Macroeconomics.

Instructor: Sir Touqeer Abbas

Long Questions

Q.1. Define Monetary Policy. Explain the different objectives of

monetary policy in developing country?

Meaning of Monetary Policy:-

Monetary policy refers to the measures which the central bank of the country takes in controlling

the money and credit supply in the country with a view to achieving certain specific economic

objectives.

Objectives of Monetary Policy:-

The objectives of monetary policy differ from country to country according to their economic

conditions. In the less developing countries like India or Pakistan its objective may be the

maintenance of monetary stability and help in the process of economic development. In the

developed countries its objective may be to achieve full employment, without inflation. Anyhow

following are the main objectives of the monetary policy.

1.Control of Inflation and Deflation:-

Inflation and deflation both are not suitable for the economy. If the price level is reasonable and

there is an adjustment between the price and cost, rate of output can increase. Monetary policy is

used to coordinate the cost and price. So price stability is achieved through the monetary policy.

2. Exchange Stability:-

Monetary policy second objective is to achieve the stable foreign exchange rate. If the rate of

exchange is stable it shows that economic condition of the country is stable.

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 Macroeconomics. Instructor: Sir Touqeer Abbas

3. Economic Development:-

Monetary policy plays very effective role in promoting economic growth by providing adequate

credit to productive sectors.

4. Increase in the Rate of Employment:-

Monetary policy another objective is to achieve full employment but without inflation.

5. Equal Distribution of Credit:-

Monetary policy should also ensure that distribution of credit should be equitable and purposeful.

The credit priority should be given to backward areas.

6. Improvement in Standard of Living:

It is also the major objective of the monetary policy that it should improve the quality of life in

the country.

These are the objectives of the monetary policy but efforts should be made to minimize the

conflicts.

Q.2. Explain the different instruments of monetary policy?

Monitory Policy:

Monetary policy is the process by which the monetary authority of a country, like the central

bank or currency board, controls the supply of money, often targeting an inflation rate or interest

rate to ensure price stability and general trust in the currency.

Instruments of Monitory Policy:

The Federal Reserve’s three instruments of monetary policy are open market operations, the

discount rate and reserve requirements.

 Open Market Operations:

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 Macroeconomics. Instructor: Sir Touqeer Abbas

The Fed conducts open-market operations when it buys government bonds from or sells

government bonds to the public.

When the Fed buys government bonds, the money supply increases. The money supply

decreases when the Fed sells government bonds.

 Changing Discount Rate:

The discount rate is the interest rate the Fed charges banks for loans.

Increasing the discount rate decreases the money supply. Decreasing the discount rate

increases the money supply.

 Changing Reserve Requirements:

The Fed also influences the money supply with reserve requirements. Reserve requirements

are regulations on the minimum amount of reserves that banks must hold against deposits.

The reserve requirement is the amount (%) of a bank’s total reserves that may not be loaned

out.

Increasing the reserve requirement decreases the money supply. Decreasing the reserve

requirement increases the money supply.

Q.3. Explain the different tools and objectives of Fiscal policy?

Fiscal Policy:

According to Semuelson:

“Fiscal policy is concerned with all those activities which are adopted by the government to

collect revenues and make the expenditures so that economic stability could be attained without

inflation and deflation”

Tools of Fiscal Policy:

There are two main tools of Fiscal Policy.

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 Macroeconomics. Instructor: Sir Touqeer Abbas

Government Spendings:

Government spending includes the purchase of goods and services - for example, a fleet of new

cars for government employees or missiles for national defense. Government spending is a fiscal

policy tool because it has the power to raise or lower real GDP. By adjusting government

spending, the government can influence economic output.

It also includes Productive(Dams, Roads, Mills, Bridges etc) and Non-productive

Revenues(Health, Defence, Social Security, Justice etc)

Taxes(Collection):

Taxes are a fiscal policy tool because changes in taxes affect the average consumer's income, and

changes in consumption lead to changes in real GDP. So, by adjusting taxes, the government can

influence economic output. Taxes can be changed in several ways. Firstly, marginal tax rates can

be raised or lowered. Secondly, they can be eliminated entirely, or the tax rules can be modified.

It also includes Fines, Fees, and Loans(External and Internal Loans)

Objectives:

 To Achieve Equal Distribution of Wealth

 Increase in Savings

 Degree of inflation

 To Achieve Economic Stability

 Price stability

Q.4. List the reasons why unions cause unemployment and,

alternatively, why unions might increase efficiency in some cases?

Causes of Unemployment:

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 Macroeconomics. Instructor: Sir Touqeer Abbas

In an ideal labor market, wages would adjust to balance the supply and demand for labor,

ensuring that all workers would be fully employed.

Frictional unemployment refers to the unemployment that results from the time that it takes to

match workers with jobs. In other words, it takes time for workers to search for the jobs that are

best suit their tastes and skills.

Structural unemployment is the unemployment that results because the number of jobs

available in some labor markets is insufficient to provide a job for everyone who wants one.

Job search is the process by which workers find appropriate jobs given their tastes and skills.

Results from the fact that it takes time for qualified individuals to be matched with appropriate

jobs. This unemployment is different from the other types of unemployment. It is not caused by a

wage rate higher than equilibrium. It is caused by the time spent searching for the “right” job.

Union increases efficiency:

The theory of efficiency wages states that firms operate more efficiently if wages are above the

equilibrium level.

Worker Health: Better paid workers eat a better diet and thus are more productive.

Worker Turnover: A higher paid worker is less likely to look for another job.

Worker Effort: Higher wages motivate workers to put forward their best effort.

Worker Quality: Higher wages attract a better pool of workers to apply for jobs.

Q.5. Define unemployed person and how unemployment rate is

measured?

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 Macroeconomics. Instructor: Sir Touqeer Abbas

Unemployed Person:

A person who is over 18 years of age, is ready and able to undertake full time employment,

jobless, actively seeking work is called an Unemployed Person.

How it is measured?

The size of the labor force is used to determine the unemployment rate. The percentage of the

unemployed in the labor force is called the unemployment rate.

Unemployment Rate = (Number of Unemployed / Labor Force) * 100

Labor Force = Number of Employed + Number of Unemployed

Q.6. Define inflation. Explain stages, types, causes and effects of

inflation?

Inflation: Inflation is a rise in the general level of prices of goods and services in an economy

over a period of time. When the price level rises, each unit of currency buys fewer goods and

services. A chief measure of price inflation is the inflation rate.When Prices rise the Value of

Money falls.

Stages: There are four stages in inflation.

1. Creeping Inflation (0%-3%)

2. Walking Inflation ( 3% - 7%)

3. Running Inflation (10% - 20 %)

4. Hyper Inflation ( 20% and abv)

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 Macroeconomics. Instructor: Sir Touqeer Abbas

Types: There are Two types of Inflation.

1. Demand Pull Inflation: is asserted to arise when aggregate demand in an economy outpaces

aggregate supply.

2. Cost Push Inflation: is inflation caused by an increase in prices of inputs like labor, raw

material, etc.

Causes: for increase in demand.

 Increase in Money Supply

 Increase in Black Marketing

 Increase in Hoarding

 Repayment of Past Internal Debt

 Increase in Exports

 Deficit Financing

 Increase in Income

 Demonstration Effect

 Increase in Black money

 Increase in Credit facilities

For increase in cost:

 Increase in cost of raw materials

 Shortage of Supplies

 Natural calamities

 Industrial Disputes

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 Macroeconomics. Instructor: Sir Touqeer Abbas

 Increase in Exports

 Increase in Wages

 Increase in Transportation Cost

 Huge Expenditure on Advertisement

Effects of Inflation: Inflation can have positive and negative effects on an economy.

Negative effects of inflation include loss in stability in the real value of money and other

monetary items over time; uncertainty about future inflation may discourage investment and

saving, and high inflation may lead to shortages of goods if consumers begin hoarding out of

concern that prices will increase in the future. Positive effects include a mitigation of

economic recessions, and debt relief by reducing the real level of debt.

1. Effect on Producers 2. Effect on Debtors

1. Effect on Creditors 4. Effect on Fixed Income Group

5. Effect on Wage Earners 6. Effect on Equity Holders

7. Effect on farmers 8. Effect on Prodution

9. Effect on Hoarding 10. Effect on value of Money

11. Effect on Investment 12. Effect on savings

Q.7. Explain the saving and investment in national income

accounts?

Short Questions

1. Define Natural rate of unemployment?

Composed By: Farooq Ahmad

 Macroeconomics. Instructor: Sir Touqeer Abbas

The natural rate of unemployment is unemployment that does not go away on its own even in

the long run. It is the amount of unemployment that the economy normally experiences. The

natural rate of unemployment is a combination of frictional, structural and surplus

unemployment.

2. Define cyclical unemployment?

Cyclical unemployment refers to the year-to-year fluctuations in unemployment around its

natural rate. It is associated with with short-term ups and downs of the business cycle.

For example, an auto worker may be laid off during a recession, when people are buying

fewer cars. When people buy fewer cars, the auto makers don't need as many employees to

meet the consumer demand. So as the demand for cars decreases, so does the demand for

auto workers.

3. Define unemployed person?

See Long Question No.5

4. Define labour force?

The labor force is the total number of workers, including both the employed and the

unemployed.

Labor Force = Number of Employed + Number of Unemployed

5. Define formula to measure unemployment rate?

Composed By: Farooq Ahmad

 Macroeconomics. Instructor: Sir Touqeer Abbas

The percentage of the unemployed in the labor force is called the unemployment rate.

Unemployment Rate = (Number of Unemployed / Labor Force) * 100

6. What is meant by labor-force participation rate?

The labor-force participation rate is the percentage of the adult population that is in the labor

force.

Labor-force Participation Rate= (Labor Force / Adult Population) * 100

7. Who is discouraged worker?

Discouraged workers, people who would like to work but have given up looking for jobs

after an unsuccessful search, don’t show up in unemployment statistics.

8. Define frictional unemployment?

Frictional unemployment refers to the unemployment that results from the time that it takes

to match workers with jobs. In other words, it takes time for workers to search for the jobs

that are best suit their tastes and skills.

9. Define structural unemployment?

Structural unemployment is the unemployment that results because the number of jobs

available in some labor markets is insufficient to provide a job for everyone who wants one.

10.Define worker’s union?

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 Macroeconomics. Instructor: Sir Touqeer Abbas

A union is a worker association that bargains with employers over wages and working

conditions. In the 1940s and 1950s, when unions were at their peak, about a third of the U.S.

labor force was unionized. A union is a type of cartel attempting to exert its market power.

11.What is meant by collective bargaining?

The process by which unions and firms agree on the terms of employment is called collective

bargaining.

12.Define efficiency wage?

Efficiency wages are above-equilibrium wages paid by firms in order to

increase worker productivity. The theory of efficiency wages states that firms

operate more efficiently if wages are above the equilibrium level.

13.Define financial system?

A financial system (within the scope of finance) is a system that allows the exchange of

funds between lenders, investors, and borrowers.

14.Define financial markets?

A financial market is a market in which people trade financial securities, commodities, and

other fungible items of value at low transaction costs and at prices that reflect supply and

demand. Securities include stocks and bonds, and commodities include precious metals or

agricultural products.

15.Define financial intermediaries?

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 Macroeconomics. Instructor: Sir Touqeer Abbas

A financial intermediary is an entity that acts as the middleman between two parties in a

financial transaction, such as a commercial bank, investment banks, mutual funds and

pension funds.

16.Define Bond?

A written and signed promise to pay a certain sum of money on a certain date, or on

fulfillment of a specified condition. The Federal government, states, cities, corporations, and

many other types of institutions sell bonds.

17.Define stock market?

The market in which shares of publicly held companies are issued and traded either through

exchanges or over-the-counter markets. It is also known as equity market.

18.Define Bank?

A bank is a financial institution licensed to receive deposits and make loans. There are two

types of banks: commercial/retail banks and investment banks.

19.Define Mutual Funds?

A mutual fund is an investment of funds collected from many investors to purchase securities

such as stocks, bonds, money market instruments and similar assets.

20.What is the difference between national savings and private savings?

National Savings: The sum of a nation's public and private savings. National savings equals

a nation's income minus consumption and government expenditures.

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 Macroeconomics. Instructor: Sir Touqeer Abbas

Private Savings: Saving by households and businesses. Private saving is equal to personal

saving plus after-tax corporate profits minus dividends paid.

21.What is the difference between budget surplus and budget deficit?

Budget Deficit: A government’s budget deficit is the difference between what it spends (G)

and what it collects in taxes (T) in a given period.

Budget Deficit= G-T

Budget Surplus: The amount by which a government income exceeds its spending.

Effective tool to achieve the objective of price stability.

22.Define market for loanable funds?

Loanable funds is the sum total of all the money people and entities in an economy have

decided to save and lend out to borrowers as an investment rather than use for personal

consumption. The theory of loanable funds uses a classical market analysis to describe the

supply, demand, and interest rates for loans in the market for loanable funds.

23.What is meant by Bank Rate of Interest?

Bank rate is the rate of interest which a central bank charges on the loans and advances to a

commercial bank. Whenever a bank has a shortage of funds, they can typically borrow from

the central bank based on the monetary policy of the country.

24.Define Cash Reserve Ratio?

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 Macroeconomics. Instructor: Sir Touqeer Abbas

Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of

customers, which commercial banks have to hold as reserves either in cash or as deposits

with the central bank. CRR is set according to the guidelines of the central bank of a country.

25.Define Statutory Liquidity Ratio?

A given amount of assets that commercial banking customers must have on hand in order to

receive credit. These assets can include securities, gold, or cash.

26.Define Open market Operations?

Open market operation is a monetary policy tool used by central banks to increase or

decrease money supply by buying and selling government bonds in the open market.

27.Define Margin Requirements?

A Margin Requirement is the percentage of marginable securities that an investor must pay

for with his own cash.

28.Define Deficit Financing?

A government policy of financing large public expenditures by borrowing money rather than

by raising taxes. It is also called deficit spending.

29.Define fiscal policy?

See long question no. 3

30.Define monetary policy?

See long question no. 1

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 Macroeconomics. Instructor: Sir Touqeer Abbas

31.Define Money?

Money is the set of assets in an economy that people regularly use to buy goods and services

from other people.

32.What is meant by Medium of exchange?

A medium of exchange is an item that buyers give to sellers when they want to purchase

goods and services. A medium of exchange is anything that is readily acceptable as payment.

33.What is meant by Unit of account?

A unit of account is the yardstick people use to post prices and record debts.

34.What is meant by Store of value?

A store of value is an item that people can use to transfer purchasing power from the present

to the future.

35.Define liquidity of money?

Liquidity is the ease with which an asset can be converted into the economy’s medium of

exchange.

36.Define commodity money?

Commodity money takes the form of a commodity with intrinsic value. Examples: Gold,

silver, cigarettes.

37.Define fiat money?

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 Macroeconomics. Instructor: Sir Touqeer Abbas

Fiat money is used as money because of government decree. It does not have intrinsic value.

Examples: Coins, currency, check deposits.

38.What is the difference between currency and demand deposits?

Currency: Currency is the paper bills and coins in the hands of the public.

Demand Deposits: Demand deposits are balances in bank accounts that depositors can

access on demand by writing a check.

39.Define money multiplier?

The money multiplier is the amount of money the banking system generates

with each dollar of reserves. The money multiplier is the reciprocal of the

reserve ratio: M = 1/R

With a reserve requirement, R = 20% or 1/5, The multiplier is 5.

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