20191 25777

HARIS ULLAH SIDIIQUI

FINAL ANSWER SHEET
ECO102
M-5743
INSTRUCTOR: M. AJAZ RASHEED
MACRO ECONOMICS

Q1)
a)
Products are exempted from GDP (services provided by people and their relatives, e.g. Meat, etc., also
known as un-market goods, and, secondly, illicit goods, as they are not both included in the measurement
of GDP product approach.
GDP is to be adjusted however, but these non-marketed goods are ignored in the calculation but are or
partially incorporated. Same goes with the illegal goods they are als ignored and not included in the GDP
but to make adjustments so, that the GDP does not over rise or fall an adjustment for under reported
income is being made to avoid miscalculations.

b)
TIRES, SEATS, HEADLIGHTS: These are intermediate products, which are not included in the GDP in
order to avoid double counting of the finished goods, because only finished goods are counted in the GDP
calculation.
ROBOTS: Are the final goods to be used in the GDP calculation and added to the industry but not listed
in the automobile industry as it will be included in the technical industry.
ENGINE: It is the intermediate good and is not counted in the GDP in order to avoid double counting
with the final goods because only final goods are included in the calculation of GDP.
CAR: It is a final good and hence, will be added in the GPD of the industry.

c)
We should use the industry's real GDP because it accounts for inflation-related price increases over the
years so that we only calculate the actual growth in goods / services production and therefore prevent
miscalculation of GDP due to inflation impact.
d)
The payments made to these foreign employees in the car industry would go to the foreign nation which
will become the part of GNP of the foreign country hence, will not increase our GNP. But the resulting
increase in the productivity of the country will increase the GDP of the industry hence, making the GDP
of our country's GDP higher.
Q2)
a)
Loss of capital means that user cost of capital has shifted up causing a backward movement along the
MPKf curve causing a rise in MPKf. This leads to fall in Cd and Id. MPKf rises as capital and has
declined due to diminishing marginal productivity.

b)
A drop in current production due to the lack of capital causes the savings needed to fall as part of the
revenue saved is now being consumed
Government can cut the tax to minimize the burden on Kashmir's people, which will lead to savings only
if consumption does not take into account a potential tax cut.
c)
Due to fall in the capital, assuming that Sd hasn’t changed. Cd will fall due to the loss of capital. Loss of
capital will also cause Id to shift to the left causing a new eq to form rd. This new equation is below the
previous equation indicating a fall in the real interest rate.
Q3)
a)
National savings do not have to be equal to investments because Small open economies have are not
developed enough to affect real world interest rates. Thus, suppose the real-world interest rate is higher
than the domestic interest rate in Pakistan, Savings will be higher than investment; and Lower than
investment when the world real interest rate is lower.

b)
When savings in Pakistan is greater than Investment, the difference between desired savings over desired
investments is usually lend out to the international market. This leads to an improved net borrowing,
which is equivalent to improved net exports. Therefore, to lead to large current account deficits, there
must be an increase in desired investments and a reduction in desired savings, which will worsen the net
borrowing position of the country. This is equivalent to a worsened net exports, hence a large current
account deficit

c)
The total of government savings and private savings equate to the net exports of an economy, which is the
current account component of a country. M-X=(I-S) +(T-G) Thus, increase in government deficit implies
that there is an increase in G, without a corresponding rise in Tax collections, which improves the current
account balance.

d)
budget deficit: When expenditures surpass revenue and indicate a country's financial safety, a budget
deficit happens. The government uses the word budget deficit generally when referring to expenses rather
than businesses or individuals.
Current account deficit: The current account deficit is a measure of the economy of a nation in which the
value of the goods and services that it imports exceeds the value of the items it exports.
The relation between the budget deficit and the current account deficit can be written as follows:
CA = SPvt –I-(G-T).
Where, CA stands for current account balance, Spvt for private saving; I for savings, G for government
purchases; and T for government-collected direct taxes from household firms. The government deficit is
given by G-T.
The government budget deficit and the current account deficit are related, because if an increase in the
government budget deficit decreases national savings, the current account deficit will increase.
Q4)
a)
If the government provides higher interest rates on savings and makes them tax-free then according to
Solow's model a higher savings rate will raise living standards over the long run as production per worker
and consumption per worker as well as capital per worker will grow to a higher stable level. It is because
higher savings result in higher investments, resulting in more capital stock that causes a rise in the capital
labor ratio, raising the standard of living. While higher savings long-term increase consumption per
worker, it's at the expense of low current consumption as savings are going into investment in the initial
process, so the government should understand how much of today's consumption is going to trade off for
future consumption and living standards.

b)
If the government pursues policies to reduce the rate of population growth then according to Solow's
model, living standards would increase because large numbers of the population would not join the
workforce so rapidly and there would be no need to convert output into capital to equip the new
workforce. Increasing the living standards by having more output for people. As the consumption output
and capital per labor is at a steady state or higher steady state then initially.

c)
It will also benefit a one-year tax break on high-tax imports to boost productivity, because the industry
would be able to achieve a high degree of technological advancement in the market at lower prices than
could cost the economy and contribute to increased productivity. Increased capital stack of capital and
income per worker and better living conditions as people became more educated and trained that could
lead to more creativity and a increase in research and development that could lead to higher living
standards, etc. as analyzed by the Solow model also can result in more labor demand and supply.

d)
The endogenous growth theory can possibly change the thinking of the government about the
effectiveness of pro-growth policies as it also believes similarly like a bit of the Solow model that the
economic growth is the prime result of the endogenous factors of growth namely, rise in human capital,
rise in knowledge and skills and innovation etc. might be more beneficial as they suggest that everything
is based on diminishing marginal returns as same with the physical capital and other physical things like
labor. However, with the endogenous factors like knowledge they have an increasing return to scale
whatsoever. As a result, they are able to explain the sustained and increasing growth levels in developing
or developed countries etc. and has possibly changed the thinking of the governments to some extent.
Q5)
a)
Demand is declining and it moves to the left as people are saving more and confidence is decreasing
because of which demand is decreasing. People want to save money in a recession, because confidence is
declining. Saving is more appealing when people foresee to get unemployed (or fear unemployment),
they don't want to spend and borrow. Declining consumer confidence or business confidence can make
demand shift to the left.

b)
Due to pandemic (covid-19) situation, people are uncertain about their job which makes them pessimistic
about their future so they want to save more but as govt. decreases tax collection it will encourage people
to spend. Borrowing or giving bonds that the money is take from the economy and given to the govt.
which decreases the money supply and increase the aggregate demand for money.

c)
As inflation is expected to rise, people tend to buy and satisfy their basket of needs or basic necessity
before the price level goes up, so they demand more money which increases the economy's aggregate
demand for money.
d)
Digital transaction means people are buying through debit card, credit card and online banking. So, this
means people will need less physical money in their pocket in order to buy goods. This will reduce money
demand hence shifting the demand curve to the left.

Q6)
a)

As the demand and supply of labor both reduces this will cause the demand curve to shift leftward and
supply curve to shift leftward. Hence the labor market will not operate at equilibrium which means it will
not be working at full potential. Which will cause the production function to shift inwards due to decrease
in demand but due to decrease in supply it will cause movement along the curve in the shifted curve of
the production function which will cause the FE line (full employment) curve shift leftward. As aggregate
demand is greater than aggregated supply this will increase the price level, hence reducing money supply
which will cause people to sell their non-monetary asset, this will increase the supply of non-monetary
asset as a result reducing the price of non-monetary which will increase the interest rate, resulting in the
LM curve to shift leftward, creating a new equilibrium at e2.
b)

As govt. expenditure increases, this causes the IS curve shift rightward which increases the aggregate
demand more than aggregate supply which causes the price level to increase causing money supply to
decrease (M/P) downward. As a result, people will sell non-monetary asset which will increase the supply
of non-monetary asset, causing the price of non-monetary asset to decrease which will increase the
interest rate. As interest rate rises, this causes the LM curve ti shift leftward hence creating a new
equilibrium from e1 to e3. At e2 interest rate is higher because of govt. expenditure. Due to increase in
interest people will increase their saving and decrease their consumption hence reducing aggregate
demand AD = (downward arrow) C+I+G
c)

Due to reduction in private consumption on durable and non-durable good courses the Is curve to the left.
At this point aggregate demand is less than aggregate supply which causes the price level to decrease due
to which money supply increase M/P which will lead people to buy non-monetary assets, this will
increase the demand of non-monetary causing price of non-monetary asset to increase leading to interest
rate to decrease causing the LM curve to shift rightwards. Hence creating a new equilibrium.
d)

If the rate of return of non-monetary assets reduces, this will decrease the demand for non-monetary
assets causing price of non-monetary assets to decrease which will lead interest to increase, causing LM
curve to shift leftwards, establishing new equilibrium at e2.