Revision areas

1 Define GDP.

Answer
GDP is the total value of final goods and services produced in a nation in a given
time period.
2 Which of the following is included in the GDP and which are excluded?
i) Second hand cars sold in the given year
ii) Imputed rent on homes occupied by the owners.
iii) Vegetable grown for own consumption.
Answer
i) Second hand cars traded in a given year is excluded as the value of the
cars were included in the GDP in the year they were produced.
ii) Imputed rent is included
iii) Vegetables produced for own consumption is not included as there is
no recorded data.
3 Compute the GDP at cost price.
C = $10m
I = $2m
G =$3m
X = $4m
M= $2m
Depreciation =$2m
Indirect taxes = $2m
Subsidies= $1m
Answer
GDP market price = C+I+G+NX – Indirect taxes + Subsidies= $(10+2+3+4-2-
2+1)m = $16m

4 Calculate the household consumption using the following information.

 GDP = $5,000
 Private investment = 1,000
 Government spending = $1,500
 Net exports = $500
Answer

GDP(Y) = C + I + G + NX
$5000 = C + $1000 + $1500 + $500
C = $5000 - $1000 - $1500 - $ 500 = $ 2000
5 Compute the GDP and households disposable income of a small economy if the
household consumption is $3,000; government expenditure is $2,000; exports are
$500; import is $600; transfer payments $ 800; tax collected is $1000, and
investment $1,200.

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 Answer
GDP(Y) = C + I + G + NX
Y = $3000 + $1200 + $2000 + $500 - $600 = $6100
Households disposable income (Yd) = Y + transfer payments – T= $6100 + $800 -
$1000 = $5900
6 What is the purpose of computing CPI and inflation rate?
Answer
A consumer price index (CPI) measures changes in the price level of a market
basket of consumer goods and services purchased by households. The CPI is a
statistical estimate constructed using the prices of a sample of representative items
whose prices are collected periodically.

Inflation rate is the percentage increase in te eneral level of prices over a period. It
represents the rate at which the purchasing power of money has eroded over a
period.

The general economy-wide inflation rate is calculated as the rate of change in

consumer price index (CPI) over a period using the following formula:
Inflation Rate Current Period CPI − Prior Period CPI
= Prior Period CPI
7 What are the reasons the CPI to be overstated?
Answer
CPI is overstated because the items in the basket are fixed. There are three types of
biases causing the CPI to be overstated.

Quality bias
An example would be enhanced performance of personal computers. Generally
speaking, greater and greater speeds and features have become available, without
substantial increases in price. Quality bias can cause a consumer price index (CPI)
to be overestimated, since a CPI may not completely reflect quality improvements.

Substitution bias
The substitution bias is a weakness in the Consumer Price Index that overstates
inflation because it does not account for the substitution effect, when consumers
choose to substitute one good for another after its price becomes cheaper than the
good they normally buy.

Introduction of new goods bias

The third problem with the CPI is the introduction of new items. As time goes on,
new items, enter into the basket of goods and services purchased by the typical
consumer. For example, if in time period 4 consumers in Country B began to
purchase books, this would need to be included in an accurate estimate of the cost
of living. But since the CPI uses only a fixed basket of goods, the introduction of a
new product cannot be reflected. Instead, the new items, books, are left out of the

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 calculation in order to keep time period 4 comparable with the earlier time periods.

8 What is the similarity between CPI and a GDP deflator?

Answer
CPI and GDP deflator are used to measure the inflation rate of an economy.
9 a) If the price of a textbook was $100 in 2010 and the CPI in 2010 was 105.
What is the price of the textbook in 2022 if the CPI for 2022 was 210?
b) Given the nominal wage as $10 per hour and the price index was 110, what
is the real wage?
Answer

a) Price of the textbook in 2022 = Price textbook 2010 x CPI(2022)?

CPI(2010)
= $100 x (210/105) = $200
b) Real wage = Nominal wage/Price Index x 100
= ($10 per hour of labor / 110 ) x 100 = 9.09
10 How to determine the living standard?
Answer
Productivity . Higher productivity means higher living standard.
11 Nation A has 2000 population and only 1500 are working and they work 10 hours
a day and produce 100,000 units of final goods. What is the labor productivity of
Nation A.

Answer
Labor productivity = total amount goods produced/ total labor hours used
Labor productivity = 100,000/ 1500 x 10 hrs = 6.67 units per labor hour.
12 Explain the effect of technological advancement.

Answer
Technological advancement will increase the labor productivity. Therefore, more
output can be produced with the given resources.
13 Distinguish between constant returns to scale and diminishing returns to scale.

Answer
The production function has the property constant returns to scale: Changing all
inputs by the same percentage causes output to change by that percentage. For
example, Doubling all inputs (multiplying each by 2) causes output to double: 2Y
= A F(2L, 2K, 2H, 2N)

Diminishing marginal returns are an effect of increasing input while at least one
production variable is kept constant, such as labor or capital, which occurs in the
short run.

14 What happened to output and productivity if an economy increases by x% its

workers, natural resources, and human capital, but the technology is constant and
the economy experiences constant returns to scale?

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 Answer
Output increase, but the productivity is constant due to constant returns.

15 Explain catch-up effect.

Answer
The idea of convergence in economics (also sometimes known as the catch-up
effect) is the hypothesis that poorer economies' per capita incomes will tend to
grow at faster rates than richer economies.

An additional capital given to a poor country will give an additional output which
is much greater than a rich country as the poor country is at a lower production
curve.

16 What is the difference between an inward trade policy and an outward trad policy?
Which policy will enhance economic growth?

Answer
Inward looking policy is like import substitution, basically putting
up trade barriers and trying to become self sufficient.

Outward looking policy is growth through exports, think of the tiger economies
(South Korea and Singapore).
17 Using the market for loanable fund model to examine the impact of an increase in
the rate of interest.
Answer
If the interest rate increases , the demand for loanable fund will fall and the supply
of loanable will increase causing the market for loanable fund to be in a
disequilibrium situation. The supply of loanable fund will be greater than he
demand for loanable fund, creating a surplus of loanable fund. The surplus of
loanable fund will cause the rate of interest to fall.
18 Examine the effect of the following events on the rate of interest and the amount
of loanable using the market for loanable fund model
i) The supply of loanable fund increase.
ii) The demand for loanable fund decreases.

Answer
i)

4
 r S
S1

r0 e
f
r1
D

Quantity of loanable fund

L0 L1

Initially, the demand for loanable fund and the supply of loanable fund
curves are represented by D and S respectively. The initial equilibrium
interest rate and quantity of loanable fund are ro and Lo respectively.
If the supply of loanable fund increases and the demand for loanable fund
to remain unaffected,will cause the interest rate to fall and the quantity of
loanable fund to increase. The new equilibrium interest rate is at r1 and the
new equilibrium quantity of loanable fund is L1.
ii)The demand for loanable fund decreases.
Answer

r S

r0
e
r1 f
D
D1

Quantity of loanable fund

L 1 L0

Initially, the demand for loanable fund and the supply of loanable fund
curves are represented by D and S respectively. The initial equilibrium
interest rate and quantity of loanable fund are ro and Lo respectively.If the
demand for loanable fund decreases and the supply of loanable fund to
remain unaffected,will cause the interest rate to fall and the quantity of
loanable fund to decrease. The new equilibrium interest rate is at r1 and the
new equilibrium quantity of loanable fund is L1.

19 What is a cyclical unemployment? What causes cyclical unemployment?

Answer
Cyclical unemployment is defined as workers losing their jobs due to business
cycle fluctuations in output, i.e. the normal up and down movements in the
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 economy as it cycles through booms and recessions over time.

Cause of cyclical unemployment.

Cyclical unemployment exists when individuals lose their jobs as a result of a
downturn in aggregate demand .If the decline in aggregate demand is persistent,
and the unemployment long-term, it is called either demand deficient
unemployment.
20 What are the two types of natural unemployment?

Answer
i) Structural unemployment
ii) Frictional unemployment
21 What causes frictional and structural unemployment?
Answer
Structural unemployment is a form of unemployment caused by a mismatch
between the skills that workers in the economy can offer, and the skills demanded
of workers by employers (also known as the skills gap). Structural unemployment
often occurs when the demand for specific types of labor changes as the economy
changes.

Frictional unemployment is when workers leave their jobs to find better ones. It's
usually thought of as a voluntary exit, but can also occur as a result of a layoff or
termination with cause.

22 What are the two components of the labor force?

Answer
i) Number labor force employed
ii) Number of labor force unemployed
23 Provide examples of those who are in the labor force.

Answer
 A fresh graduate looking for a job
 A man working as an engineer for a firm
24 Give examples of those who are not in the labor force.
Answer
People who working adult are neither working nor looking for work are counted as
“not in the labor force,”. The example of those not in the labor force is ill health or
disabled; retirees; homemakers; going to school; discouraged workers.
25 Examine , what happen to the labor force participation rate and the unemployment
rate if an employed person becomes unemployed and actively looking for a job.
Answer
i) The labor force participation rate remain the same
ii) Unemployment rate increases
26 What the functions of money?
Answer
i) Medium of exchange : Money is used by households, firms and

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 government to buy goods and services.
ii) Unit of account: Money is the common standard for measuring relative
worth of goods and service.
iii) Store of value: Money is the most liquid asset (Liquidity measures how
easily assets can be spent to buy goods and services). Money’s value
can be retained over time. It is a convenient way to store wealth

27 Examine the impact of an increase in money supply to:

 Interest rate
 Price
 Production or Real GDP
Answer

r MS MS1

r0 e
f
r1
DM

Quantity of money

M0 M1

The initial money market equilibrium is at point e, where the demand for money
(DM) curve intersects the money supply curve(MS). The interest rate was ro and
quantity of money was Mo. An increase in the money supply shifted the money
supply curve to MS1, shifting the equilibrium point to point f. The new equilibrium
interest rate and quantity of money is r1 and M1 respectively.

The decline in the interest rate will increase investment and hence the aggregate
demand, causing the aggregate demand to shift to the right. As a result, the real
GDP and price level increases.

28 List the components of M1 and M2 definition of money.

Answer
Money supply is the entire stock of currency and other liquid instruments in a
country's economy as of a particular time.

 M1: currency, demand deposits, traveler’s checks, and other checkable

deposits.
 M2 : M1 plus savings deposits, small time deposits, money market mutual
funds, and a few minor categories.

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29 What are the three monetary tools used by the Fed?
Answer
i) Reserve requirement ratio
ii) Discount rate
iii) Open market operation

30 What is a commercial bank asset and liability?

Answer
Assets : Reserves and Loans
Liability : Deposits
31 James deposited $1,000 in a commercial bank and if the commercial is required to
hold $100 as reserves.
i) What is the reserve requirement ratio?
ii) What is the value of the money multiplier?
iii) What is the total money supply in the economy if the commercial
loaned out all the excess reserves?
Answer
i) Reserve requires ratio = (Reserves/Deposits) x 100 = ($100/$1000) x
100 = 10%
ii) Money multiplier = (1/ reserve requirement ratio) x 100 = (1/10%) x
100 = 10
iii) Total money supply = Money multiplier x initial deposits = 10 x $1000
= $10,000
32 Use the following data to calculate the nominal GDP, Real GDP , GDP deflator
for 2013 and 2014 and the inflation rate. Use 2013 as the base year when
calculating the Real GDP.
Goods and 2013 2013 2014 Price 2014
Services Price per unit Quantity per unit Quantity
Haircuts $10 20 $12 24
Handbags $50 10 $60 12
Magazines $5 40 $6 50

Answer

The value of the The value of the The value of the

goods and The value of the goods and goods and
services goods and services services services
calculated at calculated at calculated using calculated using
current price current price base year price base year price
(2013) (2014) (2013) (2014)
$200 $288 $200 $240
$500 $720 $500 $600
$200 $300 $200 $250
Nominal GDP Nominal Real GDP 2013 Real GDP 2014
2013 = $900 GDP(2014)= = $900 = $1,090

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 $1,308

Nominal GDP(2013) $ 900

GDP deflator (2013) = x 100= x 100=100
Real GDP(2013) $ 900

Nominal GDP(2014) $ 1,308

GDP deflator (2014) = x 100= x 100=120
Real GDP(2014) $ 1,090

Inflation rate(2014) =
GDP deflator ( 2014 )−GDP Deflator (2013) (120−100)
x 100= x 100=20%
GDP deflator (2013) 100

33
Year Price of bread Quantity of Price of eggs Quantity of
breads eggs
2013 $2 20 $2 12
2014 $3 12 $3 20
2015 $4 40 $5 25

Using the data given in the table:

 Calculate the nominal GDP and real GDP in 2013, 2014 and 2015. Take
2013 as the base year.
 Calculate the GDP deflator for 2013, 2014 and 2015 .
 Calculate the inflation between 2013 and 2014, and between 2014 and
2015.
Answer

GDP
Year Nominal GDP Real GDP
Deflator
2013 $64 $64 100
2014 $96 $64 150
2015 $285 $130 219.2

Inflation rate(2014) =
GDP deflator ( 2014 )−GDP Deflator (2013) (150−100)
x 100= x 100=50 %
GDP deflator (2013) 100

Inflation rate(2015) =
GDP deflator ( 2015 ) −GDP Deflator (2014) (219.2−120)
x 100= x 100=46.13 %
GDP deflator(2014) 150

34 A basket of goods contains 10 apples and 20 breads. The price of breads and
apples are as stated in the table below. Use the given information appropriately to
calculate the cost of the baskets for each year, the consumer price index for each

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 year by taking 2014 as the base year and the inflation rate between 2014 and 2015.

Year Price of Price of

apples breads
2014 $1 $3
2015 $2 $4

Answer

Price Price Expenditur Expenditure

(2014) (2015) Quantity e (2014) (2015
Apples $1 $2 10 $10 $20
Breads $3 $4 20 $60 $80
Cost of the basket $70 $100

Cost of basket (2014) $ 70

CPI (2014) = x 100= x 100=100
Cost of basket Base Year $ 70

Cost of basket (2015) $ 100

CPI (2015) = x 100= x 100=142.86
Cost of basket Base Year $ 70

Inflation rate(2014-2015) =
CPI (2015 )−CPI (2014 ) (142.86−100)
x 100= x 100=42.86 %
CPI (2014) 100

35 Suppose the basket of goods in the CPI consisted of 3 units of beef and 4 units of
corn.
Year Price of beef Price of corn
2014 $20 $12
2015 $25 $18
 What is the consumer price index for 2015 if the base year is 2014?
 What is the inflation rate in 2015?
Answer

Price Price Expenditure Expenditure

(2014) (2015) Quantity (2014) (2015
Beef $20 $25 3 $60 $75
Corn $12 $18 4 $48 $72
Cost of basket $108 $147

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 Cost of basket (2014) $ 108
CPI (2014) = x 100= x 100=100
Cost of basket Base Year $ 108

Cost of basket (2015) $ 147

CPI (2015) = x 100= x 100=136.11
Cost of basket Base Year $ 108

Inflation rate(2014-2015) =
CPI (2015 )−CPI (2014 ) (136.11−100)
x 100= x 100=36.11%
CPI (2014) 100

36 Suppose 180 thousand people are employed, 20 thousand people are unemployed,
the working-age population is 250 thousand, and 50 thousand people are out of the
labor force.

Use the above information to calculate the:

a) Unemployment rate
b) Labor force participation rate
Answer
a)
Number of unemployed 20,000
Unemployment rate = x 100= x 100=10 %
Labor Force 200,000

Labor force participation rate =

Labor force 200,000
x 100= x 100=80 %
Workingadult population 250,000

37 A country working adult population is given below.

Male Female
A working adult 10 million 8 million
population
Not in the labor force 4 million 4 million
Number employed 5.4 million 3.68 million

Determine the following

i) Number of males who are unemployed
ii) Number of females who are unemployed
iii) Total labor force
iv) Adult labor force participation
v) Adult female labor force
vi) Adult male labor force
vii) Adult male labor force participation
viii) Adult female unemployment rate

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 Answer

i) Number of males unemployed = Labor force (Males) – Number of

males employed = 6 million – 5.4 million = 0.6 million
ii) Number of females unemployed = Labor force (Females) – Number of
females employed = 4 million – 3.68 million = 0.32 million
iii) Total labor force = Total working adult population – Total working
adult not in the labor force = (10 + 8) million – (4 + 4 )million = 10
million
iv) Adult labor force participation =
Total labor force 10 million
x 100= x 100=55.6 %
Total adult population 18 million
v) Adult female labor force = Adult working population(female) – Not in
the labor force(female) = 8 million – 4 million = 4 million
vi) Adult male labor force = Adult working population(male) – Not in the
labor force(male) = 10 million – 4 million = 6 million
vii) Adult labor force participation(male) =
Total labor force (male) 6 million
x 100= x 100=60 %
Total adult population(male) 10 million
0.32 million
viii) Adult female unemployment rate = x 100=8 %
4 million

38 Distinguish between private saving, public saving and national saving.

Answer
Private saving = Y – T – C
Public Saving = T – G
National saving = Private saving + Public Saving = Y – C – G

39 A country GDP is equal to $20,000. The tax collected by the government is

$6,000 and the government expenditure is $5,000. The household consumption
expenditure is $ 10,000.

Calculate :
i) Private saving
ii) Public saving
iii) National saving
iv) Total demand for loanable fund
Answer

i) Private saving = $20,000 - $6,000 - $10,000 = $4,000

ii) Public saving = $ 6,000 - $ 5,000 = $1,000
iii) National saving = $4,000 + $1,000 =$5,000
iv) Total demand for loanable fund = Investment = Saving = $5,000
40 A country GDP is equal to $50,000. The tax collected by the government is
$10,000 and the national saving is $12,000. The household consumption
expenditure is $ 30,000.

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 Calculate :
i) Private saving
ii) Government expenditure
iii) Is the government budget a surplus or deficit
iv) Public saving
v) Total demand for loanable fund
Answer
i) Private saving = $50,000 - $10,000 - $ 30,000 = $10,000
ii) Government expenditure = Y– C-National saving = $50,000 -$30,000 -
$12,000= $8,000
iii) Budget = T – G = $10,000 - $8,000 = $2,000 ( Surplus budget)
iv) Public saving = National saving – Private saving = $12,000 – $10,000
= $2,000
v) Total demand for loanable fund = Investment = National saving =
$12,000
41 What is a monetary policy?
Answer
Monetary policy is the process by which the FED controls the supply of money,
often targeting an inflation rate or interest rate to ensure price stability and general
trust in the currency.

42 Complete the following table;

Monetary Tools Impact on Money Impact on interest Impact on Real
supply rate GDP
Reduce the reserve Increases decreases Increases
requirement ratio
Increase the Decreases Increases Decreases
discount rate
FED sells Decreases Increases Decreases
government bonds
and securities in
the open market
operations

43 State, what the FED has to do to increase the money supply?

Monetary Tools Action
Reserve Reduce
requirement ratio
Discount rate Reduce
Open market Buy government
operations securities
44 If a bank receive a new deposit of $10,000 and given the reserves requirement

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ratio of 10%. What is the total money supply at the end of the credit creation
process if the bank loan out all the excess reserves.

Answer:

The total money supply at the end of the credit creation process can be calculated
using the money multiplier formula. The money multiplier is the reciprocal of the
reserve requirement ratio.

Money Multiplier = 1 / Reserve Requirement Ratio

In this case, the reserve requirement ratio is 10%, so the money multiplier would
be:

Money Multiplier = 1 / 0.10 = 10

Now, you can use the money multiplier to calculate the total money supply:
Total Money Supply = Initial Deposit × Money Multiplier
Total Money Supply = $10,000 × 10 = $100,000
Therefore, if the bank loans out all the excess reserves and goes through the credit
creation process, the total money supply at the end would be $100,000.

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