Noman Rasheed

BBA191011
Macroeconomics

Questions/Answers
Q1. Describe Economic Growth? How Is Economic Growth Measured?
Ans: Economic growth is an increase in the production of goods and services over a specific
period. To be most accurate, the measurement must remove the effects of inflation. Economic
growth creates more profit for businesses. As a result, stock prices rise. That gives company’s
capital to invest and hire more employees. As more jobs are created, incomes rise. Consumers
have more money to buy additional products and services. Purchases drive higher economic
growth. For this reason, all countries want positive economic growth. This makes economic
growth the most-watched economic indicator.
Gross domestic product (GDP) is the best way to measure economic growth. It takes into
account the country's entire economic output. It includes all goods and services that businesses
in the country produce for sale. It doesn't matter whether they are sold domestically or
overseas.

Q2. Briefly discuss the Phases of Economic Growth during the 50 years.
Ans: Between 1972 and 2010, Pakistan’s GDP grew at an average annual rate of about 4.9 per
cent. However, our growth was volatile and showed a declining trend. In contrast, other
regional economies such as India, Sri Lanka and Bangladesh, showed less volatility (particularly
in recent years) and more importantly the trend in growth rate in these countries was
increasing overtime. The China-Pakistan Economic Corridor (CPEC) is widely considered a
turning point for both Pakistan and the region. It is an important stimulus for Pakistan, and
promises rapid economic growth, massive infrastructure development, 700,000 new jobs in the
next ten or fifteen years and the creation of special economic zones along the way.
After four years of Phase I of CPEC, Pakistan is now ready to enter Phase II. Some 27 projects
are planned within the framework of Phase II. This phase emphasizes industrial cooperation,
agricultural development and trade promotion. The tourism sector is also expected to expand
during this phase. These initiatives are very promising for the expansion of job opportunities for
local residents.

Q3. Strategies to increase economic growth. Developed vs Developing countries.

Ans: Developed Countries:

 Economic growth is driven oftentimes by consumer spending and business investment.

 Tax cuts and rebates are used to return money to consumers and boost spending. Tax cuts
and tax rebates are designed to put more money back into the pockets of consumers.
Ideally, these consumers spend a portion of that money at various businesses, which
increases the businesses' revenues, cash flows, and profits. Having more cash means
companies have the resources to procure capital, improve technology, grow, and expand.
All of these actions increase productivity, which grows the economy. Tax cuts and
rebates, proponents argue, allow consumers to stimulate the economy themselves by
imbuing it with more money.
 Deregulation relaxes the rules imposed on businesses and have been credited with
creating growth but can lead to excessive risk-taking. Deregulation is the relaxing of rules
and regulations imposed on an industry or business. It became a centerpiece of economics
in the United States under the Reagan administration in the 1980s, when the federal
government deregulated several industries, most notably financial institutions. Many
economists credit Reagan's deregulation with the robust economic growth that
characterized the U.S. during most of the 1980s and 1990s. Proponents of deregulation
argue tight regulations constrain businesses and prevent them from growing and
operating to their full capabilities. This, in turn, slows production and hiring, which
inhibits GDP growth. However, economists who favor regulations blame deregulation
and a lack of government oversight for the numerous economic bubbles that expanded
and subsequently burst during the 1990s and early 2000s.
 Infrastructure spending is designed to create construction jobs and increase productivity
by enabling businesses to operate more efficiently. Infrastructure spending occurs when a
local, state, or federal government spends money to build or repair the physical structures
and facilities needed for commerce and society as a whole to thrive. Infrastructure
includes roads, bridges, ports, and sewer systems. Economists who favor infrastructure
spending as an economic catalyst argue that having top-notch infrastructure increases
productivity by enabling businesses to operate as efficiently as possible. For example,
when roads and bridges are abundant and in working order, trucks spend less time sitting
in traffic, and they don't have to take circuitous routes to traverse waterways.

Developing Countries:
Promote economic growth through innovation. The 2013 International CES®, innovation
and start-ups fuel our economic growth. They are the ultimate job creators who start with
ingenious ideas, take risks and create value

 Industry Service:
Industry is also one sector of service in every religion. With this sector, people get
their necessities of life while labors and unemployment person get job. If
industrialist prepare goods with durable material and with his true intention and he
gets prescribed right price of goods from customers. And he pays true wages timely
to his workers and to the other staff then this act is reward able. But if he prepare
defective or low quality material for profiteering and gaining money illegally or sells
 his goods more than its prescribed prices then his act is punishable. Then there will
be worry able this life and humiliation in the world hereafter. Industrial sector is
encouraged by the different investors and the technicians also as compared to the
agricultural sector which has low income and the low chances of improving the
standard of living. This is why industrial countries have high per capita income as
compared to the agricultural countries.
 Monetary Authority & Growth:
Anyhow besides the relations of external world, for the domestic countries
monetary and fiscal policies are also important. Monetary resources are linked with
monetary authorities who fix these resources for different projects. By setting itself
a steady course and keeping to it, the monetary authority could make a major
contribution to promoting economic stability. By making that course one of steady
but moderate growth in the quantity of money, it would make a major
contribution to avoidance of either inflation or deflation of prices. Other forces
would still affect the economy, require change and adjustment and disturb the even
tenor of our ways. But steady monetary growth would provide a monetary climate
favorable to the effective operation of those basic forces of enterprise ingenuity,
invention, hard work and thrift that are the true springs of economic growth.
 Tax structure Suitability:
It is suitable to collect taxes from the rich class rather than the poor. But
unfortunately the rich class of the society in the developing countries like
Pakistan’s gets concessions and different rebates from the ruling authorities due
to different linkages. The biggest burden of taxes levied on the poorest people…
The rent and the malia tax which is received from the poor farmers more than
the rich. So, the poor people pay more tax than the rich. And this is very shameful
for Pakistanis that we improve taxes on the income of poor man for our Army.

Q4. What is the relationship between technology absorption capacity and economic
development?
Ans: Technology absorption based on technology input–output is a main source of regional
economic growth, and it can be one of the mechanisms to achieve regional sustainable
development.

Q5. Define GDP and use the circular flow model to explain why GDP equals aggregate
expenditure and aggregate income.
Ans: Ans: GDP or gross domestic product, is the market value of all final goods and services
produced in a country in a given time period.
GDP and the Circular Flow of Expenditure and Income
GDP measures the value of production, which also equals total expenditure on final goods and
total income. The equality of income and output shows the link between productivity and living
standards.

The circular flow diagram shows the transactions among households, firms, governments, and
the rest of the world
These transactions take place in factor markets, goods markets, and financial markets. Firms
hire factors of production from households. The blue flow, Y, shows total income paid by
firms to households. Households buy consumer goods and services. The red flow, C, shows
consumption expenditures. Households save, S, and pay taxes, T. Firms borrow some of what
households save to finance their investment. Firms buy capital goods from other firms. The
red flow I represents this investment expenditure by firms. Governments buy goods and
services, G, and borrow or repay debt if spending exceeds or is less than taxes. The rest of the
world buys goods and services from us, X and sells us goods and services, M—net exports are
X – M. And the rest of the world borrows from us or lends to us depending on whether net
exports are positive or negative. The blue and red flows are the circular flow of expenditure
and income. The green flows are borrowing and lending. The sum of the red flows equals the
blue flow.
Y=C+I+G+X–M
The circular flow demonstrates how GDP can be measured in two ways.
Aggregate expenditure: Total expenditure on final goods and services, equals the value of
output of final goods and services, which is GDP.
Total expenditure = C + I + G + (X – M).
Aggregate income: Aggregate income earned from production of final goods, Y, equals the total
paid out for the use of resources, wages, interest, rent, and profit. Firms pay out all their
receipts from the sale of final goods, so income equals expenditure,
Y = C + I + G + (X – M).
Q6. Will the cost of living be stable?
Ans: Price stability exists when average prices are constant over time, or when they are rising at
a very low and predictable rate. Price inflation occurs when average prices are rising above this
low and predictable rate, and price deflation occurs when average prices are falling. In both
cases, the effects are potentially extremely harmful to a country’s economic performance and
to the welfare of its citizens. As Pakistani cities quickly evolve into some of the most
cosmopolitan destinations in the world, it’s no surprise that more and more expats are moving
to the country. Hence there are less chances that the cost of living will be stable.

Q7. Explain how we use real GDP to measure economic growth and describe the limitations of
our measure.
Ans: The first step in calculating real GDP is to calculate nominal GDP, which is the value of
goods and services produced during a given year valued at the prices that prevailed in that
same year.
The new method of calculating real GDP, which is called the chain-weighted output index
method, uses the prices of two adjacent years to calculate the real GDP growth rate.
Step 1: Value last year’s production and this year’s production at last year’s prices and then
calculate the growth rate of this number from last year to this year.
Step 2: Value last year’s production and this year’s production at this year’s prices and then
calculate the growth rate of this number from last year to this year.
Step 3: Calculate the average of the two growth rates. This average growth rate is the growth
rate of real GDP from last year to this year.
Step 4: Repeat steps 1, 2, and 3 for each pair of adjacent years to link real GDP back to the base
year’s prices.
Q8. Explain how we measure the effects of the sources of economic growth and identify why
growth rates fluctuate.
Ans: The effects of the sources of economic growth is measured by GDP and GNP. In terms of
monetary spending, the gross domestic product is the logical extension of calculating economic
growth. For example, if a statistician wants to understand the steel industry’s productive
output, he only needs to track the dollar value of all the steel that entered the market during a
given period. GNP measures the total Income accruing to the population over a specified
amount of time. Unlike gross domestic product, it does not take into account income accruing
to non-residents within country’s territory; like GDP, It is only a measure of productivity and is
not intended to be used as a measure of the welfare or happiness of a country.
Economic growth fluctuates due to number of reasons such as;

 Increase in aggregate demand due to increase in consumption, which is caused by

rise in income levels and decrease in interest rates, house price inflation. Rise in
government spending and a balance of payments surplus.
 Labor shortage, shortage of labor in specified areas means that economy will not be
able to utilize its resources efficiently and so economic growth will slow.
 Increase in demand for imports, this will worsen the balance of payments deficit.
 Economic growth also fluctuate because of demand and supply side shocks this can
lead to instability in the economy, demand side shocks are caused by a significant
rise and fall in exchange rates in short term. Changes in economic growth for
countries that you trade a lot with. Change in aggregate demand. A boom in capital
expenditure example in construction or ICT. Supply side shocks are caused by
technology, natural disasters which impact supply of goods for example crops.
Political situations that influence the supply of products example Oil.
 Change In trend rates, this is influenced by investment, education, training and
technology change.

Q9. Explain the main theories of economic growth.

Ans: There are three main theories of economic growth.
1. Classical Theory
2. Neoclassical Growth Theory
3. New Growth Theory
 1. Classical Growth Theory: This Theory states that there is a subsistence real wage
rate, which is the minimum real wage rate needed to maintain life.

 Advances in technology lead to investment in new capital

 Labor productivity increases and the rate rises above the subsistence level.
 When the real wage rate is above the subsistence level, the population grows.
 Population growth increases the supply of labor and brings diminishing returns
to labor. As the population increases the real wage rate falls.
 The population continues to grow until the real wage rate has been driven back
to the subsistence real wage rate.
 At this real wage rate, both population growth and economic growth stops.
 Contrary to the assumption of the classical theory, the historical evidence is that
population growth rate is not tightly linked to income per person and
population growth does not drive incomes back down to subsistence levels.
2. Neoclassical Growth Theory: This theory focuses on three factors that impact
economic growth; labor, capital and technology begins to advance rapidly.
 New profit opportunities arise.
 As technology advances and the capital stock grows, real GDP per person rises.
 Diminishing returns to capital lower the real interest rate and eventually growth
stops unless technology keeps on advancing
3. New Growth Theory: New growth theory holds that real GDP per person grows
because of choices that people make in the pursuit of profit and that growth can
persist indefinitely. The theory begins with two facts about market economies:
 In a market economy, discoveries result from choices.
 Discoveries bring profit and competition destroys profit.

Q10. Explain how expenditure plans and real GDP are determined when the price level is fixed.
Ans: When the price is fixed, expenditure plan components sum to real GDP which determines
expenditure plan at fixed price level.
Y=C + I + X – M
Consumption expenditure is determined by disposable income and the marginal propensity to
consume (MPC) determines the change in consumption expenditure brought about by a change
in disposable income. Real GDP determines disposable income.
Consumption expenditure = YD = Y-T (GDP-Taxes)
YD=C+S
Consumption function + saving Function
MPC= Δ C/ Δ YD
MPS=Δ S/Δ YD
MPC + MPS = 1
Imports are determined by the real GDP, and the marginal propensity to import determines the
change in imports brought about a change in real GDP.
MPI = Δ M / Δ GDP
Real GDP is determined at fixed price level, by aggregate planned expenditure.
Aggregate planned expenditure depends on real GDP. The relationship between 2 can be
described by the aggregate planned schedule.
Consumption expenditure minus imports which varies with real GDP, is induced expenditure.
Sum of investment, government expenditure and exports which does not vary with GDP is
autonomous expenditure.
Actual aggregate expenditure is always equal to real GDP. Firms have unplanned changes in
inventories so aggregate planned expenditure differs from aggregate expenditure.
Equilibrium expenditure occur when aggregate planned expenditure equals actual expenditure
and real GDP.
Multiplier is the amount by which a change in autonomous expenditure is multiplied to
determine the change in equilibrium expenditure and real GDP.
The multiplier is determined by the slope of aggregate planned expenditure (AE) curve. Slope of
AE is influenced by the marginal propensity to consume, the marginal propensity to import, and
income tax rate.
Multiplier = 1 ÷ (1-Slope of AE Curve)
MPC = Δ C / Δ YD
MPS = Δ S / Δ YD
If the change in real GDP is DY, the change in autonomous expenditure is DA, and the change in
induced expenditure is DN, then
Multiplier = DY ÷ DA
When there are no income taxes and no imports, the slope of the AE curve equals the marginal
propensity to consume, so the multiplier is
Multiplier = 1 ÷ (1-MPC)
But 1 – MPC = MPS, so the multiplier is also
Multiplier = 1 ÷ MPS

Q11. Explain how real GDP is determined when the price level is fixed.
Ans: Aggregate planned expenditure depends on real GDP. The component of fixed expenditure
sum up to real GDP;
Y= C + I + G + X – M
Two of the components of aggregate expenditure consumptions and imports are influenced by
real GDP
So there is a two way expenditure real GDP.
1. An increase in real GDP increases aggregate expenditure.
2. An increase in expenditure increases real GDP.
Aggregate demand determines the aggregate quantity of goods and services sold, which equals
real GDP. Aggregate demand is determined by aggregate expenditure plans. When real GDP
increases, planned consumption expenditure and planned imports increase. The relationship
between aggregate planned expenditure and real GDP can be described by an aggregate
expenditure schedule, which lists the level of aggregate expenditure planned at each level of
real GDP.

Q12. Explain the expenditure multiplier when the price level is fixed.
Ans: The simple expenditure multiplier is the ratio of change in aggregate production to an
autonomous change in an aggregate expenditure to an autonomous change in an aggregate
expenditure when consumption is the only induced expenditure. The multiplier is as simple as is
gets while capturing the fundamentals of the multiplier. Autonomous investment triggers the
multiplier process and induced consumption provides the cumulatively reinforcing interaction
between consumption, aggregate production, factor payments, and income.
The formula for this simple expenditure multiplier, m, is:
Multiplier = 1 ÷ (1 - MPC).
But 1 – MPC = MPS, so the multiplier is also
Multiplier = 1 ÷ MPS.
Where MPC is the marginal propensity to consume and MPS is the marginal propensity to save.
Q13. Explain the relationship between aggregate expenditure and aggregate demand and
explain the multiplier when the price level changes?
Ans: The Multiplier and the Price Level Aggregate Expenditure and Aggregate Demand The
mixture expenditure curve is the relationship between mixture deliberate expenditure and real
GDP, with all other influences on mixture planned expenditure closing the same.
The combination call for curve is the relationship between the amount of actual GDP demanded
and the fee level, with all other influence on the mixture and call for remain the same Deriving
the Aggregate Demand Curve When the price level changes, a wealth effect and substitution
effects change aggregate planned expenditure and change the quantity of real GDP demanded.