MACROECONOMICS

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COURSE

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DATE

A 1.If we steal from each other we do not become richer. Discuss?

A stolen item is a valuable resource that has been taken away from a source without the knowledge of the owner. Richness is the creation of more wealth and increasing the value of current wealth. For people to become rich they need to invest more so that they can create a multiplier effect which will cause an increase in GDP. This is not possible when we steal.

Stealing will show lack of security and people will scared to invest the money hence they won’t become richer. If there is much stealing people will only t prevent stealing rather than try and invest.

Through stealing there is no investment since wealth just circulates around the same place. When one steals no increase in wealth takes place only that the person who stole the money is rich.

2. Explain the determinants of investment.

Interest rate.

There is a negative relationship between interest rate and investment. When interest rate is high people will invest less. If the interest rates are low people will invest more since profits from investment is higher than that of securities.

Technology

An introduction of superior technology reduces cost of production hence attracting investors thus investment increases with all other factors held constant. But when technology is inferior production cost becomes high thus investment level goes down.

Stock of capital at hand.

If there exist unsold inventories it implies there is excess investment, this would make investors not invest more. But if there is less capital at hand investors invest more.

Expectation of future profits.

Expectation of increase in future profits investors will invest more now but an expectation of losses more investment will be carried out now.

Taxes

An increase in the level of taxes reduces the rate of investment. But when the level of taxes is low investment rate is high.

Acquisition, maintenance and operating cost of capital.

When all this three factors are high level of investment goes down. But when they are low investment goes high.

3 .Briefly explain three theories of money.

Quantity theory of money (fishers equation/by irving fisher)

According to this theory value of money depends on the quantity of money in circulation with other things held constant, double the quantity of money double the prices. Factors being constant are: number of transactions, velocity of money, barter transactions, hoarding.

The cash balance equation theory/Cambridge equation.

It is also known as the demand & supply theory of money. The theory supports the Keynesian theory that depends on; transaction motive, precautionary motive, speculative motive. While supply of money depends on; currency notes, coins, bank notes. It states that price level is equal to total money in circulation divided by volume of production multiplied by proportion of national income people prefer to hold.

Money demand and supply equilibrium theory

The amount of money supplied depends on interest rate since money demand also depends on interest rate. To increase demand & supply we lower interest rate.

4 .Briefly explain the law of comparative advantage.

It is a law that states when each country specialises in production of that commodity in which the relation has comparative advantage the total world output of commodity necessarily increases with the result that every country becomes better off. A country is said to have comparative advantage in production of a commodity in which its degree of superiority is high.

5. Prove that the investment multiplier is k=mps-1

B.1. using the Keynesian theory discuss the national income equilibrium.8

Equilibrium GDP is that output which creates spending just sufficient to buy that output, equilibrium is always along the help line. Introduction of a certain consumption function equilibrium will be at a certain point in the, help line beyond that point there is no equilibrium. Meaning all GDP not been bought hence there will be spending of investment which will change the equilibrium. The economy will be in no time be in disequilibrium due to: multiplier, paradox of thrift, Say’s law.

2. it’s unfair to have rich people while others are extremely poor. Discuss.

Inequality of distribution of national income is caused by the following reasons.

Inherited resources. People in rich families inherit land factories and business. They become rich because they are born in rich families while poor families don’t get the chance to be rich.

Private ownership. People are free to increase their wealth to any extent. People who get a chance to succeed become rich.

Social evils this is the main cause of unequal distribution of income in underdeveloped countries. it includes corruption, smuggling etc. A few persons become too rich.

Better opportunities, the lucky ones get better opportunities in life. They become rich.

Natural gift, naturally gifted people earn a lot of money due to extra ordinary talents. Persons with ordinary talents remain poor.

Arguments in favour with equitable distribution of income.

Higher consumption. Income distribution is fair when all persons spend more than their basic wants. Consumption of goods and services is higher as a result of production increase.

Equity of opportunities, this enables the talented persons to come up and succeed in life.

Political stability, fair and equitable distribution enhances population stability conflict between the rich and the poor brings political instability.

Social justice, income distribution is fair when the whole population maintains high living standards. Social justice is enhanced in the society.

C1. Explain the determinants consumption function.

There are two groups of determinant of consumption function. They subjective and objectives.

Subjective.

Precautionary motive-every person has a strong feeling to prepare for emergencies. So they build up reserves for such emergencies.

Foresight motive-every man has future needs. They need to save for their old age.

Motive for independence-most of us have a strong desire to be independent financially .so we tend to save by sacrificing present consumption.

Standard of living- we always want to improve the standard of living for which we reduce consumption and save for the future.

Objective function.

Distribution of income-this is an important factor of propensity to consume. The more inequality in income distribution, the lower will be the propensity to consume. poor people have a higher MPC , their basic and primary needs are not satisfied. So, increase in income tends to increase MPC whereas rich people have lower MPC.

Expectations-every consumer has certain calculations about their future changes. This may be regarding price, income or employment. When they expect price increase in future, they tend to consume immediately, or if they expect unemployment in future, they tend to consume less and save more.

Windfall gains and losses-when the consumers get huge profit, they tend to consume more as income increases. However, loss will make them consume less due to decrease in income.

Fiscal policies-fiscal policy is related to tax structure and government expenditure. When the taxes are decreased the disposable income with people with increase and so will the consumption and vice versa.

Stock of wealth-if any individual has enough stock of wealth in the form of bonds, fixed deposits etc. He tends to consume more of his current income. But if the stock of wealth is low, the individual will spend less and tend to save more.

2. The world is just recovering from an economic depression. Discuss the demerits of this fearful business situation.

Low economic activity. This is because there is great uncertainty in the economy hence few activities

Low prices. Prices of commodities are usually too low that investors find it hard to invest. This lowers the economic growth of the state even further.

High wage rates. There are high wage rates for employee as they are affected by poor standards of living and the higher living standards.

Unemployment, there higher rate of unemployment since investment for one isn’t taking place due to the low prices. Again companies want to minimize the number of employees.

3. Explain the function of the central bank to the government

It acts as a banker’s bank.

Its serves as a lender of last resort to commercial banks and also the government.

It encourages the adoption of the financial system according to the changing needs of the market.

It administers external results, exchange controls and handles external financial relations.

Manages the national reputation. It takes into account accumulated borrowings undertaken by the government to fund expenditure

It has the sole responsibility of issuing currency. Regulates issue of coins and notes.

Acts as a government banker. It does not maintain business accounts and individuals in the private sector. It only maintains the accounts of the government sector. This usually starts a bank returns as public deposit.

Important of all is that it acts as a government agent. This is when it implements the monetary in the pursuit of the governments’ national economic development. As part of this process, the bank acts as a medium for two way transmission between the government and the financial market. Among other things it collects extensive statistical information on all financial institutions. The information is usually about the following: the volume of the business, the sector of the economy that would need lending.

The central bank has the obligation to supervise banking industry in general. The bank can directives to commercial banks and other financial institutions indicating how much they should be lending. This has been done through what has been known as persuasion. The bank is mandated to inspect and supervise the directives given to non- governmental institutions and commercial bank.

D.1.in the 1990’s the government of Kenya exercised exchange rate control. Discuss some consideration for this policy.

Improve the balance of payment. A government fixes a high exchange rate that would discourage importation but on the other hand encourage exportation.

To protect domestic industries. In order to protect domestic industries against foreign competition higher exchange rate is fixed.

To maintain a stable exchange rate. To develop the economy by use of foreign currency. Development of a country depends on foreign exchange reserves which are required to purchase items necessary for development.

To check flows in capital. If in a country there symptoms of foreigners wanting to withdraw their capita a high exchange rate would devalue their capital.

2. Explain some measures the government can use to counteract the ever raising exchange rate.

Exchange clearing- in these two countries agree to match their receipts and payments. Imports in either country will pay in local currencies.

Fixed exchange rate- the government maintains exchange rate at a specific level and ensures that the rates stay in the prescribed limits by buying and selling the currency to bring the rates into this limits.

Exchange restrictions- the government requires that all foreign exchange deals must be transacted through most preferable channels e.g. the central bank.

Blocked currency account- where payments by citizens or residents to foreigners are paid in blocked accounts with the name of foreigners. These beneficiaries can only draw such funds from such accounts with the permission and approval by the central bank.