Macroeconomics Assignment: Economic Models, Policies, and Analysis

This macroeconomics assignment delves into key economic models and concepts. It begins with multiple-choice questions covering GDP, business cycles, output gaps, the Keynesian multiplier, and the effectiveness of fiscal and monetary policies. The assignment then explores the Keynesian model, calculating equilibrium output and analyzing the impact of government spending. Furthermore, it utilizes the IS-LM model to examine the effects of demonetization and fiscal policies on output and interest rates. The assignment also uses the AD-AS model to analyze deflation, the Phillips curve, and the drivers of inflation. The solution provides detailed explanations and calculations, offering a comprehensive understanding of macroeconomic principles and their applications.

Macroeconomics

Table of Contents
MAIN BODY.......................................................................................................................................3
Part 1.....................................................................................................................................................3
Part 2.....................................................................................................................................................7
1. The economy of “Keynesia” has the following economic structure:...............................................7
1. What is the equilibrium level of output in Keynesia?..................................................................8
2. Calculation of new level of output if Government spendings increased by increasing the Fiscal
spendings to reduce the unemployment in the country....................................................................8
C. Size of spending multiplier in Keynesia and net change in the new and original level of output
.........................................................................................................................................................9
D. Calculation when savings have declined to 10% and Government spending increased from 20
to 30.................................................................................................................................................9
2. Using the IS-LM model, analyzing the following:.........................................................................10
A. Impact of Demonetisation and why does it matter for India?...................................................10
B. How Fiscal Policies boosts output and their impact on interest rates?.....................................10
C. Circumstances which not let an expansionary fiscal policy to result in higher interest rates?. 10
D. Interest rates are affected only by monetary policies or there are some other factors?............10
3. Using the AD-AS model, analyzing the following:........................................................................11
A. Meaning of Deflation along with the respective causes of a benign deflation and malign
deflation?........................................................................................................................................11
B. Defining Phillips curve..............................................................................................................11
C. Unemployment rate fallen faster or slower in the absence of monetary and fiscal policy
easing.............................................................................................................................................11
D. Defining the drivers of inflation...............................................................................................12
REFERENCES...................................................................................................................................13

MAIN BODY
Part 1
1. Which of the following is false regarding GDP?
A. GDP can be measured in three ways: production, income and expenditure
B. If measured correctly, all three ways of measuring GDP are equivalent
C. The production method aggregates total production across all industries
D. The income method aggregates income accruing to all factors of production, i.e., labor,
capital and land
E. The expenditure method aggregates spending in the economy, which consists of
consumption, investment, government spending and net export
Answer - If measured correctly, all three ways of measuring GDP are equivalent
2. Short- to medium term fluctuations in the economy (i.e., business cycles) are primarily driven
by changes (or shocks) to:
A. Underlying trend growth
B. Aggregate supply
C. Inflation expectations
D. All of the above
E. None of the above
Answer - Aggregate supply
3. An economy has a negative output gap when:
A. Actual GDP is lower than potential GDP
B. Actual GDP growth is lower than potential GDP growth
C. Potential GDP is lower than actual GDP
D. Potential GDP growth is lower than actual GDP growth
E. None of the above
Answer - Actual GDP is lower than potential GDP
4. In the Keynesian multiplier model, a rise in the marginal propensity to save (MPS) results in:
A. A steeper AD curve and higher equilibrium output
B. A steeper AD curve a lower equilibrium output

C. A flatter AD curve and higher equilibrium output
D. A flatter AD curve and lower equilibrium output
E. An upward shift in the AD curve and higher equilibrium output
Answer - A flatter AD curve and lower equilibrium output
5. Empirical evidence suggest that the fiscal multiplier is:
A. Smaller when there is a negative output gap
B. Larger when there is a negative output gap
C. Smaller when there is a positive output gap
D. Larger when there is a positive output gap
E. B. and C.
Answer - Smaller when there is a negative output gap
6. If investment becomes less responsive to changes in the interest rate, then:
A. The IS curve will become flatter
B. The LM curve will become flatter
C. The IS curve will become steeper
D. The LM curve will become steeper
E. Both the IS curve and LM curve will become flatter
Answer - The IS curve will become steeper
7. Monetary policy tends to be more effective when:
A. Money demand is not sensitive to interest rate
B. Investment sensitive to interest rate
C. The economy is not in a liquidity trap
D. The IS curve is flat
E. All of the above
Answer - Investment sensitive to interest rate
8. Fiscal policy tends to be more effective when:
A. Money demand is not sensitive to interest rate
B. Investment is sensitive to interest rate
C. The LM curve is steep
D. All of the above
E. None of the above
Answer - Money demand is not sensitive to interest rate

9. If output rises while the price level also rises, the economy is most likely is being hit by:
A. A positive demand side shock
B. A negative demand side shock
C. A positive supply side shock
D. A negative supply side shock
E. B. and D.
Answer - A positive demand side shock
10. Other things equal, a rise in price (or inflation) expectation causes:
A. The aggregate demand curve to shift down, reducing output and price level
B. The aggregate demand curve to shift up, raising output and the price level
C. The aggregate supply curve to shift down, raising output and the price level
D. The aggregate supply curve to shift up, lowering output and raising the price level
E. The aggregate supply curve to shift down, raising the output and reducing the price level
Answer - The aggregate demand curve to shift up, raising output and the price level
11. If an economy is hit by a permanent adverse supply side shock:
A. Output will fall and policy should boost aggregate demand to restore full employment
B. Output will rise and policy should curb aggregate demand to reduce inflation
C. Output will fall while the price level rises
D. Output will rise while the price level falls
E. None of the above
Answer - Output will fall while the price level rises
12. If there is an adverse demand side shock (e.g. a decline in consumer and business confidence)
and the government refrains from implementing any macro stabilization policy, the economy:
A. Will be permanently stuck at below full-employment output
B. Will quickly “self-correct” to full employment output if wage and price are flexible
C. Will quickly “self-correct” to full employment output if wage and price are “sticky”
D. Will quickly “self-correct” if wage is flexible but price is “sticky”
E. Will quickly “self-correct” if wage is sticky but price is flexible
Answer - Will quickly “self-correct” to full employment output if wage and price are flexible
13. Broad money supply is determined by:
A. The central bank

B. Commercial banking system
C. The public
D. All of the above
E. A. and B. only
Answer - The central bank
14. In a balance sheet recession (e.g., the great recession), the money multiplier is low because:
A. Money velocity is low
B. The interest sensitivity of money demand is low
C. Banks are willing to lend but consumers are unwilling to borrow
D. Banks’ reserve ratio low
E. None of the above
Answer - Banks’ reserve ratio low
15. A central bank can tighten monetary policy by:
A. Selling bond in an open market operation and thereby increase bank reserves
B. Selling bond in an open market operation and thereby decrease bank reserves
C. Buying bonds in an open market operation and thereby increase bank reserves
D. Buying bonds in an open market operation and thereby decrease bank reserves
E. Lower the required reserve ratio
Answer - Selling bond in an open market operation and thereby decrease bank reserves
16. The Phillips curve refers to the relationship between:
A. Inflation rate and the unemployment rate
B. The change in inflation rate and the change in unemployment rate
C. Output level and the level of unemployment rate
D. Output growth and the change in unemployment rate
E. Inflation rate and the output gap
Answer - Inflation rate and the unemployment rate
17. Inflation tends to rise when:
A. The output gap is positive, i.e., aggregate demand exceeds potential output
B. The economy is buffeted by a series of adverse supply shocks (e.g. rising oil or food
price)
C. Inflation expectations rise

D. All of the above
E. None of the above
Answer - The output gap is positive, i.e., aggregate demand exceeds potential output
18. If the market interest rate equals the “natural“ rate, it is likely that:
A. Aggregate demand equals potential output
B. Desired savings equals desired investment
C. Inflation will be constant
D. All of the above is true
E. None of the above is true
Answer - Aggregate demand equals potential output
19. Other things equal, the “natural” rate of interest will fall if:
A. Supply of saving falls
B. Household consumption rises
C. Investment demand rises
D. All of the above
E. None of the above
Answer - Supply of saving falls
20. If the central bank maintains policy interest rate at a higher than the natural rate, it is likely that:
A. The economy will go into recession and asset prices will fall
B. The economy will go into recession and asset prices will rise
C. The economy will go into a boom and asset prices will rise
D. The economy will go into a boom and asset prices will fall
E. The effect on the economy and asset prices is uncertain
Answer - The economy will go into recession and asset prices will rise.
Part 2
1. The economy of “Keynesia” has the following economic structure:
Consumption: C = 25 + 0.75Y
Investment: I0 = 30
Government spending: G0 = 20

1. What is the equilibrium level of output in Keynesia?
The equilibrium level of output of any country refers to the equal amount of production and market
demand. The Equilibrium level of the country depends on the country's output and the price at
which they are sold. The country's output is the production is equal to the consumer demand to buy
the product. The country's GDP represents the business manufacturing products produced by the
companies in the domestic country only. GDP is equal to total expenditure in the country to produce
those products. The level of output can be measured by
Y= C+I+G
Where, Y is aggregate income
C is consumption
I is Investment
G is Government expenditure
The Equilibrium level of output of the “Keynesia” is
Y= 25+0.75 Y + 30 + 20
0.25 Y= 75
Y= 300
The equilibrium level of output of the Keynesia is 300 which shows that the level of output of the
country. This also that any change in the Government spending increases and all other expenditures
stay constant, the level of aggregate income must also increase to maintain the equilibrium level of
income.
2. Calculation of new level of output if Government spendings increased by increasing the Fiscal
spendings to reduce the unemployment in the country
If the Government spending reduces to 30 than their will be following impact on the level of output
of the country-
A. Y= 25+.75 Y + 30 +30
B. .25 Y= 85

C. Y= 340
As the Government is increasing its fiscal spending to reduce the unemployment in the
country. The new level of output in the country will 340. This represents that if the spendings are
high than the output level will be increasing. It means that the higher level of expenditure leads to
higher level of output in the country.
C. Size of spending multiplier in Keynesia and net change in the new and original level of output
The size of spending multiplier effect lies behind focusing on the extra demand and incomes
created. The multiplier effect comes into the economy due to the increase in demand of goods and
services into the circular flow of income. The net change in output is because of the increase in the
fiscal spending by Government. Government spending are the part of the level of aggregate income.
If the Fiscal spendings are increasing which are part of the Government spending that means that
their will be increase in the level of output more employees will be working so their will be more
production in the country which ultimately leads to the increase in the level of output.
D. Calculation when savings have declined to 10% and Government spending increased from 20 to
30
Now, the new consumption function is C= 25+0.9 Y and Government spending have been increased
from 20 to 30. The new level of output is

Y= 25+0.9 Y+30+30
.10 Y= 85
Y= 850
These changes are due to decline in the savings because previously in the country their were
savings of 25% but now it has declined to 10%. This shows that country money flow has been
increased because which people are more investing in their businesses. Due to increase in the
investments level of output is also increases and also Government spendings are also increasing
which led to the decrease in the unemployment. Also, more employment lead to the more
production in the country which increased the level of output in the country.
2. Using the IS-LM model, analyzing the following:
A. Impact of Demonetisation and why does it matter for India?
India as economy suffered due to cash in the economy was suddenly reduced because of the
change in the economy. India is a country who is having high population who is uneducated and
illiterate. They did not know the use of the digitalisation and various techniques to use the net
banking etc. This matters to India because it was sudden announcement without prior news which
caused huge problems in the country (Ferraresi and et.al., 2015). This directly impacted growth of
the country due to which businesses started suffering and whole economy was affected.
B. How Fiscal Policies boosts output and their impact on interest rates?
Fiscal Policies are related to the spending of Government to level up the liquidity in the
economy and tax rates in order to monitor and influence the nation’s economy. When Government
runs a deficit, they issue some bonds. They compete with private borrowers for money loaned by
the savers. This causes the raise in the interest rates to reduce the fraction of output composed of
private investment (Sassi, 2019). For example at the time of Great Depression Government applied
same Fiscal policies to bring back the economy in the balance.
C. Circumstances which not let an expansionary fiscal policy to result in higher interest rates?
Expansionary Policies are when Government expands its money supply in the economy. It is
used in order to cut down taxes or increase the spending. The main purpose of this policy is to boost
growth to a healthy economic level (Ferraresi and et.al., 2015). Expansionary Fiscal Policy puts
more money in hands of the consumers in order to give them more purchasing power. For example,
The Trump administration used these policies in order to cut taxes. Obama used these policies with
the Economic Stimulus Act.
D. Interest rates are affected only by monetary policies or there are some other factors?
In some global economy interest rates are lower due to perfect combination of monetary
policies and fiscal policies in the economy. The interest rates are not only affected by monetary
policies but there are many other things which affect the interest rates. These other factors are
lenders and borrowers who largely affect the interest rates in the market (Sassi, 2019). The lender
takes the risk that borrower may not pay him back the loan in contradictory he increases the interest
rates with the risk of inflation. These causes increase in the rise of the interest rates.

3. Using the AD-AS model, analyzing the following:
A. Meaning of Deflation along with the respective causes of a benign deflation and malign
deflation?
Deflation – It is defined as a decline in the amount or prices of goods and services taking place at
the time when the rate of inflation fall below 0%. The main cause of deflation is when the supply of
money in the economy is fixed (Fleckenstein, Longstaff and Lustig, 2017). The purchasing power
of currency and wages becomes higher than before. There are two types of deflation -
1. Benign deflation – This type of inflation is related with the increase in the productivity because
of high use of the latest technologies and advancements resulting in decline in the pricing factors.
For example – economy of the US in the 1990s.
2. Malign deflation – It is concerned with the fact of weak demand which in turn causes a high
decline or downward spiral in the prices of the good and services. For example - Japan for nearly
two decades following the bursting of the asset price bubble in 1990 (Oulton and et.al., 2018).
B. Defining Phillips curve.
The Phillips curve defines the inverse relationship between the unemployment rate level and the
inflation rate. The Phillips curve is generally negatively sloped because in the short run time period,
the expected inflation varies from the actual inflation and the real wages declines by going down.
Since the Great Recession, the Phillips curve has become flatter which means that the
Phillips Curve depicts that the wages and prices are adjusting with slow phase to the changes in
Aggregate Demand as a result of imperfections persisting in the labor market (Coibion and
Gorodnichenko, 2015). The theory of Phillips curve states that with the growth of economic aspects
inflation comes which results in leading to more creation of job option and focuses on less
unemployment.
The policy implication of a flat Phillips curve relates to the extent by making use of the
monetary and fiscal policies for controlling the inflation rates without unemployment level going to
high.
C. Unemployment rate fallen faster or slower in the absence of monetary and fiscal policy easing.
During the time period of Great Recession, the rate of unemployment in the US has rose
from 4.5% to the peak of 10% in the mid of the year 2009. The unemployment rate has taken more
than seven years to fall back to 4.5%. Fiscal policy generally affects the aggregate demand factor by
making changes in the spending of government amount and taxation rate. These factors create
influencing impact on the employment as well as household income, which then impact the overall

level of spending and investment of the customer (Piore, 2017). Monetary policy of the country
creates impact on the money supply in the economy. It also influences the interest rates as well as
the inflation rate of the country thereby affecting the unemployment level.
D. Defining the drivers of inflation.
Two main causes of inflation includes Demand pull and Cost push aspects. These factors are
considered as responsible general rise in the level of the prices in every business economy. The Cost
push factor of inflation occurs in case situation when the cost of supply force prices are higher.
Demand pull inflation is a result of when the aggregate demand for the goods and services rises
in the economy with increase as well as rapid phase as compared to the productive capacity of the
economy (Bernanke and et.al., 2018).

REFERENCES
Books and Journals
Bernanke, B. S. and et.al., 2018. Inflation targeting: lessons from the international experience.
Princeton University Press.
Piore, M., 2017. Unemployment and inflation: institutionalist and structuralist views. Routledge.
Coibion, O. and Gorodnichenko, Y., 2015. Is the Phillips curve alive and well after all? Inflation
expectations and the missing disinflation. American Economic Journal: Macroeconomics. 7(1).
pp.197-232.
Fleckenstein, M., Longstaff, F. A. and Lustig, H., 2017. Deflation risk. The Review of Financial
Studies. 30(8). pp.2719-2760.
Oulton, N. and et.al., 2018. Double deflation: theory and practice. Economic Statistics Centre of
Excellence, Discussion Paper, ESCoE DP. 17.
Ferraresi, T and et.al., 2015. Fiscal policies and credit regimes: a TVAR approach. Journal of
Applied Econometrics. 30(7). pp.1047-1072.
Sassi, F., 2019. Global public health challenges, fiscal policies, and yellow vest. The
Lancet. 393(10173). pp.745-746.
Online
Aggregate demand side shock. 2019. [Online]. Available through:
<https://www.economicsonline.co.uk/Managing_the_economy/Demand_shocks.html>.