Student :_____________________________________________

Final Exam Spring 2023 May 23rd. 2023 - BUS251 Advanced Macroeconomics Theory
By: Mr. Stergios Papageorgiou

- Make sure you provide full – well rounded answers, not simply Yes or No, always within the context and
terms of “Macroeconomics” as discussed over the Semester.
- Address all key areas within each topic/question.

1. When a Goverment decreases taxes, what could be the likely effect on; a) Consumption, b) Investment,
and c) Savings?

The effects of government tax cuts on consumption, investment, and savings are complex and can vary
depending on a range of factors. It is important to consider several general expectations when assessing
the potential impact of tax cuts:
- Consumption:
When taxes are reduced, individuals and households may have more disposable income, which can lead
to increased spending on goods and services. This can provide a boost to businesses through higher
demand. However, the impact on consumption may differ based on income distribution and the
structure of the tax cut. Tax cuts that primarily benefit higher-income individuals may have a smaller
effect on consumption, as this group tends to save a larger portion of their income.
- Investment:
Tax cuts can make it more financially viable for businesses to invest in new equipment, technology,
research, and development, and expand their operations. This can lead to economic growth, job
creation, and improved productivity. However, the impact on investment may depend on factors such
as business confidence, market conditions, and regulatory environment.
- Savings:
The impact of tax cuts on savings is less clear and can vary depending on individual behavior. Some
individuals may choose to save a portion of their tax savings, while others may use the extra money for
immediate spending, resulting in lower savings rates. The overall impact on savings will depend on the
behavior of individuals and their preferences for consumption or saving.
It is important to note that the actual impact of tax cuts on consumption, investment, and savings is
influenced by a range of factors, including the specific design of the tax cut, the overall economic
conditions, and the response of individuals and businesses. While economic models and empirical
studies can provide insights into potential effects, the outcomes can differ in practice.

2. A Gov’t is considering increasing the Money Supply to help the economy. Is this a correct policy?

Increasing the money supply to help the economy can be an effective policy tool in certain situations,
but it also carries potential risks and should be implemented carefully. Here are some considerations:
1. Economic Stimulus: Increasing the money supply can provide a boost to economic activity by making
more funds available for lending and spending. This increased liquidity can stimulate investment,
consumption, and overall economic growth.
 2. Monetary Policy Tool: Adjusting the money supply is a common tool used by central banks to
influence economic conditions. By increasing the money supply, central banks can lower interest rates,
making borrowing cheaper and encouraging investment and spending.
3. Addressing Deflationary Pressures: Increasing the money supply can help combat deflationary
pressures in the economy. When prices are falling, consumers may delay purchases, leading to reduced
economic activity. By injecting more money into the system, it can encourage spending and stabilize
prices.
4. Managing Liquidity and Financial Stability: Adequate money supply is essential for maintaining
liquidity in the financial system. Insufficient money supply can lead to liquidity shortages, credit
crunches, and financial instability. Increasing the money supply can address these issues and promote
stability in the banking sector.
However, it's important to consider the potential risks and challenges associated with increasing the
money supply:
1. Inflationary Pressures: One of the main risks is the potential for inflation to rise. When the money
supply increases faster than the growth of goods and services in the economy, it can lead to higher
inflation. Excessive inflation erodes purchasing power and can have negative consequences for
economic stability.
2. Bubbles and Asset Price Inflation: Increasing the money supply can potentially lead to asset price
inflation, as excess liquidity searches for investment opportunities. This can create asset bubbles, such
as in real estate or financial markets, which may eventually burst and result in financial instability.
3. Exchange Rate Effects: A significant increase in the money supply can put downward pressure on the
currency's value, leading to depreciation. This can have implications for import costs, export
competitiveness, and overall macroeconomic stability.
4. Effectiveness and Timing: The effectiveness of increasing the money supply depends on various
factors, including the state of the economy, interest rate levels, and overall market conditions. Timing
and coordination with other fiscal and monetary policies are crucial to ensure the desired impact.
In summary, increasing the money supply can be a viable policy tool to stimulate the economy under
certain circumstances. However, careful consideration of potential risks, such as inflationary pressures
and financial instability, is necessary. Implementing such policies requires a balanced and measured
approach, taking into account the specific economic conditions and long-term sustainability. Central
banks and policymakers closely monitor economic indicators and use discretion to determine
appropriate measures to support economic growth and stability.

3. Please state the “National Income Accounts” along with a numerical example.

National income accounts, commonly known as national accounts or national income and product accounts
(NIPA), provide a crucial framework for measuring and tracking economic activity and income within a
country. These accounts offer a comprehensive structure for analyzing and understanding a nation's overall
economic performance. The primary components of national income accounts include:

1. Gross Domestic Product (GDP): GDP represents the total value of all final goods and services
produced within a country's borders during a specific time period (usually a year). It is often used as a
measure of a country's economic output.
2. Personal Income: Personal income refers to the income received by individuals from all sources,
including wages, salaries, rental income, interest, dividends, and transfer payments such as social security
benefits.
3. Disposable Income: Disposable income is the amount of income that individuals have available for
spending or saving after paying taxes.
4. Government Expenditure: Government expenditure includes all spending by the government on
goods, services, and transfer payments. It encompasses both consumption by the government (e.g., public
services, defense) and investment in infrastructure or public projects.
5. Investment: Investment refers to the spending on capital goods (such as machinery, equipment, and
buildings) that are used for production purposes. It includes both business investment and residential
investment (e.g., construction of new homes).
6. Net Exports: Net exports represent the difference between a country's exports and imports. If
exports exceed imports, it results in a trade surplus, whereas if imports exceed exports, it leads to a trade
deficit.
Here's a simplified numerical example illustrating the national income accounts:
Gross Domestic Product (GDP): $10 trillion

Personal Income: $8 trillion

Disposable Income: $6 trillion

Government Expenditure: $2 trillion

Investment: $3 trillion

Net Exports: $1 trillion (surplus)

In this example, the GDP of the country is $10 trillion, which represents the total value of all goods and
services produced within the country's borders.

Personal income is $8 trillion, indicating the total income received by individuals from various sources.

Disposable income is $6 trillion, which represents the amount of income available to individuals after paying
taxes.

Government expenditure is $2 trillion, reflecting the total spending by the government on goods, services,
and transfer payments.

Investment is $3 trillion, representing the spending on capital goods for production purposes.

Net exports indicate a trade surplus of $1 trillion, implying that exports exceed imports by that amount.
These figures provide a simplified representation of the national income accounts and their components. In
reality, national income accounting is a complex system that involves various adjustments, statistical
methodologies, and data sources to ensure accuracy and consistency in measuring economic activity.

4. Discuss the main differences between bonds (debt finance) and stocks (equity finance).
Companies and governments often use financial instruments like bonds and stocks to raise capital for their
operations. Bonds and stocks have significant differences in terms of ownership rights, payment obligations,
priority in bankruptcy, and risk and return profiles. Here are the main distinctions between the two:

1. Ownership and Control:

Bondholders lend money to the issuer and receive interest payments and the principal amount at maturity.
They do not have any ownership rights or voting power. On the other hand, stockholders own a part of the
company and have ownership rights that include voting power in corporate decisions and the potential to
receive dividends.

2. Risk and Return:

Bonds are less risky than stocks and offer more predictable returns. Bondholders receive fixed interest
payments over a specific period and get the principal amount back at maturity. On the other hand, stocks
carry higher risk but offer higher potential returns. Stockholders can benefit from capital appreciation and
may receive dividends but bear the risk of capital loss.

3. Payment Obligations:
Bond issuers have an obligation to make regular interest payments and repay the principal amount at
maturity. Bondholders have priority in receiving payments from the issuer. In contrast, stockholders do not
have a fixed payment obligation from the company. Dividends are discretionary, and the company may
choose to distribute profits to shareholders.

4. Priority in Bankruptcy:
Bondholders have a higher priority in receiving payments compared to stockholders in case of bankruptcy or
liquidation. They have a claim on the company's assets and are likely to recover their investment before
stockholders. Stockholders have lower priority in receiving payments and are typically the last to receive any
remaining assets.

5. Dilution and Voting Rights:

Owning bonds does not lead to dilution of ownership or voting rights. Bondholders maintain their initial
ownership percentage throughout the bond's term. But additional stock issuances can lead to dilution of
ownership and voting rights for existing stockholders.

When choosing between bonds and stocks, it's essential to consider various factors like the issuer's financial
needs, risk appetite, capital structure, and investor preferences. Both have their advantages and
considerations.

5. The recent COVID pandemic has produced a decline/ning trend of the Real GDP. What were the effects
in terms of Unemployment Rate, Investments, and Savings? Please explain.

The COVID-19 pandemic has had a profound impact on the global economy, affecting various areas such as
employment, investments, and savings. It is important to explore and understand the implications of these
effects.

Firstly, the pandemic has resulted in a rise in unemployment rates in many countries. This is due to the
forced closure of businesses, disrupted supply chains, and a decrease in economic activity. Companies have
had to make difficult decisions, such as laying off employees or reducing working hours, as they struggle to
generate revenue. Some industries, particularly travel, hospitality, and retail, have been hit hard, leading to
significant job losses.

Secondly, the pandemic has caused a decline in investments due to the uncertainty and economic turmoil it
has created. Businesses have faced numerous challenges, such as reduced demand, supply chain disruptions,
and financial constraints, which have made them hesitant to invest in new projects or expand their
operations. The uncertainty surrounding the future economic conditions and consumer behavior has also
made businesses more cautious when making long-term investment decisions. As a result, investment levels
have dropped during the pandemic, contributing to a decrease in overall economic activity.

Thirdly, the pandemic has had contrasting effects on savings. While some individuals and households have
faced financial difficulties due to job losses and reduced incomes, others have been able to save more due to
limited spending opportunities during lockdowns. The restrictions on social activities, travel, and
entertainment, coupled with reduced consumption, have led to higher savings rates in some cases.
Additionally, some individuals have increased their savings as a precautionary measure to cope with the
uncertainty surrounding the pandemic and its potential long-term impacts.

It is important to note that the effects on employment, investments, and savings may vary across countries
and industries. These effects depend on factors such as the severity of the pandemic, government policies,
and the overall resilience of the economy. The extent and duration of these effects also rely on the
effectiveness of government interventions, such as fiscal stimulus measures, monetary policy actions, and
support programs for businesses and individuals impacted by the pandemic.

6. What does the Y = F(K, L) function represent? Define & explain each of its components.

In economics, the Y = F(K, L) function is a widely-used mathematical representation that reveals the
relationship between the output of a production process (Y) and the inputs of capital (K) and labor (L). Its
purpose is to analyze how inputs and outputs are related in the production process.

Let's break down the components of the production function:

1. Y: Y is the total output of goods and services. Its measurement can vary depending on the context, such as
quantity, value, or utility. The production function aims to explain how capital and labor inputs affect the
quantity or value of output.

2. F: F stands for the functional relationship or production technology. It represents how capital and labor
are combined and transformed into output. The form of F can differ depending on the production process's
assumptions and characteristics. Various production functions, such as linear, Cobb-Douglas, or constant
elasticity of substitution (CES), have been proposed to capture different production behaviors and patterns.
3. K: K represents the input of capital in the production process. Capital refers to physical assets like
machinery, equipment, buildings, and infrastructure used to produce goods and services. Capital is an
essential factor of production that enhances productivity and contributes to the production process.

4. L: L represents the input of labor in the production process. Labor refers to human effort, skills, and time
spent on the production of goods and services. It includes the number of workers employed, their hours of
work, and their productivity level. Labor is another crucial factor of production that contributes to output.

The production function Y = F(K, L) assumes that output depends on the combination and efficiency of
capital and labor inputs. It provides a framework for analyzing how changes in capital and labor inputs affect
output levels and productivity. By studying the production function, economists can examine various aspects
such as technological progress, economies of scale, input substitution, and efficiency in the production
process. The production function is a fundamental concept in economic theory that helps to understand the
relationship between inputs and outputs in the economy.

7. A Goverment has decided to lower the “Minimum Wage”. Explain what the impact would have on the
economy/labor force.
Lowering the minimum wage can have a significant impact on the economy and the labor force, with
potential effects in various areas. Here are some of the impacts that could result from lowering the minimum
wage:

1. Increased Employment Opportunities: Lowering the minimum wage could lead to increased employment
opportunities. Employers in labor-intensive industries may find it more affordable to hire additional workers.
This could reduce unemployment rates and provide job opportunities for those who were previously unable
to find work.

2. Reduced Labor Costs: Lowering the minimum wage can benefit businesses by reducing labor costs.
Employers can allocate their resources more efficiently with lower wage requirements, resulting in cost
savings. This could encourage business expansion, investment, and job creation.

3. Income Inequality: Lowering the minimum wage may exacerbate income inequality. Workers earning
minimum wage or close to it will experience a decrease in their income, making it more challenging for them
to meet their basic needs. This could potentially widen the gap between the highest and lowest earners in
society.

4. Poverty and Welfare: Lowering the minimum wage can increase the risk of poverty among low-wage
workers. Workers may struggle to support themselves and their families if the minimum wage falls below a
livable income threshold. This could lead to a greater reliance on government assistance programs, such as
welfare or food stamps, placing an additional burden on public finances.

5. Decreased Consumer Demand: Lowering the minimum wage may result in a decrease in consumer
spending. Workers with lower wages will have less disposable income, which can lead to reduced purchasing
power. This can impact businesses that rely on consumer spending, potentially leading to decreased sales
and profitability.

6. Quality of Workforce: Lowering the minimum wage may discourage skilled and experienced workers from
accepting low-paying jobs. If wages are deemed too low, qualified individuals may seek alternative
employment opportunities or pursue further education and training to enhance their qualifications. This
could result in a less skilled and motivated workforce in certain sectors.

7. Potential for Exploitation: A lower minimum wage could potentially increase the likelihood of labor
exploitation. Workers may be more susceptible to unfair treatment, longer working hours, and inadequate
labor standards if they are unable to demand higher wages. This can negatively impact workers' well-being
and labor market conditions.

It's essential to note that the impact of lowering the minimum wage can vary depending on the specific
context, including factors such as overall economic conditions, industry dynamics, and labor market
structure. Economic policies need to carefully consider both the potential benefits and drawbacks associated
with changes to the minimum wage to ensure a balanced approach that promotes economic growth and the
well-being of workers.

8. What is the effect of rising interest rates to the economy?

When interest rates rise, it can have various effects on the economy. Firstly, borrowing becomes more
expensive for individuals, households, and businesses, which can deter borrowing and lead to a
decrease in consumer spending and business investment. This can also make it more challenging for
businesses to expand or make capital expenditures, or invest in new projects. Secondly, higher interest
rates can impact consumer spending patterns, reducing consumer spending, particularly for big-ticket
items, which can negatively impact industries such as real estate, automotive, and retail. Thirdly, rising
interest rates can also deter businesses from making new investments or expanding their operations,
decreasing business investment, which can negatively affect economic growth and job creation.
Fourthly, higher interest rates can affect the housing market, reducing housing demand, slowing down
the real estate market, and potentially leading to a decrease in housing prices. Fifthly, higher interest
rates can attract foreign investors seeking higher returns on their investments, leading to an increase in
demand for the country's currency, causing it to appreciate in value relative to other currencies. A
stronger currency can make exports more expensive and imports cheaper, potentially leading to a
decrease in export competitiveness and an increase in trade imbalances. Sixthly, rising interest rates can
incentivize individuals to save more, providing individuals with more financial security, and contributing
to a pool of funds available for investment, which can have long-term positive effects on the economy.
Lastly, the combined effects of reduced consumer spending, lower business investment, decreased
housing demand, and potential impacts on exports can contribute to slower economic growth. It's
worth noting that the impact of rising interest rates can be influenced by other factors in the economy,
such as inflation levels, fiscal policies, and global economic conditions. Additionally, central banks and
policymakers may adjust interest rates based on their assessment of the overall economic situation,
aiming to achieve a balance between controlling inflation and supporting economic growth.
9. Producing more expensive items where their demand is rising, what economic theory explains it better?
(explain fully)

The economic theory that best explains the phenomenon of producing more expensive
items when their demand is rising is the theory of supply and demand, specifically the
concept of price elasticity of supply.

According to the theory of supply and demand, the price of a product is determined by the
interaction of its supply and demand in the market. When the demand for a particular item
rises, it creates an upward pressure on the price of that item. Producers respond to this
increased demand by increasing the quantity supplied in order to capture the higher prices
and potentially higher profits.

The price elasticity of supply refers to the responsiveness of the quantity supplied to
changes in price. In situations where the demand for a product is rising, producers may face
constraints on their ability to rapidly increase supply. This can be due to factors such as
limited production capacity, availability of resources, or time needed to expand production.
When supply is relatively inelastic, meaning it is less responsive to changes in price,
producers have less ability to increase output quickly, resulting in higher prices.

Additionally, the concept of scarcity plays a role in this phenomenon. As demand increases
for a particular item, the available supply becomes scarcer relative to the demand. Scarce
goods tend to command higher prices in the market as consumers are willing to pay more
to obtain them.

In summary, the economic theory of supply and demand, along with the concept of price
elasticity of supply, provides insights into why producers may produce more expensive
items when their demand is rising. The limited ability to rapidly increase supply, coupled
with the scarcity of the product, leads to higher prices as producers aim to balance supply
and demand in the market.

10. Studying the short-run behavior of the economy, an assumption of ________________ is more likely, as
against studying the long-run equilibrium behavior of an economy, where an assumption of
___________ is more possible. (Choose one combination)

One appropriate combination for the given statement would be as follows:

Studying the short-run behavior of the economy, an assumption of of Sticky Prices is

more likely, as against studying the long-run equilibrium behavior of an economy,
where an assumption of of Flexible Prices is more possible.
When studying the short-run behavior of the economy, economists often make the
assumption of sticky prices. This assumption suggests that prices do not adjust immediately
or fully in response to changes in supply and demand conditions. In the short run, prices are
relatively inflexible, leading to deviations from equilibrium. As a result, other factors such as
changes in aggregate demand or supply shocks can have a more significant impact on
variables like output, employment, and inflation in the short run.

Conversely, when examining the long-run equilibrium behavior of an economy, economists

typically assume flexible prices. Flexible prices imply that prices adjust freely and quickly in
response to changes in supply and demand conditions. Over the long run, markets have
ample time to adjust, allowing prices to fully reflect changes in market conditions. In this
equilibrium state, aggregate demand equals aggregate supply, and the economy operates
at its potential output level.