1. Suppose that the government spends £100 million building a new hospital? Explain why, as a result, GNP will generally increase by more than £100 million
Gross national product is the total dollar value of all final goods and services produced for consumption in a society during a particular time period. Gross national product measures a nation's economic performance. Real Gross national product is an effective tool for making yearly comparisons of changes in the physical output of the country because it is not affected by changing prices. Gross national product will increase by more than £100 million because it is calculated by summing consumption, investments, government spending and net exports. Gross national product is total income paid to the factors that produced the goods and services. Gross national product measures the overall economic strength of a country; these figures can be used to analyze the wealth distribution throughout a society, or the purchasing power of an individual in a country. Increase in exports will increase Gross national product whereas Increase in imports will decrease Gross national product.
2. Describe the different methods by which government can finance an increase in public spending.
Public spending is expenditure incurred by the public sector in course of its activities. The government raises money through taxes which is money from the collective pockets of the people. Another way to finance increase in public spending is through debt which is money borrowed, the government competes for money and is willing to pay exorbitant fees and interest on the debt. Another way to finance is through income which is money that the government earns by participating in the free market, they offer some goods or service and get paid for it. Another way to raise finances is through fines which is money collected as punishment for crimes committed by individuals or corporations, fines are usually useful remedy, quite easy to collect and impose. Another way to raise finances is through inflation, this is what happens when the government simply prints new money and issues it. the revenue for the government has three components which are tax revenue which is revenue from taxes like income tax and corporate tax, also from non-tax revenue which revenue that the government earns by things like dividends and income from cash receipts which is mostly borrowings. Majority of revenue is from taxes, companies pay the largest share of taxes and income taxes.
Capital receipts are things like short term borrowing like short term borrowings and external debt. a high level of taxation is necessary for the government to finance increase in spending, a tax is a financial charge imposed on an individual or a legal entity by a state, taxes are divide into direct and indirect taxes. Government can also issue bonds, government expenditure is also known as national debt, government debt can also be classified as internal debt which is owned to lenders within the country and external debt owed to foreign lenders. Government usually borrows through the issue of government bonds and bills securities. Government also raise money through seigniorage which is revenue from issuing of currency, it arises from the difference between the face value of a bank note and the cost of producing, distributing and retiring it to circulation, it provides a very small proportion of revenue.
3. What is the money supply multiplier? Why is it generally greater than one?
Money supply multiplier defines the relationship between money supply and the monetary base. During the last ten years the demand for cash by the public has fallen and demand for bank deposits has increased. The change in money supply can be defined in terms of changes in the money multiplier and the monetary base. the size of the multiplier effect depends on the percentage of deposits that banks are required to hold as reserves i.e. it is money used to create more money and is calculated by dividing total bank deposits by the reserve reqirement.the higher the reserve requirement, the tighter the money supply, which results in a lower multiplier effect for every dollar deposited.
The money multiplier is generally greater than one because deposits are generally greater than the reserves. The money multiplier could be equal to one if reserves are exactly equal to a deposit that is if banks are permitted to lend out any portion of deposits placed under their control. The multiplier is the multiple by which expansion in the money supply is greater than the increase in the monetary base. The changes in the money supply can be defined in terms of changes in money multiplier and the monetary base. The multiplier explains why the money supply as excess reserves is added to the banking system. The easiest way to understand the way multiplier works is through the following assumptions which are, banks keep a fixed fraction of deposits to meet reserve requirement, customers of the banks pay each other by checks not by withdrawing cash, and when customers do not receive payments they do not withdraw any money from the bank.
4. Explain two ways in which the Bank of England could reduce the supply of money.
The bank of England is the UK's central bank. The bank's monetary policy committee meets monthly to determine short term interest rates the extent of money supply is determined by the amount of notes or coins in supply coupled with the reserve ratio of the banks. The Bank of England will sell as many notes and coins to the commercial banks as they wish, it simply debits the account of these banks that they operate with the appropriate amount. The cash base of British monetary system is not just notes and coins that banks have in their branches but whatever money in their accounts with the Bank of England as well. The Bank of England controls money supply by specifying the total amount of notes and coins a bank must have available at its branches, in addition the amount on deposit with it, in relation to the amount of money the bank had created by granting its customers overdrafts and loans. This means that if at any time the Bank of England felt that the amount of money in circulation is too high and causing inflation, it could force banks to deposit more funds in their accounts. The Bank of England abolished its minimum reserve ratio in 1981, and now allows a reserve agreement be set individually by each bank, this reflects the level of competition faced by the banks from their foreign rivals. The problems with this policy is that interest rates would be volatile as attempts were made to keep the desired range of money, also that the Bank of England is the lender of last resort therefore banks can always get enough cash, and banks can keep cash surplus to their requirements so they are not affected by minimum reserve requirements.
The second way that the Bank of England control money supply is by open market operations, which involve the buying or selling, interest bearing bonds. If it sells bonds the purchaser pay for them by writing checks drawn on their commercial banks account to the Bank of England, subsequently the bank debits the accounts of commercial it operates with relevant amounts, thus reducing amount of money in circulation. As a banker to the government and to the banks, the bank is able to forecast fairly accurately the pattern of money flow between the government accounts and commercial banks, and act on daily basis to smooth out imbalances which arise. The bank supplies the cash when the banking system needs to achieve the balance by the end of each settlement day. it can choose which interest rates to charge. The interest rate charged is quickly passed throughout the financial system influencing the rates of the entire economy. Problem with this method is that there are difficulties in selling bonds. The Bank of England can control the national money supply by altering the interest rates at which it lends funds to banks that fail to keep positive balances in their accounts with it.
The Bank of England has indicated authority over supply of money due to the following factors; these include the utilization of monetary aggregates, the inclusion of interest rates determination in the bank's operations and the development of the new monetary policy in the country that involves the open market operations. in addition the role of Bank of England in the country banking system indicates its ability to control the quantity of money. These include the ability to limit the amount of bank deposits banks can have, force rates of interest to discourage customers from making loans as well as to reduce the level of liquid assets. Considering that Bank of England issues coins and notes, the amount of cash in the money supply can easily be controlled. However while the Bank of England may have certain degree of control other factors limit the authority for example, the bank has no full control over all money holders as well as retail banks as well as their customers can not be manipulated by the bank.( Hoffman ,2007)
5. You are advising the government of a country with mass unemployment. What policies would you suggest to reduce unemployment?
Unemployment is an economic condition marked by the fact that individuals who actively seek jobs remain unemployed. The level of unemployment varies with economic conditions and circumstances. The most causes of unemployment are getting fired and laid off for a specific reasons e.g. if the company is going out of business or if there are positions no longer needed by the company. Some people cannot be hired because they do not have an education and not qualified to do the job. Others cannot find work because of disabilities or health problems. In some cases people cannot get a job because the economy is down. Other causes for unemployment are raising costs, lack of funding for education and low demand in certain areas. Rising costs that can force a business to cut down on labor is one factor leading to increase in unemployment. Another cause of unemployment is where there is a mismatch in the types of jobs in the area and the type of skills of the workers in that same area. Another reason of unemployment is rapid technology growth being produced which can reduce the number of employees needed and still be efficient. Another reason for unemployment is the inability to get proper training for good jobs because people are uniformed about how to get it. Unemployment can be dealt with in the following ways, an individual who is unemployed can learn to budget money and not to buy unnecessary things, also set aside some cash so that there is some money now that there is no job available. Another way is to search for jobs using every available resources, another one could also expanding job search to also include jobs abroad. Unemployment can be minimized by increasing funding in educational institutions and career fairs that help people find jobs.
Effective policies to reduce mass unemployment should include the following, an improvement in the employability of labor supply so that the unemployed have the right skills to do the available job opportunities. Policies should focus on improving the mobility of labor. An improvement in the incentives for people to search and then accept paid work which may require some reforms of the tax and benefits system. A sustained period of economic growth so that new jobs are created this requires that aggregate demand be high enough for businesses to be looking to expand their work force. Improving skills and reducing occupational immobility by creating policies that provide the unemployed skills they need to find re-employment and improve the incentives to find work, structural unemployment is because of labor immobility. Improvements in education and training will result to increase in the human capital and giving these workers a better chance of taking new jobs that become available in the economy. Increasing aggregate demand through lowering interest rates or lower taxes might encourage foreign investment into the economy from multinational companies, because of increase in output the demand for labor at each wage rate will grow leading to increase in employment. Benefits and tax reforms through reduction in the real money value of unemployment benefits which might increase the incentive to take a job especially if the real worth of unemployment is well below the national minimum wage rate.
Employment subsidies especially government subsidies to those firms that take on long term unemployed, this will create incentive for the firms to increase the size of their work force. Economic growth creates jobs for people entering the labor market the first time and it provides employment opportunities for people currently unemployed. Increase in government spending directly increase aggregate demand and can have multiplier effect on the equilibrium national income, the government can increase spending by investing in capital stock e.g. spending money in new hospitals which provide sustained economic growth which will provide a platform for more jobs. Lowering interest rates by relaxation of monetary policy will encourage demand for credit, reduces savings and increase consumers' disposable income, which will boost consumption and encourage the firms to invest. The government could reduce unemployment by reducing taxes for the low paid and therefore encourage them to find work more quickly. Better information on job vacancies can help reduce job search in the labor market. The government can give grants and subsidies to firms located in areas of high unemployment and this can increase in employment in such firm.