Francis M.

Macharia
PH.D. BA/2023/40959

` BPCU002

Macroeconomic Theory and Policy Analysis

CAT ONE
Question One
a) Meaning of National Income and its Equilibrium
National income means the value of goods and services a country produces during a financial
year. Thus, it is the net result of any country’s economic activities during one year and is valued
in terms of money. National income is an uncertain term and is often used interchangeably
with the national dividend, national input, and national expenditure. Equilibrium means
balance. The equilibrium level of National income is that level of national income which
remains unchanged at a particular level. At this level, there is no tendency for income/
output to rise or fall.
National income and its equilibrium, therefore, means the income we receive from the
value of goods and services produced in a country during any financial year versus
output does not rise or fall.

b) Equilibrium level of consumption, expenditure, and saving.

Consumption, expenditure, and saving equal income. Thus to get the saving at each
level of income, consumption, and expenditure is subtracted from income.

c) Need to have statistics/estimates of the National income of the country.

The study of national income estimates gives us a systematic view of the whole
economy. According to Benhan, the best way to get a picture of the economic life of a
country is to study detailed estimates of its national income. This is done through:-
i) A comprehensive summary of the economic activity.
National income estimates give us detailed data relating to a country’s production,
savings, investments, capital formation, and various other economic activities in a
particular year. All these data give us a comprehensive picture of the people’s
economic activities during that year.
ii) Assessment of relative importance and progress of different sectors.
The national income data relating to the sources of national income gives us an idea
of the relative importance of the different sectors (namely, agriculture industry,
trade and commerce, service, e.t.c.) in the economy of the country.
 National income statistics enable us to have a clear idea of the structure of the
economy. It allows us to know the relative importance of various sectors of the
economy and their contribution toward national income. It:-
i) Provides information to be used for making economic policies or budgeting or
planning. The National Economic figure is an important tool for macroeconomic
analysis and policy. National Economic estimates are the most comprehensive
measures of aggregate economic activity in an economy. It is through such estimates
that we know the aggregate yield of the economy and lay down future economic
policy for development. It is an important tool for long-term economic planning. A
country cannot possibly frame a plan without having prior knowledge of the trends
in national income. The national income estimates help us to divide the national
product into various levels of government. According to E. Levy (pdf), statistics assist
in the branches and sectors to which they relate. It is necessary to organize and
consolidate the mass of primary statistics and information into a system designed to
bring out the main national aggregates and interrelationships pertaining to income
product and expenditure.
ii) Provides information on the contribution of each sector of the economy to the
national income. The sectors comprise the primary sector which retrieves and
produces commodities from raw materials, the secondary sector which transforms
raw materials into goods, and the tertiary sector which supplies goods and services
to consumers and businesses. These sectors help us to know how income is
produced, how it is distributed, and how much is spent, saved, or taxed. We are able
to know the relative roles of the public and private sectors in the economy.
iii) Provides a breakdown of consumer expenditure and government expenditure. It
enables us to provide for reasonable depreciation to maintain the capital stock of
the community. It helps us determine the subscription and quotas of different
countries to international organizations e.g. UNO, IMF, e.t.c. and how to fix the
burden of payments equitably.
iv) Provides information on the distribution of income. According to Oscar M. (1962),
methods such as “Double declining balance and the sum of the years digits, lifo, and
fifo, present realistic appraisal of the depreciation of capital that actually takes place
in the economy in a given time interval. It enables us to have an idea of inflationary
and deflationary gaps.
v) Provides Information on types of factor incomes in the economy. It helps us to know
the resources used to produce goods and services. The use of land is called rent,
labor-generated income is called wages, and interest is generated on capital and
profit from the enterprise. Through factor income, the government of a nation is
able to distinguish between gross domestic product and gross national product. It
helps us determine income generated both domestically and from citizens abroad.
vi) Provides statistics for measuring the economic growth of the county. GDP is the
most popular way of measuring economic growth. This is calculated by adding up all
 the money spent by the government, entrepreneurs, and consumers in a given
period. A relationship between resource input and total economic output is
established.
vii) Provides information used to measure the standard of living in the country. It helps
us compare the standards of living of people in different countries and of people
living in the same country at different times. This is measured using GDP per capita
which is calculated by establishing the gross domestic product and then dividing it by
the population.
viii) Provides information used for comparing the economic performance of the country
across two or more years. Economic performance helps to determine the success or
failure in achieving countries set objectives.
d. Showing per capita income of a hypothetical country.

Per capita income is a measure of the amount of money earned per person in a nation or
geographical region in a given year.
Formula: PC = RSN/RP
Where PC = per capita
RSN = Relative Standard Number
RP =Relative Population
Taking imaginary figures of RSN as $2.72trillion and RP as 1.36 trillion people
PC = $2.72 / 1.36 trillion
PC=$2,000
This means that the GDP Per Capita earning for each individual is $2,000.
Per Capita helps correlate with key indicators. On a per capita basis, GDP is a more effective
indicator of the quality of life. On average, higher levels of GDP per capita can be associated
with some key quality of life statistics.
Per capita helps to compare countries. Using per capita, we are able to identify the average
income within a country. This is useful for businesses making investment decisions as it allows
them to identify investment plans.
Per capita also helps businesses identify income levels in parts of the country whilst making a
like-for-like comparison. GDP per capita in Mombasa in Kenya might be higher than that of
Nairobi, but due to the high population in the slums in Nairobi, the investors opt to invest here
due to cheap labor.
However, per capita doesn’t provide a representation of the standard of living in a population.
For example, for 100 people living in Mombasa, 90 of them earn $10,000 and 10 of them earn
$1000, the per capita income is $8,900. This doesn’t show a realistic picture of income
distribution in the town.
To conclude, per capita is a very useful metric to use for a variety of reasons. It can show
important statistical data in any sector, from finance to social issues. However, the metric isn’t
always useful or accurate for certain issues.

Question Two
Determinants of money supply

The money supply is the sum total of all currency and other liquid assets country’s economy on the date
measured. The money supply includes all cash in circulation and all bank deposits that the account
holder can easily convert to cash.

Government issue paper currency and coins through the central bank or treasuries or a combination of
both. In order to keep the economy stable, banking regulators increase or reduce the available money
through policy changes and regulatory decisions.

Economists track the money supply over time in order to determine whether too much money is
flowing, which can lead to inflation or too little money is flowing which can cause deflation. In order to
keep the economy growing at a reasonable level:-

i) Interest rate is controlled by setting the key rates that it changes to the nation for the
overnight loans of government money that keep the banking system running. The rates for
all other loans are derived from the lending rates.
ii) Cash is added or removed from the system by changing the amount of money that flows to
banks for use in loans to businesses and consumers.
iii) The money supply is tracked over time as a key factor in analyzing the health of the
economy, pinpointing its weak spots, and developing policies to correct the weakness.

To increase money in an economy like ours, we can take the following measures:-

i) Reducing interest rates. Lower interest rates reduce the cost of borrowing. This will make
investment relatively profitable and so encourage economic activity. Consumers will also
see cheaper mortgage payments leading to higher disposable income.
ii) Qualitative easing. The government increases bank reserves effectively to create money out
of thin air. The created money can be used to buy assets; the idea is to increase the cash
reserves of banks.
iii) Reduce the reserve ratio for lending. The reserve ratio is the percentage of deposits that
keep cash reserves. If the cash reserve ratio is reduced, the bank will be led more and due to
the money multiplier, we will see a rise in bank lending. However, Central Bank should set a
minimum reserve ratio.
iv) Increase confidence in the banking system. If banks have confidence in the financial system,
then they will be more willing to lend. Banks in a credit crisis are guaranteed bank deposits
and nationalized struggling ones.
v) Central Bank buying securities. The Central Bank pays investors holding bonds. If the Central
Bank buys government securities (or corporate bonds people who are holding the bonds
have money to spend.
 Francis M. Macharia
DHDBA/2023/40959

BPCU002

MACRO-ECONOMICS

CAT TWO
Question One
Money supply, Interest rate, and economic growth. Their effect on an economy of a country.

An increase in the supply of money typically lowers the interest rates which in turn generates more
investments and puts more money in the hands of consumers thereby stimulating spending. Businesses
respond by ordering more raw materials and increasing production. The increased business activity
raises the demand for labor.

When the money supply falls, or when its growth rate declines the opposite occurs. Banks led less,
businesses put off new projects, and consumer demand declined.

Change in the money supply has long been considered to be the key factor in driving economic
performance and business cycles. For a long time measuring money supply has shown that there are
relationships between money supply and inflation, and between money supply and price levels.
However, since 2000, these relationships have become less predictable, reducing their reliability as a
guide for monetary policy. Although money supply measures are widely used, they are among a number
of economic measures that economists collect, track, and review.

In order to keep the economy growing, interest rates are controlled by setting the key rates that it
charges to the nation for the overnight loans of government money that keep the banking system
running. The rates for loans are derived from the lending rates