HARAMAYA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF MANAGEMENT

Assignment on the course macroeconomic

No Name ID

6
1. Discuss the major macroeconomic problems in Ethiopia. Indicate the
primary Causes of those macroeconomic problems in the country.
Some major macroeconomic problems in Ethiopia include:

1. Inflation: Ethiopia has faced persistent inflationary pressures, which

erode purchasing power and can lead to economic instability.

2. Unemployment: High levels of unemployment, particularly among

youth, pose a significant challenge to Ethiopia’s economic development.

3. External Debt: Ethiopia has accumulated significant external debt,

which can strain the country’s finances and limit its ability to invest in
critical areas such as infrastructure and social services.

4. Balance of Payments: Persistent trade deficits and reliance on imports

can strain Ethiopia’s balance of payments, affecting its ability to
maintain stability in the foreign exchange market.

5. Poverty: Despite recent economic growth, poverty remains widespread

in Ethiopia, contributing to social and economic challenges.

Primary causes of these macroeconomic problems include:

1. Weak infrastructure: Insufficient infrastructure, such as transportation

and energy systems, hampers productivity and economic growth.
 2. Limited diversification: Ethiopia’s economy is heavily reliant on
agriculture, leaving it vulnerable to external shocks and fluctuations in
commodity prices.

3. Governance challenges: Weak governance, corruption, and political

instability can hinder effective policymaking and implementation,
exacerbating macroeconomic problems.

4. Limited access to finance: Lack of access to finance, particularly for

small and medium-sized enterprises, constrains investment and job
creation.

5. Population growth: Rapid population growth puts pressure on

resources and infrastructure, exacerbating unemployment and poverty
levels.

2. List and explain the properties of consumption function.

The consumption function is a concept in economics that describes the

relationship between household consumption and disposable income. It’s
typically expressed as C = f(Y), where C is consumption and Y is disposable
income. The properties of the consumption function include:

1. Positive slope: The consumption function generally has a positive slope,

indicating that as disposable income increases, consumption also
increases. However, the slope may vary depending on factors such as
income distribution and consumer preferences.
2. Marginal propensity to consume (MPC): This refers to the change in
consumption resulting from a change in disposable income. It is
represented by the slope of the consumption function. The MPC is
usually less than one, meaning that consumers typically do not spend all
additional income, but rather save some of it.

3. Autonomous consumption: This is the level of consumption that occurs

even when disposable income is zero. It represents the consumption
expenditure that households undertake regardless of their income level.
Autonomous consumption captures factors such as basic necessities and
fixed expenses.

4. Average propensity to consume (APC): This is the ratio of consumption

to disposable income. It indicates the proportion of income that
households spend on consumption. The APC typically declines as income
rises, reflecting the tendency for households to save a larger portion of
their income at higher income levels.

5. Consumption function shifts: The consumption function can shift due to

changes in factors such as consumer confidence, wealth, interest rates,
and government policies. For example, an increase in consumer
confidence may lead to higher consumption at each income level, causing
the consumption function to shift upward.

6. Stability: The consumption function is assumed to be relatively stable

over time, reflecting stable consumer preferences and economic
conditions. However, shifts in factors like income distribution,
 technological advancements, or cultural changes can lead to changes in
the consumption function over the long term.

Understanding these properties helps economists analyze consumer behavior

and predict the effects of changes in income, policy interventions, and other
economic variables on consumption patterns and overall economic activity.

3. Discuss the main contradictions that led to the Keynesian

consumption puzzle.
The Keynesian consumption puzzle refers to discrepancies between the
predictions of Keynesian consumption theory and observed consumption
behavior. The main contradictions that led to this puzzle include:

1. Permanent Income Hypothesis vs. Keynesian Consumption Function:

The Permanent Income Hypothesis (PIH), developed by Milton
Friedman, suggests that individuals base their consumption decisions
on their long-term, or permanent, income rather than their current
income. This contradicts Keynesian theory, which emphasizes the
importance of current income in determining consumption. The puzzle
arises because empirical evidence supports aspects of both theories,
leaving economists to reconcile the conflicting findings.

2. Consumption Smoothing: Keynesian theory suggests that individuals

will try to smooth out consumption over time, adjusting spending in
response to fluctuations in income. However, empirical studies have
shown that consumption tends to be more volatile than income,
indicating that households do not always engage in perfect consumption
smoothing as predicted by Keynesian theory.
3. Wealth Effects: Keynesian theory predicts that changes in wealth should
have a significant impact on consumption. However, empirical evidence
has shown that wealth effects on consumption are often weaker than
predicted, suggesting that other factors may influence consumption
decisions.

4. Ricardian Equivalence: Ricardian equivalence posits that individuals

will adjust their consumption and saving behavior in anticipation of
future changes in taxes or government spending. This contradicts the
Keynesian view that changes in government policies, such as tax cuts or
increases in government spending, will have a direct and immediate
impact on consumption. The puzzle arises because empirical studies
have produced mixed results regarding the extent to which individuals
behave in a manner consistent with Ricardian equivalence.

5. Psychological Factors: Keynesian theory tends to focus on rational

economic decision-making based on income and expectations of future
income. However, empirical evidence suggests that psychological
factors, such as behavioral biases and social influences, also play a
significant role in shaping consumption behavior. These factors may
lead individuals to deviate from the predictions of Keynesian theory,
contributing to the consumption puzzle.

Overall, the Keynesian consumption puzzle highlights the complexity of

consumer behavior and the challenges of developing a unified theory that
accurately predicts consumption patterns in various economic contexts.
 Resolving these contradictions requires further research and analysis that
integrates insights from behavioral economics, finance, and other
disciplines.
4. Explain the implications of ”crowding out effect” and ”paradox of
thrift”.
The "crowding out effect” and the “paradox of thrift” are both concepts in
economics that describe how changes in one sector of the economy can affect
another sector, often in unintended ways.

1. Crowding Out Effect:

- Definition: The crowding out effect occurs when increased government
spending leads to a decrease in private investment, either through higher
interest rates or reduced availability of funds.
- Implications:
- Higher Interest Rates: Increased government spending typically requires
borrowing, which increases demand for loans, leading to higher interest rates.
This can discourage private investment because businesses and individuals
find it more expensive to borrow money for investment purposes.
- Reduced Private Investment: Higher interest rates and increased
government borrowing can “crowd out” private investment by making it less
attractive or less feasible for businesses and individuals to invest in capital
projects or other endeavors.
- Potential Long-Term Consequences: If private investment is crowded out, it
can lead to slower economic growth and reduced productivity in the long run,
as businesses may delay or scale back investments in new technologies,
equipment, or expansion projects.

2. Paradox of Thrift:
- Definition: The paradox of thrift occurs when increased saving by
households leads to a decrease in overall consumption and can result in lower
aggregate demand, which may lead to economic contraction.
- Implications:
- Reduced Aggregate Demand: When individuals decide to save more of their
income rather than spend it, consumption decreases, leading to a decrease in
aggregate demand. This can lead to a decrease in production, employment, and
income levels, potentially resulting in a recession.
- Self-Defeating Behavior: While saving is generally considered prudent at
the individual level, if everyone in the economy tries to save more
simultaneously, it can have negative consequences for the economy as a whole.
This is because one person’s spending is another person’s income, so when
overall spending decreases, incomes also decrease, leading to a downward
spiral of reduced spending and economic activity.
- Need for Policy Response: The paradox of thrift highlights the importance
of government intervention during times of economic downturns to stimulate
demand through fiscal and monetary policies. Government spending increases
or tax cuts can help offset the decline in private consumption and investment,
boosting aggregate demand and helping to restore economic growth.

In summary, both the crowding out effect and the paradox of thrift underscore
the interconnectedness of different sectors of the economy and the potential
unintended consequences of individual and government behavior on overall
economic outcomes.

5. Define investment and explain at least the three factors that

determine the
Investment decisions.
Investment, in economics, refers to the expenditure of resources (such as
money, time, or effort) in the expectation of generating future benefits,
typically in the form of increased production capacity, technological
advancement, or financial returns.

Three factors that determine investment decisions are:

1. Expected Rate of Return: The expected rate of return on an investment is

a crucial factor influencing investment decisions. This refers to the
anticipated profit or benefits that an investor expects to receive from an
investment relative to the cost of that investment. Investors typically
compare the expected rate of return on different investment options and
choose the one with the highest potential return for a given level of risk.
Factors that affect the expected rate of return include market conditions,
demand for goods or services, technological advancements, regulatory
environment, and competition.
 2. Risk: Risk refers to the uncertainty or variability associated with the
expected returns of an investment. Investors are generally risk-averse
and seek to minimize the risk of loss while maximizing potential returns.
Different types of investments carry different levels of risk, with riskier
investments typically offering higher potential returns. Factors that
influence the risk associated with an investment include market
volatility, economic stability, political stability, industry-specific risks,
and financial leverage.

3. Cost of Capital: The cost of capital refers to the cost of obtaining funds for
investment, which includes both the cost of debt (interest rates on loans)
and the cost of equity (required rate of return expected by investors).
The cost of capital is a critical factor in investment decisions because it
represents the opportunity cost of using funds for investment rather
than alternative uses, such as paying dividends to shareholders or
repaying debt. Factors that affect the cost of capital include prevailing
interest rates, inflation expectations, creditworthiness of the borrower,
market conditions, and investor sentiment.

These three factors interact to influence investment decisions, as investors

assess the potential returns, risks, and costs associated with various
investment opportunities to determine the optimal allocation of resources.
Additionally, external factors such as government policies, technological
advancements, and global economic conditions can also impact investment
decisions by affecting market dynamics and investor confidence.
6.Mention and briefly discuss the determinants of investment in Ethiopia.
In Ethiopia, like in any other economy, investment decisions are influenced
by various factors. Some key determinants of investment in Ethiopia
include:

1. Macroeconomic Stability: The overall stability of the economy, including

factors such as low inflation, stable exchange rates, and manageable
levels of debt, is crucial for attracting investment. A stable
macroeconomic environment provides confidence to investors and
reduces uncertainty, encouraging them to commit resources to long-
term investments.

2. Infrastructure Development: Adequate infrastructure, such as

transportation networks, power supply, telecommunications, and water
resources, is essential for facilitating business operations and
supporting investment activities. Improvements in infrastructure can
reduce production costs, enhance productivity, and attract both
domestic and foreign investment.

3. Government Policies and Regulations: Government policies and

regulations play a significant role in shaping the investment climate.
Factors such as investment incentives, tax policies, trade regulations,
property rights protection, and bureaucratic efficiency can influence
investment decisions. Clear and consistent policies that support private
sector development and create a conducive business environment are
essential for attracting investment in Ethiopia.

4. Access to Finance: Availability of finance and access to credit are critical

factors for investment, especially for small and medium-sized
enterprises (SMEs) and new ventures. A well-functioning financial
system that provides affordable credit, venture capital, and other forms
 of financing can stimulate investment and entrepreneurship in Ethiopia.

5. Market Potential: The size and growth prospects of domestic and

regional markets influence investment decisions. Ethiopia’s large and
relatively untapped domestic market, as well as its strategic location in
East Africa, make it an attractive destination for investment in various
sectors such as manufacturing, agriculture, and services.

6. Human Capital Development: Skilled labor and human capital

development are essential for driving innovation, technology transfer,
and productivity growth. Investments in education, vocational training,
and workforce development programs can enhance the quality of the
labor force and attract investment in Ethiopia’s knowledge-intensive
sectors.

7. Political Stability: Political stability and governance are fundamental

prerequisites for attracting investment. A stable political environment
reduces investment risks and uncertainties, while effective governance
mechanisms promote transparency, accountability, and the rule of law,
fostering investor confidence and long-term commitment.

These determinants interact with each other and with external factors to
shape the investment landscape in Ethiopia. Addressing challenges related
to infrastructure development, regulatory reforms, access to finance, and
skills development can help unlock Ethiopia’s investment potential and
drive sustainable economic growth and development.
7.Define money and briefly explain the basic functions of money.
Money is a medium of exchange, a unit of account, and a store of value widely
accepted in transactions for goods, services, and debts. It can take various
forms, including physical currency (such as coins and banknotes) and digital
currency (such as bank deposits and electronic transfers).

The basic functions of money are:

1. Medium of Exchange: Money facilitates transactions by serving as a medium

of exchange, enabling individuals to buy and sell goods and services without
the need for barter. Instead of exchanging goods directly, individuals use
money as an intermediary to acquire the goods and services they need. This
function of money increases the efficiency of trade and promotes
specialization and division of labor in economies.

2. Unit of Account: Money provides a common measure of value, allowing

individuals to express the prices of goods and services in terms of a
standardized unit. By assigning numerical values to goods and services,
money simplifies economic calculations, budgeting, and financial planning.
This function of money enables individuals to compare the relative value of
different goods and services and make informed decisions about resource
allocation.

3. Store of Value: Money serves as a store of value, allowing individuals to hold

wealth in a convenient and portable form over time. Unlike perishable or
highly specific goods used in barter, money retains its value over time and
can be easily stored and retrieved for future use. This function of money
enables individuals to save for future consumption, invest in productive
assets, and protect against uncertainty and risk.

These functions of money are essential for facilitating economic transactions,

promoting economic efficiency, and fostering economic growth and
development. Money acts as a lubricant for the wheels of commerce, enabling
individuals and businesses to engage in mutually beneficial exchanges and
allocate resources efficiently in modern economies.

8. Suppose an economy has the reserve deposit ratio (rr) of 10% of deposit
and
Currency in circulation of 200 billion. Given the deposit level of 400
billion.
(a) Determine the monetary base.

(b) Derive and interpret the money multiplier.

(C) Determine the money supply equation.

(c) Find total money supply if monetary base is 100 billion.

9. Distinguish between the four sources or types of unemployment.

Unemployment can arise from various sources or causes, each with distinct
characteristics. The four main types of unemployment are:

1. Frictional Unemployment:
- Definition: Frictional unemployment occurs when individuals are
between jobs or transitioning from one job to another. It is often
temporary and voluntary, reflecting the time it takes for individuals to
search for suitable employment opportunities that match their skills,
preferences, and qualifications.
- Characteristics: Frictional unemployment is a natural and unavoidable
feature of dynamic labor markets. It can result from factors such as
changes in technology, geographic mobility constraints, mismatch between
job vacancies and job seekers, and information asymmetry between
employers and job seekers.
- Example: A recent college graduate searching for their first job or an
experienced worker who voluntarily quits their job to seek better
opportunities would be considered frictionally unemployed.

2. Structural Unemployment:
 - Definition: Structural unemployment occurs when there is a mismatch
between the skills and qualifications of available workers and the
requirements of available jobs. It arises from long-term changes in the
structure of the economy, such as technological advancements, shifts in
consumer preferences, or changes in global trade patterns.
- Characteristics: Structural unemployment tends to persist over time and
can affect specific industries, regions, or demographic groups
disproportionately. It requires structural adjustments, such as retraining
programs, education reforms, or geographical mobility, to address the
underlying mismatches between supply and demand in the labor market.
- Example: Workers in declining industries such as coal mining or
traditional manufacturing may experience structural unemployment due to
technological advancements or outsourcing of production to other
countries.

3. Cyclical Unemployment:
- Definition: Cyclical unemployment results from fluctuations in economic
activity or business cycles. It occurs when there is insufficient demand for
goods and services in the economy, leading to a decline in production and
layoffs by firms. Cyclical unemployment tends to rise during economic
downturns and decline during periods of expansion.
- Characteristics: Cyclical unemployment is closely tied to macroeconomic
conditions, such as changes in aggregate demand, investment, consumer
spending, and business confidence. It is considered involuntary, as it stems
from macroeconomic factors beyond the control of individual workers.
- Example: During a recession, companies may cut back on production
and lay off workers due to reduced consumer spending and investment,
leading to an increase in cyclical unemployment.
4. Seasonal Unemployment:
- Definition: Seasonal unemployment occurs when certain industries or
occupations experience predictable fluctuations in demand based on
seasonal patterns or cycles. It is temporary and expected, reflecting
variations in production, consumption, or weather-related factors.
- Characteristics: Seasonal unemployment is driven by factors such as
agricultural cycles, weather conditions, holiday seasons, tourism trends, or
construction activity. Workers in seasonal industries may be unemployed
during off-peak seasons but find employment during peak periods.
- Example: Ski resort workers may be unemployed during the summer
months when there is little demand for skiing, but they may find
employment during the winter ski season when demand is high. Similarly,
agricultural workers may experience seasonal unemployment during the
offseasons between planting and harvesting seasons.