Week 6

Question 1

Elements of Balance of Payments account and categorization private and official sector

Answer 1

1. CA: current account, private
2. KA: financial and capital account, private
3. Reserves account: official

Question 2

The receipts and payments of KA

Answer 2

receipts (+) from the sale of assets to foreigners

payments (-) for assets from foreigners (investment by our country in foreign country)

totale: net investment in our country

Reminder: private sector

Question 3

implications of surplus and deficit KA

Answer 3

KA in surplus (KA>0), receipts> payments, net international borrrower

KA in deficit (KA<0), receipts< payments, net international lender

Question 4

Implications of surplus and deficit in reserve assets

Answer 4

Decrease of reserve assets, official sector (CB), more of a net borrower (receipts > payments)

Increase of reserve assets , official sector (CB) more of a net lender (receipts< payments)

Question 5

Net borrower

Answer 5

receipts > payments (as FDI is in your country)

Question 6

Net lender

Answer 6

Receipts< payments (you invest in other country)

Question 7

Philips curve

Answer 7

Theory that claims that with economic growth comes inflation, which in turn should lead to more jobs and less unemployment.

Wages rise faster the lower the unemployment rate

Relationship behind inflation in AS-AD model
y-axis: inflation rate
x-axis: unemployment rate

Question 8

AS-AD model & multiplier in short run

Answer 8

SRAS: the type of AD and AS shocks determine the new SRAS

new SRAS and AD intersect, not in equilibrium with LRAS

Question 9

Business cycle theory & keynesian view, three reasons of equilibria

Answer 9

• Disequilibria (from potential) exist because prices are sticky
• Disequilibria (from potential) exist due to over-/underinvestment
• Disequilibria (from potential) exist because actors or not strictly rational
(e.g. “animal spirits” or “spontaneous urge to action” or the lack thereof)

Question 10

Two formulas to calculate unemployment rate

Answer 10

1. number of people unemployed/ workforce x 100
   workforce: Ls= number employed (= Ld) + number unemployed

Number of people employed (Ld)= national income/ labour productivity
2. ((labour productivity* available labour)-national income)/ (labour productivity* available labour) *100

Question 11

Formula determining the size of AD curve shift

Answer 11

change in AE * multiplier

Question 12

Implications steepness of slope of SAS curve

Answer 12

the steeper the slope of SAS curve, the larger the increase in price level and the smaller is the ultiplier effect on real GDP

Question 13

Two approaches to Business cycle

Answer 13

1. mainstream business cycle theory
   potential GDP grows at steady rate while AD grows at fluctuating rate. As money wage rate is sticky, if AD grows faster than potential GDP, real GDP exceeds potential GDP as well and inflationary gap emerges
2. real business cycle theory (RBC theory)

random fluctuations in productivity as main source of economic fluctuations
Fluctuations of productivity can result from fluctuations in pace of technological development, internationaldisturbances, climate fluctuations, natural disasters

RBC impulse generated mainly by R&D that leads to the creation and use of new technologies

Question 14

Two sources of inflation cycles

Answer 14

1. demand-pull inflation: inflation that results from an initial increase in AD
   - initial effect of an AD rise
   - money wage response
   - demand-pull inflation process
2. cost-push inflation: inflation kicked of by an increase in costs
   two main sources of an increase in costs
   - increase in money wage rate
   - increase in money price

Question 15

Capital accumulation

Answer 15

growth of capital resources, i.e. human capital

Question 16

Two main purposes of use of real GDP

Answer 16

1. compare standard of living over time

2. compare standards of living across countries

Question 17

Lucas wedge

Answer 17

measure of loss of potential GDP when economy doesn’t grow as fast as optimal situation

Question 18

Business cycle and its two phases

Answer 18

periodic but irregular up-and-down movement of total production and other measures of economic activity.

unpredictable but two phases

1. Expansion: period during which real GDP increases
2. Recession: period during which real GDP decreases, growth rate is negative

Question 19

Formula real GDP growth rate

Answer 19

(real GDP current year- real GDP previous year)/ real GDP previous year *100

Question 20

Two reasons for increase in real GDP

Answer 20

1. return to full employment in an expansionary phase of business cycle (taking up slack from last recession)
   -> no economic growth
   movement from inside production possibility frontier to point on PPF
2. potential GDP increase -> economic growth
   outward movement of PPF to new PPF curve

Question 21

PPF

Answer 21

production possibility frontier

Question 22

Compound interest formula

Answer 22

rule of 70 to calculate the number of years for a variable to double approximately
70/ annual growth rate of variable

Question 23

Determination of potential GDP: model with two components

Answer 23

1. Aggregate production function: relationship that tells how real GDP changes as quantity of labour changes
   y-axis: real GDP
   x-axis: labour
2. Aggregate labour market: LD, LS and labour market equilibrium
   y-axis: real wage
   x-axis labour
   real wage rate: money wage rate/ price level

Question 24

Growth of potential GDP by two categories

Answer 24

1. growth of supply of labour
   effect: real wage rate falls and equilibrium quantity increases, potential GDP increases
   ! use of two models
2. growth in labour productivity
   labour productivity rises> expansion production possibilities> firms demand for labour increases
   ! use of two models

Question 25

Preconditions for labour productivity growth

Answer 25

incentive system created by firms, markets, property rights and money
these elements enable trade and specialization