Financial Management Problems

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1. The rate of inflation computed using the CPI is better index of inflation than the rate of inflation computed using the GDP inflator.

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True: The CPI is the best measure for adjusting payments to the consumers when the plan is to permit customers to buy at today's costs, a business basket of merchandise and services comparable to one that they could buy in a prior period. It is additionally the best measure to use to decipher retail deals and hourly or week after week income into real or inflation-free dollars.

2. The propensity to consume has to be positive, but beyond that it can take on any positive value.

False: The prosperity must be less.

3. The equilibrium condition for the goods market states that consumption equals output.

False: At the equilibrium demand is always equivalent to output.

4. An increase of one unit in government spending leads to an increase of one unit in equilibrium output.

False: if one unit increase in government spending, it results to more than one unit increase in output, since the multiplier is larger than 1.

5. The demand for money does not depend on the interest rate because only bonds earn interest.

False: The demand for money depends on the interest rate in as much as the bonds may earn interests.

6. The central bank can increase the supply of money by selling bonds in the market for bonds.

True: This is to increase money supply and is focused on reducing interest rates.

7. Bond prices and interest rates always move in opposite directions.

True: When the interest rate rises the bond price decreases, since their relationship can be described as follows: P=100/1+i

8. The LM curve is upward sloping because a higher level of money supply is needed to increase output.

False: The upward sloping LM curve shows the relationship between output and the rate of interest, because equilibrium in financial markets implies that as output increases, so does the demand for money and, thus the equilibrium interest rate.

9. During a given year, the following activities occur: a silver mining company pays its workers $200,000 to mine 75 kilograms of silver. The silver is the solid to a jewelry manufacturer for $300,000. The jewelry manufacturer pays its workers $250,000 to make silver necklaces, which it sells directly to consumers for $1,000,000. Using the Production of final goods approach, what is GDP in the economy? In this approach the goods that have been purchased for final use or goods that will not be resold or used in production within the year is considered?

$1,000,000 which is the value of the silver necklaces.

10. What is the value added at each stage of production? Using the value added approach, what is GDP?

VA= Value Added

VA in first stage VA1= $300,000 ($100,000 in profits and $200,000 in wages)

VA in second stage VA2 = $700,000 ($450,000 in profits and $250,000 in wages)

Therefore using the value-added approach the GDP can be derived as follows

GDP = VA1 + VA2

GDP= $300,000+ $700,000 = $1000,000

11. What are the total wages and profits earned? Using the income approach, what is GDP?

Wages: $200, 000+$250,000=$450,000

Profits= ($300,000-$200,000)+($1000,000-$250,000-$300,000)

=$100,000+$450,000= $550,000

GDP: $450,000+$550,000= $1,000,000

12. Suppose that in a given month in Kirkland, there are 18 million working-age people. Of these, only 14 million have jobs. Of the remainder, 2 million are looking for work. 1.5 million have given up looking for work and 0.5 million do not want to work. What is the labour force?

The labor force is the sum of those employed and those unemployed.

L= N + U

L- Labour force

N - Employed

U - Unemployed

Therefore: Number of employed + number of Unemployed

Therefore: 14 million + 4 million= 18 Million

13. What is the labour force participation rate?

Number of people actively in the labour force/Total number of people eligible to participate

Therefore: (14million/ 18 million) * 100 = 77.8

14. What is the official labor rate?

(Number of people / number of people) by 100

(18 million/ 18million)*100 =100

15. Suppose that the economy is characterized by the following behavioral equations:

C = 160 + 0.6Y D

I = 150

G = 150

T = 100

Solve for Equilibrium GDP (Y). The equilibrium condition will be given by Y=cY-T+ I+G ,YD=(Y-T). Substitute in the equation above and solving simultaneously to get Y.

Y=160+0.6 X Y-100+ 150+1500.4Y=460-60Y=1000 Disposable income (YD).

YD=Y-TYD=1000-100YD=900 Consumption spending (C).

C=160+0.6YDC=160+0.6 X 900C=7005.

16. We argued that the reason investment depends negatively on the interest rate is the following: When interest rate increases, and this discourages investment. However, firms often finance their investment projects using their own funds. Because no borrowing actually occurs, will higher interest discourage investment in this case? Explain.

It is very clear that several firms do not embrace borrowing as means of financing their projects. This is because the firms fear paying high interest rates charged on the loans borrowed by the firms.

However, firms have decide to finance the projects using their own funds, higher interest rates charged on loans will still affect the investment and possibly discourage the company from further investing in the project. This is because inflation in the interest rates tempts companies to save their money in deposit accounts because of the interests gained by their capital.

17. Using the IS-LM graph, determined the effects on out-put and an interest rate of a decrease in government spending. Why is the effect on investment ambiguous?

In this situation, both the IS and the LM graph will definitely shift to the right. The effect on the output is unambiguous that is increasing while the effect on the interest rate is uncertain as the shift in the IS definitely causes a drastic increase in the interest rate while the shift in LM will do the opposite.

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