ECS2602/201/1/2017

Tutorial letter 201/1/2017

Macroeconomics
ECS2602

Department of Economics
First semester

Answers to Assignment 01

BARCODE
Dear student

Let us formally welcome you to the Macroeconomics module and wish you well in all your endeavours.
Please take note of our contact telephone numbers.

Listed below are the contact details of the lecturers responsible for the module.

Telephone number Telephone number

Name of lecturer Email address
(Inside SA) (Outside SA)

Mrs T Uys uysmd@unisa.ac.za 012 433 4702 +27 12433 4702

Mrs S Kennedy-Palmer kennes@unisa.ac.za 012 433 4666 +27 12433 4666

Kindly direct content-related queries to your e-tutor on the discussion forum of your e-tutors
website on myUnisa and contact the university administration if you have any problems regarding all
others matters.

How can students contact Unisa? Visit the myUnisa website. Click on the "Contact" icon where you will
find all the necessary contact details.

Please only contact your lecturers with content-related queries if you are unsatisfied with the response of
your e-tutor.

We trust that you will avail yourselves of the opportunity presented to you.

1. HOW MUCH TIME MUST I SPEND STUDYING ECS2602?

ECS2602 is a semester module with a credit value of 12 that must be completed for a B Com degree in
Economics. Each credit is equivalent to 10 notional hours. This means that to be successful, the
average student must spend 120 notional hours on this module. The notional hours includes time that is
spent studying the learning units, completing the activities in TL102, doing assignments, preparing for
the examination, and writing the examination. Students whose capabilities are below average must
therefore spend more than 120 notional hours studying ECS2602 in order to be successful.

That boils down to 30 work days (4 hours per day) or 60 work days (at least 2 hours per day) that must
be devoted to this module in order for the average student to pass it. This is the way in which each
module is designed. In other words, you cannot plan your semester on the basis of completing
assignments only.

2. ANSWERS TO ASSIGNMENT 01

(Unique number: 801518)

The first assignment was based on learning units 1 to 3. If you experience any problems with these
sections, work through the activities in TL102 again.

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The correct answers are:

Question Option Question Option Question Option

1 5 13 5 25 4

2 2 14 3 26 2

3 3 15 3 27 1

4 3 16 1 28 3

5 2 17 3 29 1

6 3 18 1 30 3

7 1 19 5 31 3

8 4 20 5 32 5

9 5 21 1 33 3

10 2 22 5 34 4

11 2 23 2 35 1

12 4 24 5

Study guide = MO001

Question 1 is based on learning unit 0 of the study guide.

1. The correct option is 5. Microeconomics focuses mainly on the behaviour and decisions of
individual consumers, households, business enterprises and other organisations. It also studies the
demand for and supply of individual goods and services and the determination of their prices.
Macroeconomics studies the behaviour and performance of the economy as a whole.
Macroeconomics focuses on areas such as the aggregate output level, the employment level, and
the aggregate price level of the whole economy (i.e. inflation).

Question 2 is based on learning unit 1 of the study guide.

2. The correct option is 2. Statements a and b are correct and refer to the calculation of GDP.
Statement c is incorrect. Real per capita GDP = real GDP divided by the population. If the
population increases at a faster rate than the real GDP then the real GDP of the average person
will decrease (not increase).

Questions 3 to 24 are based on learning unit 2 of the study guide.

3. The correct option is 3. Refer to the section at the end of the study guide labelled Summary:
Exogenous vs. endogenous variables and make sure that you understand the difference between
an exogenous and an endogenous variable and how these variables affect the various models.
The level of output and income is endogenous in the goods market, however marginal propensity
to consume and investment spending are both exogenous, therefore statements 1 and 2 are
incorrect. Statement 4 is incorrect. It is only in the IS-LM model that investment spending has an
endogenous component, in the goods market it is fully exogenous.

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4. The correct option is 3. Expenditure on the GDP is the total value of spending on final goods and
services within the borders of a country, including exports but excluding imports it is therefore the
total value of spending on South African produced goods and services, i.e. it is the demand for
domestic goods. GDE is the total value of spending on final goods and services within the borders
of a country, including imports but excluding exports it is therefore the total value of spending in
South Africa, i.e. it is the domestic demand for goods. Study learning unit 1 and 2 in the study
guide and make sure that you understand the difference between GDP, GDE and expenditure on
the GDP as these differences will become important when we look at an open economy.

5. The correct option is 2. Refer to section 2.1 in learning unit 2. Transfer payments are government
subsidies and payments to advance social objectives. Transfer payments are excluded from
governments final expenditure (G) because they do not represent governments payment for
goods and services, therefore they do not directly have an impact on the demand for goods and
services and the level of output and income.

6. The correct option is 3. Refer to the diagram labelled Gross fixed capital formation 2013 under
section 2.1 of learning unit 2 in the study guide.

7. The correct option is 1. The three statements summarise the demand for goods in a closed
economy. See learning unit 2 in the study guide.

8. The correct option is 4. Statements b and c are correct. Refer to the section at the end of the study
guide labelled Summary: Exogenous vs. endogenous variables and make sure that you
understand the difference between an exogenous and an endogenous variable and how these
variables affect the various models. Statement a is incorrect. Autonomous consumption is an
exogenous variable in the goods market therefore it will not be affected by a change in income.
Statements b and c are correct. Induced consumption (cYD) is affected by a change in income (Y)
therefore it is an endogenous variable. Disposable income (YD) is also affected by a change in
income (Y) therefore it is also an endogenous variable.

9. The correct option is 5. Only statement b is correct. Statement a is incorrect because an increase
in the marginal propensity to consume will change the slope of the consumption function and not
the intercept. Statement b is correct because the availability of credit is one of the factors which
determine autonomous consumption. Statement c is incorrect because a decrease in the marginal
propensity to save implies that the marginal propensity to consume increases. If the marginal
propensity to consume increases, consumption spending will increase and that will cause the
equilibrium level of output and income to increase.

10. The correct option is 2. Statements a and b are correct. A change in the marginal propensity to
consume will change the proportion of income that is spent on consumption. Assuming a marginal
propensity to consume of 0.8 and autonomous consumption spending of R80 million, the first
round of consumption spending will be 0.8 x (R80 million) = R64 million and through the multiplier
process consumption will be 1/1-0.8 x 80 = 5 x 80 = R400 million. If the marginal propensity to
consume increases to 0.9, households will spend 0.9 x (R80 million) = R72 million in the first round
and through the multiplier process consumption will be 1/1-0.9 x 80 = 10 x 80 = R800 million.
Statement c is incorrect. Refer to page 67 of the prescribed book in the box labelled The paradox
of saving. If the marginal propensity to consume decreases, the marginal propensity to save
increases. This increase in savings is the initial effect. This decrease in the marginal propensity to
consume leads to a decrease in consumption spending and therefore income will also decrease
which will also lead to a decrease in savings (applicable in the short run). The net effect will not be
a decrease in the original level of savings. Therefore the paradox of savings is that if households
increase their savings the end result is that the level of output and income will decrease and
households will end up with the same amount of savings. Therefore it is the marginal propensity to
save that will increase but the amount of savings will stay the same.

11. The correct option is 2. Statements a and b are correct. See the diagram. Statement c is correct. In
country A autonomous consumption is 2 000 while in country B it is 1 000. Autonomous
consumption is therefore higher in country A.

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Statement d is correct. Induced consumption is that part of consumption spending that depends on
income: to know what the induced consumption is we need to know what the marginal propensity
to consume is and what the disposable income is.
Therefore in country A it is 0.7(5 000) = 3 500 and in country B it is 0.9(5 000) = 4 500. It is higher
in Country B. Statement e is incorrect. The consumption spending formula is C = co + cYD. :
Therefore Country A = 2 000 + 0.7(5 000) = 2 000 + 3 500 = 5 500 and for Country B = 1 000 +
0.9(5 000) = 1 000 + 4 500 = 5 500. It is the same for both countries.

12. The correct option is 4. Statements a and c are correct. The effect of a decrease in consumer
confidence and investor confidence will be a decrease in the level of output and income. Therefore
in order to combat this impact government must take actions to increase the level of output and
income. An expansionary fiscal policy entails an increase in the demand for goods in the economy
by increasing government spending and/or decreasing taxes resulting in an increase in the level of
output and income. Statements b and d are incorrect as they describe a contractionary fiscal policy
which will result in a decrease in the level of output and income.

13. The correct option is 5. Statements c and d are correct. Statement a is incorrect. The ZZ curve will
shift upwards if taxes decrease. Statement b is incorrect. A decrease in taxes does not impact on
autonomous consumption, it will impact on induced consumption through a change in the
disposable income of households. Statements c and d are correct: T YD C Z Y.
Statement e is incorrect. A decrease in taxes increases disposable income and consequently
induced consumption spending increases (not decreases). As consumption spending increases
producers increase output and consequently income increases. The multiplier effect is in operation.

14. The correct option is 3. Statements a, b, d and e are correct. Statement c is incorrect. Government
spending, investment spending and autonomous consumption will all have a direct impact on the
demand for goods (Z) which will affect the level of output and income (Y) however taxes have an
indirect impact on the demand for goods through disposable income and consumption spending.
For statement c to be correct it should have been as follows: T YD C Z Y.

15. The correct option is 3. All the statements except statement a are correct. Autonomous
consumption is only represented by c0.

16. The correct option is 1. All three of these statements are correct. Gross capital formation is
another way of saying investment spending. Make sure that you understand the difference
between financial and real investment and why we only look at real investment in our analysis. In
the goods market model an increase in investment causes an increase in the demand for goods
and consequently the level of output and income increases. As the level of output and income
increases, savings increase since savings are a positive function of income: I Z Y S.

17. The correct option is 3. To calculate the equilibrium level of output and income:

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Y = 1 - c (c0 + + G cT)
Y = 1/1 0.75 (100 + 300 + 200 0.75(60))
Y = 1/0.25 (600 45)
Y = 4 (555)
Y = 2 220

18. The correct option is 1.

The income gap = full employment level of income (YF) equilibrium level of output and income
(Y). R2 460 R2 220 (calculated in answer 17) = R240 million.

Statement a is correct. The required increase in government spending would be the income
gap/the multiplier = 240/4 = 60.

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 Statement b is correct. Taxes affect the level of output and income through the marginal propensity
to consume and therefore the change in c(T) needs to be 60, since
60 = c(T)
60 = 0.75(T)
T = 60/0.75
T = 80

Taxes need to decrease by R80 million to ensure that full-employment will be reached.

If a combination of an increase in government spending of R30 million and a decrease in taxes of

R40 million is used then the effect would be:
Increase in government spending: G x multiplier = 30 x 4 = 120. Income increases by R120
million.
Decrease in taxes: c(T) x multiplier = 0.75(40) x 4 = 30 x 4 = 120. Income increases by R120
million.
Add the two together and you get an increase in income of R240 million which is the income gap
(calculated in answer 18), therefore statement c is correct.

19. The correct option is 5. All the statements are correct.

To answer this question correctly you must do the following:
Calculate the multiplier. The formula for the multiplier is 1/1-c. Given a marginal propensity to
consume of 0.5 the value of the multiplier is 2.
Calculate the equilibrium level of output and income. The formula for the equilibrium level of
output and income is
1
Y = 1 c (c0 + + G cT)

Given the information in the question the equilibrium level of income is 2 x (600 million + 40 million
+ 280 million 0.5(300 million)) = 2 x R770 million = R1 540 million. Note that you must subtract
cT.
Calculate the budget balance. The budget of government is the difference between tax revenue
and government spending (T G) or (G T). In this case there is a budget surplus of R20 million
since T = R300 million and G = R280 million.
Calculate consumption spending at the equilibrium level of output and income. The
consumption spending in this model is C = co + cYD. Given a value of R600 million for c0 and
YD = Y T = (R1540 million R300 million) = R1 240 million, consumption spending at the
equilibrium level of income = 600 + 0.5(1 240) = R600 million + R620 million = R1 220 million.

20. The correct option is 5. None of these statements are correct.

The following diagram shows the economy of PORTHOS.
The vertical intercept is 770:
c0 + + G cT = 600 + 40 + 280 0.5(300) = R920 million R150 million = R770 million.

The equilibrium level of output and income is R1 540 million (calculated in answer 19) and the level
of full employment R1 650 million, that is R1 540 million + R110 million (the output and income
gap).

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In this particular model one way of reaching full employment is to increase autonomous spending.
The increase in autonomous spending that is required is equal to 110 million/2 = R55 million.
Remember a multiplier of 2 indicates that for every R1 increase output and income increases with
R2.

Statement a is incorrect.
If government spending is to be used it implies that government spending must increase by R55
million. This will increase autonomous spending by R55 million. In this case the budget surplus of
government changes from R20 million to a budget deficit of R35 million. Tax revenue is still R300
million but government spending is now R280 million + R55 million = R335 million.
Thus T G = R300 million R335 million = R35 million.

Note that an increase in government spending of R80 million (as indicated in statement a) will take
the economy beyond full employment while the budget deficit increases to R60 million. [T G =
300 (280 + 80) = 300 360 = R60 million].

Statement b is incorrect.
If taxation is to be used to get an increase of R55 million in autonomous spending it implies that the
decrease in taxes should be R110 million. The reason why taxes should be decreased by R110
million is due to the fact that households increase their spending not by the full amount of the
decrease in tax but only by c(T). In other words, c(T) must be equal to R55 million. It therefore
follows that T = R55 million/0.5 = R110 million. Tax revenue decreases to R300 million R110
million = R190 million while government spending is R280 million. In this case the budget surplus
of R20 million changes into a deficit of R90 million (T G = 190 280 = R90 million).

Note that a decrease in taxation of R160 million (as indicated in statement b) will take the economy
beyond full employment while the budget deficit increases to R140 million.
[T G = (300 160) 280 = 140 280 = R140 million].

Statement c is incorrect.
An increase in government spending of R40 million increases output and income by 2 x 40 million
= R80 million while a decrease in taxes of R80 million increases output by 0.5(R80 million) x 2 =
40 x 2 = R80 million. The net change in output and income is therefore R80 million + R80 million =
R160 million. The impact on the budget of government is that the budget surplus of R20 million
(see question 19) changes into a deficit of 100.
[T G = (300 80) (280 + 40) = 220 320 = R100 million].

21. The correct option is 1. If taxes are cut by R150 million then output and income increases by c(T) x
the multiplier = 0.5(R150 million) x 2 = R75 x 2 =R150 million.

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22. The correct option is 5. Statements c, d and e are correct.
Statement a is incorrect. A balanced budget is one where the change in government spending is
equal to the change in taxes (G = T).

Statement b is incorrect. Assume that c = 0.8.

The value of the multiplier is 1/1c = 1/10.8 = 1/0.2 = 5.
An increase of 200 in government spending increases Y by 200 x 5 = 1000.
An increase of 200 in taxes decreases Y by 0.8(200) x 5 = 160 x 5 = 800.
The net effect is an increase of 200 (1000 800) in the level of output and income.

Statement c is correct. Assume that c = 0.6.

The value of the multiplier is 1/1c = 1/10.6 = 1/0.4 = 2.5.
An increase of 300 in government spending increases Y by 300 x 2.5 = 750.
An increase of 300 in taxes decreases Y by 0.6(300) x 2.5 = 180 x 2.5 = 450.
The net effect is an increase of 300 (750 450) in the level of output and income.

Statement d is correct. The net effect of a balanced budget, in other words where G = T will be
expansive. In the case of statement b the net effect was 200 and the expansionary effect in the
case of statement c was 300.

Statement e is correct. The balanced budget multiplier is equal to one that is for every 1 unit
increase in government spending, output and income increase by 1 unit.

23. The correct option is 2. When government increases its spending, by 500, output and income
directly increase by 500 and the multiplier starts to operate from 500. When government increases
taxes by 500 it withdraws 500 from the economy. However, households do not decrease their
spending by 500, but only by c x 500. The multiplier starts to operate not from 500 but from c x
500.

The following example illustrates this expansionary effect of the balanced budget:
Assume that c = 0.8 and that G increases by 500 and T increases by 500.
The value of the multiplier is 5.
An increase of 500 in government spending increases Y by 500 x 5 = 2500 and the ZZ curve will
shift upwards.
An increase of 500 in taxes decreases Y by 0.8(500) x 5 = 2000 and the ZZ curve will shift
downwards.
The net effect is an increase of 500 (2500 2000) in output and income and therefore the net
effect on the ZZ curve is that it will shift upwards.

24. The correct option is 5. Statements b, c and d are correct. There is no such option and therefore
you must choose option 5.
Statement a is incorrect. The multiplier is 5 since 80/100 = 0.8 mpc; (1/1c = 1/10.8 = 1/0.2 = 5)
or 1 000/200 = 5.
Statement b is correct. If government spending increases by R100, the autonomous spending will
be now equal to 300 (200 + 100 = 300). Autonomous spending x multiplier = equilibrium level of
output and income: 300 x 5 = 1 500.
Statement c is correct. The value of the marginal propensity to consume (c) is given as 0.8 (see
the diagram); therefore c(T) = 80 since 0.8(100) = 80. Autonomous spending will decrease by 80
and now be equal to 220 (300 80) therefore the equilibrium level of income and output will be
1 100 (220 x 5), represented by point a in the diagram.
Statement d is correct.
Statement e is incorrect. The net effect will be 100 (the difference between 1 100 and 1 000). See
the diagram below:

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Questions 25 to 35 are based on learning unit 3 of the study guide.

25. The correct option is 4. In the financial market: the interest rate is a fully endogenous variable and
the part of the demand for money that is negatively related to the interest rate is endogenous.
The exogenous variables in the financial market are the nominal money supply and the part of the
demand for money that is influenced by expectations, business confidence, and political and social
factors.

26. The correct option is 2. There is a negative relationship between the demand for money and the
interest rate, an increase in the interest rate will cause an upward movement along the Md curve.

An upward movement along the money demand curve indicates that as the interest rate increases
the quantity of money demanded decreases. As the interest rate increases the opportunity cost of
holding money increases and financial market participants are inclined to hold less money. The
below diagram illustrates the above explanation.

27. The correct option is 1. A positive relationship exists between income and the demand for money.
As the level of output and income increases from Y to Y1, the demand for active balances
increases as financial market participants wish to do more transactions. At each interest rate the
quantity of money demanded is therefore higher and a rightward shift of the money demand curve
takes place. The below diagram illustrates the above explanation.

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28. The correct option is 3. In this module we follow the traditional approach to the supply of
money. This implies that the money supply is controlled by the central bank and is presented
graphically by a vertical straight line which is entirely inelastic with regards to the interest rate.

29. The correct option is 1. Statements a and d are correct. Statement a is correct and statement b is
incorrect. At the initial interest rate of 10%, an increase in the money supply from MS to MS1 will
result in an excess supply (or surplus) of money of R50 million. This excess supply of money
causes a decrease in the interest rate and a downward movement along the money demand curve
occurs until a new equilibrium is reached where Ms = Md at a lower interest rate. The opposite is
also true, therefore statement c is incorrect and statement d is correct.

30. The correct option is 3. The shift from Ms to Ms2 represents the impact of a contractionary monetary
policy. In order to decrease the money supply, the central bank will sell bonds (treasury bills) on
the open market. This increase in the supply of bonds will decrease the price of bonds and results
in a higher interest rate.
Ms: SB PB i

31. The correct option is 3. To calculate the rate of return on a treasury bill you need to do the
following:
Nominal return/Price paid x 100
The nominal return is calculated as follows: Face value minus price paid. (Face value = R150 000)
If the price paid is R138 000 the nominal return is R150 000 R138 000 = R12 000 and the rate of
return is 8.70%. [12 000/138 000 x 100 = 8.69% 8.70%.]
If the price paid increases to R145 000, the rate of return (interest rate) will decrease because a
negative relationship exists between the price of bonds (treasury bills) and the interest rate.

32. The correct option is 5 since all the statements are correct.
To calculate the rate of return on a treasury bill you need to do the following:
Nominal return/Price paid x 100
The nominal return is calculated as follows: Face value minus price paid (Face value = R250 000).
If the price paid is R245 000 the nominal return is R5 000 and the rate of return is 2%.
If the price paid is R243 000 the nominal return is R7 000 and the rate of return is 2.9%.
If the price paid is R242 750 the nominal return is R7 250 and the rate of return is 3%.
If the price paid is R210 000 the nominal return is R40 000 and the rate of return is 19%.

33. The correct option is 3. Statements a and b are correct. Statement a is correct. An increase in
income increases the number of transaction and the demand for money increases. This is
represented by a rightward shift of the demand for money curve. Statement b is correct. An
increase in the interest rate is represented by an upward movement along the demand for money
curve.

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Statement c is incorrect. The supply of money is determined by the central bank and is
independent of the interest rate and is therefore a vertical line, not a horizontal line.

34. The correct option is 4. Remember that financial market participants are holding the amount of
money and bonds they wish to hold, given the level of output and income (positive relationship)
and the interest rate (negative relationship). A liquidity trap implies that at a very low or nearly zero
interest rate the demand for money curve is completely elastic (horizontal). In this region, known as
a liquidity trap (see diagram below) an increase in the money supply through monetary policy has
no impact on the interest rate.

Therefore only statements b and d are correct. Statement a is incorrect because the return on
holding bonds will be extremely low, close to zero. Statement c is incorrect because there will be a
low demand for bonds due to the low interest rate, the opportunity cost of holding money is very
low in a liquidity trap so there will be a high demand for money and a low demand for bonds.

35. The correct option is 1. A decrease in income will shift in the demand for money curve to the left
and contractionary open market operations by the central bank will shift the money supply curve to
the left. The resultant interest rate will be indeterminate because a leftward shift of the demand for
money curve results in a lower interest rate whilst a leftward shift of the money supply curve will
result in a higher interest rate.

Remember to work through all the activities in TL102 (the workbook).

Best of luck with your studies.

Your lecturers

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