THE UNIVERSITY OF ZAMBIA

HUMANITIES AND SOCIAL SCIENCES

ECONOMICS DEPARTMENT

EC225 TEST ONE

DATE: 16TH APRIL 2004 TIME 10- 11 Hrs
TIME: 1 HOUR
INSTRUCTIONS: ANSWER ALL QUESTIONS AND SHOW YOUR WORKING

1) If the consumption function is given by C = $250bn + 0.725Yd and that equilibrium

national income is given by Y = 1/s (a –cT + Ip +G) where s is the MPS and c is the
MPC.
a) What will be the change in equilibrium national income if government increased its
purchases of goods and services (G) by $125 billion? (15 marks)
b) By how much would equilibrium national income decrease if government increased
taxes by $135 billion? (15 marks)

2. Use graphs (IS-LM model) to answer questions 2a and 2b

a) Show the effect of an open market purchase of government bonds by central bank on
national income and interest rates (15 marks)
b) Show the effect of an expansionary fiscal policy on national income and interest rates
(15 marks)

3 Consider the following economic model:

Y = C + I +G………………………………………………………………….. (1)
C = c(Y - T) 0 < c' < 1 ………………………………………………….(2)
I = I(r) I' < 0 ……………………………………………………...(3)
M/P = M(r, Y) Mr < 0, My >0 ………………………………………………(4)

Where Y = GNP Output Mr = δM/δr

C = Consumption
I = Planned Investments
G = government spending My = δM/ δY
I' = δI/ δr
c' = δC/ δY
Mr = δM/ δr
My = δM/ δY
a) Derive the Investment – Savings (IS) equation and show that the IS has a
negative slope (20 marks)
b) Derive the Liquidity- Money (LM) equation and show that it has a positive
slope (20 marks)

Good luck!