1.

Explain how Gross National Product is measured using the expenditure approach and
the income approach.

a. The Expenditure Approach. GNP is the sum of the following categories of output:
(1) Consumption goods and services
(i) Consumer durables (e.g., household appliances, car, household
furnishings)
(ii) Consumer non-durables (e.g., food, clothing, fuel, medicine, etc.)
(iii) Consumer services (e.g., travel, medical fees, educational expenses)
(2) Gross Domestic Investment
(i) New construction and durable equipment for production purposes
(ii) New housing and public construction
(iii) Increase in stocks of goods (inventories) of business firms
(3) Government or public goods and services
(i) Consumption of goods (e.g., postal services, health and medical services,
police and fire protection, national defense)
(ii) Public investment (e.g., roads, school building, bridges, dams, parks,
harbors, airports, government buildings)
(4) Net Exports
Export of goods and services less import of goods (trade) and services (invisibles
or nontrade)

b. Income Approach. GNP equals the sum of items below.

(1) Factor income of persons (wages or compensation of employee)
(2) Government income from capital
(3) Undistributed corporate profits
(4) Indirect business taxes
(5) Depreciation allowance (consumption of fixed capital)

2. What is the formula for GNP if computed by adding the values of the various industry
sectors?

The GNP may be determined as follows:

GNP by Industrial Sector at Current Prices (in Million Pesos)
Year
Agriculture, Fishery and Forestry …………………. P xx
Mining and Quarrying …………………………….….... xx
Manufacturing ……………………………………………… xx
Construction ………………………………………………… xx
Transportation, Communication, Storage,
and Utilities ……………………………………… xx
Commerce ………………………………………….……….. xx
Services …………………………..…………………………… xx
Net Domestic Product …………………………………. xx
 Net Factor Income from Abroad ……….. xx
Net National Product or National Income …….. xx
Indirect Taxes ……………………………………. xx
Depreciation Allowance ……………………. xx
Gross National Product ………………………………… P xx

3. Differentiate aggregate demand from aggregate supply.

Aggregate demand reflects the real domestic output demanded at each possible
price level. This is an inverse relationship, so the curve slopes downward. As the price
level falls real purchasing power increases, interest rates decline, and foreign purchases
increase. The determinants of aggregate demand are changes in consumer spending,
investment, government spending, and net exports.

Aggregate supply reflects the real domestic output available at each possible
price level. This is a direct relationship. This curve has horizontal, upward sloping, and
vertical components. This assumption is that price level will not rise when productive
resources are substantially underused. However, at full employment, the price level will
rise with no increase in real output. In the intermediate range, both the price level and
real output increase. The determinants of aggregate supply are changes in input prices,
productivity, and the legal and institutional environment. The short-run curve tends to
flatten out as the economy reaches full capacity. In the long-run, new factories can be
built, which results in a continuously rising supply curve. The long-run supply curve has a
steeper slope, which means an increase in demand can cause substantial price
increases.

4. What is the formula for disposal personal income?

Disposal Personal Income can be determined as follows:

Gross National Product

 Depreciation allowance
 Indirect taxes

National Income
 Retained earnings of corporations
 Government income from capital
+ Transfer payments from government and abroad
Personal Income
 Personal Taxes

Disposable personal Income

5. What are the four stages of a business cycle? Describe each.
The Business Cycle
The term “business cycle” (or economic cycle or boom-bust cycle) refers to economy-
wide fluctuations in production, trade, and general economic activity. From a
conceptual perspective, the business cycle is the upward and downward movements of
levels of GDP (gross domestic product) and refers to the period of expansions and
contractions in the level of economic activities (business fluctuations) around a long-
term growth trend.

Business cycles are identified as having four distinct phases: expansion, peak,
contraction, and trough.
1ST STAGE: EXPANSION
An expansion is characterized by increasing employment, economic growth, and upward
pressure on prices.

2ND STAGE: PEAK

A peak is the highest point of the business cycle, when the economy is producing at
maximum allowable output, employment is at or above full employment, and
inflationary pressures on prices are evident.

3rd STAGE: CONTRACTION

Following a peak, the economy typically enters into a correction, which is characterized
by a contraction where growth slows, employment declines (unemployment increases),
and pricing pressures subside.  

4TH STAGE: TROUGH

The slowing ceases at the trough and at this point the economy has hit a bottom from
which the next phase of expansion and contraction will emerge.

6. What are the general assumptions of Keynesian Economics?

The macroeconomic study of Keynesian economics relies on three key assumptions--
rigid prices, effective demand, and savings-investment determinants. First, rigid or inflexible
prices prevent some markets from achieving equilibrium in the short run. Second, effective
demand means that consumption expenditures are based on actual income, not full
employment or equilibrium income. Lastly, important savings and investment determinants
include income, expectations, and other influences beyond the interest rate. These three
assumptions imply that the economy can achieve a short-run equilibrium at less than full-
employment production.

7. What are the formulae for the following?

a. Marginal propensity to consume
* Marginal Propensity to Consume(MPC) formula = Change in Consumer spending /
Change in Income
                       Or
 * Marginal Propensity to Consume formula = ΔC / ΔI
                          Or
* Marginal Propensity to Consume formula = (C1 – C0) / (I1 – I0), 
where: 
C0 = Initial consumer spending,         
 C1 = Final consumer spending,         
 I0 = Initial disposable income,          
I1 = Final disposable income

b. Marginal propensity to save

MPS can be calculated as the change in savings divided by the change in income

MPS= Change in Savings ÷ Change in Income

Or mathematically, the marginal propensity to save (MPS) function is expressed as

the derivative of the savings (S) function with respect to disposable income (Y).

MPS= dS÷ dY
where: 
dS= Change in Savings
dY= Change in Income

c. Average propensity to consume

The average propensity to consume (APC) is the ratio of consumption expenditures
(C) to disposable income (DI), or 
                       APC = C / DI.

d. Average propensity to save

The ratio of total saving to total income is called APS. Alternatively, it is that part of
total income which is saved.

By dividing total saving (S) with total income , we get APS. Symbolically:

APS = S/Y

For instance, in the following table when national income is Rs 200 crore, saving is
Rs 30 crore. In this case APS = SA’ = 30/200 = 0.15 or 15%.

8. Explain how the following affect profitability.

a. Rate of growth of technology
Because the new products and innovations are often profitable, firms will invest more
when technological growth rate is high
b. Interest rates
As real interest rates increase, marginal investments are not undertaken, thus
lowering total business investment. The real rate is the nominal rate minus the
inflation premium.
c. Stock of capital goods
 The higher the stock, the lower the demand for new capital hoods (until the stock is
depleted).
d. Government actions
Changes in tax rates, depreciation allowances, and government spending can
change the expected probability of a given investment.
e. Acquisition and maintenance costs.
The higher rate the purchase price and life-long operating costs of a capital good, the
lower the expected profitability on the investment.

9. Distinguish between autonomous investment and induced investment.

Autonomous investments are investment expenditures made by businesses that are
independent of the level of national income and that are undertaken for their expected
profitability. The level of autonomous investment will be constant regardless of an
expansion or a recession of economic activity while induced investments are
investments made as a result of increased economic activity.

10. What comprises M1, M2, M3, and M4 in the computation of money supply.
 M1 (also called narrow money)- includes coins and currency that are in
circulation, demand deposits, checking deposits and other money equivalents
that can be converted easily to cash.
 M2- includes M1 and, in addition, short-term time-deposits in banks and 24-hour
money market funds.
 M3- includes M2 in addition to long-term deposits and money market funds with
more than 24-hour maturity.
 M4- includes M3 plus other deposits.

11. What is the relationship between the supply and demand for money?
The supply of money and the demand for money give money market equilibrium
interest rate (price of money). Varying the supply of money alters the interest rate,
affecting investment in society. For example, increasing the supply of money moves one
down to the right along the demand curve. This decreases the interest rate of
investment in the economy.

12. What are the tools of monetary policy in regulating total money supply?
The major tools of monetary policy in regulating total money supply are reserve
requirements, amount and rate of rediscounting, and open market operations. The
minor tools, on the other hand, which are non-global in character are the selective
credit controls, maximum interest rates, and moral suasion.
Major tools
 Reserves. The legal reserve ratio is the percentage of deposits that must be kept on
hand
i) Lowering the percentage is expansionary (allowing banks to put more of their
excess reserves into circulation through loans.)
 ii) Raising the percentage is contractual.
iii) This tool is not frequently used because it has very powerful effects on the
economy.
 Rate of rediscounting. This pertains to the interest rate at which member banks may
borrow from the BSP.
i) Lowering the rate encourages borrowing, increases saving, and decreases money
supply.
ii) Raising the rate discourages borrowing, increases saving, and decreases the
money supply.
iii) Changing the funds rate is another way in which the BSP affects interest rates,
the money supply, and economic activity.
 Open-market operations. Purchase and sale of government securities is the primary
mechanism of monetary control.

Minor tools
 Selective credit controls. An example is when the BSP requires a certain percentage
of down payment on durable good purchases.
 Margin requirements. The margin is the percentage of the purchase price of
securities that cannot be borrowed. It determines the down payment requirements
on stock purchases.
 Moral suasion. “Jawbone control” entails merely asking banks to hold down rates.

13. Define inflation. What are the different types of inflation?

Inflation is a sustained and general increase in prices in all or nearly all of the markets in an
economy. Inflation has basic types:
1. Demand-pull inflation – generated by excess aggregate demand for goods and services.
2. Cost-push inflation – generated by increased production costs which are passed to
consumers in the form of higher prices
3. Structured inflation – arises from bottlenecks in the economic system due to inadequacy
of social overhead capital (e.g., power, transportation and communication) deficiency in
tax system, low agricultural production and inadequate foreign exchange supply.

14. What are the different types of unemployment?

• Frictional unemployment is the amount of unemployment caused by the normal
workings of the labor market. This definition acknowledges that some unemployment
exists at any given time as workers search for jobs or wait to take jobs in the near term.
• Structural unemployment exists when aggregate demand is sufficient to provide full
employment, but the distribution of the demand does not correspond precisely to the
composition of the labor force.
• Cyclical unemployment is caused by insufficient aggregate demands. During economic
downturns, unemployment will occur due to lack of demand.
• Seasonal unemployment results from the change in seasons.
 • Regional unemployment occurs when industries relocate.

15. What factors can affect the exchange rate value of a currency?
The changes are:
a. Differential growth rates of income.
An increase in domestic income will encourage the nation’s residents to spend a
portion of their additional income on imports. Thus, when the income of a nation grows
rapidly relative to its trading partners, the nation’s imports tend to rise relative to
exports. These two forces will restore equilibrium in the exchange market at a new
higher rate.
Just the opposite happens when the income of a nation lags. A slow growth of
domestic income coupled with rapid growth of income abroad will lead to a decline in
imports relative to exports. The relative strength of the nation’s exports will cause the
demand for the currency of the slow-growth nation to rise. Paradoxical as it may seem,
other things constant, sluggish growth of income relative to one’s trading partners
causes the slow-growth nation’s currency to appreciate, since the nation’s imports
decline relative to exports.

b. Differential rates of inflation.

Other things constant, domestic inflation will cause a nation’s currency to
depreciate on the exchange market, whereas deflation will result in appreciation.
Suppose prices in the Philippines rise by 50% while our trading partners are
experiencing stable prices. The domestic inflation will cause Philippine consumers to
increase their demand for imported goods (and foreign currency). In turn, the inflated
domestic prices will cause foreigners to reduce their purchase of Philippine goods,
thereby reducing the supply of foreign currency to the exchange market.
Exchange rate adjustments permit nations with even high rates of inflation to
engage in trade with other countries experiencing relatively stable prices. A depreciation
in a nation’s currency in the exchange rate market compensates for the nation’s
inflation rate. Inflation contributes to the depreciation of a nation’s currency only when
a country’s rate of inflation is more rapid than that of its trading partners.

c. Changes in interest rates.

Short-term financial investments will be quite sensitive to changes in real
interest rates – that is interest rates adjusted for the expected rate of inflation.
International loanable funds will tend to move toward areas where the expected
real rate of return (after compensation for differences in risk) is highest. For example, if
real interest rates increase in the United States relative to European Union countries,
borrowers will demand dollars (and supply their currencies) in the exchange rate market
to purchase the high yield American assets. The increase in demand for the dollar and
supply of European currencies will cause the dollar to appreciate relative to European
currencies.
In contrast, when real interest rates in the other countries are high relative to
the United States, short-term financial investors will move to take advantages of the
 improved earnings opportunities abroad. As investment funds move from the United
States to other countries, there will be an increase in the demand for foreign currencies
and an increase in the supply of dollars. Depreciation in the dollar relative to the
currencies of countries experiencing the high real interest rates will be the result.

16. How do monetary and fiscal policy influence the exchange rate?
Unanticipated restrictive money policy will raise the real interest rate, reduce the rate of
inflation, and, at least temporarily, reduce aggregate demand and the growth of income. These
factors will in turn cause the nation's currency to appreciate on the foreign exchange market. In
contrast, expansionary monetary policy will result in currency depreciation. Fiscal policy tends
to generate conflicting influences on the exchange rate. To the extent that expansionary fiscal
policy (larger budget deficits) stimulates income, it promotes imports relative to exports,
causing a currency to depreciate. However, to the extent expansionary fiscal policy increases
the real interest rate of a nation, it causes an appreciation of a nation's currency due to an
inflow of foreign investment. The analysis is symmetrical for restrictive fiscal policy.