 120, planned savings will be:

S = Y -C
= Y - (8 + 0.7Y )
= 120 - 8 - 0.7 ¥ 120
= 28

So, planned savings exceeds planned investment by 28 - 22 = 6 , ie

£6 million.

(v) Increase in equilibrium national income

If I = 28, equilibrium income will be given by:

Y = C +I
= 8 + 0.7Y + 28
= 36 + 0.7Y

So:

0.3Y = 36

 Y = 120

So, starting from the initial equilibrium of 100, the increase is £20 million.

14 Subject CT7, April 2013, Question 33

(i) Injections, withdrawals and aggregate expenditure

Income (Y) 40 80 120 160 200 240 280

Consumption (C) 40 70 100 130 160 190 220
Injections (J) 20 20 20 20 20 20 20
Withdrawals (W) 0 10 20 30 40 50 60
Aggregate 60 90 120 150 180 210 240
expenditure (AD)

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(ii) Marginal propensity to consume domestically produced goods

The marginal propensity to consume domestically produced goods is:

DCd 30
mpcd = = = 0.75
DY 40

(iii) Equilibrium level of national income

The equilibrium level of national income is £120bn.

15 Subject CT7, April 2014, Question 32

Domestic firms pay incomes to households (Y) in return for using the factors
they own (land, labour, capital and raw materials) to produce goods and
services.

Households spend a large part of the income received on goods and

services produced by these same domestic firms. This represents the
income of firms (Cd).

Together, these represent the inner circular flow of income between firms
and households.

INJECTIONS

FIRMS
The productive
sector Investment, I
Government
spending, G
Exports, X
Consumption
Factor of domestically
payments, produced goods Banks Government Abroad
Y and services, Cd

Imports, M
Net taxes, T
HOUSEHOLDS Net savings, S
Owners of factors of
production
WITHDRAWALS

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In addition, part of households’ income leaks out of the circular flow via
withdrawals such as:
 net savings (S) – the net amount of money deposited in banks and
financial institutions
 net taxes (T) – taxes paid to the government less receipts of benefits
 spending on imports from abroad (M).

However, there are also corresponding injections of spending back into the
circular flow in the form of:
 investment spending by firms on new projects and capital goods (I)
 government spending on goods and services (G)
 spending on exports by households and firms (X).

16 Subject CT7, April 2014, Question 34

(i) Level of national income at which the budget is balanced

In this economy, G = £200 million and T = 0.25Y. So, the government has a
balanced budget (G = T) when:
£200 = 0.25Y

 Y = £800

(ii) Government budget deficit/surplus if national income were £600

million

Whilst G would still be £200 million, tax revenue would be equal to:

T = 0.25Y = 0.25 ¥ 600 = 150

So:

G - T = 200 - 150 = 50

As G > T, this corresponds to a budget deficit of £50 million.

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(iii) Increase in the national income if government expenditure is

increased from £200 million to £300 million

Approach 1: Using the multiplier

The consumption function is:

C = 0.8 Yd

The relationship between total income and disposable income is:

Yd = (1 - 0.25) Y

and so:

C = 0.8 ¥ (1 - 0.25) Y
= 0.6Y

Hence, the multiplier is equal to:

1
k= = 2.5
1 - 0.6

An increase of £100 million in government spending, G , will therefore

increase (equilibrium) national income by:

DY = k ¥ DG
= 2.5 ¥ 100
= 250

Approach 2: First principles

Prior to the increase in government spending, equilibrium national income is

given by:

Y = C +I +G

So, using the relationship Yd = (1 - 0.25) Y :

Y = 0.8Yd + 100 + 200

= 0.8 (1 - 0.25) Y + 300
= 0.6Y + 300

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and the equilibrium level of national income is:

Y * = 750

Suppose G increases to 300, then the new equilibrium level of national

income is given by:

Y = 0.8 Yd + 100 + 300

= 0.8 (1 - 0.25) Y + 400
= 0.6Y + 400

ie Y * = 1, 000

So, the increase in equilibrium national income is:

1, 000 - 750 = £250 million

(iv) Government expenditure required to achieve full-employment level

of income of £900 million

Y = 0.6Y + I + G

So to achieve Y * = 900 we need:

900 = 0.6 ¥ 900 + 100 + G

ie G = 900 - 540 - 100 = £260 million

17 Subject CT7, September 2014, Question 36

(a) Equilibrium level of national income

The equilibrium level of national income is Y, where:

Y = AD = C + I + G
= 10 + 0.75Y + 20 + 40
= 70 + 0.75Y
0.25Y = 70
Y = 280

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(b) Consumer savings at the equilibrium level of national income

Savings, S, can be found from:

Y = C + S +T
= 10 + 0.75Y + S + 0.1Y
0.15Y = 10 + S

At the equilibrium level of national income, this is:

0.15 ¥ 280 = 10 + S
42 = 10 + S
S = 32

(c) Value of withdrawals at the equilibrium level of national income

At the equilibrium level of national income, withdrawals are given by:

W = S +T
= 32 + 0.1 ¥ 280
= 60

(d) New level of national income if government expenditure increases

by €10m

The equilibrium level of national income is Y, where:

Y = AD = C + I + G
= 10 + 0.75Y + 20 + 50
= 80 + 0.75Y
0.25Y = 80
Y = 320

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18 Subject CT7, April 2015, Question 33 (part)

(i) The equilibrium level of national income

Approach 1

Equilibrium arises when actual output equals aggregate demand, ie:

Y = AD = C + I + G
= 0.6Y + 20 + 80
= 0.6Y + 100

So:

Y = 250

Approach 2

All income is either spent on consumption or withdrawn from the circular

flow. So:

Y = C + S +T
= 0.6Y + S + T

ie S + T = 0.4Y

Equating injections and withdrawals then gives:

I + G = S +T
20 + 80 = 0.4Y

So:

Y = 250

(ii) The government’s tax revenue and the level of savings

As government spending is €80bn and the budget deficit is €17.5bn, so:

T = G - 17.5 = 80 - 17.5 = 62.5

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Approach 1

In equilibrium, injections equal withdrawals, so:

I + G + X = S +T + M

 20 + 80 + 0 = S + 62.5 + 0

 S = 20 + 80 - 62.5 = 37.5

Approach 2

All income is spent on either consumption or withdrawals, so:

Y = C + S +T + M

 S = Y - C -T - M
= 250 - 0.6 ¥ 250 - 37.5 - 0
= 62.5

(iii) The proportion of national income that is invested

20
= 0.08 , or 8%
250

19 Subject CT7, September 2016, Question 34

(a) Gross national income

Gross domestic product plus net income from abroad.

It represents the total income generated by factors of production owned by

domestic citizens regardless of where the factors are located.

(b) Depreciation

The reduction in value of capital equipment due to physical wear and tear
and/or obsolescence.

(c) Net national income

Gross national income less depreciation.

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20 Subject CT7, April 2017, Question 35

(a) The equilibrium value of national income

At equilibrium, national income (Y ) equals planned expenditure (E ) . So:

Y =E
= C +I +G
= £10m + 0.75Y + £20m + £40m
= 0.75Y + £70m
= £280m

Alternatively, at equilibrium, planned injections equal planned withdrawals.

In this case I + G = S , ie 20 + 40 = 0.25Y - 10 , so Y = £280m .

(b) Savings at the equilibrium value of national income

The equilibrium value of national income is £280m and S = 0.25Y - £10m .

Therefore, S = £60m .

Alternatively, at equilibrium, planned injections equal planned withdrawals.

In this case I + G = S , so S = 20 + 40 = £60m .

(c) The value of injections at the equilibrium value of national income

At the equilibrium value of national income, planned injections equal planned

withdrawals, ie I + G = S = £60m .

(d) The new level of national income

At equilibrium, national income (Y ) equals planned expenditure (E ) . So:

Y =E
= C +I +G
= £10m + 0.75Y + £20m + £50m
= 0.75Y + £80m
= £320m

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Alternatively, we could use the multiplier (k ) :

1 1
k == = =4
1 - mpcd 1 - 0.75

Therefore DY = DG ¥ k = £10m ¥ 4 = £40m and the new level of national

income is £320m (£280m + £40m ) .

21 Subject CT7, October 2017, Question 32

(i) Value of the multiplier

The value of the multiplier k is given by:

Y 120
k   2.4
E 50

(ii)(a) Marginal propensity to consume

The marginal propensity to consume domestic goods is given by:

Cd 85
mpcd    0.802
Y 106

(ii)(b) Size of multiplier given mpcd in (ii)(a)

The value of the multiplier k is given by:

1 1
k   5.05
1  mpcd 1  0.802

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Long-answer questions

1 Subject CT7, September 2010, Question 37

(i) The Keynesian explanation of the business cycle

Keynesian theory supports the view that changes in aggregate demand

cause fluctuations in output over the business cycle.

At the bottom of the cycle, in a recession, the economy is suffering from low
aggregate demand, high unemployment and a lack of business confidence.
Prices, wages, rents and interest rates are low and banks may be reluctant
to lend.

The recovery begins when aggregate demand revives. This may happen
because:
 consumption and investment might have reached a floor, so consumers
will need to replace durable goods and firms will need to replace
worn-out capital to survive competitive pressures. (These echo effects
will lead to an increase in aggregate demand.)
 low interest rates might also encourage consumers and firms to borrow
in order to spend and invest
 increased demand from abroad, perhaps due to a low exchange rate,
could lead to increased exports.

There will be a rapid expansion as output and income grow and

unemployment falls. As consumer and business confidence return, financial
well-being increases, banks increase lending and a wave of optimism takes
over, consumer spending and investment spending increase and firms
increase stock levels.

Eventually, the expansion turns into a boom, with high aggregate demand
and low unemployment. Prices, wages, rents and interest rates are high due
to capacity constraints.

The decline begins as aggregate demand falls. This may happen because:
 national output has reached its natural ceiling and factor and goods
prices are high, so firms and consumers cut back on investment and
consumption

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 high interest rates, restrictions in bank lending and/or a fall in business

and consumer confidence result in further reductions in investment and
consumption.

As a consequence, national output and employment begin to fall.

(ii) The interaction of the multiplier and the accelerator in the business
cycle

The multiplier is the ratio of the change in national income to the change in
injections that caused it.

A change in injections (investment, government spending and exports) has a

multiplier effect on income. This is because the initial increase in aggregate
demand increases income and this increase in income causes further
increases in consumption and hence further increases in income.

The multiplier is larger, the larger the marginal propensity to consume

domestic goods (or the lower the marginal propensity to withdraw spending
from the circular flow of income (in the form of savings, taxation and
imports)).

According to the accelerator theory, new investment depends on the rate of

change of national income. Thus, percentage changes in investment tend to
be much greater than percentage changes in income.

The multiplier and the accelerator interact to magnify the booms and slumps
in the business cycle.

At the recovery stage, when income is rising, investment increases to

provide additional capacity to cope with the increase in demand (the
accelerator effect). Since investment is an injection into the circular flow of
income, any change in investment then has a multiplier effect on national
income.

In the rapid expansion stage, as the rate of increase in income increases,

new investment increases and this causes a further increase in income.

In the boom stage of the business cycle, as the economy approaches

full-capacity output, the rate of increase in national income slows down, and
therefore new investment falls (via the accelerator).

Thus, income falls (via the multiplier) leading to further falls in investment
(via the accelerator). In other words the negative multiplier and accelerator
effects come into operation and the economy moves into recession.

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2 Subject CT7, September 2013, Question 38

(i)(a) The effect of an increase in business confidence

The following diagram shows an initial equilibrium position.

E=Y
planned
expenditure, E
E1 = C + I1

o
45
Y1 Ye1 Y2 GDP, Y

In a simple economy with no public sector and no trade:

E1 = C + I1

For equilibrium, E1 = Y . Using the 45 line, which shows the locus of points
at which E = Y , the initial equilibrium income must be Ye1 since here, the
amount that people and firms want to buy is equal to the amount produced.

If business confidence increases, the level of investment will increase and

therefore the level of aggregate demand (or planned expenditure, E) will
increase from E1 to E2 .

E=Y
planned unplanned
E2 = C + I2
expenditure, E decrease
in stock E1 = C + I1

I

o
45
Ye1 Ye2 GDP, Y

Y
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At the original level of equilibrium income, Ye1 , people and firms want to buy
more than is actually produced, so there is an unplanned decrease in stock
levels. Firms will consequently produce more to satisfy demand and restore
stock levels. Output will continue to rise until a new equilibrium is reached at
Ye 2 .

The change in investment causes income to change by a multiple of the

change in investment, ie DY = k DI , where k is the injections multiplier.

This occurs because as firms increase output and employment to cope with
the extra investment demand. This creates extra income for the owners of
the factors of production employed, which then leads to further increases in
consumption of domestically produced goods and hence more income. The
higher the marginal propensity to consume domestic goods out of national
income ( mpcd ), the higher the multiplier effect will be. This can be seen in
the following formula:

1
k=
1 - mpcd

(i)(b) The effect of an increase in marginal propensity to consume

The marginal propensity to consume (mpc) is the proportion of any increase

in income that is spent on any goods and services. This is the same as the
marginal propensity to consume domestically produced goods and services
out of national income ( mpcd ) when there are no imports, as all spending is
on domestic goods.

In a simple model, the only alternative to spending is saving, so the mpc

might increase if it becomes more advantageous to spend rather than save,
eg if interest rates decrease or if consumer confidence increases.

DC
The mpc can be calculated as and is the gradient of the consumption
DY
function (and of the aggregate demand function when there are no imports).

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E=Y
planned E3 = C2 + I1
expenditure, E
E1 = C1 + I1

o
45
Ye1 Ye3 GDP, Y

If there is an increase in the mpc, the gradient of the aggregate demand

schedule increases.

Since people are consuming a higher proportion of any extra income they
receive, there is excess demand at the original income, which leads to an
unplanned decrease in stocks. Firms respond to this by increasing output
and employment to meet the additional demand. This process continues
and output increases until the new equilibrium is reached at Ye3 .

There is no multiplier effect in this case. However, the change in the mpc
causes a change in the value of the multiplier. Since the mpc has increased,
the value of the multiplier has also increased. This means that any
subsequent increase in injections will have a greater multiplier effect on
income.

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(ii) Inflationary and deflationary gaps

An inflationary gap

E=Y
planned E3 = C2 + I1
expenditure, E inflationary
gap

o
45
Yf Ye3 GDP, Y

A deflationary gap

E=Y
deflationary
planned
gap
expenditure, E E3 = C2 + I1

o
45
Ye3 Yf GDP, Y

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3 Subject CT7, October 2015, Question 38

(i) Multiplier within the Keynesian model of aggregate expenditure

The (injections) multiplier is the number of times greater the change in

equilibrium national income or GDP is to the change in injections that
caused it, ie:

DY DGDP
k= =
DJ DJ

The multiplier therefore means that an increase / decrease in investment,

government spending, exports or autonomous consumption will lead to a
greater absolute, ie a multiplied, increase / decrease in equilibrium national
income. This is shown in the diagram above.

E=Y
planned E2
expenditure, E
E1

E

o
45

Y e1 Y e2 GDP, Y

Y
Starting from an initial equilibrium national income of Ye1 , an increase in
injections of DJ , which increases total aggregate expenditure from E1 to
E2 , will result in a greater absolute increase in equilibrium national income
of:

DY = Ye 2 - Ye1 > DJ

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(ii) Why some countries have a smaller multiplier than others

The multiplier can be calculated as:

1 1
k= =
1 - mpcd mps + mpt + mpm

where:
 mpcd = the marginal propensity to consume domestically produced
goods and services
 mps = marginal propensity to save
 mpt = marginal propensity to pay tax
 mpm = marginal propensity to consume imported goods and services.

In each case, the marginal propensity is the proportion of each extra unit of
income that is spent in the way mentioned.

The value of the multiplier will be therefore be smaller the lower is the mpcd
and the higher are the values of the mps, mpt and mpm.

The mps might be higher in countries:

 with a tradition of higher saving
 that typically have higher interest rates and so the reward for saving is
greater
 with a higher GDP per capita and so a higher proportion of income is left
over after paying for everyday consumption.

Tax rates, and hence the mpt, might be higher in countries with:
 more highly developed welfare systems to fund
 a commitment to a lower level of fiscal deficit and/or national debt
relative to GDP.

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The mpm is likely to be higher in countries with:

 more specialised economies, which therefore need to import the goods
and services that aren’t produced domestically
 fewer natural resources (eg developed economies with little land)
 more free trade agreements with other countries and hence higher
volumes of trade.

4 Subject CT7, October 2017, Question 38

(a) Decrease in government expenditure on healthcare

A decrease in government spending on healthcare will lead to a reduction in

aggregate demand (AD).

Consequently, the AD curve will shift to the left, ie from AD1 to AD2 on the
diagram below.

The resulting excess of aggregate supply (AS) over AD will lead to:

 a fall in the average price level from p1 to p2

 a reduction in real GDP from Y1 to Y2 , ie a recession

 a fall in employment, as firms will employ fewer workers to produce the

reduced level of output.

average
price SRAS
level, p

p1 AD1
p2
AD2

Y2 Y1 real GDP (Y)

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(b) A rise in the price of oil

A rise in the price of oil will lead to an increase in production costs and
hence a reduction in aggregate supply (AS).

Consequently, the short-run AS curve will shift to the left, ie from SRAS1 to
SRAS2 on the diagram below.

The resulting shortfall of AS compared to AD will lead to:

 a rise in the average price level from p1 to p2

 a reduction in real GDP from Y1 to Y2

 a fall in employment, as firms will employ fewer workers to produce the

reduced level of output.

If cost increases persist and prices continue to rise, the economy will be
suffering from cost-push inflation.
SRAS2
average
price SRAS1
level, p

p2
p1 AD

Y2 Y1 real GDP (Y)

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FINAL COMMENTS

Finally, we set out a checklist of the definitions, formulae and explanations

that we think you most need to know for this topic. We have based this upon
past exam papers in this subject and on what we feel are likely questions in
the future, bearing in mind the contents of the syllabus and Core Reading.

This list, however, cannot be considered exhaustive. In particular, you must

always remember that the examiners can ask a question on any part of the
Core Reading. So there is always a possibility that some ‘new’ area, –
ie one that has not been examined before – might come up, particularly on
the topics that were first introduced to the Subject CB2 Syllabus in 2019.

There is a lot to learn for Subject CB2. One useful way of learning lists of
ideas is via acronyms and mnemonics, and the best ones are probably those
that you create yourself. Beware though that you don’t just write down what
you have learned without considering carefully the specific situation given in
the question. The examiners are keen to see that you can apply your
knowledge intelligently to the question. By intelligently, we mean that only
those points from the list that are relevant to the specific question being
asked should be included in your answer. It is by selection that you
demonstrate understanding to the examiner, rather than just the ability to
memorise lists of facts.

We also stress that learning definitions, formulae etc is not a substitute for
understanding. Many of the explanations we have described in this booklet
(and in the course) become ‘obvious’ once you have fully understood the
concepts involved. So, if you do not feel that the subject has become
‘obvious’ to you, then it may be that you need to take a step back and revisit
the Course Notes, or maybe do some more Q&A Bank questions.

Finally we stress again how useful and important it is to do some exam

questions, including preferably a complete past paper or Mock Exam, under
examination conditions. Only by completing questions successfully in the
time and conditions available in the exam room will you know if you are fully
prepared to sit the exam.

We hope that you have found this booklet to be a useful revision aid. If you
have any comments that might help us to improve this set of booklets then
please email your ideas to [email protected].

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CHECKLIST

This checklist can be used as a detailed set of learning objectives that you
need to have mastered for this part of the Subject CB2 exam. Note that the
objectives listed below correspond to those in the checklists in Modules 2,
11, 16, 17 and 23 of the Course Notes.

You can use the boxes that follow each item to indicate when you have first
understood the objective (a), and when you have become fully fluent with it
(z) (ie you have reached exam speed – being able to perform the task
required under exam conditions and in the time available).

1 Define the following key terms:

 surplus value (a): ______(z): ______
 labour power (a): ______(z): ______
 heterodox economists. (a): ______(z): ______

2 Describe Marx’s labour theory of value. (a): ______(z): ______

3 Explain why Marx predicted the collapse of capitalism.

(a): ______(z): ______

4 Explain why the Austrian school:

 believes central planning would be impossible (a): ______(z): ______
 places little weight on modelling equilibrium outcomes.
(a): ______(z): ______

5 Give an example of irrational behaviour and explain how, according to the

Austrian school, the market can cope with irrational behaviour.
(a): ______(z): ______

6 Explain the Austrian school’s view of government intervention in the form of:
 providing a legal framework (a): ______(z): ______
 regulation (a): ______(z): ______
 monetary policy. (a): ______(z): ______

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7 Define the following key terms:

 rate of economic growth (a): ______(z): ______
 business cycle or trade cycle (a): ______(z): ______
 number unemployed (economist’s definition) (a): ______(z): ______
 labour force (a): ______(z): ______
 unemployment rate (a): ______(z): ______
 rate of inflation (a): ______(z): ______
 balance of payments account (a): ______(z): ______
 exchange rate (a): ______(z): ______
 financial instruments (a): ______(z): ______
 financialisation (a): ______(z): ______
 economic agents (a): ______(z): ______
 balance sheet (a): ______(z): ______
 asset (a): ______(z): ______
 liability (a): ______(z): ______
 net worth. (a): ______(z): ______

8 Describe why the financial system is important to economies.

(a): ______(z): ______

9 Explain how financial well-being of the country can be analysed.

(a): ______(z): ______

10 State the five main macroeconomic objectives. (a): ______(z): ______

11 Give examples of macroeconomic policy instruments.

(a): ______(z): ______

12 Define the following key terms:

 withdrawals (W) or leakages (a): ______(z): ______
 transfer payments (a): ______(z): ______
 injections (J). (a): ______(z): ______

13 Distinguish between money and income in terms of stock and flow concepts.
(a): ______(z): ______

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14 Draw and explain the circular flow diagram. (a): ______(z): ______

15 Explain why planned withdrawals need not equal planned injections.

(a): ______(z): ______

16 State the condition for an equilibrium level of national income.

(a): ______(z): ______

17 Explain how equilibrium is restored if there is a change in withdrawals or

injections. (a): ______(z): ______

18 Define the following key terms:

 gross domestic product (GDP) (a): ______(z): ______
 gross value added (GVA) at basic prices (a): ______(z): ______
 stock (or inventory) appreciation (a): ______(z): ______
 GDP at market prices (a): ______(z): ______
 gross national income (GNY) (a): ______(z): ______
 depreciation (a): ______(z): ______
 net national income (NNY) (a): ______(z): ______
 households’ disposable income (a): ______(z): ______
 nominal GDP (a): ______(z): ______
 real GDP (a): ______(z): ______
 purchasing power parity (PPP) exchange rate (a): ______(z): ______
 purchasing power standard (PPS) GDP (a): ______(z): ______
 social capital (OECD definition). (a): ______(z): ______

19 Calculate GDP at market prices and basic prices by the:

 product method (a): ______(z): ______
 income method (a): ______(z): ______
 expenditure method. (a): ______(z): ______

20 Calculate GNY and NNY at market prices and basic prices.

(a): ______(z): ______

21 Calculate households’ disposable income. (a): ______(z): ______

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22 Describe the ways in which national income figures can be adjusted to take
account of inflation, population and different currencies.
(a): ______(z): ______

23 Discuss the problems involved in using real per capita PPS GDP as an
indicator of the standard of living. (a): ______(z): ______

24 Define the following key terms:

 GDP deflator (a): ______(z): ______
 international substitution effect (a): ______(z): ______
 inter-temporal substitution effect (a): ______(z): ______
 real balance effect. (a): ______(z): ______

25 Explain the shapes of the AD and (short-run) AS curves.

(a): ______(z): ______

26 Use the AD-AS diagram to:

 show the equilibrium price level and the equilibrium level of real national
income (a): ______(z): ______
 analyse the effect of a change in AD or AS on the equilibrium position.
(a): ______(z): ______

27 Define the following key terms:

 market for loanable funds (a): ______(z): ______
 gold standard (a): ______(z): ______
 Say’s law (a): ______(z): ______
 quantity theory of money (a): ______(z): ______
 equation of exchange (a): ______(z): ______
 velocity of circulation (a): ______(z): ______
 neutrality of money (a): ______(z): ______
 crowding out (a): ______(z): ______
 money illusion (a): ______(z): ______
 natural level of real income (or output). (a): ______(z): ______

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28 Explain why, according to classical theory:

 savings equals investment (a): ______(z): ______
 imports equals exports (a): ______(z): ______
 taxation must equal government spending (a): ______(z): ______
 there will be no deficiency of demand (and therefore no unemployment)
(a): ______(z): ______
 an increase in the money supply causes inflation.
(a): ______(z): ______

29 Discuss some of the main causes of the Great Depression in the UK in the
1930s. (a): ______(z): ______

30 Discuss the classical view of the following policies to combat the depression:
 encouraging wage cuts (a): ______(z): ______
 encouraging saving (a): ______(z): ______
 public works projects. (a): ______(z): ______

31 Use the labour market model to explain why classical economists believe
that the labour market is always at equilibrium and that only natural
unemployment will occur. (a): ______(z): ______

32 Use the AD-AS model to explain why classical economists believe that the
long-run AS curve is vertical. (a): ______(z): ______

33 Define the following key terms:

 multiplier effect (a): ______(z): ______
 fiscal policy (a): ______(z): ______
 monetary policy (a): ______(z): ______
 demand-management policies (a): ______(z): ______
 stop-go policies. (a): ______(z): ______

34 Explain how Keynes criticised the classical:

 policy of cutting wages (a): ______(z): ______
 loanable funds theory (a): ______(z): ______
 quantity theory of money (a): ______(z): ______

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 Say’s law. (a): ______(z): ______

35 Explain why Keynes concluded that a market economy is unlikely to achieve

full employment. (a): ______(z): ______

36 Explain Keynes’ main policy recommendation to achieve full employment

and stable prices. (a): ______(z): ______

37 Give an example of a fiscal and a monetary policy that could be used:

 if aggregate demand is too low (a): ______(z): ______
 if aggregate demand is too high. (a): ______(z): ______

38 Describe the criticisms of Keynesian policies that emerged in the 1960s.

(a): ______(z): ______

39 Use the labour market model to explain why Keynesian economists believe
that the labour market is not always at equilibrium and that demand-deficient
unemployment can occur. (a): ______(z): ______

40 Use the AD-AS model to explain why Keynesian economists believe that the
short-run AS curve may be horizontal and that the long-run AS curve is not
vertical. (a): ______(z): ______

41 Define the following key terms:

 aggregate expenditure (E) (a): ______(z): ______
 endogenous variable (a): ______(z): ______
 exogenous variable (a): ______(z): ______
 consumption function (a): ______(z): ______
 marginal propensity to consume (a): ______(z): ______
 disposable income (a): ______(z): ______
 consumption smoothing (a): ______(z): ______
 credit-constrained households (a): ______(z): ______
 debt-servicing costs (a): ______(z): ______
 marginal propensity to save (a): ______(z): ______
 marginal tax propensity (a): ______(z): ______
 marginal propensity to import (a): ______(z): ______
 marginal propensity to withdraw. (a): ______(z): ______

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42 Draw a consumption function of the form C = a + bY and explain the

relationship between consumption and income. (a): ______(z): ______

43 Discuss the main factors (other than income) that affect consumption.
(a): ______(z): ______

44 Describe the difference between the marginal propensity to consume and

the marginal propensity to consume out of disposable income.
(a): ______(z): ______

45 Distinguish between factors that cause:

 a movement along the consumption function (a): ______(z): ______
 a change in the slope of the consumption function, (ie change in b)
(a): ______(z): ______
 a change in the position of the consumption function (ie change in a).
(a): ______(z): ______

46 Explain why the consumption function might be steeper in the long run than
in the short run. (a): ______(z): ______

47 Draw and explain the relationship between total consumption (C) and the
consumption of domestically produced goods and services ( Cd ).
(a): ______(z): ______

48 Draw and explain the withdrawals function ( W = S + T + M ) .

(a): ______(z): ______

49 Describe the factors that affect:

 net savings (a): ______(z): ______
 net taxes (a): ______(z): ______
 imports. (a): ______(z): ______

50 State the relationship between Cd and W. (a): ______(z): ______

51 Draw and explain the injections function ( J = I + G + X ).

(a): ______(z): ______

52 Discuss the main factors that affect:

 investment (a): ______(z): ______
 government spending (a): ______(z): ______

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 exports. (a): ______(z): ______

53 Define the following key terms:

 (injections) multiplier (a): ______(z): ______
 (injections) multiplier formula (a): ______(z): ______
 principle of cumulative causation. (a): ______(z): ______

54 State the two conditions for equilibrium national income.

(a): ______(z): ______

55 Draw the Keynesian 45 diagram showing equilibrium national income where
Y = E. (a): ______(z): ______

56 Draw a diagram to show equilibrium national income where W = J.

(a): ______(z): ______

57 Explain:
 how equilibrium national income is restored if the economy is not initially
at equilibrium (a): ______(z): ______
 the effect of a change in injections or withdrawals on the equilibrium
level of national income (a): ______(z): ______
 why a change in injections has a multiplier effect on national income.
(a): ______(z): ______

58 Calculate:
 equilibrium national income within a Keynesian model
 the (injections) multiplier (a): ______(z): ______
 the tax multiplier. (a): ______(z): ______

59 Derive the formula for the injections multiplier. (a): ______(z): ______

60 Explain why the tax multiplier is one less than the injections multiplier.
(a): ______(z): ______

61 Define the following key terms:

 full-employment level of national income (a): ______(z): ______
 deflationary (or recessionary) gap (a): ______(z): ______
 inflationary gap. (a): ______(z): ______

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62 Draw diagrams to show and describe policies to close:

 a deflationary gap (a): ______(z): ______
 an inflationary gap. (a): ______(z): ______

63 Explain why an inflationary gap might close automatically.

(a): ______(z): ______.

64 Draw, and explain the shape of, the aggregate supply curve that is:
 implied by the simple Keynesian model (a): ______(z): ______
 likely in practice. (a): ______(z): ______

65 Explain why unemployment and inflation can exist at the same time.
(a): ______(z): ______

66 Explain how the existence of unemployment and inflation at the same time
impedes demand-management policies. (a): ______(z): ______

67 Explain why the multiplier process following an increase in aggregate

demand reduces as the economy approaches full employment and ceases
to operate when the economy reaches full employment.
(a): ______(z): ______

68 Define the following key terms:

 accelerator theory (a): ______(z): ______
 induced investment (a): ______(z): ______
 accelerator coefficient (a): ______(z): ______
 marginal capital/output ratio. (a): ______(z): ______

69 Explain the Keynesian view of the causes of the business cycle in terms of
fluctuations in aggregate demand, particularly private sector spending,
compounded by market imperfections. (a): ______(z): ______

70 Explain the accelerator theory of investment. (a): ______(z): ______

71 Explain why the size of the accelerator effect is difficult to predict.

(a): ______(z): ______

72 Discuss how the multiplier and accelerator interact to increase the swings in
output over the course of the business cycle. (a): ______(z): ______

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73 Describe changes in the following over the course of the business cycle:
 stocks (a): ______(z): ______
 borrowing and debt. (a): ______(z): ______

74 Give three reasons for the persistence of booms and slumps.

(a): ______(z): ______

75 Give six reasons for turning points in the business cycle.

(a): ______(z): ______

76 Define the following key terms:

 stagflation (a): ______(z): ______
 natural rate of unemployment (a): ______(z): ______
 adaptive expectations hypothesis (a): ______(z): ______
 supply-side policies. (a): ______(z): ______

77 Outline the reasons for the rise of monetarism. (a): ______(z): ______

78 Explain how, according to monetarists:

 an increase in the money supply causes ever-increasing inflation in the
long run (a): ______(z): ______
 an increase in the money supply might result in lower unemployment in
the short run but not in the long run (a): ______(z): ______
 a decrease in the money supply will reduce inflation without increasing
unemployment in the long run. (a): ______(z): ______

79 Explain why monetarists suggest that the government should set targets for
the rate of growth of the money supply. (a): ______(z): ______

80 Explain why, according to monetarists, the long-run Phillips curve is vertical.

(a): ______(z): ______

81 Explain why, if the government wishes to reduce the natural level of

unemployment, it should use supply-side policies to do so.
(a): ______(z): ______

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82 Define the following key terms:

 new classical school (a): ______(z): ______
 continuous market clearing (a): ______(z): ______
 rational expectations (a): ______(z): ______
 policy ineffectiveness proposition (a): ______(z): ______
 real business cycle theories. (a): ______(z): ______

83 Explain why, according to the new classical school, an anticipated change in

aggregate demand will lead to a rise in prices but no increase in output or
employment in the short run. (a): ______(z): ______

84 Explain why monetary surprises that could increase unemployment will not
occur in the new classical model. (a): ______(z): ______

85 Explain the real business cycle theory, giving examples of supply-side

shocks or impulses. (a): ______(z): ______

86 Give examples of monetarist and new classical policies introduced from the
1980s. (a): ______(z): ______

87 Define the following key terms:

 expectations-augmented Phillips curve (a): ______(z): ______
 natural rate hypothesis. (a): ______(z): ______

88 Describe the expectations-augmented Phillips curve with reference to

adaptive expectations. (a): ______(z): ______

89 Explain the implications of the assumptions regarding the formation of

expectations and the speed of market clearing for the natural rate
hypothesis. (a): ______(z): ______

90 Define the following key terms:

 accelerationist hypothesis (a): ______(z): ______
 political business cycle. (a): ______(z): ______

91 Describe the short-run and long-run effects of both expansionary and

contractionary policy within the context of the accelerationist hypothesis.
(a): ______(z): ______

92 Outline the implications of the accelerationist hypothesis for the long-run

Phillips curve. (a): ______(z): ______

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93 Explain two possible causes of stagflation. (a): ______(z): ______

94 Describe the way in which the monetarist adaptive expectations model

illustrates the political business cycle. (a): ______(z): ______

95 Outline the implications of the monetarist model for economic policy

(ie demand-side policy, supply-side policy and the use of rules and targets).
(a): ______(z): ______

96 Define the following key terms:

 new Keynesians (a): ______(z): ______
 efficiency wage hypothesis (a): ______(z): ______
 insiders and outsiders (a): ______(z): ______
 hysteresis (a): ______(z): ______
 non-accelerating inflation rate of unemployment (NAIRU).
(a): ______(z): ______

97 Draw a diagram to show the effect of menu costs on a monopolistically

competitive firm faced with a decrease in demand. (a): ______(z): ______

98 Explain the implications of price rigidity for the new classical view that real
output is not affected by changes in aggregate demand.
(a): ______(z): ______

99 Describe six sources of market imperfections. (a): ______(z): ______

100 Explain why hysteresis might cause the natural or NAIRU rate of
unemployment to increase. (a): ______(z): ______

101 Describe the Keynesian view of demand-management policies.

(a): ______(z): ______

102 Give a broad outline of the development of macroeconomic theory including:

 classical period (1920s and 1930s) (a): ______(z): ______
 Keynesian period (1940s to 1960s) (a): ______(z): ______
 controversial monetarist period (1970s and 1980s)
(a): ______(z): ______
 consensus (1990s and 2000s) (a): ______(z): ______
 post-crisis debates (2008 onwards). (a): ______(z): ______

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103 Explain the different views on:

 the flexibility of prices and wages (a): ______(z): ______
 the flexibility of aggregate supply (a): ______(z): ______
 the role of expectations (prices and output) (a): ______(z): ______
 the importance of reducing budget deficits (a): ______(z): ______
 the role of government in the economy (a): ______(z): ______
 the importance of the short run and the long run (a): ______(z): ______
 the closeness of the economy to full employment
(a): ______(z): ______
 the possibility of hysteresis (a): ______(z): ______
 demand-side and supply-side policies for growth (a): ______(z): ______
 market-orientated and interventionist supply-side policies.
(a): ______(z): ______

104 Define the following key terms:

 dynamic stochastic general equilibrium (DSGE) models
(a): ______(z): ______
 stochastic shocks (a): ______(z): ______
 constrained discretion (a): ______(z): ______
 inflation bias. (a): ______(z): ______

105 Describe the consensus of beliefs that emerged in the period known as the
Great Moderation. (a): ______(z): ______

106 Explain the following elements of DSGE models:

 dynamic (a): ______(z): ______
 stochastic (a): ______(z): ______
 general equilibrium (a): ______(z): ______
 market imperfections and frictions. (a): ______(z): ______

107 Explain how central bank independence supports a policy of constrained

discretion. (a): ______(z): ______

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108 Define the following key terms:

 sovereign debt crisis (a): ______(z): ______
 post-Keynesians (a): ______(z): ______
 paradox of debt (or of deleveraging) (a): ______(z): ______
 downward causation. (a): ______(z): ______

109 Describe the reasons given by economists for the financial crisis.
(a): ______(z): ______

110 Describe the fiscal policies adopted by many governments in response to

the financial crisis and in its aftermath. (a): ______(z): ______

111 Discuss the stimulus-austerity debate after 2008. (a): ______(z): ______

112 Describe the views of the post-Keynesian economists who were never
participants in the new classical-new Keynesian consensus.
(a): ______(z): ______

113 Explain the paradox of thrift and the paradox of debt. (a): ______(z): ______

114 Describe the criticisms of the models used and assumptions made by the
new classical-new Keynesian consensus. (a): ______(z): ______

115 Summarise areas of general agreement among economists.

(a): ______(z): ______

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NOTES

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NOTES

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NOTES

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NOTES

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NOTES

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NOTES

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EXAM PREPARATION CHECKLIST

Past Exam Questions

We recommend that you work through as many questions as possible under

exam conditions. By doing so, you’ll get used to the style of question asked,
the style of answers required and to working under time pressure. Keep a
note of which questions you have attempted and when. Watch your
multiple-choice score improve!

Multiple-choice questions (1½ marks per question)

Attempt Date Score (max 130½)

1
2
3

Short-answer (S) and long-answer (L) questions

Q Date Q Date Q Date

S1 S12 L1
S2 S13 L2
S3 S14 L3
S4 S15 L4
S5 S16
S6 S17
S7 S18
S8 S19
S9 S20
S10 S21
S11

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