National Income Determination

Question 1

Business Cycles

Answer 1

They are economic-wide fluctuations in total national output, income, and employment usually lasting for a period of 2 to 10 years marked by widespread expansion or contraction in most sectors of the economy.

Question 2

Two main phases of business cycles

Answer 2

1. Prosperity

2. Depression

Question 3

All the phases of the business cycle

Answer 3

1. Expansion
2. Peak
3. Recession
4. Trough
5. Recovery

Question 4

Expansion

Answer 4

There’s an increase in various economic factors such as production, employment, output, wages, profit, demand and supply of products, and sales.

Question 5

Peak

Answer 5

Increase in growth rate of business cycle achieves its maximum limit

Question 6

Recession

Answer 6

Is a recurring period of decline in total output, income, and employment lasting usually from 6 months to a year and marked by widespread contractions in many sectors of the economy.

Question 7

Trough

Answer 7

Economic activities of a country decline below the normal level. Growth rate becomes negative and there is a rapid decline in national income and expenditure.

Question 8

Characteristics of recession

Answer 8

1. Sharp contraction in consumer spending
2. Fall in labour demand
3. Fall in inflation rate
4. sharp falls in business profits

Question 9

Two main theories of business cycles

Answer 9

1. Exogenous

2. Internal.

Question 10

Exogenous sources of business cycles

Answer 10

They’re factors outside the economic system that lead to economic fluctuations, eg. Elections, pandemic, oil price shocks, wars

Question 11

Internal sources of business cycles

Answer 11

They’re the factors within the economic system that generate expansions and contractions

Question 12

[T/F] Business cycles may also be induced by aggregate demand or aggregate supply

Answer 12

True

Question 13

[T/F] Demand-induced business cycles result from fluctuations in aggregate demand

Answer 13

True

Question 14

[T /F] Supply-induced business cycles result from shocks to production that leads to fluctuations in economic activity.

Answer 14

True

Question 15

Aggregate demand

Answer 15

Total quantities of goods and services demanded by households, firms, governments, and the external sector at various price levels

Question 16

Mathematically, Aggregate demand is

Answer 16

AD = C^d + I^d + G + NX

where C^d = desired consumption
I^d= desired investment

Question 17

Main determinants of consumption

Answer 17

1. Current income
2. Future income
3. Wealth
4. Interest rate
5. Taxes

Question 18

The Keynesian Consumption Function

Answer 18

Expresses consumption as a function of current disposable income

C= a + BY^d

Y^d is disposable income
a is autonomous consumption
B is marginal propensity to consume

Question 19

Autonomous consumption

Answer 19

It is the level of consumption that does not depend of income

Question 20

Marginal Propensity to Consume

Answer 20

Measures the change in consumption per unit change in income.

Question 21

Properties of the Keynesian Consumption Function

Answer 21

1. MPC is constant

2. Average Propensity to Consume decreases with income. [see notes]

Question 22

Factors that determine investment

Answer 22

1. The user cost of capital (real interest rate)
2. Business expectation about the future prospects of the economy
3. Taxes
4. Investment tax credit

Question 23

The Keynesian Savings Function

Answer 23

[- a + (1 - B) Y^d]

-a is autonomous dissaving
(1 - B) is marginal propensity to save.

Question 24

Investment tax credit

Answer 24

An amount that businesses are allowed by law to deduct from their taxes, reflecting an amount they reinvest in themselves

Question 25

Net exports depends on

Answer 25

1. Domestic income 2. Foreign income 3. Real exchange rate

Question 26

The real exchange rate

Answer 26

The real exchange rate measures the price of foreign goods relative to the price of domestic goods.

Question 27

Mathematically, real exchange rate is

Answer 27

The ratio of a foreign price level and the domestic price level, multiplied by the nominal exchange rate.

Question 28

Fiscal policy

Answer 28

Refers to the changes in the level of government spending and/or taxes meant to influence the level of economic activity.

Question 29

Types of fiscal policy

Answer 29

1. Expansionary policy (fiscal loosening) | 2. Contractionary policy (fiscal tightening)

Question 30

Expansionary policy (fiscal loosening)

Answer 30

refers to increases in government spending or reduction taxes

Question 31

Contractionary policy (fiscal tightening)

Answer 31

Refers to increases in government taxes and/or reduction in government spending. Fiscal austerity

Question 32

Austerity

Answer 32

A set of economic policies a government implements to control public sector debt.

Question 33

Output (GDP) Gap

Answer 33

The difference between what the economy could have produced and what actually is produced thus, potential output minus actual output

Question 34

If output gap is positive i.e potential GDP is greater than actual GDP

Answer 34

We have recessionary gap

Question 35

If output gap is negative i.e potential GDP is less than Actual GDP

Answer 35

We have inflation gap

Question 36

If output gap is zero i.e potential GDP is equal to actual GDP

Answer 36

We have full employment

Question 37

Major goal of fiscal policy

Answer 37

Is to stabilize actual output close to the potential output

Question 38

[T /F] If actual output is greater than potential output (inflationary gap), contractionary fiscal policy can be used to reduce output to potential output

Answer 38

True

Question 39

[T /F] If actual output is less than potential output (recessionary gap), expansionary fiscal policy can be used to increase output to the full employment output

Answer 39

True

Question 40

Automatic stabilizers

Answer 40

In-built fiscal mechanisms within an economy that dampens effects of fluctuations in aggregate demand on actual output. Example, unemployment insurance

Question 41

Crowding out

Answer 41

Refers to offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduce investment spending.