International Economics

Assessment– 1



  1. On the graft below, draw the consumption function C=$150+0.8YD.

Consumption is $billions per year.

Disposable income is $100 billion per year.

Answer the following questions:

  • At what level of income do households begin to save? Indicate the point on the graph with the letter A.

  • y how much does consumption increase when income raises $200 beyond point A? Indicate this new level of consumption with point econimics indivdual - Sara B

econimics indivdual - Sara  11000

Consumption ($bn per year)


econimics indivdual - Sara  2econimics indivdual - Sara  3400

econimics indivdual - Sara  4200

0 200 400 600 800 1000

Spend ($bn per year)

Consumption = a + bYd

YD= Disposable income = $ 100


150 +0.8(100)= 230

MPS =1-b=1-0.8= 0.2

0.2*100= 200

The presence of the reference line indicates that Y=C. Therefore since consumption is 230, then the income is also 230

Saving = -a+(1-b)Y = -150+(1-0.8)*100 = -130

An increase of income by 200

The original amount of income, therefore, is 330=200+130

Since consumption is Y=C, then the new consumption will be$ 330

2. Fiscal and monetary tools are used to fix the macro economy. Briefly, explain how a tax cut might affect both AD and AS? (10 marks)

Fiscal tools are used to formulate policies by the national government that is geared towards the institution of a deliberate change in either government spending or taxes to stimulate or slow down the economy. The change in taxes is one of the measures that are used to either raise of low the level of aggregate demand and aggregate spending. The decrease in tax rates through a tax cut causes the disposable income to increase the national income. It also has a ripple effect that makes the consumption rise at every single level of the national income. As a result of this, the aggregate demand for goods increases as the levels of employment increase. The increase in the levels of employment does stipulate the presence of more disposable income in the hands of the citizens. The aggregate supply also increases with time in the long run.

Monetary tools are used to implement policies that influence the economy through changes in money supply and available credit. The tools are used by the Federal Bank of the country to impact change, and they often include use of interest rates, open market operations among other factors. The decrease in taxes by the government results in the increase in money supply in the market, as a result, the interest rates are lowered. The decrease in interest rates will result in the increase in borrowing and increase in the supply of money this will result in the shift of the aggregate demand outwards to the right while the aggregate supply also increases. To regulate the situation the federal bank does raise the interest rate which forces the commercial banks to raise theirs hence decreasing the supply of money in the market. Additionally, the federal bank can sell their securities and ensure that the supply of money is regulated.

  1. One of the goals of a Federated Government is to stimulate the economy. This may be achieved in three distinct steps. You are required to use three different grafts to indicate these three steps. (15 marks).

The federal government has an obligation to stimulate the economy through the application of 3 major distinctive steps. They include monetary measures, fiscal measures and non-monetary measures. The monetary measures refer to policies that influence the economy through changes in the money supply and available credit. Therefore, to stimulate the economy, the federal central bank is tasked with the responsibility of carrying out the following aspects. Firstly, the federal bank does reduce their rates resulting in the commercial banks reducing their rates. Because of the diminish in the rates of interest, borrowing is encouraged which results in an increase in investments hence increasing the money supply in the economy. Secondly, the open market operations policy is instituted whereby; the federal bank holds its securities to stimulate the increase in money supply. Thirdly, the reserve requirements for the commercial banks is decreased which does increase the money at the disposal of commercial banks. The policy does encourage the consumers to increase their borrowing rates whereby they channel the amount to investment projects this does stipulate the economy.

The fiscal measures refer to the policy adopted by the federal government through its spending or reduction in taxes to stipulate the economy. The government focuses on increasing its public expenditure this results in the increase in money supply in the market providing the citizens with an opportunity to invest the amount in other projects that will automatically stimulate the growth of the economy. Secondly, the Federal government can reduce its taxes which results in the increase in disposable income in the hands of the consumers. The consumers can decide to save or invest the disposable income. Investment results in the increase in the GDP of the nation are hence increasing the economy’s growth margin tremendously. Thirdly, the government can carry out public borrowing. The public borrowing reduces the aggregate demand for goods resulting in the decrease of prices. The decrease in prices leads to the increase in the product of goods hence stimulating the economy.

From the non-monetary perspectives, the Federal Government has to adjust the wages. The wages have to be raised at regular intervals to enable the individuals to maintain their purchasing power. Secondly, the government needs to adjust its output. Adjustment of output can be carried out through the government instituting price controls and rationing policies. The price control is often set on certain necessities, and they cannot be altered by anyone else apart from the government. On the aspect of rationing, the government does control the purchase of certain commodities hence stimulating production which does result in economic growth.


Roy, S. (2016). International Economics. Presentation, Abu Dhabi School of Management(adsm).