Macro economics

Page 7

1. a. What does the Consumer Price Index (CPI) measure? List three
ways in which it differs from the GDP deflator.

The CPI measures the average change over time in the prices paid by consumers
for a basket of goods and services, such as food, housing, transportation, and
healthcare. It helps track inflation (rising prices) or deflation (falling prices)
affecting everyday consumers.

3 Differences Between CPI and GDP Deflator

1.​ What They Measure

○​ CPI tracks prices of goods and services bought by consumers.
○​ GDP Deflator measures price changes in all goods and services
produced domestically (including business and government spending).
2.​ Imported vs. Domestic Goods
○​ CPI includes imported goods (like foreign cars or electronics).
○​ GDP Deflator only counts domestically produced goods.
3.​ Fixed vs. Changing Basket
○​ CPI uses a fixed basket of goods (updated occasionally).
○​ GDP Deflator adjusts automatically based on current production.

Simple Summary

●​ CPI = Consumer prices (including imports).

●​ GDP Deflator = All domestic production prices (no imports).
●​ CPI has a fixed basket; GDP Deflator changes with the economy.
1. b. Why is it easier for the central bank to deal with demand shocks
than with supply shocks?

Demand Shocks (Easier to Handle)

●​ What they are: Changes in spending by consumers, businesses, or the

government (e.g., people suddenly buy fewer cars).
●​ How central banks respond:
○​ Lower demand (recession)? → Cut interest rates or print money
(stimulate spending).
○​ High demand (inflation)? → Raise interest rates (slow down spending).

Why easy? Central banks control money supply and interest rates, which
directly affect demand.

2. Supply Shocks (Harder to Handle)

●​ What they are: Sudden changes in production costs or availability of

goods (e.g., oil price spikes, natural disasters, pandemics).
●​ Why is it hard to fix?
○​ Stagflation risk: Prices rise (inflation) while the economy slows
(unemployment).
○​ Central bank tools don’t work well:
■​ Raising rates fights inflation but worsens unemployment.
■​ Cutting rates boosts jobs but worsens inflation.
○​ Solution requires more than just monetary policy (e.g.,
government action to increase supply).

Simple Summary

●​ Demand shocks: Central banks can easily tweak interest rates to fix.
●​ Supply shocks: No perfect solution—the central bank faces a tough trade-off
between inflation and jobs.
Example: Demand Shock vs. Supply Shock

1. Demand Shock (Easy to Fix) – 2008 Financial Crisis

●​ What happened? People and businesses stopped spending due to fear

(housing crash, job losses).
●​ Central Bank Response (Easy):
○​ The Fed slashed interest rates (near 0%) to encourage borrowing and
spending.
○​ Printed money (Quantitative Easing) to boost the economy.
●​ Result: Over time, demand recovered, and inflation stayed low.

2. Supply Shock (Hard to Fix) – 1970s Oil Crisis

●​ What happened? OPEC cut oil supply → prices quadrupled → factories and
transport got costlier.
●​ Central Bank’s Dilemma (Hard):
○​ Option 1: Raise rates to fight inflation → but would kill jobs (recession
got worse).
○​ Option 2: Keep rates low to save jobs → inflation kept soaring
(stagflation).
●​ Result: The Fed finally raised rates aggressively (Paul Volcker, 1980s) to kill
inflation, but it caused a painful recession.

Key Difference:

●​ Demand shocks = Central bank just adjusts the "gas pedal" (interest rates) to
speed up or slow down spending.
●​ Supply shocks = Like a car with engine trouble—hitting the gas (lower rates) or
brakes (higher rates) won’t fully fix the problem.
1. c. How should policymakers try to promote growth in the economy's
natural level of output?
Policymakers should focus on long-term strategies to boost the economy’s natural

level of output (also called potential GDP). This is the maximum sustainable amount

of goods and services an economy can produce using its resources (labor, capital,

and technology) efficiently.

Key Ways to Promote Growth in Natural Output:

1. Improve Education & Skills (Human Capital)

●​ A better-educated workforce is more productive.

●​ Example: Government funding for schools, vocational training, and
scholarships helps workers gain skills for high-tech jobs.

2. Encourage Technological Innovation

●​ New technology makes production faster and cheaper.

●​ Example: Tax breaks for companies investing in AI, robotics, or green energy
can boost efficiency.

3. Increase Physical Capital (Machines, Factories, Infrastructure)

●​ Better infrastructure (roads, internet, power) helps businesses run smoothly.

●​ Example: Building highways reduces transportation costs, helping farmers
and factories deliver goods faster.

4. Promote Competition & Business-Friendly Policies

●​ Less red tape and fair competition push firms to improve.

●​ Example: Simplifying business licenses helps small startups grow faster.
5. Maintain Stable & Supportive Institutions

●​ Strong legal systems and low corruption encourage investment.

●​ Example: Enforcing contracts fairly makes foreign companies more willing to
invest.

6. Encourage Savings & Investment

●​ More savings mean more money for businesses to borrow and expand.
●​ Example: Tax incentives for retirement savings can increase funds available
for loans.

Real-World Example: South Korea’s Growth

South Korea invested heavily in education, technology (like Samsung), and

infrastructure in the 20th century. This turned it from a poor country into a high-tech

economy.

What Doesn’t Work?

●​ Short-term fixes (like printing more money) don’t increase natural output.
●​ Over-regulation can slow down business growth.

Conclusion

Policymakers should focus on education, technology, infrastructure, and good

policies to sustainably grow the economy’s natural output. This leads to higher

wages, more jobs, and better living standards in the long run.

a. Why might a banking crisis lead to a fall in the money supply?

A banking crisis can lead to a fall in the money supply for several simple

reasons:
1. Banks Lend Less Money

●​ In a crisis, people and businesses lose trust in banks.

●​ Banks become afraid of borrowers not repaying loans, so they reduce
lending.
●​ When banks lend less, less new money is created (since loans create
deposits in the economy).

2. People Withdraw Cash

●​ If people fear banks will collapse, they withdraw money and keep it as
cash.
●​ Banks then have less money to lend, reducing the money supply.

3. Bank Failures

●​ If banks collapse, deposits disappear, directly reducing the money

supply.
●​ Surviving banks become more cautious, lending less.

4. Central Bank & Government Actions

●​ If the central bank doesn’t inject new money, the supply shrinks.
●​ Government bailouts may help, but if too slow, money supply keeps
falling.

Result:

Less money circulating → Businesses and people spend less → Economy slows

down.

In short, a banking crisis makes banks lend less, people hoard cash, and failed

banks wipe out deposits—all shrinking the money supply​

b. What is the impact of an increase in taxes on the interest rate,
income, consumption, and investment?
Impact of an Increase in Taxes

When the government raises taxes, it affects the economy in several ways:

1. Interest Rates (↓ Likely Decrease)

●​ Higher taxes reduce people’s disposable income, so they save less.

●​ With less savings, banks have less money to lend, reducing the supply of
loanable funds.
●​ Lower demand for loans (due to reduced business profits and consumer
spending) can push interest rates down.

2. Income (↓ Decreases)

●​ People have less take-home pay after taxes, reducing overall income.
●​ Businesses may also earn lower profits due to reduced consumer spending.

3. Consumption (↓ Decreases)

●​ When people have less disposable income, they spend less on goods and
services.
●​ Example: If taxes rise by $500/month, a family might cut spending on dining
out, vacations, or new gadgets.

4. Investment (↓ Likely Decreases)

●​ Businesses see lower demand (due to reduced consumption), so they invest

less in new projects.
●​ Example: A company expecting lower sales may delay buying new machinery
or expanding factories.

Example: Tax Increase in a Country

Scenario: The government raises income taxes by 5%.

 ●​ Effect on Interest Rates:
○​ People save less → banks have fewer deposits → interest rates fall
slightly.
●​ Effect on Income:
○​ Workers take home less pay → average household income drops.
●​ Effect on Consumption:
○​ Families spend less on non-essentials (e.g., fewer restaurant visits).
●​ Effect on Investment:
○​ Businesses see weaker sales → postpone new investments (e.g., no
new factory construction).

Final Result:

Higher taxes → Lower income, spending, and investment → Slower economic

growth.​

(Interest rates may drop due to reduced borrowing demand.)

c. Describe four problems affecting measurement of the

government budget deficit.

A budget deficit happens when the government spends more money than it collects
in taxes.​
That sounds simple, but measuring the deficit correctly can be tricky because of
some hidden issues.

✅ 1. Timing of Revenues and Spending (Cash vs. Accrual Accounting)

Governments usually use cash accounting. This means they only count money when it
is actually paid or received.

But this can hide the real deficit.

Example:

If a government delays paying big bills until the next year, it can make the current
year’s deficit look smaller — even though it’s just pushing the problem forward.
✅ 2. Off-Budget Items & Hidden Debts
Some government costs don’t show up in the official budget.

Examples:

●​ Public-private partnerships (PPPs): These are deals where the government

promises to pay private companies later. That future payment may not appear
now in the budget.​

●​ Unfunded pensions or social security promises: The government promises

future payments to retirees, but doesn’t always count them in the current
budget.​

🔍 Result: The deficit may look smaller than it really is, because some future costs are
hidden.

✅ 3. Inflation Confuses the Picture

Governments report deficits in nominal terms (just the number), not adjusting for
inflation.

But inflation reduces the real value of money over time.

Example:

If inflation is 10%, then a $1 trillion debt is actually worth less in today's money — but
the numbers don’t show this.

So during inflation, the deficit can look worse than it really is.

✅ 4. Cyclical vs. Structural Deficits

There are two types of deficits, and it's important to tell them apart:

●​ Cyclical deficit: Happens when the economy is doing poorly (like during a
recession). Tax revenue drops, spending may rise (like unemployment benefits).​

●​ Structural deficit: Happens when a government is always spending more than

it earns, no matter how the economy is doing.​

🔍 Problem: If we don’t separate them, we might:

 ●​ Think a temporary problem is permanent​

●​ Or ignore a long-term issue thinking it’s just temporary​

🧠 Why Does All This Matter?

●​ Wrong deficit numbers = bad decisions​

○​ The government might cut spending too much (austerity)​

○​ Or borrow too much, thinking things are fine​

●​ Investors can lose trust​

○​ If hidden debts suddenly come out, it can cause a debt crisis (like what
happened in Greece)​

✅ Summary (in one line):

Measuring a budget deficit seems simple, but real numbers can be
misleading due to timing tricks, hidden costs, inflation, and not knowing
if the problem is temporary or permanent.

ii. People start holding more cash because of ATM virus rumors —
What happens?

●​ If people are scared ATMs will stop working, they take out more cash
and hold it.
●​ So they hold less in bank deposits, and more in physical currency.

Why is that a problem?

●​ Banks use deposits to give loans.

●​ Less deposits → less lending → less money created.
●​ So, the money multiplier goes down.
●​ This might slow down economic activity, and maybe even reduce the
speed (velocity) of money in the economy.
✅ Result: Less bank lending and possibly slower money movement.
iv. Bangladesh Bank flies a helicopter over 52 Victory Day of
Bangladesh in Dhaka City and drops newly printed tk100 bills.

Imagine the Bangladesh Bank drops free money from the sky — everyone
gets cash!

●​ That’s called "helicopter money" — a fast way to increase the money

supply.​

●​ Now, people have more money and they start spending more.​

●​ But if the number of goods and services stays the same, and everyone
wants to buy more…​

❗ Prices go up → Inflation happens.

✅ Result: Free money boosts demand → If supply doesn’t keep up →
Inflation rises

b. In the Solow model, how does the saving rate affect the
steady-state level of income? How does it affect the steady-state
rate of growth?

What is the Saving Rate in the Solow Model?

The saving rate (s) is the part of a country's income that people don’t
spend—they save it, and it gets used to invest in capital (like machines, tools,
buildings, etc.).

🔼 What Happens If People Save More?

 ●​ More saving → More investment​

●​ More investment → More capital (machines, tools, etc.)​

●​ More capital → Workers become more productive​

●​ More productivity → Higher income per person (GDP per worker)​

So, when a country saves more, it ends up richer in the long run.

💡 Example:​
If a country starts saving 20% of income instead of 10%, it will eventually
reach a higher level of income.

⚠️ But There’s a Limit

There’s something called diminishing returns. This means:

●​ The first few machines help a lot.​

●​ But adding more and more machines gives smaller and smaller gains.​

So, saving more helps, but the extra benefit gets smaller as the economy
builds up capital.

📈 What About Long-Term Growth?

In the long run, the growth rate of income per person does NOT depend on
saving.

✅ Long-term growth comes from technology — like better machines, smarter

ways of working, new inventions.

So:
 ●​ Saving helps the economy reach a higher income.​

●​ But it doesn’t change how fast the economy grows over time.​

🧠 That’s why things like:

●​ Education​

●​ Innovation​

●​ Research and development​

...are so important. These are what keep the economy growing over the long
run.

🧾 Summary:
Saving Rate Effect

⬆️ Higher saving ⬆️ Higher income (long run)

⬇️ Lower saving ⬇️ Lower income (long run)
But... 🚫 No effect on long-term
growth rate

Long-term growth 🧪 Technology & innovation

depends on

c. What is the difference between a positive and a normative

statement? Give an example of each.

Positive vs. Normative Statements

1. Positive Statement (Fact-Based, Objective)

What it means:​
A positive statement tells us what is happening or what will happen, based
on facts.​
It can be checked or tested using real data.

Important point:​
It does not include opinions.

Example:

"Increasing the minimum wage by 20% will lead to higher

unemployment among low-skilled workers."​
We can check this by looking at job data.

2. Normative Statement (Opinion-Based, Subjective)

What it means:​
A normative statement tells us what should happen or what is right or wrong,
based on opinions or values.

Important point:​
It cannot be tested with data — it’s about personal beliefs.

Example:

"The government should raise the minimum wage to reduce

poverty."​
This is an opinion. People may agree or disagree.

Key Differences

Aspect Positive Statement Normative Statement

Type Based on facts Based on opinions

Can test Yes (using data) No (depends on personal

it? beliefs)
Example "Tax cuts increase "Tax cuts are unfair to poor
growth." people."

Why This Matters in Economics

●​ Positive statements help us understand how the economy works.​

→ Example: “Will a carbon tax reduce pollution?”​

●​ Normative statements help make decisions about what policies to

choose, based on values.​
→ Example: “We should tax carbon to save the planet.”

Easy Way to Remember

●​ Positive = “What is” (Facts, science)​

●​ Normative = “What should be” (Opinions, values)​

d. Suppose that the demand for real money balances depends on disposable income.
That is, the money demand function is:

🧠 Disposable income =​
Total income (Y) – Taxes (T) = Y – T

So people hold money based on what they actually have to spend, not just
what they earn.

We’ll use the IS-LM model, which helps show how the goods market (IS) and
the money market (LM) work together.
i. 📌 What happens when Government Spending
Increases (G ↑)

👉 Example: The government builds roads, gives jobs, etc.

Step-by-step:

1.​ Government spends more → People earn more income → Y increases​

2.​ Taxes (T) stay the same → So Y – T (disposable income) increases​

3.​ People now have more money to spend → They want to hold more
money (for purchases, etc.)​

➡️ So money demand increases​

➡️ That puts pressure on interest rates to rise​
➡️ The LM curve shifts slightly left (upward)
At the same time:

●​ The IS curve shifts right because government spending increases

demand.​

🎯 Final Result:
●​ Output (Y) increases​

●​ Interest rate (r) also increases​

✅ Conclusion: The effect is mostly the same as before. Only a small change in
the LM curve because of change in disposable income.
ii. 📌 What happens when Taxes Increase (T ↑)
👉 Example: Government raises taxes, people pay more to the government.
Step-by-step:

1.​ Taxes go up → People’s take-home income drops → Y – T decreases​

2.​ People have less money to spend, so they don’t want to hold much cash​

3.​ Money demand falls​

➡️ This makes it easier for people to get money → Interest rates drop​
➡️ So the LM curve shifts to the right (downward)
At the same time:

●​ Higher taxes mean less consumer spending → Less demand for goods​
➡️ IS curve shifts left (lower output)​
🎯 Final Result:
●​ IS curve moves left (because of less consumption)​

●​ LM curve moves right (because of lower money demand)​

●​ Interest rates fall​

●​ Effect on income (Y) is uncertain — could rise, fall, or stay similar,

depending on which shift is stronger.​

✅ Easy Summary:
 Policy What changes? IS LM Result
Curve Curve

G ↑ (Govt Y ↑ → Y–T ↑ → Money Shifts Slightly Y ↑, r ↑

spending) demand ↑ right left

T ↑ (Taxes) Y–T ↓ → Money demand Shifts Shifts r ↓, Y

↓ left right uncertain

5.a. "The supply creates its own demand". How did classical
economists justify this agreement?

Say’s Law says:

"Producing goods automatically creates the income needed to buy

them."

This idea came from French economist Jean-Baptiste Say.​

He believed that when something is produced, people earn income — and
they’ll use that income to buy other goods.​
👉 So, there won’t be long-term shortages or too much supply in the
economy.

🏛️ 2. What Classical Economists Believed

Famous economists like Adam Smith and David Ricardo supported Say’s Law.
Here's how they explained it:

a. Production Creates Income

●​ When people make things (like food, clothes, or tools), they earn money:​

○​ Workers earn wages​

 ○​ Business owners earn profits​

○​ Landowners earn rent​

🧺 Example:​
A farmer grows wheat and sells it. The money he earns becomes his income,
which he spends on other things (like clothes or tools).

b. Income Becomes Demand

●​ People use the income they earn to buy other products.​

●​ So, the money from selling goods becomes the demand for buying
goods.​

✅ This means:​
Total Supply = Total Demand

c. Prices Adjust to Fix Problems

●​ If too much is produced and not sold, prices fall.​

●​ Lower prices make people buy more — so the market fixes itself.​

🛒 Example:​
If too many apples are grown and not all are sold, the price of apples goes
down. Then more people buy apples, and the extra supply is gone.

➗ 3. Easy Math Idea

In a simple barter economy (no money, just trading goods):

What you supply = What you demand

In a money economy, classical economists said money is just a tool to trade
goods.​
In the end, people trade products for products.

❌ 4. What Keynes Argued (Criticism)

Economist John Maynard Keynes disagreed with Say’s Law.​
He said supply doesn’t always create demand, especially during bad times
like recessions.

His reasons:

●​ People might save money instead of spending it (called hoarding).​

●​ Wages and prices don’t always fall quickly, so unemployment can last a
long time.​

●​ If not enough people want to buy things, businesses can’t sell all their
products — even if they lower prices.​

📉 Example:​
During the Great Depression, many people lost jobs. Businesses had goods to
sell, but no one had enough money to buy them — so the economy stayed
weak for years.

📘 5. What Economists Believe Today

●​ In the long run: Say’s Law mostly works. Over time, prices and wages
adjust, and markets balance.​

●​ In the short run: Keynesian economics is more useful. It shows how

demand (spending) affects jobs and production in the economy.
5.c. To stabilize the fluctuation of the economy, the government
takes various stabilization policies. Explain various stabilization
policies for aggregate demand and aggregate supply.

Governments and central banks use two main types of policies to keep the
economy stable:

●​ Demand-side policies: To control total spending in the economy

(aggregate demand – AD).​

●​ Supply-side policies: To improve production (aggregate supply – AS)

and long-term economic growth.​

These policies help fight problems like:

●​ Recession (low growth, high unemployment)​

●​ Inflation (rising prices)​

●​ Stagflation (slow growth + high inflation)​

1️⃣ Demand-Side Policies (Focus on AD)

🎯 Goal: Help the economy grow during a slowdown (recession) or cool it down
when prices rise too fast (inflation).

A. Fiscal Policy (Used by Government)

a. Expansionary Fiscal Policy (Used during a Recession):

●​ Increase Government Spending​

➤ Example: Building roads, schools, hospitals.​
➤ More jobs and income → People spend more → AD goes up.​
 ●​ Decrease Taxes​
➤ People keep more money → Spend more → Businesses earn more.​

✅ Result: Boosts total demand and helps the economy recover.

b. Contractionary Fiscal Policy (Used during Inflation):

●​ Decrease Government Spending​

➤ Fewer public projects → Less money in the economy.​

●​ Increase Taxes​
➤ People have less disposable income → Spend less → Prices fall.​

✅ Result: Slows down demand and helps control inflation.

B. Monetary Policy (Used by Central Bank)

a. Expansionary Monetary Policy (Used during a Recession):

●​ Lower Interest Rates​

➤ Cheaper loans → More spending and investment by people and
businesses.​

●​ Increase Money Supply​

➤ Central bank adds money to the economy (e.g., by buying
government bonds).​

✅ Result: Increases borrowing, spending, and investment → AD goes up.

b. Contractionary Monetary Policy (Used during Inflation):

 ●​ Raise Interest Rates​
➤ Loans become expensive → People and businesses borrow/spend less.​

●​ Reduce Money Supply​

➤ Central bank takes money out of the economy.​

✅ Result: Decreases demand → Slows inflation.

2️⃣ Supply-Side Policies (Focus on AS)

🎯 Goal: Make the economy more efficient by increasing production, lowering

costs, and improving long-term growth.

A. Market-Based Supply-Side Policies

●​ Lower Corporate Taxes​

➤ Businesses keep more profit → Invest more → Increase production.​

●​ Deregulation​
➤ Fewer rules for businesses (like labor laws, environmental rules) →
Lower costs.​

●​ Free Trade Agreements​

➤ Cheaper imports → Lower input costs → More competitive products.​

✅ Result: Businesses can produce more at lower costs.

B. Interventionist Supply-Side Policies

 ●​ Education and Training​
➤ Better-skilled workers → More efficient and productive.​

●​ Infrastructure Investment​
➤ Good roads, internet, ports → Faster and cheaper production and
transport.​

●​ Subsidies for Key Industries​

➤ Government support for important sectors (like green energy) →
Encourage growth.​

✅ Result: Improves the economy’s capacity to produce more goods and

services.

🧠 When to Use Which Policy?

Economic Use Demand-Side Policy Use Supply-Side Policy (AS)
Problem (AD)

Recession Expansionary policy: more Invest in skills, infrastructure

spending, lower taxes to boost productivity

Inflation Contractionary policy: cut Reduce production costs (e.g.,

spending, raise taxes tax cuts, deregulation)

Stagflation Use demand policies Focus on supply-side (e.g.,

carefully energy reforms)
📚 Real-World Examples
●​ 2008 Financial Crisis:​
➤ USA used expansionary fiscal policy (stimulus checks, infrastructure)
and expansionary monetary policy (very low interest rates) to boost
spending.​

●​ 1970s Oil Crisis:​

➤ High inflation + low growth (stagflation) → Focused on supply-side
solutions like deregulation and alternative energy development.​

✅ Key Takeaways
●​ Demand-side policies (fiscal and monetary) work quickly but may cause
inflation if overused.​

●​ Supply-side policies take longer to show results but help create

sustainable long-term growth.

👉 These are actions taken by the government or central bank to keep the
economy stable — meaning:

●​ No big ups and downs 🚀📉​

●​ Prices stay under control 📊​

●​ People have jobs 👩‍🏭👨‍🏫​

●​ The economy keeps growing steadily 🌱​

b. In a two-sector supply economy with neither government nor foreign trade,
investment (I) is identically equal to saving (S) - Justify with reasoning.

What is a Two-Sector Economy?

In this very simple model of the economy, there are only two players:

1. Households (People):

●​ They own the resources like labor, land, and capital.​

●​ They work for firms and earn income (like wages, rent, profits).​

●​ They use their income to either:​

○​ Spend on goods and services (Consumption, C), or​

○​ Save the rest (Saving, S)​

2. Firms (Businesses):

●​ They use the resources from households to produce goods and

services.​

●​ They sell these goods to households.​

●​ They also invest (I) in things like machines, tools, or buildings to

grow their business.​

❌ No Government
❌ No Foreign Trade​
This means: No taxes, no exports/imports. It’s a closed and simple
economy.

💸 Total Income and Spending

We can look at the economy in two ways:

➤ Income Side:

●​ Households earn income (Y) from firms.​

●​ They use this income to:​

○​ Spend (C)​

○​ Save (S)​

So,​
👉Y=C+S
➤ Spending Side:

●​ All spending in the economy is done by:​

○​ Households (C)​

○​ Firms (I)​

So,​
👉Y=C+I
Since both equal Y:

👉C+S=C+I
Now subtract C from both sides:​
👉S=I
🧠 What Does “Saving = Investment” Mean?
Let’s understand it simply:

●​ Households save a part of their income.​

●​ Firms borrow money to invest.​

●​ In this simple economy, there’s no other source of money for firms

to invest.​

So:

●​ If people save more, firms can invest more.​

●​ If people save less, firms can’t invest much.​

👉 That’s why saving must always equal investment in this model.

📊 Example:
Let’s say:

●​ Income (Y) = ₹1000​

 ●​ Consumption (C) = ₹800​
Then, Saving (S) = ₹1000 - ₹800 = ₹200​

Also,​
Spending = C + I​
₹1000 = ₹800 + I​
So, I = ₹200

✅ So, S = I = ₹200
Now Imagine:

If people save ₹300 instead of ₹200:

●​ S = ₹300​

●​ But firms only invest ₹200 → S > I​

●​ This means ₹100 is not used → economy slows down → possible

recession​

If firms want to invest ₹300 but people only save ₹200:

●​ S < I → not enough money available → investment is limited​

🎯 Final Conclusion
In a two-sector economy (no government or foreign trade):
✅ All income is either spent or saved​
✅ All savings are used for investment​
✅ So, Saving = Investment
This is a basic rule in macroeconomics and helps the economy stay in
balance (equilibrium).

distinguish between current account and capital account of blance

payment

The Balance of Payments is a record of all money coming into a country and
going out to other countries. It shows how a country interacts with the rest of
the world economically.

The BoP has three parts:

1.​ Current Account​

2.​ Capital Account​

3.​ Financial Account​

Let’s focus on the Current Account and Capital Account.

1️⃣ Current Account

🧾 The current account keeps track of everyday economic transactions

between a country and the world. It includes:

A. Trade in Goods (Visible Trade)

●​ Exporting cars, clothes = money in​

 ●​ Importing oil, electronics = money out​

B. Trade in Services (Invisible Trade)

●​ Foreigners coming for tourism = money in​

●​ Paying for software from abroad = money out​

C. Primary Income

●​ Earnings from foreign investments (like interest, dividends)​

●​ Wages sent by people working abroad​

D. Secondary Income (Current Transfers)

●​ One-way transfers like:​

○​ Remittances (money sent home by citizens working abroad)​

○​ Foreign aid or gifts from other countries​

💡 Example:​
If Bangladesh exports garments, receives remittances, and earns interest from
foreign banks — it’s recorded in the current account.

2️⃣ Capital Account

🏦 The capital account tracks one-time, non-regular transactions that affect

a country’s assets. It includes:
A. Capital Transfers

●​ Debt forgiveness (when a country’s debt is canceled)​

●​ Migrants’ transfers (when people move and take their assets with them)​

B. Sale or Purchase of Non-Financial Assets

●​ Selling rights to things like:​

○​ Patents​

○​ Copyrights​

○​ Trademarks​

○​ Natural resource rights​

💡 Example:​
If a country sells the rights to mine gas to a foreign company, or gets debt
canceled — it’s recorded in the capital account.

📊 Key Differences Between Current and Capital

Account

Feature Current Account Capital Account

Type of Day-to-day trade, income, One-time asset or capital

Transactions transfers transfers

Frequency Regular and ongoing Rare and occasional

Examples Exports, imports, tourism, Selling patents, debt
remittances forgiveness

Impact Shows how well a country Shows changes in

earns and spends ownership of assets

🧠 Extra: What is the Financial Account?

People often confuse the Capital Account with the Financial Account.

📌 The financial account records money flows for investment, such as:
●​ FDI (Foreign Direct Investment)​

●​ Buying or selling stocks and bonds​

●​ Loans between countries​

●​ Central bank foreign currency reserves​

✅ Final Summary:
●​ Current Account = Trade (Goods + Services) + Income + Transfers​

●​ Capital Account = One-time transfers + Buying/Selling intangible assets​

●​ Financial Account = Investment and loan flows​

And remember:
👉 Current Account + Capital Account + Financial Account = 0
This means the money in = money out, so everything balances in the end.

NEW

Explain the difference between macroeconomics and microeconomics.

How are these two fields related?

🌱 Microeconomics – "Small Picture"

What it studies:

●​ Microeconomics looks at the small parts of the economy.​

●​ It studies individuals, households, and businesses and how they

make decisions.​

Key questions it asks:

●​ Why do people buy more of a product when the price goes down?​

●​ How do companies decide how much to produce?​

●​ Why do workers in some jobs earn more than others?​

Topics include:

●​ Demand and supply​

 ●​ Pricing of goods and services​

●​ Consumer behavior​

●​ Production and costs​

●​ Market structures (like monopoly, competition)​

🧠 Think of it as studying a single tree in the forest.

🌍 Macroeconomics – "Big Picture"

What it studies:

●​ Macroeconomics looks at the whole economy of a country or the

world.​

●​ It studies the overall performance, trends, and problems of the

economy.​

Key questions it asks:

●​ Why does inflation (price increase) happen?​

●​ What causes unemployment?​

●​ How can a country grow its economy?​

Topics include:

●​ Gross Domestic Product (GDP)​

●​ Inflation and deflation​

●​ Unemployment​

●​ Economic growth​

●​ Government policies (like taxes and spending)​

●​ Exchange rates and trade​

🧠 Think of it as studying the entire forest, not just one tree.

🔄 How Are Microeconomics and Macroeconomics Related?

●​ Micro builds Macro: The overall economy (macroeconomics) is
made up of many small decisions by people and firms
(microeconomics).​
​
👉 Example: If many people stop buying cars (micro behavior), it
can reduce national production and employment (macro effect).​

●​ Macro affects Micro: The big economy also affects individuals and
firms.​
​
👉 Example: If inflation is high (macro issue), people may buy
 fewer goods, and companies may raise prices or cut costs (micro
behavior).​

●​ Government policies use both micro and macro insights. For

example:​

○​ A tax cut might encourage people to spend more (micro

effect),​

○​ Which increases overall demand in the economy (macro

effect).​

✅ Summary Table
Feature Microeconomics Macroeconomics

Focus Individuals, firms Economy as a whole

Scope Small units National/international

economy

Examples Price of one product, a Inflation, GDP,

firm’s cost unemployment

Main Decision making Economic growth,

concern stability
Relation Forms the base of macro Affects micro-level
decisions

What is GDP? What are the components of GDP? Give an example of

each

📊 What is GDP?
GDP stands for Gross Domestic Product.

It is the total value of all final goods and services produced within a country
during a specific time period (usually a year or a quarter).

✅ It tells us how big and healthy a country’s economy is.

🔸Example:
If a country produces:

●​ 1,000 cars,​

●​ 500 tons of rice,​

●​ 200 TVs, and​

●​ provides services like teaching, hospital care, etc.,​

Then the total money value of all these things together is called that country’s
GDP.

🧩 What are the Components of GDP?

GDP has 4 main components, often written as:

GDP = C + I + G + (X − M)

Let’s understand each:

1. C = Consumption

Money spent by households on goods and services.

✅ Example:
●​ Buying food from a restaurant 🍔​
●​ Paying for a Netflix subscription 📺​

●​ Purchasing clothes 👗​

🧍 Who spends it? You and me (consumers)

2. I = Investment

Money spent by businesses on things they will use to produce more

goods/services.

✅ Example:
●​ A company buying a new machine 🏭​
●​ A builder constructing a new house 🏠​

●​ A tech firm buying computers 💻​

🏢 Who spends it? Firms and businesses

(Note: Buying stocks or bonds is not included here.)

3. G = Government Spending

Money spent by the government on goods and services.

✅ Example:
●​ Building roads or bridges 🛣​
●​ Paying salaries to government employees 👮‍♀️​
●​ Buying military equipment or vaccines 💉​
🏛 Who spends it? The government
(Note: Welfare payments like pensions or unemployment benefits are not
counted, because they're transfers, not actual purchases.)

4. (X − M) = Net Exports

This means: Exports – Imports

●​ Exports (X): Goods sold to other countries (+)​

●​ Imports (M): Goods bought from other countries (−)​

✅ Example:
●​ Bangladesh exports garments to Europe (X) 👕​
 ●​ Bangladesh imports oil from the Middle East (M) ⛽​
So, if exports = $100B and imports = $80B, then net exports = $20B.

🧠 Quick Summary Table:

Component Meaning Example

C- Spending by households Buying food, clothes,

Consumption services

I - Investment Business spending on capital Buying machines, building

a factory

G - Government Government spending on Building roads, paying

goods/services salaries

X - M (Net Exports minus imports Exporting garments,

Exports) importing oil

A: Real GDP and Well-being — Effects of Different

Events

i. A hurricane in Florida forces Disney World to shut down for a month.

 ●​ Effect on Real GDP: Decreases​
Disney World is a major business — when it closes, tourism, hotel stays,
food sales, and jobs are all reduced.​

●​ Effect on Well-being: Decreases​

Workers lose income, tourists cancel plans, and the area suffers damage.​

ii. The discovery of a new, easy-to-grow strain of wheat increases farm

harvests.

●​ Effect on Real GDP: Increases​

More wheat = more food production = higher GDP.​

●​ Effect on Well-being: Increases​

More food may reduce prices and hunger. Farmers earn more,
consumers save money.​

iii. Increased hostility between unions and management sparks a rash

of strikes.

●​ Effect on Real GDP: Decreases​

When workers strike, production stops. That means fewer goods and
services.​

●​ Effect on Well-being: Decreases​

Workers lose wages during strikes; companies may lose customers.​
iv. Firms throughout the economy experience falling demand, causing
them to lay off workers.

●​ Effect on Real GDP: Decreases​

Less demand → less production → lower GDP.​

●​ Effect on Well-being: Decreases​

More people are unemployed and have less income. It may cause stress
and hardship.​

v. Congress passes new environmental laws that prohibit firms from

using production methods that emit large quantities of pollution.

●​ Effect on Real GDP: Might decrease in the short run​

New laws can increase costs or slow production for some firms.​

●​ Effect on Well-being: Increases in the long run​

Cleaner air, better health, and long-term environmental benefits help
everyone.​

vi. More high school students drop out of school to take jobs mowing
lawns.

●​ Effect on Real GDP: May slightly increase short-term​

More people working = more output.​
 ●​ Effect on Well-being: Decreases in the long term​
Dropouts earn less over their lifetime, and may struggle to find better
jobs in the future.

​
difference between frictional and structural unemployment in easy
words and full detail so you understand clearly.

🌟 What is Unemployment?
Unemployment means people who want to work but don’t have a job.

But not all unemployment is the same. Two common types are:

✅ 1. Frictional Unemployment (Short-term and

Normal)

🧠 What is it?
Frictional unemployment happens when people are temporarily unemployed
while they are:

●​ Switching jobs​

●​ Looking for their first job​

●​ Coming back after a break​

This type is normal in any healthy economy.

🧾 Examples:
●​ A university student graduates and is looking for their first job.​
 ●​ A person quits their job to find a better one.​

●​ Someone moves to a new city and hasn’t found work yet.​

🧑‍🏫 Easy Explanation:

Imagine you leave a job because you want something better — you’re not
jobless because of a problem in the economy. You're just between jobs.

⏳ How long does it last?

Usually a short time — a few weeks or months.

🚧 2. Structural Unemployment (Long-term and

Serious)

🧠 What is it?
Structural unemployment happens when there’s a mismatch between people’s
skills and available jobs. This means:

●​ The economy has changed​

●​ Your skills are no longer needed​

Even if jobs are available, people can’t get them because they don’t have the
right training or education.

🧾 Examples:
●​ A factory worker loses his job because machines (robots) replaced him.​
 ●​ A coal miner loses his job because the country now uses solar energy.​

●​ A typist becomes jobless because now everyone uses computers and

software.​

🧑‍🏫 Easy Explanation:

It’s like having the wrong key for a lock — jobs exist, but your skills don’t fit.

⏳ How long does it last?

Long time — months or even years, unless people get new training or
education.

🧮 Comparison Table
Feature Frictional Structural Unemployment
Unemployment

🔁 Happens People are Skills don’t match available jobs

when between jobs

⌛ Time Short-term Long-term

🔧 Main Normal job search Economic or technological

Cause changes

👩‍🏫 Example Graduate looking Coal miner can’t find work in

for a job solar industry
 💡 Solution Time and job New skills or retraining
search

Why might the real wage stay above the level that balances labor supply and
demand?

Sometimes, the real wage (the wage after adjusting for inflation) stays higher
than the level where the number of people wanting to work = number of jobs
available. This happens because of barriers or rules that stop wages from
falling to the level where everyone who wants to work can get a job.

✅ Reasons Why Real Wage Might Stay Too High:

1.​ Minimum Wage Laws​

○​ The government sets a legal minimum wage.​

○​ If the minimum wage is higher than what the market would pay,
employers hire fewer workers, and some people who want to work
can’t find jobs.​

○​ Example: If a fair market wage is 200 Taka/hour but the law says
minimum wage is 300 Taka/hour, some companies might not
afford to hire as many workers.​

2.​ Labor Unions​

○​ Unions often bargain for higher wages for their members.​

○​ This can push wages above the balance point, and as a result,
employers hire fewer workers.​
 ○​ Example: If a union forces companies to pay more, they might
reduce the number of employees.​

3.​ Efficiency Wages​

○​ Employers might choose to pay higher wages to make workers

more productive, loyal, and healthy.​

○​ But this also means they may not hire as many workers.​

○​ Example: A company pays 20% more than average to reduce

worker laziness or job switching.​

4.​ Sticky Wages​

○​ Wages don’t easily fall, even when there’s too much

unemployment.​

○​ This could be due to contracts, customs, or fear that cutting

wages will upset workers.​

○​ Example: If a company tries to lower salaries, employees might

quit or protest, so the company keeps wages high even if they lose
money.​

5.​ Government Benefits

○​ If unemployed people receive high benefits, they might refuse
lower-paying jobs, keeping the real wage higher than
market-clearing level.​

○​ This can reduce the pressure to accept jobs at lower wages.​

🧠 In Short:
The real wage stays too high (above the balance level) because of laws, worker
power, employer strategies, and resistance to wage cuts. When that happens,
there aren’t enough jobs, and some workers stay unemployed, even though
they want to work.

A country experiences a reduction in productivity — this is called an adverse

shock to the production function.​
That means workers now produce less output per hour of work than before.

🔍 b) What happens to the labor demand curve?

✅ Answer:​
The labor demand curve shifts to the left.

💡 Explanation in Easy Words:

●​ Labor demand comes from firms.​

●​ Firms hire workers based on how much output (and therefore profit)
each worker can generate.​

●​ If productivity falls, each worker produces less, so hiring them becomes

less valuable to firms.​

●​ As a result, firms are less willing to hire at each wage level.​

📉 So, the demand for labor falls, and the labor demand curve shifts left.

🖊️ Graphically (if shown in a diagram):

 ●​ The vertical axis is real wage.​

●​ The horizontal axis is the quantity of labor.​

●​ The labor demand curve slopes downward.​

●​ A leftward shift means at each wage, firms now want fewer workers.​

Effects on the Labor Market:

1.​ ✅ Real Wages​

Stay the same (or too high), even though worker productivity has fallen.​

2.​ ❌ Employment​
Falls, because firms can't afford to hire as many workers at the same
wage when each worker now produces less.​

3.​ 🔺 Unemployment​
Rises, because there are more workers willing to work at the high
wage, but fewer jobs available.​

🧠 Summary (Rigid Wages due to Unions):

Variable Effect

Real Wage No
change
Employment Decrease
s

Unemployme Increase
nt s

role of Central Bank in conducting Monetary Policy

🎯 Easy Definition First:

Monetary policy means the control of money supply and interest rates to
keep the economy stable.

The Central Bank (like Bangladesh Bank, Federal Reserve in the US, etc.) is the
authority that manages this policy.

🧠 Main Goals of Monetary Policy:

The central bank uses monetary policy to:

1.​ ✅ Control inflation (keep prices stable)​

2.​ ✅ Support economic growth​

3.​ ✅ Keep unemployment low​

4.​ ✅ Maintain a stable financial system​

5.​ ✅ Ensure exchange rate stability (if relevant)​

🔧 Role of the Central Bank in Monetary Policy:
1. 🏦 Controls the Money Supply
●​ The central bank decides how much money should be in the economy.​

●​ If inflation is too high → it reduces money supply.​

●​ If the economy is slow → it increases money supply.​

2. 💰 Sets Policy Interest Rates

●​ It sets the base interest rate (e.g., repo rate) that influences all other
rates in the economy.​

●​ Lower interest rates → people borrow more, spend more → boosts

economy.​

●​ Higher interest rates → people borrow less, spend less → controls

inflation.​

3. 🛠️ Uses Monetary Policy Tools:

Tool What It Does Example

Open Market Buying/selling Buy bonds → adds money to

Operations (OMO) government securities economy; Sell bonds →
reduces money
Repo & Reverse Lending rates to Lower repo rate → banks
Repo Rate commercial banks borrow more → lend more

CRR/SLR (Reserve Amount banks must Raise CRR → less money to

Ratios) keep with central bank lend

Moral Suasion Advice or pressure on Encourage banks to lend

banks to follow policies less/more

4. 🏛️ Maintains Financial Stability

●​ Make sure banks are strong and don’t collapse.​

●​ Acts as a lender of last resort in crises.​

5. 🌍 Manages Exchange Rates (if needed)

●​ In countries with fixed or managed exchange rates, the central bank
intervenes in the foreign exchange market to keep the currency stable.​

📝 In Summary:
Function Explanation
Control inflation By adjusting money supply and
interest rates

Stimulate economy Lower rates to boost demand

Slow down economy Raise rates to reduce inflation

Ensure financial Monitor banks, prevent collapses

stability

Support currency Intervene in forex markets if needed

stability

What is an Open Market Operation (OMO)?

It is when the central bank (like Bangladesh Bank) buys or sells government
bonds/securities in the open market to control the money supply.

⚙️ Mechanism – How It Works

Let’s break it into two cases:

🔵 1. Central Bank BUYS Bonds (OMO Purchase)

👉 This is called an expansionary monetary policy.​
👉 Used when the economy is slow or there is unemployment.
🔄 What Happens Step by Step:
 1.​ The central bank buys bonds from commercial banks or people.​

2.​ It pays money for those bonds.​

3.​ That money goes into the banks’ reserves or people’s accounts.​

4.​ Now banks have more money to lend.​

5.​ As a result, the money supply increases in the economy.​

🟢 Effect:​
✅ Interest rates fall​
✅ Borrowing and spending increase​
✅ Economy speeds up

🔴 2. Central Bank SELLS Bonds (OMO Sale)

👉 This is called a contractionary monetary policy.​
👉 Used when there is high inflation.
🔄 What Happens Step by Step:
1.​ The central bank sells bonds to banks or people.​

2.​ Buyers pay money to the central bank.​

3.​ That money is taken out of circulation.​

4.​ Banks have less money to lend.​

5.​ So, the money supply decreases.​

🔴 Effect:​
✅ Interest rates rise​
✅ Borrowing and spending fall​
✅ Inflation comes down

🧠 In Simple Summary Table:

Action by Central What It Does Effect on Money
Bank Supply

Buys bonds Gives money to ⬆️ Increases

banks

Sells bonds Takes money from ⬇️ Decreases

banks

💡 Real-Life Example:
If Bangladesh Bank thinks inflation is rising too fast:

●​ It might sell bonds to take money out of the economy.​

●​ This reduces the money available → slows down spending → controls

inflation.​
analyse the effect of decrease interest rate on investment and
consumption

🎯 Quick Answer (Simple Summary):

🔻 When interest rates go down:
●​ ✅ Investment increases​

●​ ✅ Consumption increases​

This helps to boost economic activity.

🧠 Now Let’s Understand Why (In Easy Words):

🔹 1. Effect on Investment (by businesses)
📉 Lower interest rate = cheaper to borrow money
●​ Companies borrow money from banks to invest in:​

○​ New machines​

○​ Factories​

○​ Technology​

○​ Expansion​

●​ When interest rates are low, the cost of borrowing (loan interest) is less.​

●​ This encourages businesses to invest more, because:​

 ○​ They can make a profit more easily​

○​ It’s less risky to take loans​

✅ So, investment increases when interest rates fall.

🔹 2. Effect on Consumption (by individuals/households)

📉 Lower interest rate = cheaper loans and lower savings return
●​ People take loans for:​

○​ Buying houses, cars, electronics​

○​ Credit card spending​

●​ Lower rates mean monthly payments are smaller, so people spend

more.​

●​ Also, savings in the bank give less interest, so people prefer to spend
instead of saving.​

✅ So, consumption increases when interest rates fall.

📊 Overall Effect on the Economy:
Variable What Happens When Interest Rate
Falls
Investment ✅ Increases (cheaper borrowing for
firms)

Consumption ✅ Increases (cheaper loans + less

saving)

Total Demand ✅ Increases (more spending)

Economic ✅ Speeds up
Growth

Unemployment ❌ Falls (more jobs due to higher

demand)

📌 Example:
If the central bank reduces interest from 9% to 6%:

●​ A business that delayed buying new equipment might now invest.​

●​ A family might now decide to take a loan to buy a motorbike or

renovate their home.​

●​ More spending = more production, more jobs, and a growing economy.

​
How do institutional differences between countries explain the
differences in income per person?

Different institutions in each country—like governments, legal systems,

property rights, and political systems—play a big role in shaping how much
money people earn on average.

Some countries have strong, fair, and efficient institutions that protect
people's rights, encourage business, and reduce corruption. These help people
become more productive, start businesses, and invest in education and
technology. That’s why people in these countries usually earn higher incomes.

Other countries may have weak or corrupt institutions that don’t protect
people’s rights, don’t support businesses, or waste public money. This makes it
hard for people to grow economically, so average income stays low.

1. Property Rights

●​ Good institutions protect people's ownership of land, money, and

businesses.​

●​ If people feel safe that no one can take away what they own, they will
invest and work harder.​

●​ In some poor countries, weak laws mean people might lose their
property unfairly—so they avoid investing.​

Example:​
In countries like the USA or Germany, people trust the law to protect their
property. In contrast, in some poorer countries, land can be taken by the
government or powerful people without fair payment.

2. Rule of Law and Corruption

 ●​ Countries with strong laws and low corruption grow faster.​

●​ If police and courts are fair, businesses and workers feel safe to operate.​

●​ But in corrupt countries, bribes and unfair treatment stop economic

progress.​

Example:​
If a small business in Bangladesh has to pay bribes to get a license, it’s harder
to grow and hire people. In contrast, in a country like Japan, the process is
transparent and fair—so businesses grow faster.

3. Political Stability and Governance

●​ Stable governments can plan long-term and build roads, schools, and
hospitals.​

●​ Unstable or authoritarian governments often change rules or policies too

often, which scares investors and reduces growth.​

Example:​
Singapore had strong leadership that focused on growth, education, and
cleanliness—so it became rich. But some African countries with civil wars and
frequent government changes remain poor.

4. Education and Legal Systems

●​ Institutions that support public education help people become more

skilled and productive.​
 ●​ Countries with good schools and fair legal systems produce more
capable workers and professionals.​

Example:​
South Korea invested in education heavily after the 1950s. Now, it's one of the
richest countries in Asia. Poorer countries didn’t make the same investment.

✅ Conclusion:
Institutional differences explain why some countries are rich and
others are poor.

●​ Strong institutions = trust, safety, investment, and growth → higher

income per person.​

●​ Weak institutions = fear, corruption, less productivity → lower income

per person.​

How does endogenous growth theory explain persistent growth

without assuming exogenous technological progress? How is it
different from the Solow model?

Every country wants to grow—meaning, increase income per person

(GDP per capita). But the question is:

❓What makes an economy keep growing year after year?

That’s what these two theories (Solow and Endogenous Growth) try to
explain—but they do it in very different ways.

🔷 1. THE SOLOW MODEL – SIMPLE REVIEW

The Solow Growth Model says the economy grows from:
 ●​ Labor (number of workers),​

●​ Capital (machines, factories, etc.),​

●​ Technology (improvements in how we produce).​

🌟 BUT:
Solow says capital and labor alone cannot make the economy grow
forever, because of diminishing returns:

Adding more machines or workers eventually gives smaller and

smaller extra output.

So Solow says:

🔸 Long-run growth depends on technology​

🔸 But technology is exogenous (outside the model)​
🔸 The model doesn’t explain how tech improves, just assumes it does
over time.

🔷 2. ENDOGENOUS GROWTH THEORY – DEEPER

EXPLANATION

The word “endogenous” means coming from inside the system. So, this
theory explains how growth happens from within the economy —
especially through:

✅ Key Drivers:
1.​ Education and Human Capital​
 ○​ The more people learn, the more productive they become.​

○​ Skilled workers can create new products and ideas.​

2.​ Innovation and Knowledge Creation​

○​ Through R&D (research and development), firms and people

invent better technologies.​

○​ These ideas help the economy grow.​

3.​ Spillover Effects​

○​ When one firm invents something, others can learn from it.​

○​ This shared knowledge benefits the whole economy.​

4.​ Government Policy Matters!​

○​ Policies that support education, innovation, and

infrastructure can lead to higher long-term growth.​

○​ In Solow, policy only affects growth temporarily, not

permanently.​

🔁 KEY DIFFERENCE — Growth Without External

Technology

Here’s the BIG difference:

 ❌ Solow Model ✅ Endogenous Growth
Tech progress is assumed from Tech progress is explained inside
outside the model

Can’t explain why some countries Explains growth through

grow faster education, R&D, innovation

Long-run growth depends only on Growth continues through

exogenous technology investment in knowledge

🧠 Example to Understand It Better:

Imagine two countries:

🔴 Country A (Solow World):

●​ Doesn’t invest much in education or innovation.​

●​ Adds more machines but gets less and less benefit over time.​

●​ Waits for some external “tech miracle” to grow more.​

🟢 Country B (Endogenous Growth World):

 ●​ Spends a lot on education, trains smart people.​

●​ Encourages new ideas, research, and technology.​

●​ Growth keeps happening because people are creating new ways to

work better and faster.​

Country B will keep growing, while Country A might slow down unless
outside tech comes.

📌 Summary Table (Expanded):

Feature Solow Model Endogenous Growth Theory

Source of Long-term Exogenous tech Human capital, innovation,

Growth progress knowledge

Role of Capital Diminishing Constant or increasing (due

returns to learning)

Policy Impact Short-term only Long-term growth can be

influenced

Technology Assumed from Created by investment in

outside R&D and ideas
Human Capital Not deeply Central part of growth
considered engine

Real-World Fit Fits early stages Fits modern,

innovation-driven economies

✅ Final Thought:
Endogenous growth theory helps us understand why some
countries keep growing fast — because they focus on ideas,
people, and knowledge. It gives real tools (like education, R&D,
and policy) to shape growth.

According to the IS-LM model, what happens in the short run to

the interest rate, income, consumption, and investment under the
following circumstances? Be sure your answer includes an
appropriate graph.

REMINDER: What are IS and LM?

●​ IS Curve: Shows combinations of interest rate and income where

the goods market is in equilibrium.​

○​ Equation: Y=C(Y−T)+I(r)+GY
○​ Slopes downward: when r ↓ → I ↑ → Y ↑​
 ●​ LM Curve: Shows combinations where the money market is in
equilibrium.​

○​ Equation: M/P=L(r,Y)
○​ Slopes upward: when Y ↑ → demand for money ↑ → r ↑

i. The Central Bank Increases the Money Supply

🔄 What happens:
●​ More money → LM curve shifts right​

●​ Interest rate falls​

●​ Investment rises due to lower r​

●​ Income/output increases​

●​ Consumption rises (because Y ↑)​

📊 Graph:
●​ IS stays the same​

●​ LM shifts right → new equilibrium at lower r, higher Y​

✅ ii. The Government Increases Government
Purchases

🔄 What happens:
●​ Government spending ↑ → IS curve shifts right​

●​ Income/output increases​

●​ Consumption increases (Y ↑)​

●​ Interest rate rises​

●​ Investment falls a bit due to higher r (crowding out effect)​

📊 Graph:
●​ LM stays the same​

●​ IS shifts right → new equilibrium at higher Y, higher r​

iii. The Government Increases Taxes

🔄 What happens:
●​ Taxes ↑ → disposable income ↓ → consumption ↓​

●​ IS curve shifts left​

 ●​ Output/income falls​

●​ Consumption falls​

●​ Interest rate falls​

●​ Investment rises (due to lower r)​

📊 Graph:
●​ LM stays the same​

●​ IS shifts left → new equilibrium at lower Y, lower r​

✅ iv. Government Increases Spending and Taxes

by Equal Amounts

This is called a balanced-budget expansion.

🔄 What happens:
●​ G ↑ shifts IS right​

●​ T ↑ reduces consumption (C), partially offsetting G​

●​ Net effect: small rightward shift in IS​

So:
 ●​ Income/output (Y): increases slightly​

●​ Interest rate (r): rises slightly​

●​ Consumption (C): mixed (T↑ → C↓, Y↑ → C↑) → net effect is small​

●​ Investment (I): falls slightly (due to r↑)​

📊 Graph:
●​ LM stays the same​

●​ IS shifts slightly right → new equilibrium at slightly higher Y and r​

📈 IS-LM Graphs (All Scenarios)

Here’s a combined visual for your understanding:

●​ Panel A: LM shifts right (money supply ↑)​

●​ Panel B: IS shifts right (G ↑)​

●​ Panel C: IS shifts left (T ↑)​

●​ Panel D: IS shifts slightly right (G ↑ and T ↑ equally)​

📝 Summary Table:
 Scenario I L Y r C I
S M (In (Inte (Consum (Invest
S S co rest ption) ment)
h h me Rate
i i ) )
f f
t t

i. ↑ Money N R ↑ ↓ ↑ ↑
Supply o i
n g
e h
t

ii. ↑ R N ↑ ↑ ↑ ↓
Government i o
Purchases g n
h e
t

iii. ↑ Taxes L N ↓ ↓ ↓ ↑
e o
f n
t e

iv. ↑ G and ↑ S N Slig Sligh Neutral/s Slight

T (same li o ht t↑ mall ↑ ↓
amount) g ↑
 h n
t e
R
i
g
h
t

ii. What happens to the price level when expected

inflation increases — but money supply and output stay
the same?

Let’s break it down step by step:

🧠 Think of this formula:

Money Supply×Speed of Money=Price Level×Goods Produced

Or:

MV=PYWhere:

●​ M = Money supply (total money in the economy)​

●​ V = Velocity (how fast people spend money)​

●​ P = Price level​

●​ Y = Real output (goods and services produced)​

💡 What’s going on here?

 ●​ The money supply (M) is NOT changing.​

●​ The output (Y) is NOT changing.​

●​ But people now expect inflation (prices to go up in the future).​

🤔 So what do people do?

If people think prices will rise soon:

●​ They want to spend their money quickly before things get expensive.​

●​ That means money moves faster → velocity (V) increases.​

🔁 But MV = PY must stay balanced.

●​ M = same​

●​ V = goes up​

●​ Y = same​

So, for the equation to stay balanced, P (price level) must go up too.

✅ Final Answer (Simple):

Because people expect prices to rise, they start spending faster.​
This increases demand and pushes actual prices up, even though money
supply and output haven’t changed.

📌 So the price level increases.

iii. What should the central bank do if it wants to keep prices the
same?

Now let’s say the central bank doesn’t want prices to go up.

We know:

MV=PY

And:

●​ People spend faster → V increases.​

●​ Goods produced (Y) is the same.​

●​ So if V increases, and you want P to stay the same, then...​

➡️ You must reduce the money supply (M).

✅ Final Answer (Simple):
To stop prices from rising, the central bank should cut the money supply,
so that M × V stays the same.

📌 Reduce money supply to cancel out the faster spending

(higher velocity).

📝 Quick Summary (Easiest Words):

Part Easy Explanation
ii. What happens to People expect inflation → they spend faster
prices? → prices rise.

iii. What should the Cut the money supply to stop prices from
central bank dO? rising.

Define inflation and differentiate between demand-pull and

cost-push inflation.

✅ What is Inflation?
Inflation means a general increase in prices of goods and
services over time.

When inflation happens:

●​ Your money buys less than before.

●​ The cost of living goes up.​

●​ Example: If a packet of rice cost 100 taka last year and 110 taka
this year, that’s 10% inflation.

🔄 Two Main Types of Inflation:

Typ Name What Causes It
e

1️⃣ Demand-Pull Too much demand in the

Inflation economy

2️⃣ Cost-Push Rising production costs

Inflation

🔷 1. Demand-Pull Inflation (More People Want to

Buy)

📌 Simple Definition:
Happens when demand for goods and services is greater than
supply.

✅ Why it happens:
●​ People have more money to spend​

●​ Government spends more​

●​ Interest rates are low (easy to borrow money)​

●​ Exports rise → more money comes into the country​

🔍 What happens next:
●​ Shops and factories can’t keep up with demand.​

●​ So they raise prices.​

📦 Example:
During a festival, everyone wants to buy clothes. Shops raise prices
because they know people will pay more.

🔷 2. Cost-Push Inflation (More Expensive to Produce)

📌 Simple Definition:
Happens when the cost of making goods increases, and
businesses raise prices to cover the higher costs.

✅ Why it happens:
●​ Raw materials become more expensive (like oil, gas, or food
ingredients)​

●​ Wages increase (companies pay more to workers)​

●​ Taxes on production go up​

🔍 What happens next:

 ●​ Businesses pass the cost to customers → prices rise even if demand
stays the same.​

🛠️ Example:
If the price of cotton rises, clothing factories will raise shirt prices to stay
profitable.

📝 Summary Table:
Feature Demand-Pull Inflation Cost-Push Inflation

Caused High demand High production costs

by

Deman Too much Normal or falling

d

Supply Can’t keep up May fall due to high

costs

Exampl More consumer spending, Oil price increase, higher

es export boom wages

✅ Final Thought:
 Demand-pull = "Too much money chasing too few goods"​
Cost-push = "Costs rise, so prices rise"

b) What are the potential consequences of high inflation on

the economy?

High inflation means prices are rising quickly and constantly. This can
cause many negative effects on the economy, businesses, and people’s
daily lives.

🔴 1. Loss of Purchasing Power

●​ When prices go up, your money buys less.​

●​ People with fixed incomes (like pensioners) suffer the most.​

●​ Example: If your salary stays the same but food and rent cost
more, you can afford less than before.​

🔴 2. Uncertainty and Less Investment

●​ Businesses and investors don’t know how much costs or prices will
rise → they become afraid to invest.​

●​ Uncertainty can slow down economic growth.​

🔴 3. Rising Interest Rates

 ●​ Central banks often raise interest rates to fight inflation.​

●​ This makes borrowing more expensive, so fewer people and

businesses take loans → spending and investment fall.​

🔴 4. Hurts Saving
●​ If inflation is higher than interest earned on savings, your saved
money loses value over time.​

●​ People feel discouraged to save.​

🔴 5. Menu Costs
●​ Businesses have to frequently update prices (like reprinting menus,
changing labels) → this creates extra costs.

🔴 6. Shoe Leather Costs

●​ People make more trips to the bank to withdraw money, fearing
its value will fall quickly → more effort, more time wasted.​

🔴 7. Income Redistribution
 ●​ Inflation can unfairly hurt poor people and benefit borrowers.​

●​ Example: If you borrowed money earlier and now pay back with
money that’s worth less, you gain. But lenders lose.​

✅ In short:
High inflation reduces the value of money, slows down growth,
and causes uncertainty and inequality.

🔶 c) What are the measures that can be taken to

control inflation?

Governments and central banks can take several anti-inflation

measures. These fall into two main categories:

🔷 1. Monetary Policy (Central Bank Actions)

✅ Goal: Reduce money supply or slow down demand.
📌 Tools:
●​ Increase interest rates​
→ Loans become more expensive​
→ People spend less​
→ Demand goes down → prices fall​

●​ Sell government bonds​

→ People buy bonds → money goes to government​
 → Less money in circulation​

●​ Increase reserve requirements for banks​

→ Banks lend less money → less spending in the economy​

🔷 2. Fiscal Policy (Government Actions)

✅ Goal: Reduce spending and demand in the economy.
📌 Tools:
●​ Reduce government spending​
→ Less money in the economy → demand falls​

●​ Increase taxes​
→ People have less disposable income → spend less​

🔷 3. Supply-Side Measures
✅ Goal: Reduce the costs of production and increase supply.
📌 Tools:
●​ Subsidize key goods (like food or fuel)​

●​ Cut import taxes to reduce the price of imported goods​

●​ Support agriculture and industries to increase supply and reduce

shortages​

🔷 4. Wage and Price Controls (Rarely used today)

 ●​ The government fixes the prices or wages to stop them from
rising.​

●​ Often used in emergency situations (war, disaster), but can create

shortages or black markets.​

📝 Summary Table:
Policy Measure Effect
Type

Monetary Raise interest rates Reduce borrowing and

spending

Monetary Sell bonds Reduce money in

circulation

Fiscal Cut government Lower overall demand

spending

Fiscal Raise taxes Reduce consumer demand

Supply-side Reduce production Lower pressure on prices

cost
Direct Freeze prices/wages Immediate effect
Control (short-term only)

✅ Final Thoughts:
📌 High inflation = bad for stability, savings, and investment.​
📌 To control it, governments and central banks reduce
spending, demand, and sometimes boost supply.

Page 33
Question 1

a) "Society faces a short-run trade-off between inflation and

unemployment." Explain your opinion about how an economy works
as a whole.

●​ This statement refers to the Phillips Curve, which shows an

inverse relationship between inflation and unemployment in
the short run.​

●​ When unemployment is low, demand for goods and labor is

high, leading to wage increases and higher inflation.​
 ●​ When unemployment is high, inflation tends to be lower
because demand is weak.​

●​ However, in the long run, this trade-off may disappear as

expectations adjust.​

●​ The economy works as a whole through the interaction of

aggregate demand and supply, monetary policy, fiscal policy,
and market forces balancing inflation, unemployment, growth,
and other macroeconomic variables.​

b) State why we have markets, and according to economists, what

roles should government play in them.

Why Do We Have Markets?

🔷 Simple Meaning:
A market is a place (physical or online) where buyers and
sellers meet to exchange goods and services.

We have markets because they make buying and selling easier.

📌 Reasons Why We Have Markets:

1.​ Efficient Exchange​
 ○​ People can buy what they need and sell what they have.​

○​ Example: A farmer can sell rice in the market and buy

clothes with the money.​

2.​ Specialization​

○​ People don’t need to do everything themselves.​

○​ Example: A doctor treats patients and uses the money

to buy food from a shop instead of growing it.​

3.​ Price System​

○​ Prices are set based on supply and demand.​

○​ Prices help decide what to produce, how much to

produce, and for whom.​

4.​ Competition​

○​ Sellers compete to offer better products or lower prices.​

○​ This leads to better quality and more choices for

customers.​
🏛️ Role of Government in the Market (According to
Economists)

Even though markets work well, sometimes they fail or cause

problems. That’s when the government should step in.

Here are the key roles economists believe the government should
play:

1. Enforce Rules and Protect Property Rights

●​ The government sets laws so that people and businesses are

protected.​

●​ Example: A business owner has the legal right to their shop

and products.​

2. Provide Public Goods

●​ Some goods (like street lights, national defense) benefit

everyone, but no private company wants to sell them.​

●​ The government provides these because markets won’t.​

3. Correct Market Failures

Sometimes the market doesn’t work well. The government fixes this
by:
 ●​ Controlling externalities​
(Example: Factories polluting the air → government adds
pollution tax.)​

●​ Breaking up monopolies​
(If one company controls everything, prices go too high.)​

4. Redistribute Income

●​ The market may make the rich richer and leave the poor
behind.​

●​ The government collects taxes and gives welfare, education,

and healthcare to help reduce inequality.​

5. Stabilize the Economy

●​ During recessions or inflation, the government uses fiscal

(spending/taxes) and monetary (money supply/interest rates)
policies to help the economy stay stable.​

📌 Summary Table
 🔍 Purpose ✅ Explanation
Why we have To allow easy buying and selling, help
markets specialization, set prices through supply and
demand

Role of Protect property rights, provide public goods, fix

government market failures, reduce inequality, stabilize
economy

✅ Final Thoughts:
Markets are great for organizing economic activity, but
they’re not perfect. That’s why the government steps in to
fix problems and make things fair and efficient for
everyone.

Why markets? Markets allocate scarce resources efficiently

through the price mechanism, allowing buyers and sellers to
interact.​

Markets help coordinate decentralized decisions, promote

specialization and trade
c) Is GDP a good measure of economic well-being? Discuss.
GDP (Gross Domestic Product) is the total value of all goods and
services produced in a country in one year.

Example: If Bangladesh produces clothes, rice, furniture, and provides

services like education and transport — all of these are added up in GDP.

✅ Why GDP is a good measure of well-being:

1.​ Shows economic activity​

○​ If GDP is growing, it means more jobs, more income, more

products.​

2.​ Helps compare countries​

○​ A country with higher GDP usually has more resources to

support its people.​

3.​ Useful for planning​

○​ Governments and investors use GDP data to decide on

projects, policies, etc.​

❌ But GDP is not perfect — it has limits:

1. Doesn’t show income inequality

●​ GDP can grow while only rich people benefit.​

●​ Example: If one person becomes a billionaire but others remain

poor, GDP rises — but most people aren’t better off.​
2. Ignores unpaid work

●​ Work at home (like cooking, cleaning, raising kids) is not counted

in GDP.​

●​ But it’s important for well-being.​

3. Doesn’t measure happiness or health

●​ GDP can rise even if people are unhappy, stressed, or sick.​

4. Ignores environmental damage

●​ If a factory pollutes a river while making products, GDP increases.​

●​ But the environmental harm is not subtracted.​

5. Doesn’t include informal economy

●​ In many developing countries, people earn money informally (e.g.,

street vendors).​

●​ Their income isn’t always counted in GDP.​

✅ Conclusion:
GDP is useful for measuring economic activity, but it’s not
enough to measure true well-being.

To measure well-being more accurately, we should also look at:

●​ Health (life expectancy)​

●​ Education​

●​ Income distribution​
 ●​ Environmental quality​

●​ Happiness or life satisfaction

Question 2

a) "The long-run aggregate supply curve is vertical at the natural rate of

output." Discuss graphically.
What is “Long-run aggregate supply” (LRAS)?

●​ It means: How much the economy can produce in the long run.​

●​ It’s like saying: “What’s the maximum amount of goods and

services the country can make, if everything is working well?”​

This depends on:

●​ Number of workers​

●​ Machines and factories​

●​ Natural resources​

●​ Technology​

🔺 It does NOT depend on prices like inflation or deflation.

✅ What does “Vertical” mean in this sentence?
●​ Imagine a straight up-and-down line.​
 ●​ It means: “No matter if prices go up or down, the amount we can
produce stays the same in the long run.”​

✅ What is the “Natural rate of output”?

●​ It means: “The best possible level of output the country can
produce when everything is used efficiently.”​

●​ Also called:​

○​ Full-employment output​

○​ Potential GDP​

○​ Symbol: Y*​

🟨 Now Let’s Put It All Together:

In the long run, the amount of goods and services a country can
produce:

●​ Depends on real things like workers and technology​

●​ Does not change just because prices change​

●​ That’s why the LRAS curve is a vertical line — output stays the
same even if prices change.

📊 Now, See the Graph (In Simple Style):

markdown

CopyEdit

Price Level

| LRAS (long-run supply)

| │

| │

| │

|______________________│______________ Real GDP

(Output)

Y*

🔹 What the graph shows:

●​ Vertical line = LRAS​

●​ At Y* (natural output), the economy is at full strength.​

●​ If prices rise or fall, this line doesn’t move. The total output stays
the same.​
🟩 Simple Example:
🔸 Imagine Bangladesh has:
●​ 100 lakh workers​

●​ A certain number of machines​

●​ Good technology​

If we use all of them efficiently, Bangladesh can produce, say, Tk

5,00,000 crore worth of goods/services.​
Even if prices go up or down, we still produce around Tk 5,00,000 crore
in the long run — that’s our natural output.

🟦 Final Summary (Super Simple):

Term Meaning

Long-run Total output when the economy is using

Aggregate Supply everything efficiently

Natural Rate of The best possible amount we can produce (also

Output called full-employment)

Vertical Line Shows that output does not change with price
level in the long run
So, the LRAS curve is vertical at Y* because prices don’t affect long-run
output.

b) Describe why the aggregate demand curve slopes downward.

First, What is Aggregate Demand?

●​ Aggregate Demand (AD) is the total spending on goods and

services in a country.​

●​ It includes:​

○​ C = Consumption (by people)​

○​ I = Investment (by businesses)​

○​ G = Government spending​

○​ NX = Net exports (exports − imports)​

So:​
👉 AD = C + I + G + NX
📉 Why Does the AD Curve Slope Downward?
The AD curve slopes downward (goes down from left to right)
because when the price level falls, total demand increases, and
when the price level rises, demand decreases.

There are 3 main reasons for this:

✅ 1. Wealth Effect (Real Balances Effect)

●​ When prices go down, people feel richer because their money
can buy more.​

●​ Example: If Tk 100 used to buy 2 items, now it buys 3 — you

feel richer!​

●​ So, people spend more → Consumption (C) increases → AD

increases​

🟩 Lower prices → More real wealth → More spending → Higher

AD

✅ 2. Interest Rate Effect

 ●​ When the price level goes down, people need less money to
buy things.​

●​ So, they save more.​

●​ More savings → Interest rates fall → Borrowing becomes

cheaper.​

●​ Businesses and people borrow more → Investment (I)

increases → AD increases​

🟩 Lower prices → Lower interest rate → More borrowing →

Higher AD

✅ 3. Exchange Rate Effect (Foreign Trade Effect)

●​ When the price level in our country goes down, our goods
become cheaper for foreigners.​

●​ Our exports increase, and we import less.​

●​ So, Net Exports (NX) increase → AD increases​

🟩 Lower prices → Cheaper exports → More exports → Higher AD

📊 What Does the AD Curve Look Like?

 markdown

CopyEdit

Price Level

|\

| \

| \ ← Aggregate Demand (AD)

| \

| \

| \____________________ Real GDP (Output)

As price level falls (moving down the Y-axis), AD increases (moving

right on X-axis).

🟨 Summary Table:
Effect What Happens When Result
Price Falls
 Wealth People feel richer, ↑
Effect spend more Consumptio
n → ↑ AD

Interest Lower interest rate → ↑

Rate more borrowing Investment
Effect → ↑ AD

Exchange Exports become ↑ Net

Rate cheaper exports → ↑
Effect AD

✅ Final Answer in 1 Sentence (Easy):

The AD curve slopes downward because lower prices make people
feel richer, borrowing cheaper, and exports more attractive, which
increases total spending in the economy.

c) "A change in the money wage rate or resource prices changes only
short-run aggregate supply." Graphically explain your idea.

Step 1: Understand Aggregate Supply Curves

●​ Short-Run Aggregate Supply (SRAS): Shows the total output

firms want to produce at different price levels when some
 costs (like wages) are fixed or slow to adjust.​

●​ Long-Run Aggregate Supply (LRAS): Shows total output when

wages and prices have fully adjusted, reflecting the economy’s
potential output. It's vertical because output depends only on
resources and technology, not prices.

Step 1: What are wages and resource prices?

●​ Wages = money paid to workers​

●​ Resource prices = money paid for things like raw materials,

electricity, etc.​

These are the costs for businesses when making goods and services.

Step 2: What is short-run aggregate supply (SRAS)?

●​ It shows how much businesses want to produce at different

price levels when wages and costs don’t change quickly.​

●​ In the short run, wages are kind of "sticky" — they don’t

change immediately when prices change.

Step 3: What happens if wages or resource prices increase?

●​ It becomes more expensive to make things.​

 ●​ So, businesses want to make less at the same prices because it
costs more.​

●​ This means the SRAS curve moves to the left (shift left).​

●​ The economy produces less in the short run at every price

level.

Step 4: What about the long run?

●​ In the long run, wages and prices adjust fully.​

●​ Workers and resource suppliers will demand higher wages or

prices if costs increase.​

●​ So, businesses pass the higher costs to prices, but the total
amount the economy can produce doesn’t change.​

●​ That means the long-run aggregate supply (LRAS) curve

stays vertical and does not move.

Step 5: Simple picture in words

●​ Imagine a factory:​

○​ Short run: If wages go up suddenly, it’s costlier, so

factory slows down (SRAS shifts left).​
 ○​ Long run: Wages settle with prices, and the factory goes
back to normal output (LRAS stays the same).​

Graph in simple terms:

arduino

CopyEdit

Price Level

| LRAS (long run output, stays the same)

| |

| SRAS1 |/ (original short-run supply)

| /

| /

|------/----------------- Output

Y*

If wages go up:

lua

CopyEdit
Price Level

| LRAS (still here)

| |

| SRAS2 |/ (shifted left — less output at same

prices)

| /

| /

|-----/------------------ Output

Y*

Summary (easy):

●​ Wages or resource prices going up make it expensive to

produce in the short run → SRAS shifts left (less output).​

●​ In the long run, wages and prices adjust → LRAS stays fixed
(the economy’s capacity doesn’t change).

🟨 Summary:
 Change Effect on SRAS Effect on LRAS

Increase in SRAS shifts left No change

wages/resource (decreases output in (potential output
prices short run) unchanged)

Decrease in SRAS shifts right No change

wages/resource (increases output in
prices short run)
Question

a) What is Neo-Classical theory? State the essence and features of Adam

Smith's free market economy.

●​ It’s a way of understanding how people and businesses make choices.​

●​ People try to get the most happiness or benefit.​

●​ Businesses try to make the most profit.​

●​ Prices change based on how much people want something and how
much is available.​

●​ The market usually works well by itself, without much help from the
government.​

b) What did Adam Smith say about the free market?

Adam Smith is like the “father” of free market ideas.

The main idea:

●​ If everyone tries to do what’s best for themselves, it helps the whole

economy.​

●​ This happens naturally, like an “invisible hand” guiding things.​

●​ People should be free to buy, sell, and make things without too much
government control.​
Important points about Adam Smith’s free market:

Simple Feature What it Means

1. Private People own things like land and factories.

Property

2. Freedom of People can decide what to buy or sell.

Choice

3. Competition Many sellers compete, so prices stay fair.

4. Self-interest People work to help themselves but it helps everyone.

5. Price Prices go up or down depending on supply and demand.

Mechanism

6. Little The government only helps by protecting rights, not

Government controlling business.

In short:

●​ Neo-Classical theory says markets work best when people act freely and
prices guide everything.​

●​ Adam Smith believed if people are free to make their own choices, the
economy grows and works well by itself.
What is Neo-Classical Theory?

Definiti

●​ The Neo-Classical theory in economics focuses on how individuals and

firms make decisions to maximize utility (satisfaction) and profit,
respectively.​

●​ It explains how markets work efficiently through the forces of supply

and demand, leading to an equilibrium price and quantity.​

●​ It assumes rational behavior, where everyone tries to make the best

choices based on available information.​

Key Ideas of Neo-Classical Theory:

●​ People want to maximize happiness (consumers) or profits (firms).​

●​ Markets are usually efficient and clear prices help balance supply and
demand.​

●​ Resources are allocated efficiently through the price mechanism.​

●​ Government intervention is usually minimal because free markets tend

to correct themselves.​

b) Essence and Features of Adam Smith's Free Market

Economy

Adam Smith is called the Father of Economics and his ideas form the
base of the free market economy.
Essence of Adam Smith’s Free Market Economy:

●​ “Invisible hand” guides the economy: individuals acting in their own

self-interest unintentionally benefit society by producing goods and
services people want.​

●​ If individuals are free to trade, produce, and consume, the economy

naturally moves toward efficiency and growth.​

●​ Limited government interference; markets are mostly self-regulating.​

Features of Adam Smith's Free Market Economy:

Feature Explanation

1. Private Individuals and businesses own resources and property.

Property

2. Freedom of People can freely decide what to buy, sell, and produce.
Choice

3. Competition Many sellers and buyers compete, which improves quality

and prices.

4. Self-interest People work to benefit themselves, which leads to overall

economic benefit.
5. Price Prices adjust naturally based on supply and demand,
Mechanism guiding resources to their best use.

6. Limited The government's role is mainly to protect property rights

Government and enforce contracts, not control the economy.

b) Discuss David Ricardo's Distribution theory and International Trade

theory.

David Ricardo was a famous classical economist. He is best known

for two major ideas:

1.​ Distribution Theory – About how income is divided between

landowners, workers, and capitalists.​

2.​ International Trade Theory – About how countries benefit

from trading with each other.

1️⃣ Ricardo’s Distribution Theory (How income is shared)

📌 What it means:
Ricardo wanted to understand how the total income of a country
is divided among:

●​ Landowners (who earn rent),​

 ●​ Workers (who earn wages), and​

●​ Capitalists (who earn profits by running businesses).​

📌 Key Idea:
●​ As the population grows, more food is needed.​

●​ To grow more food, less fertile land must be used (because

good land is already being used).​

●​ Less fertile land costs more to use, so land rent goes up.​

●​ Since more money goes to landowners (rent), less is left for

profits and wages.​

✅ In simple words:
●​ As land becomes more valuable, landowners get richer.​

●​ Business owners (capitalists) earn less profit, so they invest

less.​

●​ This can slow down the economy in the long run.​

2️⃣ Ricardo’s International Trade Theory

(Also called Theory of Comparative Advantage)

📌 What it means:
Ricardo explained why countries trade and how both countries can
benefit — even if one country is better at producing everything.

📌 Key Idea: Comparative Advantage

●​ A country should specialize in making the goods it can
produce more efficiently (at lower opportunity cost).​

●​ Then it should trade with other countries to get the things it

produces less efficiently.​

✅ In simple words:
Even if one country is better at making both rice and cloth, it
should focus on the one where it is "more better" and trade for the
other.

✅ Example (super simple):

Country Cloth Rice
(hours) (hours)

Banglad 10 5
esh

Japan 4 2
 ●​ ​
Japan is better at making both cloth and rice.​

●​ But Japan is more efficient at rice (needs 2 hours vs. 5 in BD).​

●​ Bangladesh is less bad at making cloth (10 hours vs. Japan’s 4).​

So:

●​ Japan should make rice and trade.​

●​ Bangladesh should make cloth and trade.​

💡 Both countries benefit by specializing and trading.

🟩 Summary:
Theory What It Says (Simple)

Distribution As land becomes more important, landowners

Theory get richer, and others get less.

International Countries should produce what they’re

Trade Theory relatively best at and trade for the rest.
​

c) "Supply creates its own demand." Discuss it from the viewpoint

of Jean-Baptiste Say.

Say’s Law says:

"Producing goods automatically creates the income needed to buy

them."

This idea came from French economist Jean-Baptiste Say.​

He believed that when something is produced, people earn income — and
they’ll use that income to buy other goods.​
👉 So, there won’t be long-term shortages or too much supply in the
economy.

🏛️. What Classical Economists Believed

Famous economists like Adam Smith and David Ricardo supported Say’s Law.
Here's how they explained it:

a. Production Creates Income

●​ When people make things (like food, clothes, or tools), they earn money:​

○​ Workers earn wages​

○​ Business owners earn profits​

○​ Landowners earn rent​

🧺 Example:​
A farmer grows wheat and sells it. The money he earns becomes his income,
which he spends on other things (like clothes or tools).

b. Income Becomes Demand

●​ People use the income they earn to buy other products.​

●​ So, the money from selling goods becomes the demand for buying
goods.​

✅ This means:​
Total Supply = Total Demand

c. Prices Adjust to Fix Problems

●​ If too much is produced and not sold, prices fall.​

●​ Lower prices make people buy more — so the market fixes itself.​

🛒 Example:​
If too many apples are grown and not all are sold, the price of apples goes
down. Then more people buy apples, and the extra supply is gone.

➗ 3. Easy Math Idea

In a simple barter economy (no money, just trading goods):

What you supply = What you demand

In a money economy, classical economists said money is just a tool to trade

goods.​
In the end, people trade products for products.

❌ What Keynes Argued (Criticism)

Economist John Maynard Keynes disagreed with Say’s Law.​
He said supply doesn’t always create demand, especially during bad times
like recessions.

His reasons:

●​ People might save money instead of spending it (called hoarding).​

●​ Wages and prices don’t always fall quickly, so unemployment can last a
long time.​

●​ If not enough people want to buy things, businesses can’t sell all their
products — even if they lower prices.​

📉 Example:​
During the Great Depression, many people lost jobs. Businesses had goods to
sell, but no one had enough money to buy them — so the economy stayed
weak for years.

📘 What Economists Believe Today

●​ In the long run: Say’s Law mostly works. Over time, prices and wages
adjust, and markets balance.​

●​ In the short run: Keynesian economics is more useful. It shows how

demand (spending) affects jobs and production in the economy.
●​ Say’s Law: Production of goods generates the means and
demand for other goods.​

●​ Supply creates demand automatically; economic recessions

are caused by disruptions, not lack of demand.​
 ●​ Emphasizes the importance of production for economic
health.​

Question 4

a) Differentiate the IS curve from LM curve. Explain the

Keynesian Cross with the graph.

Fe IS Curve LM Curve
atu
re

Ful Investment-Saving Liquidity

l Curve Preference-Money
For Supply Curve
m

Re Equilibrium in the Equilibrium in the

pre goods market money market
sen
ts

Axi X-axis: Income (Y) X-axis: Income (Y)

s
Us Y-axis: Interest rate Y-axis: Interest rate
ed (r) (r)

Sh All combinations of All combinations of

ow interest rates and interest rates and
s incomes where incomes where money
investment = demand = money
saving (goods supply (money market
market is in is in balance)
balance)

Slo Downward sloping Upward sloping (as

pe (as interest rate ↓, income ↑, demand for
investment ↑, money ↑, interest rate
income ↑) ↑)

Ca Changes in fiscal Changes in monetary

use policy: Govt policy: Money supply
of spending or taxes or preference for
Shi liquidity
ft

Fo Output and demand Money demand and

cus for goods supply
 es
on

📘 Keynesian Cross (Simple Explanation)

The Keynesian Cross is a diagram that shows how national income
(output) is determined in the short run, assuming fixed prices and
aggregate demand driving the economy

🔵 Components in Keynesian Cross:

1.​ 45-Degree Line (Y = AE):​

○​ This is where total output (Y) equals total spending

(AE).​

○​ Every point on this line means: what the economy

produces = what is being demanded.​

2.​ Aggregate Expenditure Line (AE):​

○​ This line shows the total planned spending in the

economy.​

○​ It includes:​
 ■​ C = Consumption​

■​ I = Investment​

■​ G = Government Spending​

■​ NX = Net Exports (sometimes)​

3.​ AE = C + I + G (+ NX)​

📊 Graph of Keynesian Cross:

Here’s a simple representation:

markdown

CopyEdit

AE (Aggregate Expenditure)

│ /

│ /

│ / ← AE = C + I + G

│ . /

│ / /

│ / /
 │ / /

│ / /

│_____/_______/________________ Y (National
Income/Output)

Equilibrium (Y = AE)

●​ 45-degree line (dotted line): shows all points where spending =

income.​

●​ AE curve: shows actual planned expenditure.​

●​ The point where AE intersects the 45-degree line is the

equilibrium output (Y*).

🔁 How It Works:
●​ If AE > Y → spending is more than output → inventories fall
→ firms increase production → income increases.​

●​ If AE < Y → spending is less than output → inventories rise →

firms reduce production → income falls.​

●​ Equilibrium occurs where AE = Y.​

 🟢 What Causes the pE Line to Shift?
●​ Increase in Govt Spending (G) → AE line shifts up → Higher
equilibrium output.​

●​ Increase in Taxes → Disposable income falls → Consumption

(C) falls → AE shifts down.​

✅ Summary:
●​ IS Curve → shows equilibrium in goods market → downward
sloping.​

●​ LM Curve → shows equilibrium in money market → upward

sloping.​

●​ Keynesian Cross → shows how output is determined based on

aggregate demand → equilibrium where AE = Y.​

b) Explain the relationship between Fiscal Policy and the

Multiplier.

Fiscal policy is how the government uses:

●​ Government spending (G) and​

●​ Taxes (T)​
to influence the economy.​
Two types:

1.​ Expansionary Fiscal Policy:​

○​ Increase in government spending or decrease in taxes.​

○​ Used when the economy is in recession.​

2.​ Contractionary Fiscal Policy:​

○​ Decrease in government spending or increase in taxes.​

○​ Used when the economy is overheating or facing high

inflation.

🟣 What is the Multiplier?

The multiplier shows how a small change in spending (like G) causes
a bigger change in total income/output (Y).

Formula (Simple Spending Multiplier):

Multiplier=1/1−MPC​

Where:

●​ MPC = Marginal Propensity to Consume (how much people

spend out of each extra taka they get).​

🟢 Example:
 ●​ If MPC = 0.8,​
Multiplier=1/1−0.8=10.2=5

So, if government spends 100 crore, the total increase in output (Y)
will be:

ΔY=100×5=500 crore

🔁 Relationship Between Fiscal Policy and Multiplier

Fiscal Tool How It Works Multiplier Effect

Government Directly increases Strong effect — full

Spending (G) Aggregate Demand (AD) multiplier used

Tax Cuts (↓T) Increases disposable Smaller effect —

income → more only part is spent
consumption

c) How would you derive the LM curve using the concept of money
market? Show money market equilibrium.

●​ The LM curve shows combinations of:​

○​ Income (Y) and​

 ○​ Interest Rate (r)​
where the money market is in balance (equilibrium).​

🔶 Step-by-Step: Understanding the Money

Market

In an economy, people need money for two main reasons:

1.​ Transaction motive: to buy goods and services.​

2.​ Speculative motive: to hold money instead of bonds.​

But people don’t just hold all their income as cash — they make
choices depending on:

●​ How much income (Y) they have → more income = more

transactions = more demand for money.​

●​ What the interest rate (r) is → high interest rate = people

prefer bonds, not cash.​

🔸 The Money Market Equilibrium:

This is where:

Money Demand (Md)=Money Supply (Ms)\text{Money Demand

(Md)} = \text{Money Supply (Ms)}Money Demand (Md)=Money
Supply (Ms)
Or, in real terms:

MP=L(Y,r)\frac{M}{P} = L(Y, r)PM​=L(Y,r)

Where:

●​ MMM = Nominal money supply (decided by central bank)​

●​ PPP = Price level​

●​ MP\frac{M}{P}PM​= Real money supply (fixed)​

●​ L(Y,r)L(Y, r)L(Y,r) = Demand for real money, which depends

on:​

○​ Positively on income (Y)​

○​ Negatively on interest rate (r)​

🔷 What Happens When Income Increases?

🔹 Suppose income increases from Y₁ to Y₂:
●​ People want to spend more → need more cash.​

●​ But if the money supply is fixed, how can we balance this?​

 ●​ Only way: increase interest rate to reduce people's desire to
hold extra money.​

🔁 So, to keep the money market in equilibrium, higher Y → higher

r

👉 This is what creates the upward-sloping LM curve.

🔷 Let’s Use a Real-Life Example:
Imagine the central bank gives the public 100 crores in cash.​
People use this cash to:

●​ Buy things (needs go up with income)​

●​ Save or invest (they look at interest rates)​

Now:

●​ If income is low → people don’t need too much money →

demand for cash is low → interest rate can be low.​

●​ If income rises → demand for cash increases → but supply is

the same → interest rate must go up to reduce demand.​

This relationship gives us:

●​ Higher Y → Higher r​
●​ That’s the LM Curve.​

🟢 LM Curve Summary:
Concept Explanation

What it Points where money demand = money

shows supply

What Income (Y) and Interest Rate (r)

affects
it

Shape Upward-sloping

Why Because as Y increases, money demand

upward- increases → to stay in balance, r must
sloping? increase

Fixed Money supply (M is fixed by central bank)

variable
Question 5

a) Define National Income and Product Accounts. What are

the limitations of the GDP concept?
National Income and Product Accounts (NIPA) is like the economic
report card of a country.

📘 Definition:
NIPA is a system of accounts that measures the total income,
output, and spending of an economy over a period (usually a
year or quarter).

It tells us:

●​ How much the country produces (goods and services)

●​ How much income people earn
●​ How much is spent by households, businesses, and government

🔹 Main Components of NIPA:

1.​ Gross Domestic Product (GDP) – total value of everything
produced inside the country​

2.​ Gross National Product (GNP) – total income earned by citizens

(including from abroad)​

3.​ Net National Income (NNI) – GNP minus depreciation​

4.​ Personal Income – income received by individuals​

5.​ Disposable Income – income left after taxes​

🟣 b) What are the Limitations of the GDP Concept?
Even though GDP is widely used, it is not a perfect measure of a
country’s well-being. Here are the major limitations:

🔴 1. Excludes Non-Market Activities

●​ GDP only counts what is bought and sold.​

●​ It ignores unpaid work, like:​

○​ A mother taking care of her child at home​

○​ Volunteering​

○​ Homegrown food​

🔴 2. Ignores Income Distribution

●​ GDP shows total output but not who gets the income.​

●​ A country may have high GDP, but if the rich get everything, most
people may still be poor.​

🔴 3. Doesn’t Consider Environmental Damage

 ●​ If a factory pollutes the air while producing goods, GDP increases.​

●​ But it ignores the environmental cost (pollution, health issues,

deforestation).​

🔴 4. No Measure of Happiness or Quality of Life

●​ GDP doesn't tell us if people are happy, safe, or healthy.​

●​ A country may have high GDP but poor healthcare, unsafe streets,
or high stress.​

🔴 5. Excludes Underground or Informal Economy

●​ GDP doesn’t include:​

○​ Black market activities​

○​ Informal jobs (like street vendors, unregistered small

businesses)​

●​ In many developing countries, this sector is very large, so GDP

understates real output.​

🔴 6. Doesn’t Adjust for Leisure Time

 ●​ If people work more hours, GDP may rise, but they lose free time.​

●​ GDP doesn’t value work-life balance or rest.​

✅ Summary Table
Limitation Why It Matters

Non-market activities Misses value of unpaid work

excluded

Unequal income distribution GDP may rise but inequality

ignored may worsen

Environmental cost ignored Pollution and resource loss not

counted

No happiness or well-being Misses quality of life

measure

Underground economy Underestimates actual output

excluded

No value for leisure or free More work ≠ better life

time
National Income and Product Accounts: Systematic record of all
income earned and output produced in an economy during a
period.​

Includes GDP, GNP, NNP, National Income, Disposable

Income, etc.​

Limitations of GDP:

●​ Excludes non-market transactions (home work, volunteer

work).​

●​ Doesn’t account for income inequality.​

●​ Ignores environmental degradation.​

●​ Doesn’t measure quality of life or happiness.​

●​ Ignores underground economy or informal sectors.​

b) Write short notes on:

(i) Nominal vs Real GDP

●​ Nominal GDP: Value of goods/services at current prices

(includes inflation).​

●​ Real GDP: Adjusted for inflation; values goods/services at

constant prices, reflecting true output changes.​

(ii) Disposable Personal Income and Personal Savings

ii) What is Disposable Personal Income (DPI)?
Disposable Personal Income is the money that people
actually have in hand to spend or save after paying
taxes.

✅ Formula:
Disposable Personal Income=Personal
Income−Taxes\text{Disposable Personal Income} = \text{Personal
Income} - \text{Taxes}Disposable Personal Income=Personal
Income−Taxes

●​ Personal Income = total income received by households

(wages, rent, interest, dividends, etc.)​

●​ Taxes = mainly personal income taxes​

🧾 Example:
●​ Personal Income = 50,000 Taka​

●​ Taxes = 10,000 Taka​

→​

DPI=50,000−10,000=40,000 Taka\text{DPI} = 50,000 - 10,000 =

40,000 \text{ Taka}DPI=50,000−10,000=40,000 Taka

👉 This 40,000 Taka is the money people can either:

●​ Spend on goods and services (consumption)​

●​ Or save for the future​

🟢 What is Personal Savings?
Personal Savings is the part of disposable income that is
not spent.

✅ Formula:
Personal Savings=Disposable Income−Consumption\text{Personal
Savings} = \text{Disposable Income} - \text{Consumption}Personal
Savings=Disposable Income−Consumption

●​ Whatever is left after spending, goes into savings (like in

banks, investments, etc.)​

🧾 Example:
●​ Disposable Income = 40,000 Taka​

●​ Consumption = 35,000 Taka​

→​

Personal Savings=40,000−35,000=5,000 Taka\text{Personal Savings}

= 40,000 - 35,000 = 5,000 \text{ Taka}Personal
Savings=40,000−35,000=5,000 Taka

This 5,000 Taka is saved.

🟣 Summary Table:
Concept Definition Formula

Disposable Income left after DPI = Personal

Income taxes Income − Taxes
Personal Part of DPI that is Savings = DPI −
Savings not spent Consumption

💡 Real-World Meaning:
●​ DPI tells how much money people have to use.​

●​ Personal Savings shows how much they choose to save.​

●​ When people save more, they spend less → may slow down
economy short-term.​

●​ When people spend more, savings fall → boosts economic

activity short-term

(iii) Gross Investment vs Net Investment

iii) What is Gross Investment?

Gross Investment is the total amount spent by businesses

on capital goods like machinery, buildings, tools, and
equipment before subtracting depreciation.

It includes:

●​ New investments​

●​ Replacing old or worn-out capital​

 🧾 Example:
●​ A company buys new machines worth ₹10 crore​

●​ Also replaces old machines worth ₹2 crore​

Then:

Gross Investment=₹10 crore (new)+₹2 crore

(replacement)=₹12

🟢 What is Net Investment?

Net Investment is the part of gross investment that actually
increases the capital stock, after subtracting depreciation.

✅ Formula:
Net Investment=Gross Investment−Depreciation

Depreciation = value of capital that wears out or becomes

outdated during the year.​

🧾 Example (continued):
●​ Gross Investment = ₹12 crore​

●​ Depreciation = ₹2 crore​
Then:​
Net Investment=12−2=₹10 crore

🟣 Summary Table:
Conce Definition Include Formula
pt s

Gross Total spending on New + –

Invest capital goods Replace
ment ment

Net Actual addition to Only Gross

Invest capital stock (after new Investment −
ment depreciation) Depreciation

📌 Key Differences:
Point Gross Net Investment
Investment

Includes ✅ Yes ❌ No (it subtracts

depreciation? depreciation)
 Shows capital ✅ Yes ❌ No (only shows net
replacement? increase)

Measures total ✅ ❌ Only real growth in

spending? assets

💡 Real Meaning:
●​ If Net Investment > 0 → Capital stock is growing → economy
is expanding.​

●​ If Net Investment = 0 → Only replacing old equipment → no

growth.​

●​ If Net Investment < 0 → Capital is shrinking → bad for future

production.​

c) Describe Gross Private Domestic Investment

Gross Private Domestic Investment is the total spending by

businesses and individuals on capital goods within a country
during a specific period (usually a year or a quarter).

It includes all private investments made to:

 ●​ Create new capital (like factories or machines)​

●​ Replace old capital (due to wear and tear)​

●​ Build up inventories (unsold goods)​

🟢 Components of GPDI:
There are 3 main parts:

Component Meaning

1. Business Fixed Spending on factories, machines,

Investment equipment, tools, etc.

2. Residential Spending on new houses and apartments

Construction (by private individuals or firms)

3. Inventory Changes in business inventories (finished

Investment goods, raw materials, etc.)

🧾 Example:
Suppose in a year:
 ●​ A company builds a new factory → ₹50 crore​

●​ A family builds a new house → ₹20 crore​

●​ A business adds more inventory → ₹5 crore​

Then:

Gross Private Domestic Investment=₹50+₹20+₹5=₹75

🔶 Why is it called “Gross” and “Private”?

●​ Gross: It includes all investment, even to replace worn-out
capital (it does not subtract depreciation).​

●​ Private: Done by businesses and individuals, not the

government.​

●​ Domestic: Happens within the country.​

✅ Importance of GPDI in GDP:

GPDI is a key part of the Expenditure Method of GDP:

GDP=C+I+G+NX

Where:
●​ CCC = Consumption​

●​ III = Investment → This is GPDI​

●​ GGG = Government spending​

●​ NXNXNX = Net exports (Exports − Imports)​

📌 Summary:
Feature Explanation

Includes Factories, equipment,

housing, inventories

Excludes Government and foreign

investment

Counts ✅ Yes (that’s why it’s called

depreciat "gross")
ion?
 Part of ✅ Yes (under “I” in GDP = C +
GDP? I + G + NX)

Question 6

a) What are the sources of unemployment? Explain the

relationship between OKUN's Law and GDP gap.

Unemployment means people who are willing and able to work but
can’t find jobs.

There are several types or sources of unemployment:

1. Frictional Unemployment

●​ Happens when people are between jobs or just entering the labor
force.​

●​ It's temporary and normal in a healthy economy.​

🧾 Example: A university graduate looking for their first job.

2. Structural Unemployment

●​ Caused by mismatch between workers' skills and job

requirements.​
 ●​ Also happens when technology or global trade changes the
structure of the economy.​

🧾 Example: A typewriter repair person is unemployed because nobody

uses typewriters anymore.

3. Cyclical Unemployment

●​ Happens during a recession or economic slowdown.​

●​ Caused by falling demand for goods and services → businesses cut

jobs.​

🧾 Example: A factory lays off workers because people aren’t buying

cars.

4. Seasonal Unemployment

●​ Happens in jobs that are only needed during certain times of the
year.​

🧾 Example: Ice cream vendors may not work during winter.

5. Institutional Unemployment
 ●​ Caused by government policies, labor market rules, or union
activities that reduce the flexibility of the labor market.​

🧾 Example: Minimum wage laws that are too high might prevent
companies from hiring low-skilled workers.

🟣 Summary Table:
Type of Cause Example
Unemployment

Frictional Job search, changing New graduate looking for

careers work

Structural Skills not matching job Coal miner in a solar

market energy world

Cyclical Economic recession Factory workers laid off

Seasonal Jobs only in certain Tourist guides in

seasons off-season

Institutional Rules/policies limiting Very high minimum wage

hiring

🔵 Relationship Between Okun’s Law and GDP Gap

✅ What is Okun’s Law?
 Okun’s Law shows the relationship between unemployment
and GDP.

It says:

For every 1% increase in unemployment, the economy’s output

(GDP) falls by about 2% (or more) below its potential.

This is because when fewer people work, less is produced, so GDP falls.

✅ What is the GDP Gap?

The GDP Gap is the difference between actual GDP and
potential GDP (the level of output the economy could produce
at full employment).

GDP Gap=Potential GDP−Actual GDP

🔗 Okun’s Law and GDP Gap — How They Are Connected:

Okun’s Law helps us measure the GDP gap by looking at how much
unemployment is above the natural rate (also called full employment
level).

Let’s say:

●​ Natural unemployment = 5%​

●​ Actual unemployment = 7%​

●​ Difference = 2% → Okun’s Law says GDP will fall by around 2 × 2 =

4%​

So the economy is producing 4% less than it could.

🧾 Example:
●​ Potential GDP = $1,000 billion​

●​ Actual GDP = $950 billion​

●​ GDP Gap = $50 billion​

If unemployment increases beyond normal, Okun’s Law shows us how

much output is lost due to that.

✅ Summary:
Concept Meaning

Okun’s Law Links unemployment to loss in GDP (1% ↑ in

unemployment → ~2% ↓ in GDP)

GDP Gap How much output the economy is missing due to

unemployment

Why it Helps policymakers understand the cost of

matters unemployment

b) Explain planned aggregate expenditure and the interest rate.

Illustrate the policy effects in the goods and money market.

Planned Aggregate Expenditure is the total amount that

households, businesses, government, and foreigners plan to spend
on an economy's goods and services at a given level of income.
✅ Formula:
PAE=C+I+G+NX

Where:

●​ C = Consumption​

●​ I = Planned Investment​

●​ G = Government Spending​

●​ NX = Net Exports (Exports − Imports)​

Note: This is what people plan to spend—not always equal to actual

GDP.

🔵 What is the Role of the Interest Rate?

Interest rate is the cost of borrowing or the reward for saving.

It influences:

●​ Consumption (C): Higher interest → people save more → consume

less.​

●​ Investment (I): Higher interest → borrowing is expensive → less

investment.​

●​ Net Exports (NX): Higher interest → currency appreciates →

exports fall.​
So, interest rate affects PAE, especially Investment (I).

🟢 Illustrating Policy Effects in Goods and Money

Market (IS-LM Model)

Let’s now explain how fiscal and monetary policy affect:

●​ Goods Market (IS Curve)​

●​ Money Market (LM Curve)​

✅ IS Curve (Goods Market Equilibrium)

●​ Shows combinations of interest rates and output (GDP) where
planned spending = actual output.​

●​ Downward sloping: higher interest → less investment → lower

output.​

✅ LM Curve (Money Market Equilibrium)

●​ Shows combinations of interest rate and output where money
demand = money supply.​

●​ Upward sloping: As income (Y) increases → people want more

money → higher interest rate to balance the market.​

🔄 Policy Effects:
🔷 1. Monetary Policy (Central Bank changes money supply)
a) Expansionary Monetary Policy:

●​ The central bank increases money supply → interest rates fall →

investment rises → output rises.​

●​ LM curve shifts right/down.​

📉 Lower interest → boosts investment → higher planned expenditure

(PAE) → economy grows.

b) Contractionary Monetary Policy:

●​ Central bank decreases money supply → interest rates rise →

investment falls → output falls.​

●​ LM curve shifts left/up.​

🔶 2. Fiscal Policy (Govt changes G or Taxes)

a) Expansionary Fiscal Policy:

●​ Govt increases G or reduces taxes → more spending → PAE

increases → output increases.​

●​ IS curve shifts right.​

b) Contractionary Fiscal Policy:

 ●​ Govt reduces G or raises taxes → less spending → PAE decreases →
output decreases.​

●​ IS curve shifts left.​

🟨 Simple Diagram Sketch of IS-LM Model:

Imagine this:

perl

CopyEdit

Interest Rate (r)

| LM

| /

| /

| /

| /

| /

| /

| / IS

|/______________________
 Output (Y)

●​ Equilibrium is where IS and LM intersect → gives us the interest

rate and output level in the economy.

✅ Summary:
Concept Explanation

Planned Aggregate Total planned spending (C + I + G +

Expenditure (PAE) NX)

Interest Rate Affects investment, consumption, and

net exports

IS Curve Goods market equilibrium (downward

sloping)

LM Curve Money market equilibrium (upward

sloping)

Monetary Policy Affects LM curve by changing money

supply
Fiscal Policy Affects IS curve by changing G or
taxes

Page 77

a) Define the term ‘Macroeconomics’. Discuss the major issues

concerning macroeconomics.

Definition:​
Macroeconomics is the branch of economics that studies the
whole economy or large-scale economic factors.

It looks at things like:

●​ Total income of a country​

●​ Unemployment​

●​ Inflation​

●​ Economic growth​
 ●​ Government policies​

●​ International trade​

👉 In simple words:​
Macroeconomics is about looking at the big picture of an
economy — not just one person or one business, but the
economy as a whole.

Major Issues Concerning Macroeconomics:

Here are the main problems or areas that macroeconomics

focuses on:

1. Economic Growth

●​ It studies how a country’s total income or GDP (Gross

Domestic Product) increases over time.​

●​ Growth means more jobs, higher income, and better living

standards.​

●​ Example: Why is Bangladesh’s economy growing faster than

before?​

2. Unemployment
 ●​ Macroeconomics tries to find out why people can’t find jobs,
even when they are willing to work.​

●​ It also looks at different types of unemployment, like seasonal

or structural.​

●​ Goal: Create policies to reduce unemployment and improve

people’s lives.​

3. Inflation

●​ Inflation means the rise in prices of goods and services.​

●​ Macroeconomics studies the causes and effects of inflation.​

●​ It tries to control inflation because it reduces purchasing

power.​

4. National Income

●​ It measures the total income earned by people in a country.​

●​ Helps understand how wealth is distributed.​

●​ It answers questions like: Are people earning more this year

compared to last year?​
5. Balance of Payments and Exchange Rates

●​ Macroeconomics studies how a country trades with other

countries.​

●​ It includes exports, imports, foreign investments, and

exchange rate stability.​

6. Monetary and Fiscal Policy

●​ Macroeconomics focuses on how the government and central

banks manage the economy.​

●​ Fiscal policy = Government spending and taxation​

●​ Monetary policy = Controlling the money supply and interest

rates​

7. Business Cycles

●​ The economy goes through ups and downs (like boom and
recession).​

●​ Macroeconomics studies these cycles to reduce negative

effects like job loss or inflation.​
✅ Summary Table:
Issue What It Means

Economic Increase in total output and

Growth income

Unemployment People willing to work but can’t

find jobs

Inflation Rise in general price levels

National Income Total income earned by a

country’s people

Balance of Trade and financial dealings with

Payments other countries

Monetary & Tools to manage economy

Fiscal Policy

Business Cycle Fluctuations in economic activity

(boom/recession)
b) What is a circular flow diagram? How do its components
interact?
Circular Flow Diagram:​
The circular flow diagram is a simple model that shows how money,
goods, and services move through the economy.

It helps us understand the interactions between different parts of

the economy — mainly households and businesses — and how they
depend on each other.

Components of the Circular Flow Diagram

1.​ Households (People)​

○​ They own the factors of production: labor (work), land,

capital (machines, buildings).​

○​ They sell these factors to businesses.​

○​ They buy goods and services from businesses.​

2.​ Businesses (Firms)​

○​ They buy factors of production from households.​

○​ They produce goods and services.​

 ○​ They sell goods and services to households.​

3.​ Markets​

○​ Factor Market: Where households sell their labor, land,

and capital to firms.​

○​ Product Market: Where firms sell goods and services to

households.​

How do these components interact?

1. Flow of Resources and Products

●​ Households provide labor, land, capital to businesses through the

factor market.​

●​ Businesses use these to produce goods and services.​

●​ Businesses sell these goods and services to households in the

product market.​

2. Flow of Money

●​ Businesses pay wages, rent, interest, and profits to

households for factors of production.​
 ●​ Households use this income to buy goods and services
from businesses.​

3. Continuous Cycle

●​ Money flows from businesses to households as income.​

●​ Then money flows back from households to businesses as

payment for goods and services.​

●​ This creates a circular flow of money and resources.​

Simple Example:

●​ You (household) work at a company (business). The

company pays you a salary.​

●​ You use your salary to buy groceries and clothes from

stores (businesses).​

●​ The stores pay workers and buy supplies to keep selling

products.​

●​ The cycle keeps going!​

Summary Table:

Compone Role Interaction

nt

Househol Own factors, provide Sell factors to firms, buy

ds labor goods/services

Businesse Produce goods/services Buy factors from

s households, sell products

Factor Where resources (labor, Firms buy factors;

Market capital) are sold households sell factors

Product Where goods/services Households buy

Market are sold goods/services from
firms

What is GDP? Differentiate GDP from GNP.

GDP stands for Gross Domestic Product.

●​ It is the total value of all final goods and services produced

inside a country’s borders during a specific time period (usually
 one year).​

●​ It measures the economic activity within a country, regardless of

who owns the production.​

What is GNP?

GNP stands for Gross National Product.

●​ It is the total value of all final goods and services produced by

the residents (nationals) of a country during a specific time
period, both inside and outside the country.​

●​ It measures the production by nationals of the country, no matter

where they produce.​

Main Differences Between GDP and GNP:

Aspect GDP GNP

Definiti Value of goods/services Value of goods/services produced

on produced within the by nationals of the country (inside
country & outside)

Focus Location of production Ownership (who produces)

Include Production by foreigners Production by nationals abroad
s inside the country

Exclude Production by nationals Production by foreigners inside

s abroad country

Exampl Toyota factory in Bangladeshi worker’s income from

e Bangladesh counted in working in Saudi Arabia counted in
Bangladesh’s GDP Bangladesh’s GNP

Quick Summary:

●​ GDP = production inside country​

●​ GNP = production by country's citizens everywhere

3. a) Calculate GDP using the income approach.

Given Data:

Component Amou
nt

Wages 3,254
Rent 17

Interest 500

Corporate Profits 341

Proprietor's 403
Income

Indirect Business 530

Taxes

Depreciation 400

Net Foreign -20

Factor Income

GDP (Income Approach) =​

Wages + Rent + Interest + Profits (corporate + proprietor’s) +
Indirect Taxes + Depreciation − Net Foreign Factor Income

= 3,254 + 17 + 500 + 341 + 403 + 530 + 400 − 20 = 5,425

✅ GDP = 5,425
b) What is money? How is it measured? Differentiate fiscal policy
from monetary policy.

Money is anything that is widely accepted as a medium of exchange for

goods and services. It allows people to buy and sell without the need for
barter (trading one good for another).

Functions of Money:

1.​ Medium of Exchange – Used to buy and sell goods and services.​

2.​ Unit of Account – Measures the value of things (like price tags).​

3.​ Store of Value – Can be saved and used later.​

4.​ Standard of Deferred Payment – Used for credit payments or

loans.​

How is Money Measured?

Economists measure money using different categories based on liquidity

(how easily it can be used):

1. M1 (Narrow Money):

●​ Most liquid form.​

●​ Includes:​

○​ Currency (notes and coins in circulation)​

 ○​ Demand deposits (like money in checking accounts)​

2. M2 (Broad Money):

●​ Less liquid than M1.​

●​ Includes:​

○​ M1​

○​ Savings accounts​

○​ Time deposits (fixed deposits)​

○​ Other near-money assets​

In short:​
M1 = Cash + Demand Deposits​
M2 = M1 + Savings + Time Deposits

Differentiate Between Fiscal Policy and Monetary Policy

Basis Fiscal Policy Monetary Policy

Definitio Government policy about Central Bank policy about

n taxing and spending money supply and interest
rate
Controlle Government (Ministry of Central Bank (e.g.,
d by Finance) Bangladesh Bank)

Main - Government spending - Open market operations

Tools
- Taxes - Interest rates

- Reserve requirements

Purpose To influence economic growth, To control inflation, ensure

reduce unemployment, control currency stability, and
inflation support growth

Example Government builds roads to Central Bank lowers

increase employment interest rates to boost
investment

c) GDP Calculations (2006 & 2007)

Given Table:

Ye Fish Qt Rice Qt Beef Qt

ar Price y Price y Price y
200 7 10 8 22 10 17
6 0 5 5

200 9 10 16 27 15 27
7 0 5 5

1. Nominal GDP

Nominal GDP = Price × Quantity (of current year)

●​ 2006 Nominal GDP =​

(7×100) + (8×225) + (10×175)​
= 700 + 1,800 + 1,750​
✅ = 4,250​
●​ 2007 Nominal GDP =​
(9×100) + (16×275) + (15×275)​
= 900 + 4,400 + 4,125​
✅ = 9,425​
2. Real GDP of 2007 (in 2006 prices)

Use 2006 prices and 2007 quantities

= (7×100) + (8×275) + (10×275)​
= 700 + 2,200 + 2,750​
✅ = 5,650
3. GDP Deflator (2007)

GDP Deflator=(Nominal GDP/Real

GDP)×100=(9,4255,650)×100≈166.8

✅ GDP Deflator = 166.8

4. Consumer Price Index (CPI) of 2007

Using 2006 as base year:

●​ Cost of Basket in 2006 (base year): 4,250​

●​ Cost of same Basket in 2007 (2007 prices, 2006

quantities)​
= (9×100) + (16×225) + (15×175)​
= 900 + 3,600 + 2,625 = 7,125​

CPI=(7,125/4,250)×100≈167.6

✅ CPI = 167.6

Why is there demand for labor in economics?

Demand for labor means how many workers employers want to
hire. It depends on:

1.​Productivity of Labor – More productive = more demand.​

2.​Wage Rate – Higher wages might reduce demand.​

3.​Price of Output – If product sells at a higher price, firms

want more workers to produce more.​

4.​Technology – Can reduce or increase labor demand.​

5.​Cost of Capital (machines) – If machines are cheaper

than workers, demand for labor falls.​

In short:​
Firms hire workers only if the worker’s contribution (value of
their work) is more than or equal to their wage.

a) Basic Concepts of the Classical Model in Macroeconomics

The Classical model is one of the earliest economic theories, mainly

developed by Adam Smith, David Ricardo, and John Stuart Mill. It
explains how the economy works in the long run, assuming that markets
are always clear and the economy is self-adjusting.

🔑 Key Concepts:
1. Full Employment Assumption
 ●​ The Classical model assumes that the economy always operates at
full employment.​

●​ Unemployment is only temporary and due to wage or price

adjustments.​

2. Say’s Law

●​ "Supply creates its own demand."​

●​ This means whatever is produced will be sold because production

creates income, and income leads to spending.​

3. Flexible Prices and Wages

●​ Prices and wages are fully flexible.​

●​ If there is unemployment or inflation, wages and prices will adjust

automatically to bring the economy back to equilibrium.​

4. No Government Intervention Needed

●​ The economy is self-correcting.​

●​ There is no need for government spending or monetary

policies—"laissez-faire" approach (leave the economy alone).​

5. Long-Run Perspective
 ●​ The Classical model focuses on the long-term behavior of the
economy, not short-run fluctuations.​

●​ It assumes that any deviation from full employment will be

corrected in the long run.​

6. Quantity Theory of Money

●​ The model believes that money affects only prices, not output.​

●​ MV = PY​
(Money supply × Velocity = Price level × Output)​
→ If money supply increases, prices rise (inflation), not real
output.​

🧠 Summary:
Concept Classical View

Employment Always at full employment

Government Minimal or no intervention

Role

Prices & Fully flexible

Wages
 Demand & Supply creates its own demand
Supply (Say’s Law)

Inflation Due to increase in money supply

Cause

Focus Long-run economic growth

Why does demand for labor depend on the marginal product of

labor (MPL)?

MPL (Marginal Product of Labor) means:

The extra output produced when one more worker is hired,

keeping all other inputs constant.

For example, if a factory hires one more worker and production increases
from 100 to 110 units, then the MPL = 10 units.

💼 Why Does Labor Demand Depend on MPL?

Firms hire workers to produce goods. But they won’t hire more workers
unless those workers add value to the company.

Here's the logic:

1.​ 👉 Firms want to maximize profit.​

 2.​ 🏭 When a firm hires a worker, it gets extra output (MPL).​
3.​ 💰 That extra output can be sold for money — this is called the
Value of the Marginal Product of Labor (VMPL):

VMPL = MPL × Price of the output

4.​ 🧮 A firm compares VMPL with the wage it has to pay the worker.​
●​ If VMPL > wage → hiring the worker adds profit → hire more!​

●​ If VMPL < wage → hiring causes loss → don’t hire.

✅ Therefore:
Firms demand labor only if the extra output (MPL) that the
worker adds is worth more than the cost of hiring them.

📉 Real-World Note:
●​ Due to the Law of Diminishing Returns, MPL usually falls as more
workers are added.​

●​ So, demand for labor also falls as wages rise, forming a

downward-sloping labor demand curve.​

📌 Summary:
Concept Explanation
MPL Extra output from hiring one more worker

Why it matters Firms hire workers if the value of their

output ≥ wage

Labor demand The productivity (MPL) and price of

depends on output

b) Job Search and Job Rationing – How they create unemployment

even at full employment

1.​Job Search Unemployment (Frictional Unemployment):​

○​ People are always entering/leaving jobs or switching.​

○​ Even at full employment, some people are “between

jobs”.​

2.​Job Rationing (Structural Unemployment):​

○​ Occurs when wages are higher than the equilibrium

level (e.g., minimum wage laws, unions).​
 ○​ Firms want to hire fewer workers, creating
unemployment.​

So, even when total jobs = total workers (theoretically full

employment), these frictions and mismatches cause
unemployment.

How demand for investment and supply of savings help estimate

the real interest rate

First, What Is the Real Interest Rate?

●​ The real interest rate is the cost of borrowing after removing the
effect of inflation.​

●​ Formula:​
👉 Real Interest Rate = Nominal Interest Rate − Inflation Rate​
It is the "true" reward for saving and the true cost of investment.

🏦 1. Supply of Savings
●​ Comes from households who save part of their income.​

●​ Higher real interest rates make saving more attractive (you earn
more), so supply of savings increases.​

✅ Upward-sloping supply curve of savings

🏗️ 2. Demand for Investment
 ●​ Comes from businesses who borrow money to invest in capital (like
machines, buildings).​

●​ But if the real interest rate is high, borrowing becomes more

expensive, so investment decreases.​

✅ Downward-sloping demand curve for investment

⚖️ 3. Equilibrium Real Interest Rate

The real interest rate is determined where:

👉 Supply of savings = Demand for investment

📊 At this equilibrium point, the amount of money people want to save
is exactly equal to the amount businesses want to borrow and invest.

📉 Graphically:
Imagine this:

●​ X-axis: Quantity of loanable funds (savings/investment)​

●​ Y-axis: Real interest rate​

●​ The supply curve of savings slopes upward​

●​ The demand curve for investment slopes downward​

●​ The intersection point = real interest rate​

🧠 Summary Table:
Concept Explanation

Supply of Savings Comes from households; increases with higher

interest rates

Demand for Comes from firms; decreases with higher

Investment interest rates

Real Interest Rate Adjusts to balance savings and investment

Equilibrium Where supply = demand in the loanable funds

market

c) What is Inflation? Compare Demand-Pull and Cost-Push Inflation

Inflation is the sustained rise in the general price level of

goods and services in an economy.

1. Demand-Pull Inflation:

●​ Caused by too much demand chasing too few goods.​

●​ Happens when:​

○​ People have more money​

 ○​ Government spending increases​

○​ Exports rise​

✅ Example: Economy at full employment → more demand →

prices rise.

2. Cost-Push Inflation:

●​ Caused by a rise in production costs (e.g., wages, raw

materials).​

●​ Firms raise prices to maintain profit.​

✅ Example: Oil prices increase → transport costs rise → all

product prices go up.

How input price increase causes more inflation:

What are Input Prices?

Input prices refer to the cost of resources used in production, such as:

●​ Raw materials (e.g., oil, wheat, metals)​

●​ Wages (labor costs)​

 ●​ Utilities (electricity, water, gas)​

●​ Rent or machinery​

🔥 When Input Prices Increase…

1.​ ✅ Cost of production rises for businesses.​

2.​ ⚙️ To maintain profit, firms raise the prices of their products.​

3.​ 🛒 This leads to a general increase in prices of goods and services

in the economy.​

➡️ This type of inflation is called:

🧯 Cost-Push Inflation
Inflation caused by rising production costs (not by higher
demand).

📉 Example:
Suppose the price of crude oil goes up sharply:

●​ Transportation becomes more expensive​

 ●​ Goods that rely on fuel become costlier​

●​ Firms raise their product prices → leads to inflation​

📊 Graph Explanation (Short-Run Aggregate Supply Shift)

●​ SRAS (Short-Run Aggregate Supply) shifts leftward​

●​ Output ↓ (decreases)​

●​ Price level ↑ (increases)​

➡️ This causes stagflation: inflation + slower growth​

🧠 Summary Table:
Cause Effect

↑ Input prices ↑ Production

costs

↑ Production ↓ Supply (shift

costs left)
↓ Supply ↑ Prices
(inflation)

Type of Cost-push
inflation inflation

Next Set:

a) What is Unemployment? Types of Unemployment

Unemployment is a situation where people who are willing and

able to work cannot find jobs.

Types of Unemployment:

1.​ Frictional Unemployment:​

Short-term, between jobs or entering the labor force.​

2.​Structural Unemployment:​
Mismatch between skills and available jobs (e.g., due to
technology changes).​

3.​Cyclical Unemployment:​
Due to fall in demand during a recession.​
 4.​Seasonal Unemployment:​
Happens at specific times of the year (e.g., agriculture,
tourism).​

b) Factors That Influence Consumption and Savings

Consumption and savings are two major parts of household

behavior. When people earn income, they either spend it
(consumption) or save it for the future. Several factors influence
how much they choose to do either.

🛍️ Factors Influencing Consumption:

1.​ ✅ Income:​
○​ Higher income usually leads to higher consumption.​

○​ But as income rises, a smaller portion of extra income is

spent (called Marginal Propensity to Consume – MPC).​

2.​ 📈 Future Expectations:​

○​ If people expect higher income or stable jobs, they
spend more now.​
 ○​ If they expect a recession or job loss, they cut
consumption.​

3.​ 💳 Interest Rates:​

○​ Lower interest rates encourage more borrowing and
spending.​

○​ Higher rates make loans expensive, so consumption falls.​

4.​ 🏦 Wealth:​
○​ If people feel wealthier (due to rising stock or property
values), they tend to spend more.​

○​ This is called the wealth effect.​

5.​ 🧾 Taxes:​
○​ Lower taxes increase disposable income → more
consumption.​

○​ Higher taxes reduce it.​

6.​ 🏠 Consumer Confidence:​

 ○​ If consumers feel confident about the economy, they
spend more.​

○​ If they are uncertain or fearful, they hold back spending.​

💰 Factors Influencing Savings:

1.​ 💸 Income Level:​
○​ People with higher income generally save more.​

○​ But low-income people may not save much because most

of their income goes to basic needs.​

2.​ 📊 Interest Rates:​

○​ Higher interest rates encourage saving because people
earn more return on savings.​

○​ But sometimes, people might save less if they can reach

their goals faster with high interest.​

3.​ 🔮 Future Uncertainty:​

 ○​ Fear of job loss or unexpected expenses leads to higher
savings (precautionary savings).​

4.​ 👨‍👩‍👧‍👦 Life Stage or Age:​

○​ Young people tend to save less.​

○​ Middle-aged people often save the most.​

○​ Retired people may spend from their savings.​

5.​ 🧾 Government Policies (Taxes & Incentives):​

○​ Tax incentives on savings (like pension plans) encourage
saving.​

○​ Higher taxes reduce disposable income and may reduce

saving.​

6.​ 🎯 Personal Goals and Preferences:​

○​ Some people prefer saving for future goals like buying a
house, education, or emergencies.​

🧠 Summary Table:
 Factor Effect on Effect on Savings
Consumption

Income ↑ Income → ↑ ↑ Income → ↑

Consumption Savings

Interest Rate ↓ Rate → ↑ ↑ Rate → ↑ Savings

Consumption

Future ↑ Optimism → ↑ ↑ Uncertainty → ↑

Expectations Consumption Savings

Taxes ↑ Taxes → ↓ ↑ Taxes → ↓ Savings

Consumption

Wealth ↑ Wealth → ↑ ↑ Wealth → Mixed

Consumption impact

Age/Life Cycle Young → More Middle age → More

Consumption Saving

Factors:
 1.​Disposable Income (income after tax) – main driver.​

2.​Wealth – richer people consume more.​

3.​Interest Rates – higher rates = more savings, less

spending.​

4.​Future Expectations – fear of recession = more saving.​

5.​Inflation – may increase current spending.​

What happens when disposable income increases?

What is Disposable Income?

Disposable income = Total income minus taxes​

👉 It's the money people have available to spend or save.

✅ So, when disposable income increases:

People have more money in their hands. This leads to two
main effects:

🛍️ 1. Increase in Consumption
 ●​ People can buy more goods and services.​

●​ This boosts demand in the economy.​

●​ Businesses earn more → may hire more workers →

economic growth.​

📌 This is based on the idea of Marginal Propensity to

Consume (MPC):

When income increases, people spend a portion of the

extra income.

💰 2. Increase in Savings
●​ Not all income is spent — some of it is saved for the
future.​

●​ Higher disposable income → people save more (for

emergencies, investments, or future goals).​

📌 This relates to Marginal Propensity to Save (MPS):

The rest of the extra income is usually saved.
📈 Example:
If a person's income increases by 1,000 Taka after taxes:

●​ They may spend 800 Taka (MPC = 0.8)​

●​ And save 200 Taka (MPS = 0.2)​

🧠 Summary Table:
Result of Higher Effect
Disposable Income

🛍️ Consumption Increases

💰 Savings Increases

📊 Demand in the Rises

economy

📈 Economic activity Expands (can reduce

unemployment)
c) What is Planned Expenditure? Components and Characteristics

Planned Expenditure (PE):​

The total amount that households, firms, government, and
foreign buyers plan to spend on goods and services in an
economy.

Components:

1.​ C – Consumption (household spending)​

2.​I – Investment (business spending)​

3.​G – Government spending​

4.​NX – Net Exports (Exports − Imports)​

So,

PE=C+I+G+(X−M)PE = C + I + G + (X − M)PE=C+I+G+(X−M)

Characteristics:

●​ Depends on expectations (e.g., future profits or

government policy).​
 ●​ Can differ from actual GDP.​

●​ Changes with interest rate, taxes, and income.​

What happens when Planned Expenditure ≠ Real GDP?

1.​PE > Real GDP:​

○​ People want to buy more than is produced →

inventories fall → firms increase output → GDP rises.​

2.​PE < Real GDP:​

○​ People buy less than is produced → unsold goods pile

up → firms reduce output → GDP falls.​

Eventually, the economy moves toward equilibrium, where:

Planned Expenditure = Real GDP\text{Planned Expenditure =

Real GDP}Planned Expenditure = Real GDP

Page 82
1. a. Compare and contrast between microeconomics and
macroeconomics

Topic Microeconomics Macroeconomics

Definit Study of individual units (like Study of the economy as

ion consumers, firms). a whole.

Focus Prices of individual goods, National income,

demand & supply, consumer inflation,
behavior. unemployment, GDP.

Examp How the price of mangoes is What causes

le determined. unemployment in a
country.

Goal Efficiency in individual Economic stability and

markets. growth.

In short: Micro = small picture (individuals/firms), Macro = big

picture (entire economy).

1. b. Major issues concerning macroeconomics

 1.​ Economic Growth – How a country increases its output over
time (measured by GDP).​

2.​ Unemployment – Understanding why people are jobless and

how to reduce it.​

3.​ Inflation – Rising prices over time, its causes and control.​

4.​ Fiscal and Monetary Policy – How government (fiscal) and

central banks (monetary) control spending, taxes, interest
rates.​

5.​ Balance of Payments – Country’s exports and imports record.​

6.​ Income Distribution – How fairly income is spread among

people.​

1. c. How different markets interact with macroeconomic components

●​ Goods and Services Market: Affects GDP. More production =

more GDP.​

●​ Labor Market: Affects employment/unemployment.​

 ●​ Money Market: Affects interest rates → impacts investment
and spending.​

●​ Foreign Exchange Market: Affects trade balance → influences

GDP and currency value.​

These markets together influence inflation, income, growth, and

more.

2. a. What do aggregate supply and demand curves describe?

●​ Aggregate Demand (AD): Total demand for goods/services in

the economy at all price levels.​

●​ Aggregate Supply (AS): Total supply of goods/services firms

are willing to produce at different price levels.​

They help us understand:

●​ Output (GDP) level​

●​ Price level (inflation)​

●​ Economic equilibrium​
2. b. Keynesian vs Classical AS curve

Aspect Classical AS Curve Keynesian AS Curve

Shape Vertical Horizontal (at first), then

upward sloping

Belief Economy always at Economy can be below full

full employment employment

Wage/Price Wages/prices adjust Wages/prices are sticky

Flexibility quickly

Implication Government Government should

intervention not intervene during recessions
needed

2. c. If government reduces income tax, what happens in short run?

✅ AD increases because people have more disposable income →

they spend more.

✅ SRAS remains the same in short run.

🎯 Effect:
 ●​ Output increases​

●​ Price level rises (inflation)​

📈 Graph:
●​ AD curve shifts right → new equilibrium at higher GDP and
higher price level.​

3. a. Difference between GDP and GNP

GDP (Gross Domestic GNP (Gross National Product)

Product)

Measures income/output Measures income/output earned by

within a country’s borders nationals (regardless of location)

Includes income by Includes income by citizens abroad

foreigners inside country

Excludes income earned Excludes income by foreigners in

abroad home country

✅ Which is better?
 ●​ GDP is better for measuring domestic economic activity.​

●​ GNP is better for measuring total national income.​

3. b. What is GDP deflator? Difference with CPI and PPI?

✅ GDP Deflator:
●​ Measures price level of all final goods and services produced
domestically.​

●​ Formula:​
GDP Deflator=Nominal GDPReal GDP×100\text{GDP Deflator}
= \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100GDP
Deflator=Real GDPNominal GDP​×100

✅ CPI (Consumer Price Index):

●​ Measures price level of a fixed basket of consumer goods.​

✅ PPI (Producer Price Index):

●​ Measures price level from the producer’s perspective,
including raw materials.​
 Feature GDP CP PP
Deflator I I

Includes all ✅ ❌ ❌
goods/services

Only consumer ❌ ✅ ❌
goods

Focus on producers ❌ ❌ ✅
🎯 GDP deflator is more useful when you want to measure overall
price change in the economy, not just consumer items.

4. a. What information does production function provide?

✅ It shows the relationship between inputs (labor, capital, etc.)

and output.

For example:

Q=f(L,K)Q = f(L, K)Q=f(L,K)

Where:

●​ Q = output​
 ●​ L = labor​

●​ K = capital​

🎯 It tells us:
●​ How efficiently inputs are converted into outputs.​

●​ Whether the economy is using its resources productively.​

4. b. What if natural resources are omitted from the production

function?

If natural resources (like land, oil, water) are ignored:

●​ For resource-rich countries, this leads to incorrect

measurement of output and productivity.​

●​ For example, a country like Saudi Arabia depends heavily on

oil.​

●​ Ignoring it = serious underestimation of real production

capacity.​

✅ Conclusion: Omission matters when natural resources play a key

role in production.
4. c. Factors determining steady-state per capita output growth

In the Solow growth model, steady-state per capita output

depends on:

1.​ Savings rate (s): More saving → more capital → higher

output.​

2.​ Population growth (n): Higher population dilutes capital →

slower growth.​

3.​ Depreciation rate (δ): If capital wears out quickly, growth

slows.​

4.​ Technology (A): Better technology boosts output per worker.​

✅ Formula (simplified):
Growth rate=f(s,A)−(n+δ)\text{Growth rate} = f(s, A) - (n +
\delta)Growth rate=f(s,A)−(n+δ)

🎯 So, higher savings and better technology lead to higher per

capita growth in the long run.

5. a.

1. State the factors that influence consumption and savings

Consumption and savings depend on:

Factors Effect

Disposable Income Higher income = more consumption &

savings

Interest Rates Higher rates = more savings, less

borrowing

Wealth More wealth = more consumption

Expectations of future Optimism = more spending now

income

Taxes Higher taxes = less disposable income

= less consumption

Social security and More secure retirement = less need to

pension benefits save now

2. What happens to the consumption and saving functions when

disposable income increases?
 ●​ Consumption Function:​
Consumption increases as disposable income increases.​
But not all income is consumed — people save a portion.​
The function is upward sloping.​

●​ Savings Function:​
Savings also increase with income.​
But at low income, savings may be zero or even negative.​

📌 Both functions shift upward when disposable income

rises.

3. What is planned expenditure?

Planned Expenditure is the total amount households, businesses,

government, and foreigners intend to spend on goods and
services.

Formula (in open economy):

PE=C+I+G+(X−M)PE = C + I + G + (X - M)PE=C+I+G+(X−M)

Where:

●​ C = Consumption​

●​ I = Investment​
 ●​ G = Government Spending​

●​ X = Exports​

●​ M = Imports​

4. Characteristics of each component:

Component Feature

Consumption (C) Depends on disposable income

Investment (I) Affected by interest rates &

business expectations

Government Determined by fiscal policy

Spending (G)

Net Exports (X - M) Influenced by exchange rates,

foreign income

5. What happens when planned expenditure ≠ real GDP?

 ●​ If PE > GDP → Inventories fall → Firms increase production
→ GDP rises​

●​ If PE < GDP → Inventories rise → Firms cut production →

GDP falls​

🎯 The economy always tries to move toward equilibrium, where:

Planned Expenditure=Actual Output (GDP)\text{Planned
Expenditure} = \text{Actual Output (GDP)}Planned
Expenditure=Actual Output (GDP)

5. b.

1. Discuss unemployment patterns of adults and teenagers

Group Unemployment Implication

Pattern

Adults Lower More experience, permanent

unemployment jobs
rate
Teenag Higher Inexperienced, part-time/temp
ers unemployment jobs, seasonal
rate

🎯 This shows that teenagers often seek entry-level or temporary

jobs, while adults aim for stable, long-term employment.

2. What is Okun’s Law?

Okun’s Law shows the relationship between unemployment and

GDP.

📌 Rule of thumb:​
When unemployment increases by 1%, GDP falls by about 2% from
its potential.

\text{GDP Gap (%)} = -2 × (\text{Unemployment Rate - Natural

Rate})​
]

🎯 It helps us estimate the cost of unemployment in terms of lost

output (GDP).

3. What are the costs of perfectly anticipated inflation?

Even when inflation is expected, it still creates real costs:

 Type of Cost Explanation

Shoe-leather More trips to bank due to declining

cost value of cash

Menu cost Cost of frequently updating prices (new

menus, labels)

Tax Inflation pushes people into higher tax

distortions brackets

Unit of Difficulty in measuring real value of

account cost money over time

Do these costs change with the rate of inflation?

✅ Yes, the higher the inflation, the greater the costs:

●​ More frequent price changes (higher menu costs)​

●​ Faster erosion of money’s value (higher shoe-leather costs)​

●​ More uncertainty in contracts and savings

Page84

✅ 1. a. What is macroeconomics? What are the major

concerns?

🔹 Macroeconomics is the study of the economy as a whole.

It deals with broad aggregates, like national income, inflation,
unemployment, and economic growth.

🔹 Major concerns of macroeconomics:

1.​Output and Income (GDP) – How much is a country
producing?​

2.​Employment and Unemployment – Are people getting

jobs?​

3.​Inflation – Are prices rising too fast?​

4.​Economic Growth – Is the economy growing over time?​

 5.​Trade and Balance of Payments – Are we
importing/exporting more?​

6.​Stability – Avoiding deep recessions or extreme booms.​

✅ 1. b. How different markets interact with

macroeconomic components

Here are the key markets and how they affect

macroeconomics:

Market Macroeconomic Impact

Product Market Affects GDP, inflation, and employment

Labor Market Determines employment and wage levels

Money Market Affects interest rates → impacts

investment and consumption

Foreign Affects exports/imports, thus influencing

Exchange Market GDP and exchange rates
📌 These markets interact and influence overall demand,
supply, inflation, unemployment, etc.

✅ 1. c. Compare between microeconomics and

macroeconomics

Topic Microeconomics Macroeconomics

Defini Study of individuals & firms Study of the whole

tion economy

Focus Price of individual goods, wages, GDP, inflation,

consumer decisions unemployment

Exam Price of milk, decision of a firm National

ples to produce more unemployment
rate

✅ 2. a. Define GDP. Why is the circular flow diagram

important for understanding GDP?

🔹 GDP (Gross Domestic Product)

Total market value of all final goods and services produced
within a country in a year.

🔹 Why circular flow diagram is important:

●​ Shows how money flows between households, businesses,
and the government.​

●​ Helps understand the sources of income and spending.​

●​ Illustrates that one person’s spending = another person’s

income, which keeps the economy moving.​

📌 It connects production, income, and expenditure, all of

which are part of GDP.

✅ 2. b. How GDP is measured by income approach?

🔹 Income Approach Formula:
GDP=Wages+Rent+Interest+Profits+Indirect
Taxes–Subsidies+Depreciation\text{GDP} = \text{Wages} +
\text{Rent} + \text{Interest} + \text{Profits} + \text{Indirect
Taxes} – \text{Subsidies} +
\text{Depreciation}GDP=Wages+Rent+Interest+Profits+Indire
ct Taxes–Subsidies+Depreciation

🔹 Necessary adjustments:
1.​Add indirect taxes (like VAT) – included in market prices.​

2.​Subtract subsidies – not part of market price.​

3.​Add depreciation – to convert from net to gross income.​

4.​Include income from government and foreign firms

operating in the country.​

✅ 2. c. Describe Chain-Weighted Output Index

Method (with example)

🔹 What it is:
●​ A method to calculate real GDP over time using changing
base years.​

●​ Solves the problem of outdated base prices.​

🔹 How it works:
Suppose:

Ye Pric Quant
ar e ity

202 Tk. 100

0 10

202 Tk. 110

1 12

●​ ​
In 2020, real GDP = 10 × 100 = Tk. 1,000​

●​ In 2021 using 2020 prices = 10 × 110 = Tk. 1,100​

●​ In 2021 using 2021 prices = 12 × 110 = Tk. 1,320​

Chain-weighted method takes the average growth rate using

both years’ prices and calculates a smoother, more realistic
growth figure.
✅ 3. a. What is aggregate supply? Why is long-run AS
curve vertical (insensitive to price changes)?

🔹 Aggregate Supply (AS):

The total output firms are willing and able to produce at
various price levels.

🔹 Long-run Aggregate Supply (LRAS):

●​ Vertical curve at full employment output (Yf).​

●​ Why vertical? Because in the long run, output depends on:​

○​ Labor​

○​ Capital​

○​ Technology​

○​ Natural resources​
...not the price level.​

📌 Prices rise, but real output stays the same in the long run.
✅ 3. b. What causes the level of aggregate demand
(AD) to change?

🔹 AD Formula:
AD=C+I+G+(X−M)AD = C + I + G + (X - M)AD=C+I+G+(X−M)

🔹 Shifts in AD caused by:

Factor Effect

Consumer Increase shifts AD right

spending (C)

Investment (I) More investment → AD ↑

Government More G → AD ↑
spending (G)

Net exports (X - More exports → AD ↑

M)

Interest rates Lower rates → more

spending → AD ↑
Expectations Optimism = more
about future spending → AD ↑

✅ 3. c. What happens to real GDP if economic growth

and inflation increase?

●​ Economic growth = increase in real GDP → higher output.​

●​ Inflation = rise in price level.​

🔹 Combined effect:
●​ If growth is faster than inflation → real GDP increases.​

●​ If inflation is too high, it may offset growth gains.​

📌 So, real GDP rises only if the growth in output is greater

than the increase in price level.

✅ 4. a. Classical Model: Basic Concepts & Labor

Demand

🔹 Classical Macroeconomics – Key Ideas:

 1.​Full employment is normal – The economy naturally
operates at full employment.​

2.​Flexible wages and prices – They adjust quickly to

remove any shortages or surpluses.​

3.​Say’s Law – “Supply creates its own demand” (Production

will generate enough income to buy what is produced).​

4.​No need for government intervention – Markets are

self-correcting.​

🔹 “Demand for labor depends on the marginal product of labor (MPL)”

– What does this mean?

●​ Marginal Product of Labor (MPL) = the extra output

produced by hiring one more worker.​

●​ Firms hire workers only if the revenue from their work

(MPL × Price) is more than or equal to the wage paid.​

✅ So, higher MPL → more demand for labor​

❌ Lower MPL → firms reduce labor hiring
📌 Labor demand curve slopes downward because MPL
decreases as more workers are hired.

✅ 4. b. Job Search, Job Rationing & Unemployment

(even at full employment)

Even at full employment, some unemployment exists due to

two things:

1. Job Search (Frictional Unemployment):

●​ People are between jobs or looking for the right job.​

●​ Caused by mobility, lack of info, or time to find a match.​

📌 This is normal and temporary.

2. Job Rationing (Structural Unemployment):

●​ There are fewer jobs than people willing to work at the

current wage.​

●​ Caused by:​
 ○​ Minimum wage laws​

○​ Labor unions​

○​ Efficiency wages (firms pay more to increase

productivity)​

📌 Even when jobs are available, wages are too high for firms
to hire everyone.

✅ 4. c. How investment demand and savings supply

determine real interest rate

🔹 Loanable Funds Market:

●​ Investors demand funds (for capital, businesses)​

●​ Savers supply funds (households, firms)​

📈 At equilibrium:
●​ The real interest rate adjusts where saving = investment.​
| If interest rate is too high → savings > investment → rate
falls​
| If rate is too low → investment > savings → rate rises

🎯 So, real interest rate is where saving meets investment

demand.

✅ 5. a. Aggregate Planned Expenditure vs Real GDP

at Equilibrium

🔹 Planned Expenditure (PE):

PE=C+I+G+(X−M)PE = C + I + G + (X - M)PE=C+I+G+(X−M)

●​ Real GDP = actual output​

●​ Equilibrium happens when:​

Planned Expenditure=Real GDP\text{Planned
Expenditure} = \text{Real GDP}Planned Expenditure=Real
GDP

📊 Graph Explanation:
●​ X-axis: Real GDP​
 ●​ Y-axis: Planned Expenditure​

●​ 45° line: shows where PE = GDP​

●​ Expenditure Line: upward sloping (starts from

autonomous spending)​

✅ Where they intersect = Equilibrium Output​

📈 If PE > GDP → firms increase production​
📉 If PE < GDP → firms reduce production

✅ 5. b. Marginal Propensity to Consume (MPC) & Save

(MPS)

🔹 MPC = Change in Consumption / Change in Income

🔹 MPS = Change in Saving / Change in Income
🔁 MPC + MPS = 1

📊 Graphical Explanation:
●​ X-axis: Disposable Income​
 ●​ Y-axis: Consumption or Saving​

●​ Consumption Line: upward sloping, starts above zero (due

to autonomous consumption)​

●​ Slope = MPC​

●​ Saving Line: also upward sloping, starts below zero (if

dissaving at low income)​

●​ Slope = MPS​

✅ 5. c. Types of Inflation, Causes, and Control

Measures

🔹 Types of Inflation:
1.​Demand-Pull Inflation​

○​ Caused by too much demand​

○​ E.g., high government spending, low interest rates​

 2.​Cost-Push Inflation​

○​ Caused by rising input costs​

○​ E.g., oil prices, wages increasing​

3.​Built-in Inflation​

○​ When inflation expectations cause wages & prices to

keep rising​

🔹 Measures to control inflation:

Method Explanation

Monetary Central bank raises interest rates to

Policy reduce demand

Fiscal Policy Government reduces spending or raises

taxes
Supply-side Improve production (technology,
Policy subsidies) to lower costs

Price Controls Government temporarily freezes

(rare) prices/wages

✅ 5. d. “Reducing inflation may increase

unemployment” – Do you agree? (Phillips Curve)

🔹 Phillips Curve: Shows the inverse relationship between inflation and

unemployment (in short run)

| ↓ Inflation ➡ ↑ Unemployment​
| ↑ Inflation ➡ ↓ Unemployment

📌 Why?
●​ To reduce inflation, government may raise interest rates
or reduce spending.​

●​ This reduces demand → firms sell less → they reduce

workers → unemployment rises​
✅ Agree in short run – there’s a tradeoff.
❌ But in long run, Phillips Curve is vertical:
●​ No tradeoff.​

●​ Only natural unemployment remains, regardless of

inflation.​

PAGE-90

1. a) Define the term 'Macroeconomics'. Discuss major issues in

macroeconomics.

Macroeconomics is the branch of economics that studies the

behavior and performance of an economy as a whole. It focuses on
large-scale economic factors like national income, unemployment,
inflation, GDP, economic growth, and fiscal & monetary policies.

Major issues in macroeconomics:

1.​ Unemployment – Understanding why people are jobless and

how to reduce it.​

2.​ Inflation – The rise in prices; keeping it stable is important.​

 3.​ Economic Growth – How fast the country’s economy is
growing.​

4.​ National Income – Measuring the income of the whole

economy (like GDP).​

5.​ Fiscal & Monetary Policies – Government spending and

central bank controls.​

6.​ International Trade and Balance of Payments – Exports,

imports, foreign exchange.​

1. b) What is Circular Flow Diagram?

The circular flow diagram shows how money, goods, and services
move in an economy between households and firms.

Two main sectors:

●​ Households: Provide factors of production (labor, land,

capital) and consume goods/services.​

●​ Firms: Produce goods/services and pay wages/rents/profits.​

Interaction:
 ●​ Households → provide labor to firms.​

●​ Firms → pay income (wages, rent) to households.​

●​ Households → spend income on goods/services from firms.​

●​ Firms → earn revenue and produce again.​

When government, foreign trade, and financial markets are

included, it becomes a more complete (open) circular flow.

1. c) Compare Microeconomics vs Macroeconomics

Point Microeconomics Macroeconomics

Focus Individual units like Entire economy

consumers, firms

Exam Price of tea, demand for Inflation, GDP,

ple cars national income

Tools Supply & demand, Aggregate

elasticity demand/supply, GDP
Goal Efficiency in resource Economic growth and
allocation stability

2. What is GDP? Differentiate GDP from GNP.

GDP (Gross Domestic Product): Total market value of all final

goods and services produced within a country in a given year.

GNP (Gross National Product): Total value of all goods and services
produced by a country's citizens, regardless of where they live.

Difference:

●​ GDP: Focuses on location.​

●​ GNP: Focuses on ownership/nationality.​

Formula:​
GNP = GDP + Net Foreign Factor Income (NFFI)

GDP Calculation from Table (Using Income Approach)

Given values (in billion BDT):

●​ Wages = 3,657​
 ●​ Rent = 17​

●​ Interest = 530​

●​ Proprietor’s Income = 403​

●​ Corporate Profits = 341​

●​ Indirect Business Taxes = 500​

●​ Depreciation = 741​

●​ Net Foreign Factor Income = –20 (subtract it)​

GDP (Income Approach) =​

Wages + Rent + Interest + Proprietor's Income + Corporate Profits
+ Indirect Business Taxes + Depreciation​
= 3,657 + 17 + 530 + 403 + 341 + 500 + 741​
= 6,189 billion BDT

(GNP would be GDP + NFFI → 6,189 + (–20) = 6,169 billion BDT)

3. a) Use the following:

Y = C + I + G​
Y = 5,000​
G = 1,000​
T = 1,000​
C = 250 + 0.75(Y – T)​
I = 1,000 – 50r

i. Private Saving (Sp):

Sp = Y – T – C​
= 5,000 – 1,000 – [250 + 0.75 × (5,000 – 1,000)]​
= 4,000 – [250 + 0.75 × 4,000]​
= 4,000 – [250 + 3,000] = 4,000 – 3,250 = 750

ii. Public Saving (Sg):

Sg = T – G = 1,000 – 1,000 = 0

iii. National Saving (S):

S = Sp + Sg = 750 + 0 = 750

iv. Equilibrium interest rate (r):

From Y = C + I + G, plug in known values:

5,000 = 3,250 + I + 1,000 → I = 750​

But I = 1,000 – 50r → 750 = 1,000 – 50r​
→ 50r = 250 → r = 5

Now suppose G increases to 1,250:

i. New C:

Y – T = 4,000 → C = 250 + 0.75×4,000 = 250 + 3,000 = 3,250 (same as

before)
ii. New Private Saving:

Y – T – C = 5,000 – 1,000 – 3,250 = 750

iii. New Public Saving:

T – G = 1,000 – 1,250 = –250

iv. New National Saving:

S = 750 + (–250) = 500

v. Find new interest rate:

Y = C + I + G​
5,000 = 3,250 + I + 1,250 → I = 500​
I = 1,000 – 50r → 500 = 1,000 – 50r​
→ 50r = 500 → r = 10

3. b) Who controls the money supply and how?

The central bank (like Bangladesh Bank or Federal Reserve) controls

money supply using:

1.​ Open market operations – buying/selling government

securities.​

2.​ Reserve requirements – minimum cash banks must hold.​

3.​ Interest rates (repo rates) – to control borrowing.​

Quantity Equation of Money:

MV = PY

Where:​
M = Money supply​
V = Velocity of money​
P = Price level​
Y = Output (real GDP)

This shows the relationship between money supply and total

spending in the economy.

What is Inflation? List costs and rank them.

Inflation is the general increase in prices over time.

Costs of Inflation (in order of importance):

1.​ Loss of purchasing power – money buys less → affects poor

the most.​

2.​ Menu costs – cost of updating prices frequently.​

3.​ Shoe leather costs – more frequent bank visits due to low cash
value.​
 4.​ Uncertainty – discourages investment and planning.​

5.​ Tax distortion – inflation increases nominal income → higher

taxes.​

6.​ Inequality – hurts fixed-income people, benefits borrowers.​

What are Net Capital Outflow (NCO) and Trade Balance (NX)?

●​ Net Capital Outflow (NCO) = Buying foreign assets – Selling

domestic assets to foreigners.​

●​ Trade Balance (NX) = Exports – Imports​

Relationship:

NCO = NX

If NCO > 0 → net outflow of capital → trade surplus​

If NCO < 0 → net inflow of capital → trade deficit

1. Given:

NX = 500 – 500ε (NX = Net exports, ε = real exchange rate)​

T = 1,000​
r = 5​
Y = 5,000​
G = 1,000​
C = 250 + 0.75(Y – T)​
I = 1,000 – 50r

i. Solve for:

National Saving (S), Investment (I), Trade Balance (NX), and

Equilibrium Exchange Rate (ε)

Step 1: Calculate C​
Y – T = 5,000 – 1,000 = 4,000​
C = 250 + 0.75 × 4,000 = 250 + 3,000 = 3,250

Step 2: National Saving​

S = Y – C – G = 5,000 – 3,250 – 1,000 = 750

Step 3: Investment (at r = 5):​

I = 1,000 – 50 × 5 = 1,000 – 250 = 750

Step 4: Trade Balance (NX):​

S – I = 750 – 750 = 0, so NX = 0

Step 5: Find ε from NX = 500 – 500ε:​

Set NX = 0​
0 = 500 – 500ε → ε = 1

ii. Suppose G rises to 1,250.

Step 1: New C is still 3,250 (Y and T are unchanged)

Step 2: New National Saving:​
S = 5,000 – 3,250 – 1,250 = 500

Step 3: Investment stays the same:​

r = 5 → I = 1,000 – 50 × 5 = 750

Step 4: NX = S – I = 500 – 750 = –250 → Trade Deficit

Step 5: Solve NX = 500 – 500ε:​

–250 = 500 – 500ε​
→ 500ε = 750​
→ ε = 1.5

Interpretation: When G increases, national saving falls,

leading to a trade deficit and a higher exchange rate
(appreciation).

iii. Suppose world interest rate rises to 10% (G back to 1,000):

Step 1: I = 1,000 – 50 × 10 = 500

Step 2: C remains 3,250 (no change in T or Y)

**Step 3: National Saving: S = 5,000 – 3,250 – 1,000 = 750

**Step 4: NX = S – I = 750 – 500 = 250 → Trade Surplus

Step 5: Solve NX = 500 – 500ε​

250 = 500 – 500ε​
→ ε = 0.5
 Interpretation: When interest rate rises, investment falls,
saving stays same, leading to trade surplus and lower
exchange rate (depreciation).

2. Frictional vs Structural Unemployment

Type Frictional Structural Unemployment

Unemployment

Definitio Temporary Long-term unemployment due

n unemployment during to mismatch between worker
job search or career skills and job requirements
change

Cause Normal labor market Technology changes,

turnover globalization, outdated skills

Example A graduate looking for A factory worker loses job due

first job to automation

Policy to Better job information, Retraining programs,

Reduce career services education reform
3. Solow Model:

a) How does saving rate affect steady-state income and growth?

●​ Higher saving rate → higher steady-state capital (k*) →

higher steady-state output (y*)​

●​ But: It does not affect long-run growth rate, unless there's

technological progress.​

Summary:​
↑ Saving → ↑ Income per person​
No effect on growth rate unless tech improves

b) How does population growth affect steady-state income and

growth?

●​ Higher population growth → more capital dilution → lower

income per person in steady state.​

●​ But it does increase the long-run growth rate of total output

(not per capita).​

Summary:​
↑ Population growth → ↓ Income per capita​
↑ Growth rate of total output
c) Endogenous Growth Theory vs Solow Model

●​ Solow Model: Growth depends on exogenous (outside)

technological progress​

●​ Endogenous Growth Theory: Growth comes from internal

factors like:​

○​ Human capital​

○​ R&D and innovation​

○​ Investment in knowledge​

Key difference:​
Solow assumes growth comes from outside the model.​
Endogenous growth explains how policies, education,
innovation drive growth inside the model.

4. IS-LM Model:

a) Why IS curve slopes downward?

●​ As interest rate decreases, investment increases, so output

(Y) increases​
 ●​ So, there’s a negative relation between r and Y​

b) Why LM curve slopes upward?

●​ Higher income (Y) → higher demand for money​

●​ To keep money market in equilibrium, interest rate must rise​

●​ So, positive relationship between Y and r​

c) Effects in IS-LM Model (Short Run)

Scenario Interest Income Consumpti Investm

Rate (r) (Y) on (C) ent (I)

i. Central bank ↓ ↑ ↑ ↑
increases money
supply

ii. Government ↑ ↑ ↑ ↓ (due to

increases G ↑r)
iii. Government ↓ ↓ ↓ ↑ (due to
increases taxes ↓r)

iv. Increase in G and ↑ ↔ or ↔ ↓

T equally slight ↑

In (iv), since taxes rise with spending, effect on total

demand is small → small or no change in income.

pAGE 90
Define the term 'Macroeconomics'. Discuss the major issues concerning
macroeconomics.

Definition of Macroeconomics:

Macroeconomics is the branch of economics that studies the behavior and

performance of an economy as a whole. It focuses on aggregate variables
such as national income, total employment, overall price levels, and economic
growth rather than individual markets.

It looks at the big picture – like how a country's economy is doing, how
government policies affect the economy, and how economic indicators are
connected.

Major Issues Concerning Macroeconomics:

Macroeconomics deals with several key issues that impact the economy on a
national or global scale. The main issues are:
1. Economic Growth

●​ Refers to the increase in a country’s output of goods and services

(measured by GDP).​

●​ Macroeconomics examines how to achieve sustainable and long-term

growth.​

2. Unemployment

●​ Unemployment happens when people who are willing and able to work
can't find jobs.​

●​ Macroeconomics studies the causes, types (like frictional, structural,

cyclical), and policies to reduce unemployment.​

3. Inflation

●​ A general rise in the price level of goods and services.​

●​ Macroeconomists analyze the causes of inflation (like demand-pull or

cost-push) and find ways to control price stability.​

4. National Income

●​ Refers to the total income earned by a country's people and businesses.​

●​ Macroeconomics helps to measure and distribute income and

understand its impact on the economy.​

5. Monetary and Fiscal Policy

 ●​ Monetary policy involves controlling the money supply and interest rates
(managed by the central bank).​

●​ Fiscal policy includes government spending and taxation decisions.​

●​ Both are used to stabilize the economy.​

6. Balance of Payments and Exchange Rates

●​ Macroeconomics looks at exports, imports, foreign exchange reserves,

and currency values.​

●​ It analyzes trade deficits/surpluses and how they affect the economy.​

Summary (in simple words):

Macroeconomics is about how the whole economy works. It helps us

understand and manage big problems like unemployment, inflation, and slow
economic growth. It also guides governments in making decisions to keep the
economy stable and growing.

b) What is a circular flow diagram? How do different components of circular

flow diagram interact with each other?

(b) What is a Circular Flow Diagram?

A circular flow diagram is a simple economic model that shows how money,
goods, and services move between different parts of the economy.

It mainly shows the interaction between:

●​ Households (people or consumers)​

 ●​ Firms (businesses or producers)​

●​ Sometimes also includes the government, financial institutions, and the

foreign sector.​

🔄 Basic Idea:
●​ Households give factors of production (like labor, land, capital) to firms.​

●​ Firms use these to produce goods and services.​

●​ Households buy goods and services from firms.​

●​ Firms pay wages, rent, interest, and profit to households in return.​

This creates a continuous cycle of income and spending, like a flow in a circle.

🧩 Main Components & Their Interaction:

1. Households

●​ Provide labor and other resources to firms.​

●​ Receive income in the form of wages, rent, etc.​

●​ Use that income to buy goods and services from firms.​

2. Firms

●​ Produce goods and services using household resources.​

 ●​ Sell these goods to households and earn revenue.​

●​ Pay income to households for the resources.​

3. Product Market

●​ Where goods and services are bought and sold.​

●​ Households are buyers, and firms are sellers.​

4. Factor Market

●​ Where resources (like labor) are bought and sold.​

●​ Firms are buyers, and households are sellers.​

🔁 Circular Flow (Two-Sector Model – Simple)

lua

CopyEdit

Factor Market

---------------------->

| |

Households Firms

| |

<----------------------

Product Market
 ●​ In the outer flow, money flows:​
→ Households spend money on goods → Firms earn revenue​
→ Firms pay income → Households earn wages​

●​ In the inner flow, real goods/services and resources move.​

🏛️ In Extended Models:
●​ The government collects taxes, provides public goods, and makes
transfers.​

●​ Financial Institutions handle savings and investments.​

●​ Foreign Sector involves exports and imports.​

✅ Summary (in simple words):

The circular flow diagram shows how money and resources move in the
economy.​
Households give resources to firms → Firms make goods → Households buy
goods → Firms pay income → And the cycle goes on.

Compare and contrast between microeconomics and

macroeconomics.

✅ Comparison Between Microeconomics and Macroeconomics

Basis Microeconomics Macroeconomics
Definition The study of individual units The study of the economy as a
in the economy like whole, focusing on national and
households, firms, and global issues.
markets.

Scope Deals with individual Deals with aggregate economic

decision-making and specific activities and overall
markets. performance.

Main Supply and demand, price National income, inflation,

Focus determination, consumer unemployment, economic
behavior, cost, and growth, and fiscal/monetary
production. policy.

Level of Small/individual level Large/national level

Analysis (micro-level). (macro-level).

Examples How the price of rice is set; What causes inflation; how GDP
how a company maximizes grows; why unemployment rises.
profit.

Tools Demand & supply curves, Aggregate demand/supply

Used elasticity, cost analysis. curves, GDP analysis, IS-LM
model.

Policy Use Helpful for business and Helpful for government

market-related decisions. economic policies and planning.
✅ In Simple Words:
●​ Microeconomics is like zooming in — it looks at small parts of the
economy (like one family or one company).​

●​ Macroeconomics is like zooming out — it looks at the big picture of the

whole country’s economy.

What is GDP? Differentiate GDP from GNP?

✅ What is GDP?
GDP stands for Gross Domestic Product.​
It is the total market value of all final goods and services produced within a
country in a specific time period (usually a year).

👉 It measures the size and health of a country’s economy.

🔁 Components of GDP (using expenditure approach):
GDP=C+I+G+(X−M)

Where:

●​ C = Consumption (spending by households)​

●​ I = Investment (spending by businesses)​

●​ G = Government spending​

●​ X = Exports​
 ●​ M = Imports​

✅ Difference Between GDP and GNP:

Basis GDP (Gross Domestic GNP (Gross National Product)
Product)

Meaning Total value of goods and Total value of goods and services
services produced within produced by a country’s citizens,
a country’s borders. regardless of location.

Territorial Based on location (inside Based on ownership/nationality (by

focus the country). citizens/firms).

Includes Income earned by Income earned by citizens abroad.

foreigners within the
country.

Excludes Income earned by Income earned by foreigners within

citizens working outside the country.
the country.

Usefulness Measures domestic Measures the total income of a

economic activity. nation’s people.

📌 Formula to relate GDP and GNP:

GNP=GDP+Net income from abroad

(Net income from abroad = Income earned by citizens abroad – Income

earned by foreigners in the country)

✅ Example (in simple words):

●​ If a foreign company produces cars inside Bangladesh, it will be
counted in Bangladesh’s GDP, but not in GNP.​

●​ If a Bangladeshi engineer works in Germany and sends money home, it

will be included in Bangladesh’s GNP, but not GDP.

b) Who Controls the Money Supply and How?

The money supply is mainly controlled by a country's central bank.

🔹 In Bangladesh, this is the Bangladesh Bank.

In other countries, it may be the Federal Reserve (USA), European Central
Bank, etc.

🔧 How the Central Bank Controls the Money Supply:

1.​ Open Market Operations (OMO):​

○​ Buying or selling government securities (bonds).​

○​ Buy bonds → inject money → increase money supply​

○​ Sell bonds → take money out → decrease money supply​

2.​ Reserve Requirements:​

 ○​ The minimum percentage of deposits banks must keep and not
lend.​

○​ Lower reserve ratio → more lending → more money​

○​ Higher reserve ratio → less lending → less money​

3.​ Discount Rate (Policy Interest Rate):​

○​ The interest rate at which banks borrow from the central bank.​

○​ Lower rate → more borrowing → more money​

○​ Higher rate → less borrowing → less money​

4.​ Moral Suasion and Direct Controls:​

○​ Advising or directing banks to take certain actions regarding

credit or lending.​

💰 Quantity Equation of Money (Equation of Exchange):

MV=PY

Where:

●​ M = Money supply​

●​ V = Velocity of money (how many times money changes hands)​

●​ P = Price level​
 ●​ Y = Real output (real GDP)​

🧠 Explanation:
●​ The left side (MV) is the total money spent in the economy.​

●​ The right side (PY) is the total value of goods and services produced.​

So, the equation shows that:

Money Supply × Velocity = Price Level × Real Output

📌 Implication:
●​ If M increases, and V and Y are constant, then P (prices) must rise →
Inflation.​

●​ If Y increases, more output is produced, and prices may stay stable even
if M increases.​

This equation helps central banks understand how changes in money supply
affect the overall economy.

What is inflation? List all the costs of inflation you can think of, and
rank them according to how important you think they are.

✅ What is Inflation?
Inflation is the general increase in the price level of goods and services in an
economy over a period of time.​
When inflation occurs, the purchasing power of money falls, meaning you
need more money to buy the same things.
📌 Costs of Inflation (Listed and Ranked by Importance):
Here is a list of common costs of inflation, ranked from most important to
least important (based on typical economic impact):

🔴 1. Loss of Purchasing Power (MOST IMPORTANT)

●​ As prices rise, the value of money falls.​

●​ People can buy less with the same amount of money, which hurts low-
and fixed-income groups the most.​

🔴 2. Uncertainty and Reduced Investment

●​ High or unpredictable inflation creates uncertainty about future costs.​

●​ Businesses hesitate to invest, which can slow economic growth.​

🔴 3. Income Redistribution
●​ Inflation can unfairly benefit borrowers (they repay loans with cheaper
money) and hurt savers or lenders.​

●​ It redistributes income without any change in productivity.​

🟠 4. Menu Costs
●​ The cost for businesses to update prices frequently (e.g., printing new
menus, updating systems).​

●​ Small individually, but significant in high inflation environments.​

🟠 5. Shoe Leather Costs

 ●​ People try to avoid holding cash because its value is falling.​

●​ They make more trips to the bank or ATM, wasting time and effort (like
wearing out their "shoe leather").​

🟡 6. Distorted Price Signals

●​ Inflation can make it hard to distinguish between a real increase in
demand and just a price rise due to inflation.​

●​ This misleads producers and may cause inefficient production.​

🟡 7. Bracket Creep (Tax Distortion)

●​ If income rises due to inflation, people may move into higher tax
brackets, even if their real income hasn't increased.​

⚪ 8. Balance of Payments Problems

●​ Domestic goods become more expensive than foreign goods, reducing
exports and increasing imports.​

●​ This can worsen the trade balance.​

🟢 Summary of Ranking (Most to Least Important):

1.​ Loss of purchasing power​

2.​ Uncertainty and reduced investment​

3.​ Income redistribution​

 4.​ Menu costs​

5.​ Shoe leather costs​

6.​ Distorted price signals​

7.​ Bracket creep​

8.​ Balance of payments issues​

What is Net Capital Outflow (NCO)?

Net Capital Outflow (NCO) is the net flow of funds invested abroad by a
country’s residents minus funds invested domestically by foreigners.

NCO=Capital Outflows−Capital Inflows\boxed{\text{NCO} = \text{Capital

Outflows} - \text{Capital Inflows}}NCO=Capital Outflows−Capital Inflows​

●​ If NCO > 0 → Country is investing more abroad than foreigners are

investing inside (net lender).​

●​ If NCO < 0 → Foreigners are investing more in the country than the
country is investing abroad (net borrower).​

✅ What is Trade Balance (Net Exports, NX)?

The Trade Balance is the difference between exports and imports of goods
and services.

NX=Exports−Imports\boxed{\text{NX} = \text{Exports} -
\text{Imports}}NX=Exports−Imports​
 ●​ If NX > 0 → Trade surplus (exports > imports)​

●​ If NX < 0 → Trade deficit (imports > exports)​

🔄 Relationship Between NCO and Trade Balance (NX):

There is a direct and fundamental link:

NCO=NX\boxed{\text{NCO} = \text{NX}}NCO=NX​

This equation comes from national accounting identities and reflects the
connection between the goods market and financial market.

🧠 Explanation:
●​ When a country exports more than it imports (NX > 0), it earns foreign
currency, which is often used to invest abroad → NCO > 0.​

●​ When a country imports more than it exports (NX < 0), it needs foreign
capital to finance the excess spending, so foreigners invest more in the
domestic economy → NCO < 0.​

🌍 Example:
●​ If Bangladesh exports garments worth 100 billion BDT and imports oil
worth 80 billion BDT:​
 ○​ NX = +20 billion → Trade surplus​

○​ This surplus is used to buy foreign assets, so NCO = +20 billion​

✅ Summary (in simple words):

●​ Net Capital Outflow is about investment (where money is going).​

●​ Trade Balance is about goods and services (what is being bought or

sold).​

●​ They are always equal:​

○​ If a country sells more goods abroad, it must also be lending or

investing abroad.

🔵 (a) In the Solow Model, how does the saving rate

affect:

1. The Steady-State Level of Income?

➡️ In the Solow growth model, the saving rate (s) determines how
much of a country's output is saved and invested, rather than
consumed.

●​ A higher saving rate → more capital accumulation → higher

steady-state capital per worker → higher steady-state
 output (income) per worker.​

📌 So, increasing the saving rate increases the steady-state level

of income per worker.

However, this effect has a limit. Eventually, the economy reaches a

new steady state where capital per worker stops increasing — due
to diminishing returns.

2. The Steady-State Rate of Growth?

➡️ In the basic Solow model (without technology):

●​ The steady-state growth rate of income per worker is zero,
no matter the saving rate.​

●​ The total output grows only at the rate of population

growth.​

➡️ In the Solow model with technological progress:

●​ The steady-state growth rate of income per worker is equal
to the rate of technological progress (g), not affected by the
saving rate.​

📌 So, the saving rate affects the level of income, but not the
long-run growth rate.
🔴 (b) In the Solow Model, how does the population
growth rate affect:

1. The Steady-State Level of Income?

➡️ A higher population growth rate (n) means more workers

entering the economy.​
This requires more investment just to keep capital per worker
constant.

●​ So, if population grows faster, more of the saved output is

used to equip new workers with capital.​

●​ This reduces the steady-state capital per worker, which in

turn lowers the steady-state output (income) per worker.​

📌 Therefore, higher population growth leads to a lower

steady-state level of income per worker.

2. The Steady-State Rate of Growth?

➡️ In the basic Solow model (no technology):

●​ Total output grows at the same rate as population growth
(n).​
 ●​ But output per worker does not grow — it stays constant at
the steady state.​

➡️ In the Solow model with technology (growth rate = g):

●​ Output per worker grows at rate g.​

●​ Total output grows at rate n + g.​

📌 So, population growth increases the growth rate of total

output, but not the growth rate of income per worker.

✅ Summary Table:
Factor Effect on Effect on Steady-State Growth
Steady-State Rate
Income Level

Saving Rate Income level ↑ No effect (growth stays the

↑ same)

Population Income level ↓ Total income grows faster, but

Growth ↑ per-worker income growth
unaffected
c) How does endogenous growth theory explain persistent growth
without the

assumption of exogenous technological progress? How does this

differ from the Solow model?

🔵 1. How does endogenous growth theory explain persistent growth

without assuming exogenous technological progress?

Endogenous Growth Theory (also called New Growth Theory)

explains long-run economic growth as the result of internal forces
in the economy — rather than depending on external (exogenous)
technological progress.

🔑 Key Idea:
Growth is generated from within the economy — through
investment in human capital, innovation, knowledge, and
research & development (R&D).

📌 Main features of Endogenous Growth Theory:

1.​ Technology is Endogenous (Internal):​

○​ Technological progress is a result of purposeful actions,

like innovation or education — not something that "just
happens."​
 2.​ Increasing Returns to Scale:​

○​ Investment in knowledge or education can lead to

constant or increasing returns, unlike physical capital,
which has diminishing returns.​

3.​ No Diminishing Returns to Capital (in some models):​

○​ In contrast to Solow, some endogenous growth models

assume constant returns to capital, especially if
"capital" includes human capital or R&D.​

4.​ Policies Matter:​

○​ Government policies (like subsidies for education or

R&D) can permanently raise growth rates.​

📈 Growth Happens Because:

●​ Firms invest in innovation and ideas.​

●​ Individuals invest in education and skills.​

●​ Knowledge can spill over to others, creating more growth

(positive externalities).​
🔴 2. How is this different from the Solow model?
Feature Solow Model Endogenous Growth
Theory

Source of Growth Exogenous Growth comes from

technological progress within the model
(comes from outside (e.g., innovation,
the model) education)

Technological Assumed — not Explained as result of

Progress explained economic decisions

Returns to Diminishing May be constant or

Capital increasing

Long-Run Only possible with Possible without

Growth in exogenous tech external tech progress
Income per progress
Capita

Role of Policy Policy affects level, Policy can affect both

not growth rate level and growth rate
✅ Summary (in simple words):
●​ The Solow model says: Growth needs external technology
improvements.​

●​ Endogenous growth theory says: Growth happens because of

decisions made inside the economy — like investing in
education, R&D, innovation, etc.​

📌 This makes endogenous theory more realistic for explaining why

rich countries keep growing even without outside "technological
miracles."

a) Why does the IS curve slope downward?

IS Curve: Represents combinations of interest rates and output

(GDP) where the goods market is in equilibrium.

Reason for downward slope:

●​ When interest rates fall, investment increases because

borrowing is cheaper.​

●​ Higher investment leads to higher aggregate demand, which

raises output (GDP).​
 ●​ So, lower interest rates = higher output, and higher interest
rates = lower output.​

👉 That’s why the IS curve slopes downward: negative relationship

between interest rate and GDP.

(b) Why does the LM curve slope upward?

LM Curve: Represents combinations of interest rates and output

where the money market is in equilibrium.

Reason for upward slope:

●​ As output (income) increases, people demand more money

for transactions.​

●​ But the money supply is fixed, so to balance demand, the

interest rate must rise to reduce excess demand for money.​

●​ So, higher output = higher interest rate.​

👉 That’s why the LM curve slopes upward: positive relationship

between interest rate and GDP.

According to the IS-LM model, what happens in the short run to the
interest rate, income, consumption, and investment under the
following circumstances?
i.

ii.

. iii.

iv.

The central bank vases the money supply.

The government

The

reases government purchases.

government increases taxes.

The government increases government purchases and taxes by

equal

amounts.