Question No.

i. Total Output Approach

Output Produced by Silver Mining = $300,000
Output Produced by Jewelry Manufacturer = $700,000
(100, 000 – 300,000)
GDP = $1000,000

ii. Value Added Approach

Activity Cost of Inputs Cost of Output Value Added
Producing Silver 0 300,000 300,000
Making Jewelry 300,000 1000,000 700,000
1000,000

CALCULATION FOR NET PROFIT

SILVER
Sales $300,000

Less wages ($200,000)

Net Profit 100,000

Jewelry Manufacturer
Sales $1000,000
Less Cost of Sales ($300,000)
Gross Profit $700,000
Less Wages ($250,000)
Net Profit $450,000

iii. Income Approach

Net Profit = ($450,000 + $100,000) = $550,000
Wages = ($200,000 + $250,000) = $450,000
GDP = $1000,000
Question No. 2

a. What is a production function? What are some factors that can cause a nation’s production
function to shift over time? What do you have to know besides an economy’s production
function to know how much output the economy can produce?

Production Function

A production function gives the technological relation between quantities of physical inputs and quantities
of output of goods. The production function is one of the key concepts of mainstream neoclassical
theories, used to define marginal product and to distinguish allocative efficiency, a key focus of
economics.

Factors that can cause a Nation Production Function to Shift Overtime

A production function shows how much output can be produced with a given amount of capital and
labor. The production function can shift due to supply shocks, which affect overall productivity.
Examples include changes in energy supplies, technological breakthroughs, and management practices.

How to determine the output an economy can produce?

The amount of real output an economy can produce is determined by the quantities of the factor inputs
(labor, capital, others – land, energy…) and the state or level of technology (knowledge) about the use
(productivity) of those inputs.

b. What will happen to the equilibrium wages and quantity of labor, if the participation rate of
the economy decreases?
Factors Effecting Labor Supply Curve
(We are Talking about those workers who not working not Working so far)
➢ Wealth
o Higher Wealth reduces Labor Supply.
o Labor Supply curve shifts left.
➢ Expected Future real Wage
o Higher expected future real wage reduces labor supply.
o Labor supply curve shifts left.
➢ Population Size
o Higher Population raises labor supply.
o Labor supply curve shifts right.

Labor Market Equilibrium

➢ When Supply = demand

o Wage is equal to W
o Level of employment is equal to N
o Full employment level of output Y
 ➢ Classical Model of the Labor Market
o Wage Adjusts Quickly
o No involuntary unemployment.

What will be the effect of decrease in the participation rate of the economy on equilibrium wages and
quantity of labor?
NS1

E1
Wages (W) MPN

W2
E2
W1

ND2 ND1

N1 N2
Quantity of Labor

Explanation: In the given diagram quantity of Labor is on X Axis and the wages and marginal
productivity of Labor (MPS) is on Y Axis ND2 represent the initial demand curve of labor and NS1
represent the initial supply curve of labor. The equilibrium in the labor market exist at point E2 where
Demand initial curve and initial supply curve intersect each other. The equilibrium wage rate
represent with W2 and equibliorium quantity of labor is N2. Due to the decrease in the participation
rate of the economy MPN decrease which shift the labor demand curve left from ND1 to ND2.
Question No. 3

What is an economic system? An economic system, or economic order, is a system of production,

resource allocation and distribution of goods and services within a society or a given geographic area.
Economic systems are the means by which countries and governments distribute resources and trade
goods and services. They are used to control the five factors of production, including: labor, capital,
entrepreneurs, physical resources and information resources.

Why mixed economic system is widely acceptable in most of the economies?

A mixed economic system is a system that combines aspects of

both capitalism and socialism. A mixed economic system protects private
property and allows a level of economic freedom in the use of capital, but also
allows for governments to interfere in economic activities in order to achieve
social aims.
Most economies are considered mixed because most have some portion of the means of production
under government control. Most economic systems also have some element of the market or
capitalism. . The most vulnerable members of society benefit from a mixed economy because they are
offered some social safety net.

Toyota, Inc., has the following production schedule:

No of Workers Output
1 50
2 90
3 120
4 140
5 150
6 150

i. Find the MPN for each level of employment.

ii. Toyota can get $50 for each output it produces. How many workers will it hire if the nominal
wage is $6000? If it is $7000? If it is $8000?
iii. Graph the relationship between Toyota’s labor demand and the nominal wage. How does this
graph differ from a labor demand curve? Graph Toyota’s labor demand curve.
Solution (i)

No of Workers Output Marginal Output ΔY/ΔN

(MPN)
1 50 50 50/1
2 90 40 40/1
3 120 30 30/1
4 140 20 20/1
5 150 10 10/1
6 150 0 0/1

Solution (ii)

If MPN x P > W, hire one more worker.

MPN = (Marginal Revenue productivity of Labor)

P = Price of which output sold

W = Wage / Nominal Charges

Formula = MPN = W/P = real wages

P = 50

W = $6000 / $7000 / $8000

MPN = 6000 / 50 | 7000 / 50 | 8000 / 50

MPN = 120 | 140 | 160

Solution (iii)

6000

7000

8000

120 140 160

Question No. 4

a. Derive the equation of Aggregate demand curve. Also derive the equation for equilibrium
level of output.

Equation of Aggregate Demand

AD = C+I+G+NX ………..(1)

C= Co+CYD : YD =Y+TR-TA : TA= tY

YD = Y+TR . tY

C= Co + c(Y+TR-tY)

I = Io

G= GO

NX + NXo

AD = Co+c(Y+TR-tY)

AD= Co+cY+CTR-ctY+Io+Go+NXo

AD = Co +Io+Go+NXo+cTR+cY-ctY

AD = Ao+(c-ct)Y

AD = Ao + c(1-t)Y

Equilibrium Level of Output:

At Equilibrium

Y = AD

Y = Ao + c(1-t)Y

Y – c(1-t)Y=Ao

1-c(1-t)Y = Ao

Y= 1/1-c(1-t) Ao
 b. What will happen to the equilibrium level of output, if government increase the transfer
payments. Explain with the help of diagram.

If the Government Increase Transfer Payment, the equilibrium level of output will also
increase.

Y=AD

E2
Aggregate Demand

A2 E1
ΔG

A1 Eo
ΔTR

A AgΔG

Ag-CΔTR

Y0 Y1 Y2
Output

The increase in Output due to increase in transfer payments is less than increase in Output due to
Government spending (by a factor c).
Question No. 6

a. Define monetary and fiscal policy. What are the targets of fiscal and monetary policy?

Monetary policy refers to central bank activities that are directed toward influencing the
quantity of money and credit in an economy. By contrast, fiscal policy refers to the
government's decisions about taxation and spending. Both monetary and fiscal policies are
used to regulate economic activity over time.

What are the targets of fiscal and monetary policy?

TARGETS OF FISCAL POLICY

The main targets of fiscal policy are to achieve and maintain full employment, reach a
high rate of economic growth, and to keep prices and wages stable. But, fiscal policy is
also used to curtail inflation, increase aggregate demand and other macroeconomic
issues.

TARGETS OF MONETARY POLICY

The three most noted monetary policy targets are interest rate, monetary aggregates,
and exchange rates. These targets are usually intermediate targets that can be quickly
achieved and easily measured, but then move the economy toward the ultimate
macroeconomic goals of full employment, stability, and economic growth.

b. How expansionary monetary policy effect the general equilibrium? Explain by using IS-LM
framework.
Through making appropriate changes in monetary policy the Government can influence the level
of economic activity. Monetary policy may also be expansionary or contractionary depending on
the prevailing economic situation.

IS-LM model can be used to show the effect of expansionary and tight monetary policies. A
change in money supply causes a shift in the LM curve; expansion in money supply shifts it to
the right and decrease in money supply shifts it to the left.

Suppose the economy is in grip of recession, the Government (through its Central Bank) adopts
the expansionary monetary policy to lift the economy out of recession. Thus, it takes measures
to increase the money supply in the economy. The increase in money supply, state of liquidity
preference or demand for money remaining unchanged, will lead to the fall in rate of interest.
 At a lower interest there will be more investment by businessmen. More investment will cause
aggregate demand and income to rise. This implies that with expansion in money supply LM
curve will shift to the right.

As a result, the economy will move from equilibrium point E to D and with this the rate of
interest will fall from r1 to r2 and national income will increase from Y1 to Y2. Thus, IS-LM model
shows that expansion in money supply lowers interest rate and raises income.

Y LM1

LM2

E
Rate of Interest

R1

R2

O Y1 Y2 X
National Income
Question No.5

The following equations describe an economy:

C = 0.85(1-t)Y

t = 0.35

I = 950 -60i

G = 900

M/P = 650

L = 0.25Y-62.5i

a. What is the equation that describe the IS curve?

C = 0.85 (1-t) Y

t = 0.35

I = 900 – 50i

Go = 900

L = 0.25Y – 62.5i

M/P = 650

As we know that

Y = AD

AD = C+I+G

AD = 0.85 (1-0.35)Y + 900 – 50i + 900

AD = 0.5525Y + 1800 – 50i

Y= AD

Y = 0.5525Y + 1800 -50i

50i = 0.5525Y – Y + 1800

I = -0.4475Y + 1800 / 50

I = -0.4475Y + 36
I = 36 – 0.4475Y ……………. IS CURVE EQUATION

b. What is the equation that describe the LM curve?

As we know that

M/P = L

650 = 0.25Y – 62.5i

650 – 0.25Y = 62.5i

62.5i = 0.25Y – 650

I = 2.5Y – 650/62.5

I = 2.5y – 10.4

I = -10.4 + 2.5y ………………….. LM CURVE EQUATION

c. What is the equilibrium level of income and interest rate?

Y = Equilibrium level of income and interest rate

Find Y

Therefore we find Y through Formula IS=LM

36 – 0.4475Y = -10.4 + 2.5y

36 + 10.4 = 0.4475Y + 2.5Y

46.4 = 2.9475Y

Y = 46.4 / 2.9475

Y = 15.742