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SubjectB.A.
, BACHELOR OF ARTS
ASSIGNMENT
SECOND SEMESTER
B.ECO-201 (Fundamentals of Economics)
Q.1 Explain the roles of household, firm and government in the circular flows.
Answer
Households are buyers in the market for goods and services. Households
exchange income for goods and services. Businesses are sellers in the market
for goods and services. Businesses sell goods and services in exchange for
money, which in this case is called revenue.
Q.2 Explain the equilibrium in commodity and money markets with the help of
IS and LM curves.
Answer
This brief work is designed to provide additional ammunition for the student in
the ongoing war against IS/LM confusion and ignorance. The author has
claimed in his Notes on Macroeconomic Theory (1995) that, There should be
no mystery or uncertainty surrounding the IS/LM analysis at this point. IS/LM
curves are simply a short-cut to finding the equilibrium values for income and
interest rate. There are two equations and two unknowns—what simpler
strategy than to put them on one graph could be devised? (p. 52) The author
still worries, however, that the student is memorizing the equilibrium
condition, IS=LM generates Ye, without really understanding why the condition
works. Most students are unable to explain why setting IS equal to LM
generates the equilibrium level of output. I have, on rare occasion, heard a
student give the following explanation: "Along the IS curve the goods market is
in equilibrium; along the LM curve the money market is in equilibrium.
Therefore, for both markets to be in equilibrium, the system must be on both
curves. This only occurs at the intersection of the curves." That's pretty good,
and it's the explanation I used in Notes on Macroeconomic Theory; but I still
worry that there is too little understanding and too much memorization. I very
much want to get across true, complete comprehension of this fundamental
macro tool known as the IS/LM graph. To do this, I undertake a detailed
analysis of the meaning of equilibrium in the IS/LM Model in the pages that
follow.
Q.3 Explain how Euler's theorem holds good in perfectly competitive markets
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