STRATHMORE INSTITUTE OF MATHEMATICAL SCIENCES

Bachelor of Business Science in Actuarial Science/Financial Economics/Financial Engineering

END OF SEMESTER EXAMINATION
BSA 1202-Macroeconomics for Actuarial Science
BSE 1204-Introduction to Macroeconomics
DATE: Thursday, 21st January 2021 Time: 2 Hours
Instructions
1. This examination consists of FIVE questions.
2. Answer Question ONE (COMPULSORY) and any other TWO questions.

QUESTION ONE [30 marks]

Below is an extract from an article that was published in The Economist Newspaper - January
25, 2020.
The great Treasuries binge
In the good old days, America’s budget deficit yawned when the economy was weak and shrank
when it was strong. It fell from 13% to 4% of GDP during Barack Obama’s presidency, as the
economy recovered from the financial crisis of 2007-09. Today unemployment is at a 50-year low.
Yet borrowing is rising fast. Tax cuts in 2017 and higher government spending have widened the
deficit to 5.5% of GDP, according to International Monetary Fund (IMF) data—the largest, by
far, of any rich country . . .
Investors based in Europe appear to have been the most enthusiastic buyers. In part that reflects
some countries’ large trade surpluses. . . . Can America’s government deficit remain so wide for
much longer? Some economists worry that loose fiscal policy at a time of low unemployment will
cause the economy to overheat, rousing inflation. That would force the Federal Reserve to raise
interest rates, and push up government-borrowing costs. So far, though, there is little sign of that.
Inflation is oddly soggy; the Fed cut rates three times last year.

After reading the extract above, please answer the following questions:
a) What do you think the author means by writing “America’s budget deficit yawned when the
economy was weak and shrank when it was strong? Discuss in your own words. (3 marks)
b) The article goes on to mention that today unemployment in America is at a 50-year low.
As the U.S. economy recovered from the financial crisis of 2007-09, state one type of unem-
ployment that you think declined the most during this time. Support your answer. (2 marks)

1
 c) The article also mentions that “Investors based in Europe appear to have been the most
enthusiastic buyers (of US treasury bonds). In part that reflects some countries’ large trade
surpluses”. Discuss the effect that the demand for US treasuries from European countries
(many of them using the Euro) is likely to have on the US exchange rate. Use a diagram to
support your answer. (5 marks)

d) In addition, explain what it means for a country to have a trade surplus. (1 mark)

e) State the components of the current account and discuss the likely effect of a trade surplus
on a country’s current account. Support your answer. (4 marks)

f) Further, the article mentions that “Some economists worry that loose fiscal policy at a time
of low unemployment will cause the economy to overheat, rousing inflation.” What do you
think the author means by the term “loose” fiscal policy? Explain.(2 marks)

g) Assume the US economy is in a long-run equilibrium. Using and AD/AS diagram, illustrate
and explain how loose fiscal policy will cause the economy to overheat, leading to higher
inflation. (6 marks)

h) Finally, the article states that “Inflation is oddly soggy; (yet) the Fed cut rates three times last
year.” With reference to inflation and the components of Aggregate Demand (AD), clearly
discuss what the Federal Reserve (Fed) wanted to achieve by cutting interest rates in the
economy. (4 marks)

i) Suppose that an American financial commentator discussing the effects of a decrease in the
value of the US exchange rate makes the following observation:

ˆ The weaker dollar will also mean higher inflation in this country. Explain whether or
not you agree with this statement. (3 marks)

QUESTION TWO [20 marks]

a) The graph below shows the relationship between money supply and price levels in
Hungary’s economy from 1921 to 1925.

Describe the quantity theory of money and explain whether or not the strong association
between the two variables is in the graph above is consistent with the quantity theory of
money. (4 marks)

2
b) Below is an extract from the South African Reserve Bank.
“As from 25 February 2009 the inflation target is a range of 3 to 6 per cent for the year-on-
year increase in the headline CPI (CPI for all urban areas) on a continuous basis. This was
announced by the Minister of Finance in his Medium Term Budget Policy Statement on 21
October 2008. The inflation target is set by government after consultation with the Bank”.
Show the Taylor Rule equation and explain how the South African Reserve Bank can use
Taylor’s rule to achieve a Target rate of inflation (π ∗ ). (5 marks)

c) Below is an extract from an article that was written in The Economist - March, 2013.
Growth in national income is a poor predictor of welfare
If you look at countries’ social and economic progress since 1990, you will find that, in most
cases, it is in line with their historic performance - with some important exceptions. Accord-
ing to the United Nations Development Programme (UNDP), over 40 countries have done
much better than their recent history alone would have suggested . . . the distinctive feature
of the calculations is that they are based on the UNDP’s ‘human development index’,(HDI)
which includes social indicators (for example, health and education) and hence is a broader
measure of welfare than gross domestic product (GDP), which is based on income.
As measured by the HDI, some countries with a good but not outstanding record of GDP
growth perform exceptionally well. Mexico, Algeria and Brazil, for example, saw their in-
comes per person rise at modest annual rates of 1-1.7% from 1990-2012. But measured by the
rise in the HDI they were among the top 15 performers . . . The lesson, says the UNDP, is that
whereas GDP growth matters, countries cannot rely on it alone for broad-based development
After reading the extract above, please answer the following questions:

i) Define GDP and provide two reasons why it is desirable for a country to have a large
GDP. (3 marks)
ii) Distinguish between nominal GDP and real GDP. In addition, explain why economists
use real GDP rather than nominal GDP to gauge economic well-being. (4 marks)
iii) The United Nations Development Programme (UNDP) states that ‘whereas GDP growth
matters, countries cannot rely on it alone for broad-based development’. Discuss two
reasons why countries cannot rely on GDP alone as a measure of broad-based develop-
ment or as a measure of well-being. (4 marks)

3
QUESTION THREE [20 marks]

a) The transmission of monetary policy describes how changes made by the Central Bank to
its policy rate, flow through to economic activity and inflation. On the 8th of August 2020,
The Bank of Zambia lowered its policy rate by 125 basis points to 8%, responding to a
growing Covid-19 crisis. Clearly discuss any two channels of monetary policy transmission,
highlighting the likely effect of the lower policy rate on economic activity and inflation in
Zambia. (8 marks)

b) Suppose we have the following information for a country called Andromeda:

ˆ the marginal propensity to consume domestically produced goods out of national income
is 0.6
ˆ tax is raised at a fixed rate of 10% of all income
ˆ imports are a fixed 20% of income
ˆ consumption = $80,000
ˆ investment = $10,000
ˆ government spending = $10,000
ˆ exports = $25,000

Calculate the following for Adromeda:

i) the equilibrium level of national income. Show your working (1 mark)

ii) the level of withdrawals in the economy. Show your working (3 marks)
iii) Discuss one factor that could explain why some countries have a higher multiplier than
others. (2 marks)
iv) The government increases its annual spending on infrastructure projects by $50,000.
Calculate the new equilibrium level of national income. Show your working. (3 marks)

c) The following table contains hypothetical figures from a country’s balance of payments in
2010:
Exports of economics courses paid for in 2010 $5m
Imports of paper $3m
Exports of courses on credit (payment due on 30 June 2010+1) $1.5m
Spending by economics tutors on trips abroad $0.3m
Spending by economics students visiting the country $1.2m
Repayment of loan from domestic tuition provider to foreign bank $1m
Purchases of shares in overseas economics tuition providers $0.8m
Net errors and omissions item +$0.04m

Calculate the following items for the country:

i) Balance of trade (2 marks)

ii) current account balance (1 mark)

4
QUESTION FOUR [20 marks]

a) Distinguish between market-orientated supply-side policies and interventionist supply-side

policies and give one example of each type of policy. (4 marks).
b) Bode Bank holds $200 million in deposits and maintains a reserve ratio of 5 percent.
i) Show a T-account for Bode Bank. (2 marks)
ii) Now suppose that a firm, that has an account with Bode Bank, withdraws $20 million
in cash from its account. If BSB decides to restore its reserve ratio by reducing the
amount of loans outstanding, show its new T-account. (3 marks)
iii) Explain the effect of Bode Banks’s actions on other commercial banks in the economy.(2
marks)
iv) By how much would the total amount of deposits in the banking system increase? Show
your working. (2 marks)
c) The residents of Vegopia spend all of their income on cauliflower, broccoli, and carrots. In
2016, they spend a total of $200 for 100 heads of cauliflower, $75 for 50 bunches of broccoli,
and $50 for 500 carrots. In 2017, they spend a total of $225 for 75 heads of cauliflower, $120
for 80 bunches of broccoli, and $100 for 500 carrots.
i) Calculate the price of one unit of each vegetable in 2016 & 2017. (3 marks)
ii) Using 2016 as the base year, calculate the CPI for each year. (4 marks)

QUESTION FIVE [20 marks]

a) State the type of unemployment that is likely to be affected and explain if the following
workers are more likely to experience short-term or long-term unemployment. Support
your answer.
i) A construction worker who is laid off because of bad weather. (3 marks)
ii) An expert welder with little formal education who loses her job when the company
installs automatic welding machinery. (3 marks)
iii) A stock market crash that induces firms to lay off their workers. (3 marks)
b) Suppose an economy is in long-run equilibrium and a fall in consumer spending causes
a recession.
Illustrate the immediate change in the economy using both an AS/AD diagram and a
Phillips-curve diagram. On both graphs, label the initial long-run equilibrium as point
A and the resulting short-run equilibrium as point B. Label your diagrams fully. (7
marks)
c) Describe the effect of each of the following on the demand for Kenyan shillings and/or
the supply of Kenyan shillings and hence on the value of the shilling.
i) An improvement in technology in Kenya resulting in an increase in the demand for
Kenyan goods. (2 marks)
ii) An increase in the Kenyan rate of inflation (relative to that in other countries). (2
marks)

**END**