STREPIESKODE BAR CODE
Department of ECONOMICS
Economics IB (ECS1601) Tutorial letter 202/2011 (Second semester)
Solutions to Assignments 03 and 04.
Dear Student The purpose of this tutorial letter is to provide you with the correct answers to the assignments. 1. The solutions to Assignments 03 and 04. Assignment 03 - Unique number 810132 Explanations 3.1 The correct alternative is (3)
According to the assumptions of the simple Keynesian model, the economy only consists of the two sectors; households and firms. See section 18.2 of the text book. 3.2  The correct alternative is (2) Incorrect. In macroeconomic theory, total spending is not always equal to total production. Total spending may be greater than, less than or equal to total production. Correct. See the explanation above. Incorrect. There is no guarantee that total spending will be equal to total production or income. The correct alternative is (4) Incorrect. Say’s law states that supply creates its own demand, hence there can never be insufficient spending to achieve full employment. This is consistent with the believe that all leakages will automatically find their way back into the circular flow of income and spending. Correct. See (a) above. Correct. See (a) above. The correct alternative is (3) Incorrect. Consumption is not positively related to interest rate, but it is positively related to income. Correct. Due to other non-income determinants of consumption spending, consumption is positive even when income is zero. Correct. As income increases, part of the additional income is saved hence the increase in consumption will be smaller that the increase in income.
b. c. 3.4 a. b. c.
3.5    
The correct alternative is (1) Marginal propensity to consume indicates the proportion of additional income that will be used for consumption. Incorrect. Marginal propensity to consume is the ratio of the change in consumption to the change in income. Incorrect. Incorrect. Marginal propensity to consume is the proportion of an increase in consumption through an increase in income. The correct alternative is (3) Correct.
The shift of the investment function is caused by other factors other than the interest rate. Such factors include improvement in profit expectations or business sentiment. a. b. c. Incorrect. An increase in the repo rate would cause a movement along the investment function and not a shift of the curve. Incorrect. A decline in the lending rate would cause a movement along the investment function and not a shift of the curve. Correct. When the profit expectations improve, the level of investment at each interest rate will increase. This is indicated by the rightward shift of the investment function. The correct alternative is (3)
Movement from b to a represents a decrease in investment spending. Since investment is negatively related to interest rate, such a decrease in investment spending could have been due to an increase in interest rate. a. b. c. Correct. A movement from b to a is due to an increase in interest rate. Incorrect. Incorrect. There is no systematic relationship between investment and income.
3.8 a. b.
The correct alternative is (4) Incorrect. Using the formula, C = + cY, where c is the marginal propensity to consume, then from the function C = 50 + 3/4Y, c = ¾. Correct. Aggregate spending = C + , where C is the consumption spending and is the investment spending. Thus, if A = 500 + 3/4Y and = 50, then = 500 – 50 = 450 Correct. The multiplier is 1 1− c 1 = 3 1− 4 1 = 1 4 =4 = Where c is the m arg inal propensity to consume substitute c with 1 4 =1x 4 1 3 and subtract from 1 4
The correct alternative is (1)
The equilibrium income = multiplier times total autonomous spending. We first have to calculate the multiplier: 1 1− c 1 = 2 1− 3 1 = 1 3 =3 = Where...