Macroeconomics

Problem Set 1 Solutions

1. You’ve been given the following data:

Net non-business interest income 27

Government purchases 600
Gross private investment 500
Depreciation 10
Net exports -50
Personal consumption 2,500
Foreign factor income earned domestically 320
Income from foreign domestic factor sources 300

On the basis of these data calculate GDP, NDP, and GNP.

Answer:
(1) GDP = C + I + G + (X – M) = 2,500 + 500 + 600 + (–50) = 3,550.
(2) NDP = GDP – Depreciation = 3,550 – 10 = 3,540.
(3) GNP = GDP + Net foreign factor income = 3,550 + (300 – 320) = 3,530.

2. Determine the amount contributed to GDP from the sale of 200,000 copies of the CD by
R.L. Burnside (on Fat Possum Records) entitled “Too Bad Jim” by filling in the table below.
Base your answer on the following information:
R.L. receives $3 per CD in royalties.
Fat Possum sells each CD to wholesalers for $10.
Wholesalers sold the CD to retailers for an average price of $12 per CD.
Retailers sold 200,000 CDs to consumers for $15 per CD.
Demonstrate how the value-added approach equals the final sales approach.

Participants Cost of Value of Sales Value added

Materials
R.L.
Fat Possum
Wholesalers
Retailers
Totals
Answer:
The amount contributed to GDP from the sale of R.L.'s CDs is $3,000,000. The completed
table:

Participants Cost of Value of Sales Value added

Materials
R.L. $0 $600,000 $600,000
Fat Possum $600,000 $2,000,000 $1,400,000
Wholesalers $2,000,000 $2,400,000 $400,000
Retailers $2,400,000 $3,000,000 $600,000
Totals $5,000,000 $8,000,000 $3,000,000

The final sales approach is the value of CDs sold to consumers—$3,000,000. This is equal to
the value-added approach, $3,000,000, calculated in the final column.

3. Assume an economy produces just cars and computers; use the information in the table
below to answer the following questions about the GDP.

Cars Computers
Year Quantity Price Quantity Price
2009 100 $10,000 1,000 $1,000
2010 110 $12,000 1,100 $900

(1) Calculate nominal GDP in 2009 and 2010. What is the growth rate in nominal GDP?
(2) Using 2009 as a base year, calculate real GDP in 2010. What is the growth rate in real
GDP?
(3) Calculate the GDP deflator in 2010.

Answer:

(1) Nominal GDP in 2009 = (100 × $10,000) + (1,000 × $1,000) = $2 million.

Nominal GDP in 2010 = (110 × $12,000) + (1,100 × $900) = $2.31 million.
Growth in nominal GDP = ((2.31 – 2)/2) × 100 = 15.5%.

(2) Real GDP in 2010 = (110 × 10,000) + (1,100 × 1,000) = $2.2 million.
Growth in real GDP = ((2.2 – 2)/2) × 100 = 10%. [Note: Use base year prices to calculate real
GDP].

(3) GDP deflator in 2010 = (nominal GDP 2010/real GDP 2010) × 100 = (2.31/2.2) × 100 =
105.
4. Answer all of the following questions concerning GDP growth.
(a) Nominal GDP increases from $5 trillion to $5.5 trillion while the price level increases by
10%. Has real income increased?
(b) Nominal GDP increases from $6 trillion to $6.8 trillion while real GDP increases from $6
trillion to $6.2 trillion. What happened to the price level?
(c) Nominal GDP increases from $7 trillion to $8 trillion while real GDP increases from $7
trillion to $7.5 trillion. By what percent did real income change?

Answer:

(a) No, real income has not increased. To see this, compute the value of real GDP by dividing
nominal GDP by the GDP deflator. Since prices increased by 10%, the GDP deflator to use is
1.10. Thus real GDP = 5.5/1.1 = 5. That is, real output did not grow, so we can conclude that
real income did not grow.

(b) The price level increased by 9.7%. To compute this, use the following formula: real GDP =
(nominal GDP/GDP deflator). Rewriting this formula to solve for the GDP deflator yields the
following: GDP deflator = (nominal GDP/real GDP) = 6.8/6.2 = 1.097. Thus the GDP deflator
increased from 1 to 1.097 which shows a price level increase of 9.7%.

(c) Real income increased by 7.1%. To determine what happened to real income, determine
the change in real GDP (the information on nominal GDP is not needed). Real GDP grew by
.5/7 = .071 or 7.1%, which is the increase in real income.

5. Fill in the blanks of the following table and answer the following questions.

(a) Does the table indicate there is inflation? Explain your answer.

(b) What was the percentage change in nominal GDP in 2006 and 2007? Inflation? Real
GDP?

Answer:

(a) There is inflation because the GDP deflator has increased in each year.

(b) See the table below.

6. Assume you live in a country with the following data:
Households’ expenditure (C): 300
Gross Investments (I): 400
Government current spending (G): 100
Exports (X): 500
Imports (M): 300

a) Compute the GDP.

b) Now imagine that next year C will rise by 5 per cent, whereas I and G both drop by 10 per
cent each. Imports and the GDP itself will remain constant. What will happen to the trade
balance?

Answer

a) Y = C + I + G + (X - M) = 300 + 400 + 100 + (500 – 300) = 1000

b) Writing the time index for the current period as t and for the next period as t+1, you get:
𝐶𝑡+1=𝐶𝑡×1.05 = 300×1.05 = 315 ;
𝐼𝑡+1 = 𝐼𝑡×(1−0.1) = 400×0.9 = 360;
𝐺𝑡+1= 100×0.9 = 90;
𝑌𝑡+1=𝐶𝑡+1 + 𝐼𝑡+1 + 𝐺𝑡+1 + 𝑋𝑡+1 − 𝑀𝑡+1
Or, 1000 = 315 + 360 + 90 + 𝑋𝑡+1− 300 ⇔ 𝑋𝑡+1 = 535
𝑋𝑡+1 − 𝑀𝑡+1 = 535 – 300 = 235.
The trade balance (net exports) is larger now that imports have fallen.

7. You live in a country called Motoria (M). Motoria produces only two products: Cars and
Motorcycles. The Output and Prices of these goods are shown in the following table:

Year Output (Cars) Price (Cars) Output Price

(Motorcycles) (Motorcycles)
2014 300 1000 70 200
2015 300 2000 80 500
2016 500 2500 100 550

a) Calculate the nominal GDP for all 3 years.

b) Compute the annual growth of the nominal GDP.
c) Calculate the real GDP in 2015 and 2016 using the previous year as the base year.
d) Compute the annual growth rate of real GDP.

Answer

a) 2014: Ynom = 300 x 1000 + 70 x 200 = 314 000

2015: Ynom = 300 x 2000 + 80 x 500 = 640 000
2016: Ynom = 500 x 2500 + 100 x 550 = 1 305 000
b) From 2014 to 2015: (640−314)/314=103.8%
From 2015 to 2016 : (1305−640)/640=103.9%

c) 2014: Yreal = 300 x 1000 + 70 x 200 = 314 000

2015: Yreal = 300 x 1000 + 80 x 200 = 316 000
2016 : Yreal = 500 x 2000 + 100 x 500 = 1 050 000

d) From 2014 to 2015 : (316−314)/314=0.6%

From 2015 to 2016 : (1050−316)/316=232.3%

8. Orange growers sell $15 billion of their crop to orange juice processors and $6 billion of
their crop to supermarkets. The orange juice processors sell their orange juice to
supermarkets for $18 billion. The supermarkets sell oranges to consumers for $8 billion,
orange juice to consumers for $18 billion and orange juice to restaurants for $4 billion. The
restaurants sell the orange juice to consumers for $8 billion.

a. Calculate the amounts orange and orange juice contribute to GDP.

b. Calculate the value added by orange growers, orange juice processors, supermarkets and
restaurants.

Answer

a. Consumers buy eight billion dollars from supermarkets, which is the amount oranges
contribute to GDP. Consumers buy 18 billion dollars in orange juice from supermarkets and
eight billion dollars in orange juice from restaurants. So orange juice contributes 26 billion
dollars to GDP. Together, oranges and orange juice contribute 34 billion dollars to GDP.

b. The value added by orange growers is 21 billion dollars, the value of the crops that they
sold to orange juice processors and supermarkets. The value added by orange juice
processors is three billion dollars which is the difference between what they sell orange juice
to supermarkets for and what they pay orange growers for their oranges. The supermarkets
add two billion dollars in value to oranges, which is the difference between what consumers
pay to buy oranges from supermarkets and what supermarkets pay the oranges growers for
the oranges. Supermarkets add four billion dollars to the value of orange juice, which is the
difference between what they sell orange juice to consumers and restaurants for and the
amount the supermarkets pay to the processors for the orange juice. So supermarkets add a
total of six billion dollars to the value of output. Finally, restaurants add four billion dollars to
the value of orange juice, which is the difference between what they sell orange juice to
consumers and what restaurants pay to the supermarkets for the orange juice. The total of the
values added by orange growers, orange juice processors, supermarkets, and restaurants
equals 21 + 3 + 6 + 4 = 34 billion dollars, which equals the combined value of oranges and
orange juice purchased by consumers.