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Chapter 36- Economic Growth in Developing and Transitional Economies

Problem 1:

One of the biggest problem facing developing countries across the globe in 2009 was

disease. More than 1 million people died of malaria and over 2 million deaths were due to

HIV/AIDS, with most of these deaths occuring in Africa. Describe the effects of these diseases

on the economies of these countries. Make sure you discuss the sources of economic growth and

the use of scarce resources.

Solution:

The economic growth of the country depends a lot on the resources availability and the

ability of the country to utilize these resources in an efficient manner. Among the resouces,

availability of huamn capital is a major factor.

Human capital investment is considered to be a basic requirement for the economic

growth. Investment in human capital can be understood by looking at various health indicators

like life expectancy at birth, infant mortality rates, or nutritional status measures. Studies have

indicated that health of people and economic prosperity are interelated.

Diseases or poor health had contributed to the poor growth performances of the economy

especially in the low-income countries. However, health is a complex notion and includes

several dimensions which concern fatal and non-fatal issues of illness. Diseases create barriers to

economic growth and force countries to divert investments into health.

Most of the African countries have serious health problems because of communicable

diseases like malaria and AIDS. The african countries have about 11% of the global population,

but it has 60% of the world’s HIV and AIDS cases, and 90% of the worlds malaria cases. The

diseases are prevelent mainly in children under the age of 5 years. Because of these diseases,
these countries loose out valuable human resources who could have contributed in the economic

progress of the country.

Furtheremore, due to poverty and lack of funds they are not able to make sufficient

investments into the health sector. Due to this, there is lack of adequate hospitals, doctors, and

medicines. All of these factors have contributed to the low economic performance and growth

for these African countries.


Chapter 33- Alternative View in Macroeconomics

Problem 1:

The table gives estimates of the rate of money supply growth and the rate of real GDP growth for

five countries in 2000:

RATE OF GROWTH IN MONEY SUPPLY RATE OF GROWTH OF REAL

(M1) GDP

Australia +9.3 +4.4

Britain +7.6 +4.4

Canada +18.7 +4.9

Japan +9.0 +0.7

United States +0.2 +5.1

a. If you were a monetarist, what would you predict about the rate of inflation across the

five countries?

b. If you were a Keynesian and assuming activist central banks, how might you interpret the

same data?

Solution:

a. Here, given the below table gives the estimate of the rate of money supply growth and the

rate of real GDP growth for five countries in 2000:

COUNTRIES RATE OF GROWTH IN MONEY SUPPLY RATE OF GROWTH OF REAL

(M1) GDP
Australia +9.3 +4.4

Britain +7.6 +4.4

Canada +18.7 +4.9

Japan +9.0 +0.7

United States +0.2 +5.1

Here, in a monetarist view, inflation is purely a monetary phenomenon. The rate of

change in price level is equal to rate of change in money supply.

Thus, according to them, Canada would face severe inflation. Australia, Britain and Japan

would face moderate inflation and United States would not face inflation.

b. Assuming the activist central bank, the Government intervenes with fiscal monetary

policies to fight against inflation. From given below data, we can say that, since the

growth in money supply is greater than the growth in real GDP in four nations i.e.

Australia, Britain, Canada and Japan the rate of inflation is positive.

COUNTRIES RATE OF GROWTH IN MONEY SUPPLY RATE OF GROWTH OF REAL

(M1) GDP

Australia +9.3 +4.4

Britain +7.6 +4.4

Canada +18.7 +4.9

Japan +9.0 +0.7

United States +0.2 +5.1


For all these four nations, the aggregate supply curve has shifted upwards. There is

increase in GDP as well as price level. In United States, the growth in Real GDP is more than

increase in money supply.

Thus, we can say that price level went down, which can happen when aggregate supply

curve shifts downwards.

Problem 3(Chapter 33):

Suppose you are thinking about where to live after you finish your degree. You discover that an

apartment building near your new job has identical units—one is for rent and the other for sale as

a condominium. Given your salary, both are affordable and you like them. Would you buy or

rent? How would you go about deciding? Would your expectations play a role? Be specific.

Where do you think those expectations come from? In what ways could expectations change

things in the housing market as a whole?

Solution:

I will buy the condominium rather than to rent it. One factor that can affect my decision is my

expectation of inflation. The price of the condominium today may increase tomorrow, so if I’ll

buy the condominium then I will not have to worry if its price will increase. My expectations

about inflation affects my decisions, and this expectations may came from my past experiences,

like how I knew that the price of lands before doubles today. My expectations may also came

from the media attention to price increase. Our expectations can affect our decisions. For

example, in the housing market, consumers expecting the increase of price on condominiums

will choose to buy rather than to rent.


Chapter 35- Open-economy Macroeconomics: The Balance of Payment and Exchange

Rates

Appendix Problem:

The currency of Atlantis is the wimp. In 2012, Atlantis developed a balance-of-payments

deficit with the United States as a result of an unanticipated decrease in exports; U.S. citizens cut

back on the purchase of Atlantean goods. Assume Atlantis is operating under a system of fixed

exchange rates.

a. How does the drop in exports affect the market for wimps?

b. How must the government of Atlantis act (in the short run) to maintain the value of the

wimp?

c. If Atlantis had originally been operating at full employment (potential GDP), what

impact would those events have had on its economy? Explain your answer.

d. The chief economist of Atlantis suggests an expansionary monetary policy to restore

full employment; the Secretary of Commerce suggests a tax cut (expansionary fiscal policy).

Given the fixed exchange rate system, describe the effects of these two policy options on

Atlantis’s current account.

e. How would your answers to a, b, and c change if the two countries operated under a

floating rate system?

Solution:

Here, as given that the currency of Atlantis is wimp. In 2010, Atlantis developed a

balance-of-payment deficit with the United States, because of an unanticipated decrease in

exports; U.S. citizens cut back on the purchases of Atlantis goods.


a. A drop in the export from Atlantis reduces the demand for wimp. Then, there is a fall in

the demand for wimp, which shifts the demand curve to the left.

Now, the country is maintaining a fixed exchange rate, which means that there will be

pressure on the exchange rate. Moreover, the country will now have to use it foreign

exchange reserves to ensure that the value of the exchange rate is maintained. If the

reserves are not sufficient or if it runs out, then the country will have to devalue its

currency.

b. Here, know that the foreign exchange is that all currencies other than the domestic

currency of a given country. The country can use it foreign exchange reserves in the short

run to maintain the value of wimp.

c. If we assume that the country is operating at full employment, a fall in the exports from

Atlantis will lead to a reduction in the output for the country. This means that the

economy will now have unemployment. The fall in the exports will lower the income of

the economy, which in turn may also lower the imports. Thus, the growth in the economy

will impacted and the economy can land up in recession.

d. The chief economists suggests for an expansionary monetary policy, which means that

the economy will have low interest rate. Similarly, the secretary of commerce wants a tax

rate cut. The low interest will probably boost up investments and income of the economy

will increase due to change in tax rate. This will lead to an increase in the imports of the

country. This may further increase the current account deficit for the country.

e. Under a floating exchange rate system, the fall in the demand for the Atlantis good will

reduce the demand for wimp. Then, the value of wimp will fall in the exchange market.

This fall in the value of wimp will make products from the U.S. more expensive, so the
imports from U.S. will also fall. This process will ensure that the current account deficit

does not increase and a balance is mentioned. Again, with the fall in the value of wimp,

the Atlantis good will become cheaper and there will be a revival in the demand for

products from wimp.


Chapter 34- International Trade, Comparative Advantage and Protectionism

Problem 1:

Suppose Germany and France each produce only two goods, guns and butter. Both are

produced using labor alone. Assuming both countries are at full employment, you are given the

following information: Germany: 10 units of labor required to produce 1 gun 5 units of labor

required to produce 1 pound of butter Total labor force: 1,000,000 units France: 15 units of labor

required to produce 1 gun 10 units of labor required to produce 1 pound of butter Total labor

force: 750,000 units

a. Draw the production possibility frontiers for each country in the absence of trade.

b. If transportation costs are ignored and trade is allowed, will France and Germany

engage in trade? Explain.

c. If a trade agreement is negotiated, at what rate (number of guns per unit of butter)

would they agree to exchange?

Solution:

Here, suppose Germany and France each produces only two goods, guns and butter. Both

are produced using labor alone. Assuming that the both countries are at full employment, and

given the following information:

Germany: 10 units of labor required producing 1 gun, and

5 units of labor required to produce 1 pound of butter. Total labor force is 1,000,000.

France: 15 units of labor required producing 1 gum,

and 10 units of labor required to produce 1 pound of butter. Total labor force is 750,000 units.
a. The production possibility frontiers for each country in the absence of trade are

showed in the below table:


b. If transportation costs are ignored and trade is allowed, France and Germany would engage in

trade: The scenario before trade: With given labor both the countries can produce following

quantities, if it puts its resources in production of any one good:

Germany France

Guns 1,000,00 75,000

Butter 2,000,00 50,000

In absence of transportation cost, both the countries would export the commodity in

which it has comparative advantage in production. If both the nations put all its resources in the

production of a good, in which it has comparative advantage; Germany would put all its labor in

production of Butter and France would put all its labor in production of Guns.

Germany France

Guns 0 75,000

Butter 2,000,00 0

Thus, in absence of trade both the countries would engage in trade it would export the

commodity in which it has comparative advantage and import the commodity in which it has

comparative disadvantage.

c. In absence of trade, if both the nations divide the resources equally for production of both

the goods:
Germany France

Guns 50,000 37,500

Butter 1,000,00 25,000

If a trade agreement were negotiated, the rate of exchange that they agree would

be decided as follows: Since with specialization, both the nations would produce the good

in which it has comparative advantage.

The rate of exchange would be that the Germany would exchange less than

1,000,00 units of butter for 50,000 guns and on the other hand, France would be ready to

exchange 37,500 units of guns at least 25,000 butter units.

Thus, their trade would take place somewhere between these two limits i.e.

Germany would be ready to exchange 2 units of guns for1 unit of labor and France would

be ready to exchange 1 unit of butter for 1.5 units of guns.