Section A 1. F 2. F 3. T 4. T 5. 6. 7. 8. F 9. T 10.

Section B Question 1 2005 Nominal GDP: Production x Price 100x2 200 2004 Nominal GDP: Production x Price 100x3 600 GDP Deflator 2003 Nominal GDP X 100 Real GDP 200x100 200 = 100 Question 2 New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on neoclassical framework. Specifically, it emphasizes the importance of rigorous foundations, in which the macroeconomic model is built in analogy to the actions of individual agents, whose behavior is modeled by microeconomics. The hypothesis of rational expectations addresses this criticism by assuming that individuals take all available information into account in forming expectations. Though expectations may turn out incorrect, the deviations will not deviate systematically from the expected values. Criticisms The hypothesis is often criticized as an unrealistic model of how expectations are formed. First, truly rational expectations would take into account the fact that information about the future is costly. The "optimal forecast" may be the best not because it is accurate but because it is too expensive to attain even close to accuracy. Assumptions made by the New Classical School of Thought Assumptions of Economic Agent are maximizers: Some of the information is accessible only to the government and can affect their decision thus the need to be government intervention to make them make optimal decisions. Real GDP: Production x Price 100x 2 200

Real GDP: 600x 2 3 400 GDP deflator 2004 600x100 400 = 150

Assumptions of Expectations are rational: Only few people can understand some of the government policies and expectations would not be rational even if they have information available. This assumption is not realistic so there in need for government intervention. Assumption for Market clear: Not realistic as there has to be government intervention to regulate on wages and prices for both parties consumers and producers to be secure.

Section C Question 1 Defining economic growth Economic growth is best defined as a long-term expansion of the productive potential of the economy. Sustained economic growth should lead higher real living standards and rising employment. Short term growth is measured by the annual percentage in real GDP. Advantages of Economic Growth Sustained economic growth is a major objective of government policy not least because of the benefits that flow from a growing economy.

Higher Living Standards for example measured by an increase in real national income per head of population see the evidence shown in the chart below Employment effects: Growth stimulates higher employment. The Botswana economy has been growing since 1999 and we have seen a large fall in unemployment and a rise in the number of people employed. Fiscal Dividend: Growth has a positive effect on government finances - boosting tax revenues and providing the government with extra money to finance spending projects. The Investment Accelerator Effect: Rising demand and output encourages investment in new capital machinery this helps to sustain the growth in the economy by increasing long run aggregate supply. Growth and Business Confidence: Economic growth normally has a positive impact on company profits & business confidence good news for the stock market and also for the growth of small and large businesses alike

Disadvantages of economic growth There are some economic costs of a fast-growing economy. The two main concerns are firstly that growth can lead to a pickup in inflation and secondly, that growth can have damaging effects on our environment, with potentially long-lasting consequences for future generations.

Inflation risk: If the economy grows too quickly there is the danger of inflation as demand races ahead of aggregate supply. Producer then take advantage of this by raising prices for consumers 3

Environmental concerns: Growth cannot be separated from its environmental impact. Fast growth of production and consumption can create negative externalities (for example, increased noise and lower air quality arising from air pollution and road congestion, increased consumption of de-merit goods, the rapid growth of household and industrial waste and the pollution that comes from increased output in the energy sector) These externalities reduce social welfare and can lead to market failure. Growth that leads to environmental damage can have a negative effect on peoples quality of life and may also impede a countrys sustainable rate of growth. Examples include the destruction of rain forests, the over-exploitation of fish stocks and loss of natural habitat created through the construction of new roads, hotels, retail malls and industrial estates.

Economic Development: Economic development is the increase in the standard of living in a nation's population with sustained growth from a simple, low-income economy to a modern, high-income economy. Also, if the local quality of life could be improved, economic development would be enhanced. Its scope includes the process and policies by which a nation improves the economic, political, and social well-being of its people. Factors influencing the economic development of a country Population Growth: Large populations intend to act as a source of labour and also a market for products of industries. Dependency theorists argue that poor countries have sometimes experienced economic growth with little or no economic development; for instance, in cases where they have functioned mainly as resource-providers to wealthy industrialized countries.

Natural resources: The natural resources are the principal factor which affects the development of an economy. If a country is rich in natural resources, it is then able to make rapid progress in growth. In case a country is deficient in forest wealth, mineral resources, water supply, fertility of land etc., it is then normally not in a position to develop rapidly. Capital Formation. Capital accumulation or capital formation is an important factor in the economic growth of a country. Capital formation refers to the process of adding to the stock of capital over time. The stock of capital can be built up and increased through three different resources which are as under:Sources of capital formation: (a) An act of saving. (b) Capital market. (c) An act of investment. (a) An act of saving. An act saving involves the postponing of consumption whether voluntarily or involuntarily so that funds thus made available be used for investment. In developing countries the saving potential is low. A large majority of the people hardly keep their body and soul together with the meager income at their disposal. Saving is a luxury and far beyond their reach.

(b) Capital market. The capital market consists of financial institutions, like development banks, stock exchanges and investment banks. In low income countries, the capital market is less developed. As such it is not able to mobilize saving to the desired extent. (c) An act of investment. In less developed countries, whatever meager saving are available with households and with the businessmen, is not all channelized for investment in capital goods. The businessmen usually hesitate to invest their resources due to political and social instability in the country, fear of nationalization of industries, limited domestic market, poor roads, etc.

Question 2 a) Consumption function

The consumption function never starts at zero, because we all have to spend some money to survive even when we have no income. In this example the consumption function starts at P5.40 and slopes upward, showing that the increase in amount of money we spend us we earn more. The 45 line allows us to set points where expenditure equals income. In this case at point X. to the right of X, we are spending less than we are earning, so we are saving. The increase in price of fuel from P5.40 to P6.18 will lead to consumers using less fuel, thus save the income they have, the price above P6.18 will mean consumers will save (the shaded area).

b) AD-AS Model Vertical axis price Horizontal axis Level of income or GDP of the country e- macroeconomics equilibrium AS- positively economic sloping showing a positive relationship between price and GDP AD- Negatively slope showing a negative relationship between price and GDP

The AD-AS model shows the relationship between the incomes of the economy general price level

The decrease in demand will cause AD to shift to AD1 and this will cause income to decrease from Y2 to Y1.

The increase in general prices from P5.40 to P6.08 causes a drop in the level of demand which lead to the AD curve shifting to the left causing income to change from Liter to a new point of equilibrium liter.

The expenditure income model shows the relationship between income and total expenditure of the economy. The level of income Y1 is the same for the expenditure income model for the AD-AS

model illustrated above. Suppose the level of spending is A*(such as government expenditure or investment) decreasing, the AE curve will decrease to AE, as shown in the diagram below. This will cause the Income to decrease from Y1 to Y0 changing the equilibrium from point Litre to Litre1

Question 3 The shortcoming of GDP calculations GDP has several shortcomings when measuring the economy's performance. It does not take into account nonmarket transactions. The labor of a homeowner repairing his own house is not included in GDP, so GDP understates the total output. Also, GDP fails to account for improved product quality. Personal computers have seen drastic improvements in speed and storage capabilities since the 1990's, but their improvements are not counted in GDP. Black market economy- GDP covers only transactions in the official economy. But a significant sector of economic activity goes unreported The underground economy is, for obvious reasons, not included in GDP calculations. Gamblers, smugglers, and drug dealers comprise a substantial amount of a nation's economic activity, but their "work" is disregarded. The GDP per capita indicator emphasizes average income and neglects (changes in) the income distribution, even though an uneven distribution implies unequal opportunities for personal development and well-being. Furthermore, individuals or families with low incomes benefit relatively much from an income rise, because of the diminishing marginal utility of income. GDP per capita does not capture these features. Related to distribution is the notion of relative income and context dependent preferences. This is characterized by comparing oneself with others resulting in rivalry through the purchase of positional or status goods. As the GDP completely omits the relative income aspect of welfare, it tends to overestimate social welfare or progress. Although an increase in relative income can improve the welfare of an individual, social welfare is not being served by it. The reason is that status is a very scarce good, causing rises in relative income and welfare to resemble a zero-sum game: what one individual gains, others lose

Bibliography 1. Tony Buxton, Paul Chapman and Paul Temple, Britains Economic Performance, 2nd edition, 2001 2. David Begg, Economics, 7th edition, 2004 3. Oxford Dictionary of Economics by John Black 4. www.undp.ord/hdr2003/faq.html21- Human Development

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