GDP and Keynes - Consider an economy with three goods

Review Questions – GDP and Keynes
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 net 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 income method. Explain why
summing up the gross incomes would yield an incorrect estimate of GDP.
iii. Calculate the GDP of this imaginary economy using the expenditure method. Why must the
income and expenditure methods yield the same result?
2. Draw, label and explain the circular flow of income and expenditure.
3. With reference to the circular flow, explain the concept of an equilibrium level of GDP.
4. In the Keynesian system, what forces operate to restore GDP to its equilibrium value if
disequilibrium prevails?
5. 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?
6. Explain the concept of the marginal efficiency of capital (use a numerical example if
required).
7. 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. 8. Investment expenditure, for Keynes, is driven by animal spirits. Explain. What implications
does this have for the attainment of full employment equilibrium?
9. Distinguish between necessary and idle cash balances. Why, according to Keynes, do
individuals hold idle cash balances?
10. 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?
11. Why, in the Keynesian system, does fiscal stimulus held in attaining full employment?
Explain with the aid of the Keynesian Cross.
12. Explain the working of the Keynesian multiplier.
13. In the Classical Model individuals do not hold any idle cash balances. Explain.
14. The absence of idle cash balances ensures that every level of GDP is an equilibrium level of
GDP. Explain.
15. In the Classical Model there are no forces impeding the establishment of full employment
GDP. Explain.
16. With fully flexible wages the economy always settles at the full employment level of GDP.
Explain.
17. What form of unemployment is consistent with the Classical Model?
18. Why is monetary policy ineffective in the world of the Classical Model?