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answer 20 questions about GDP and Circular Flow and Keynes's Model and the Classical mode

The Classical Model

1. Write down the Quantity Equation and provide an explanation of all the variables included in it.

2. Use the Quantity Equation to explain the Quantity Theory of Money. Also explain why this theory implies that money is neutral to real GDP and the level of employment in the economy.

3. On a graph draw the demand and supply curves for labor. Explain why these curves are shaped the way they are. Also provide an explanation of the forces that push the wage rate to the equilibrium level.

4. At this equilibrium wage rate there is no unemployment in the labor market in the Classical Model. Is this statement accurate?

5. Provide an explanation of what is meant by the term “full employment” in the context of the Classical Model.

6. Using the Quantity Equation, derive the Aggregate Demand curve. Then use the Aggregate Demand – Aggregate Supply framework to depict the equilibrium level of output in the Classical Model? Is this equilibrium level of output equal to the full employment level?

7. Why are expansionary monetary and fiscal policy ineffective to combat recession in the world of the Classical Model?

GDP, Circular Flow and Keynes’ Model

1.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.

i.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)

ii.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.

2.Draw, label and explain the circular flow of income and expenditure.

3.Explain Keynes’ theory of consumption expenditure (use a schedule or table if required). 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?

4.Explain the concept of the equilibrium level of output or real GDP. Why, according to Keynes, does its emergence require an equality between the amount of savings (income not devoted to consumption expenditure) and the amount of investment expenditure?

5.Explain the concept of the full employment level of output. How is this concept different from that of the equilibrium level of output?

6.Assume an economy where the equilibrium level of output coincides with the full employment level. Now assume that there is a decline in the level of investment expenditure. Analyze the effects of this decline on the equilibrium level of output. In the process, also provide an explanation of the workings of the Keynesian multiplier.

7.Use the Aggregate Demand – Aggregate Supply framework to compare the Keynesian and the Classical Models of output and employment.

8.Explain the concept of the marginal efficiency of capital (use a numerical example if required).

9.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.

10.Investment expenditure, for Keynes, is driven by animal spirits. Explain. What implications does this have for the attainment of full employment equilibrium?

11.Distinguish between necessary and idle cash balances. Why, according to Keynes, do individuals hold idle cash balances?

12.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?

13.Why, in the Keynesian system, do monetary and fiscal stimulus help in attaining full employment? What role does the multiplier play in this process?


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