review questions 4

Review Questions – GDP and Keynes

  • Consider an economy with three goods – wheat, flour and bread. Wheat and flour are intermediate goods (non-durable capital goods) whereas bread is the only consumer good and no inventory of any good is maintained.
  • Draw, label and explain the circular flow of income and expenditure.
  • With reference to the circular flow, explain the concept of an equilibrium level of GDP.
  • In the Keynesian system, what forces operate to restore GDP to its equilibrium value if disequilibrium prevails?
  • Explain Keynes’ theory of the consumption function. What implications does the value of the marginal propensity to consume have for the relationship between the amount of savings and the level of income?
  • Why, in the Keynesian system, might the level of equilibrium GDP fail to coincide with the level of GDP that ensures full employment in the labor market?
  • Explain the concept of the marginal efficiency of capital (use a numerical example if required).
  • Using the concept of the MEC, explain why the level of investment expenditure shares a negative relationship with the prevailing rate of interest in the Keynesian system.
  • Investment expenditure, for Keynes, is driven by animal spirits. Explain. What implications does this have for the attainment of full employment equilibrium?
  • Distinguish between necessary and idle cash balances. Why, according to Keynes, do individuals hold idle cash balances?
  • Derive the negative relationship between the amount of money held to satisfy the speculative demand for money and the rate of interest. What implications does the existence of this speculative demand for money have for attaining full employment?
  • Why, in the Keynesian system, does fiscal stimulus held in attaining full employment? Explain with the aid of the Keynesian Cross.
  • Explain the working of the Keynesian multiplier.
  • 1. In the Classical Model individuals only hold cash in order to satisfy the transactions demand for money. Explain. What does this imply as far as the market for goods and services is concerned?
  • 2. With fully flexible wages, prices and interest rates the economy always settles at the full employment level of GDP. Explain.
  • 3. What form of unemployment is consistent with the Classical Model?
  • 4. Provide a brief explanation of the Quantity Theory of Money.
  • 5. Why is monetary policy ineffective to combat recession in the world of the Classical Model?
  • Assuming wages and profits are the only forms of income, construct an example showing the payments of the producers of the three goods (including inter-producer payments)
  • Calculate the GDP of this imaginary economy using the product, income and expenditure methods. Explain how these methods deal with the problem of double counting in the calculation of GDP.

Review Questions: The Classical Model

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