Economic Conditions

Analysis , BUS 530

Final Assignment ,Spring 2020

Submitted Date
6/4/2020

Submitted TO :
Dr. Mainul Islam Chowdhury (MCw)
Assistant Professor, Department of Economics
School of Business and Economics

Submit ted BY :
Name : AHMED AL RAFSAN
ID: 1915124060
Section : 03
Question 1.

Given: C = 250 + 0.8 Y (3+3+3+4+3+3+4=23) I = 150 G = 300 TR = 100 NX =

100 t =0.25

i) Find the equilibrium level of income.

Answer :

Equilibrium level of income:

Y = C + I + G + NX

Y = [250 + 0.8(Y + TR -tY)] + I + G + NX

Y = [ 250 + 0.8Y + (0.8 *100) – (0.8 * 2.05 Y)] + 150 + 300 + 100

Y = 880 + 0.8Y - 0.2Y

0.4 Y = 880

Y = $ 2200 (Equilibrium income)

ii) Suppose, because of the current COVID 19 situation C falls to 50, MPS falls to .
05, I falls to 10, G falls to 100 and NX falls to 10. How much TR should the
government increase to have the same level of equilibrium income as in part i)?

Answer:

MPS = 0.05, i.e. MPC=0.95 so, c=50+0.95Y

Now, Y = C + I + G + NX
Y= 50 + 0.95 (Y –tY + TR) + 10 + 100 + 10
2200 = 170 + 0.95 ( Y - 0.25Y + TR )
2200 = 170 + 0.71Y + 0.95TR
2200 = 170 + ( 0.71 × 2200 ) + 0.95TR
2200 = 170 + 1562 + 0.95 TR
0.95 TR = 468
⸫ TR = 492.63

⸫ TR should be increased by ( 492.63 – 100 ) = 392.63 to maintain the same level

of Y .
iii) In determining the required change in TR in part ii), which multiplier did you use
and why? (Hint: keep in mind the consumption tendency households may have
under the COVID 19 situation in selecting the multiplier )

Answer :

Because of COVID 19 situation , consumption tendency of households is likely.

In the previous question the consumption falls from $250 to $50(Assuming this as
the autonomous consumption)

So, the MPS falls to .05, ⸫ MPC = 1-0.05 = 0.95

⸫ the Multiplier = 1/MPS = 1/0.05 = 20

Consequently, the following changes occur:

I falls to 10
G falls to 100
NX falls to 10
t=0.25

We know, Y will be the same as in part i, Y=$2200

C = Autonomous consumption is $50
New Consumption function = 50 + 0.95 Y

In determining the required change in part II, the non-income tax multiplier is
used. Because the transfer payment ( TR) is like negative tax .

Because of COVID 19 situation the economy is suffering from a recessionary gap

due to insufficient aggregate demand , so we use that multiplier function to
determine how much government spending should be increased to return the
economy to potential GDP where full employment occurs.
 iv) Draw a graph to show the appropriate changes between part i) and part ii).

In the following diagram,income is represented by X-axis and expenditure is represented by

Y-axis . The line Y=E represents the equality of income and expenditure ( 45⁰) . Here E0 is
initial expenditure line . The equilibrium is achieved at the intersection point of E0 and Y=E
line and the equilibrium income is 2200 which is found in part I . Because of the Covid 19
situation TR has expenditure line becomes E1 with all changes including TR=492.63. This
E1 line intersect too the line of equality at point E to ensure the same level of equilibrium
output.
v) Give an example related to current Bangladeshi situation where the
government may follow a 'Transfer Promoting Policy' instead of a 'Growth
Promoting Policy' in determining who gets the transfer payment.

Answer:

Because of COVID 19 situation, the economy of Bangladesh a lot . The financial

exercises are at stop contorting the basic market equilibrium . The demand of
goods has decreased , as a result the supply of goods is very low .Because in this
lock down situation the production of goods are almost stopped . Not only this ,
public demand for goods are also decreased because everyone has money shortage
in their hands . Rich people can overcome their situation but Bangladesh
Government is trying to make the situation better means trying to develop the
economy for underprivileged people .

The role of growth-promoting policies play in shaping the vulnerability and

resilience of an economy. But during this situation the policy will not be effective
as money is not circulating in the economy .

To , overcome the situation government can try to reframe the economy. For doing
so government pay attention to safe the working class that means underprivileged
people .

There is a fundamental lack of demand due to overvalued exchange rate and

tight monetary policy. Therefore, economic development may require demand-
side policies which boost aggregate demand.

Considering the situation and to maintain a stable economic climate of low

inflation and positive economic growth transfer promoting policy may play a great
role by increasing the tax rate for rich people and government can distribute that
money to the economy .
 vi) Instead of paying transfer (TR) if the government were to increase
government spending (G), what type of crowding out would you expect? Briefly
explain

Answer :

Instead of paying transfer payment (TR) if the government were to increase

government spending (G) then this type of crowding out would happen →

When Government Expenditure (G) ↑ → Economy Income ↑ → Money

Demand ↑ → Rate of Interest ↑ → Investment ↓ .

So, if the Govt. were to increase Govt. Expenditure (G) then Interest rate would
increase because the cost of borrowing will increase so investment in private
spending would decrease . A higher magnitude of the crowding out may lead a
lesser income in economy .

vii) As we have observed recently that, a lot of the assistance from the
government is being misappropriated by dishonest individuals and as a result
is not reaching the target population. What role can proper institution play to
rectify such mishandling of government fund? Explain

Answer :

A lot of the assistance from the government is being misappropriated by dishonest

individuals and as a result is not reaching the target population. So , there can be
taken various steps to make a success . Generally , by the politicians those
Government’s assistance are being provided . In this case if those assistances are
provided by corrupted politicians government will face the harm . So Government
should get rid of them . When the structure will be reframed then the money will
be in safe . Gaining an effective result to reach the target population Government
can hire assistance from non profit organizations .
Question 2. Suppose, a Bangladeshi working in Bangladesh is earning a
taxable income of 70,00,000 (seventy lacs/six million) taka per year. How
much should this person pay in taxes?

Answer :

70,00,000
2,50,000 @ 0% = 0
....................................................
67,50,000
4,00,000 @ 10% = 40000
.....................................................
63 50 000
5 00 000 @ 15% = 75000
....................................................
58 50 000
6 00 000 @ 20% = 12000
....................................................
52 50 000
30 00 000 @ 25% = 750000
....................................................
22 50 000 @ 30 % = 675000
....................
1660000

According to the tax rates in Bangladesh the person should pay 1660000 taka .
(Ans)

Question 3. a) Suppose that Tk.10,000 in new taka bills (never seen before)
falls magically from the sky into your hands. What are the minimum increase
and the maximum increase in the money supply that may result? Assume the
required reserve ratio is 10 percent.

Answer :

Suppose Tk.10,000 in new taka bills falls magically from the sky into my hands.
Assuming the reserve ratio to be 10%,

the minimum increase is 10,000 &

The maximum increase would be: 10,000/0.1 =100,000.
Question b) Suppose you receive Tk. 10,000 from your grandmother and
deposits the money in a saving account. your grandmother gave you the
money by writing a check on her saving account. Would the maximum
increase in the money supply still be what you found it to be in part a) where
you received the money from the sky? Why or why not?

Answer :

My grandmother gave me TK. 10,000 by writing a check on her saving account

which deposit in saving account. In this case, the maximum increase would be the
same as the money was already in the system. It just a transfer from one account
to another so there is no additional change in the reserve money.

Question c) Suppose that instead you getting Tk. 10,000 from the sky or a
check through your grandmother, you get the money from your mother who
had buried it in a can in her backyard. In this case, would the maximum
increase in the money supply be what you found it to be in part a)? Why or
why not?

Answer:

If I get the money from the buried ground in my backyard then in this case the
maximum increase would be same as part a. This is because money was not in the
system previously.
 Question : 4. a) Suppose growth rate of Real GDP is 6% and the growth rate
of velocity is 3%. If Bangladesh Bank wants to have a 5 % inflation rate,
what should be the growth rate of money supply according to the
predetermined-money-growth-rate-rule?

Answer :

Growth rate of real GDP= 6%

Growth rate of velocity = 3%

Inflation rate = 5%
Predetermined-Money-Growth-Rate Rule is the annual growth rate in the money
supply will be equal to the average annual growth rate in Real GDP minus the
growth rate in velocity.

Therefore, %∆M = %∆Q - %∆V

Quantity theory of money (Fisher equation): - MV = PQ
So, M = PQ/ V
= (5%×6%) / 3%

= 0.1/ 10%

The growth rate of money supply is 10%.

Question : b) If Bangladesh Bank increases money supply at a rate that is higher than
the rate you found in part a, what will be the impact of that higher than required money
growth?

Answer ;

For economic growth money supply may have a great impact if Bangladesh Bank increases
money supply . Because by this money supply the production will be increased and more jobs
will be available in the market . But there is a great chance to create inflation if Bangladesh
Bank increases money supply at a rate that is higher than the economy’s ability to produce
goods and services . Furthermore , if the money supply keeps increasing hyperinflation will
happen there .
Question 5. What is the Taylor rule? Explain how a central bank may follow the Taylor
rule to conduct monetary policy

Answer :

Taylor Rule :

Federal funds rate target = Inflation + Equilibrium real federal funds rate + ½ ( Inflation
Gap ) + ½ ( Output Gap )

Taylor rule is one kind of targeting monetary policy rule of a central bank. To stabilize the
economic activity by setting an interest rate the Taylor rule was proposed . Central Bank may
follow the Taylor rule to conduct monetary policy . based on the federal funds rate , the price
level and the changes in real income . It suggests to regulate the economic activity be setting
up the federal rate based on the inflation gap between targeted inflation rate and actual and
natural level . This rule suggests a relatively high interest rate in the situation when actual
inflation is higher than a targeted one.

Taylor rule prescribes the central bank should alter interest rates due to changes in the
economy . It recommends a central bank about the federal Reserves should raise interest rate
when inflation is high or when employment levels are high . Conversely it also recommends
when inflation and employment levels are low , interest rates should be decreased .

So, a central bank may follow the Taylor rule to conduct monetary policy .
Question 6. Consider the following equations for the IS-LM framework.

C= 100 + 0.81( 1- t) Y (consumption)

I = 200 – 1000i (investment)

L= ½ Y – 7000i (demand for real money balances)

G = 700 (government spending)

t= 0.33 (income tax rate)

M/P = 500 (real money supply

a) Find the equilibrium level of income.

b) Find the equilibrium level of interest rate.

Answer :

The equation for IS curve is Y= C + I + G

Y = 100 +[0.8(1-t) Y] + 200 -1000i + 700
Y = 1000 + (0.8Y – 0.8tY) – 1000i
Y = 1000 + 0.8Y – 0.8Y(0.33) – 1000i
Y = 1000 + 0.8Y – 0.264Y – 1000i
Y = 1000 + 0.536Y – 1000i
Y – 0.536Y = 1000 - 1000i
0.464Y = 1000 - 1000i
Y = 1000/0.464 – 1000i/0.464

Y = 2155.2 – 2155.2i
So, IS equation is Y = 2155.2 – 2155.2i

The equation for LM curve is Md = Ms

½ Y- 7000i = 500
½ Y = 500 + 7000i
Y=2( 500 + 7000i)
Y=1000 + 14000i
So, LM equation is Y = 1000 + 14000i

At equilibrium IS = LM
2155.2 – 2155.2i = 1000 + 14000i
2155.2 – 1000 = 14000i + 2155.2i
1155.2 = 16155.2 i
i = 1155.2 / 16155.2
i = 7.2 %
therefore, equilibrium level of interest rate is 7.2%. ( Ans )

Y = 1000 + 14000i
= 1000 + 14000(7.2%)
= 2008
Therefore, equilibrium level of income is 2008 ( Ans )

THE END