hw1ansecon310fall09

7/23/2019 HW1ansecon310fall09

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Homework #1 Answers

ECO 31020 points possible

1 National Income Accounting (15 points)

Consider an economy that produces and consumes bread, coffee, and auto-mobiles. In the following table, we have data for two different years. Thefirst 2 questions refer to this table.

Year 2007 Year 2008

Price of 1 Automobile $20,000 $21,000Price of 1 loaf of Bread $1.25 $1.50Price of 1 cup of Coffee $2.00 $2.10

Number of Automobiles Produced 100 120Number of Cups of Coffee Produced 100,000 115,000

Number of Loaves of Bread Produced 400,000 380,000

1. Using the year 2007 as the base year, compute the followingstatistics for each year: nominal GDP, real GDP, the GDP deflator(a Paasche price index) and the CPI (a Laspeyres price index). For theCPI, assume that the representative basket of goods is exactly the one

produced in the year 2007Answer: To calculate nominal GDP for 2007 is

$20, 000 ∗ 100 + $1.25 ∗ 400, 000 + $2 ∗ 100, 000 =

$2, 000, 000 + $500, 000 + $200, 000 = $2, 700, 000

for 2008

$21, 000 ∗ 120 + $1.50 ∗ 380, 000 + $2.1 ∗ 115, 000 =

$2, 520, 000 + $570, 000 + $241, 500 = $3, 331, 500

To calculate real GDP for 2007, since 2007 is the base yearreal GDP 2007 equals $2,700,000

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for 2008 just use the 2007 prices

$20, 000 ∗ 120 + $1.25 ∗ 380, 000 + $2 ∗ 115, 000 =

$2, 400, 000 + $475, 000 + $230, 000 = $3, 105, 000

The amount of stuff produced in 2008, at 2007 prices is thereal GDP in 2008

To calculate the GDP deflator in both years simply divideNominal GDP by Real GDP, so for 2007

GDP deflator 2006 = $2.7 million/$2.7 million = 1

and for 2008

GDP deflator 2007 = $3, 331, 500/$3, 105, 000 = 1.073

For the CPI , just calculate it as a Laspeyres price index sothat

CP I t = a0 pat + b0 pbt + c0 pct

a0 pa0 + b0 pb0 + c0 pc0

where a stands for autos and b stands for bread. Since 2007is the base year the CPI equals one. For 2008,

CP I 2010 = 100 ∗ $21, 000 + 400, 000 ∗ $1.5 + 100, 000 ∗ $2.1

100 ∗ $20, 000 + 400, 000 ∗ $1.25 + 100, 000 ∗ $2

= $2, 100, 000 + $600, 000 + $210, 000

$2, 000, 000 + $500, 000 + $200, 000 =

$2, 910, 000

$2, 700, 000 = 1.078

2. How high was the inflation rate between 2007 and 2008, based on theGDP deflator, and based on the CPI? Answer: Based on the GDPdeflator, the inflation rate between 2007 and 2008 would be7.3%, based on the CPI it is 7.8%.

3. Consider the following events: Mr. Jordan buys for himself a hundredyear old Victorian house for $US 10 million, and Mr. O’Neal builds forhimself a brand-new villa for $US 15 million. How much do these eventstogether add to current GDP? $10 million, $15 million, or $25 million.Justify your answer. Answer: Since the Victorian house is not

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newly built, it is not included in GDP. Mr. O’Neal’s house

is newly built, hence it counts as residential fixed investmentin current GDP. Thus, the addition to current GDP is $15million.

4. Consider the following events: Mr. Merrill buys $5 million in IBM stockfrom Mr. Lynch on the New York Stock Exchange and General Motorssells $10 million in new stock to the public and uses the proceeds tobuild a new car factory. How much do these events together add tocurrent GDP? $0, $5 million, $10 million, or $15 million. Justify youranswer. Answer: When Mr. Merrill buys $5 million in stockhe invests $5 million, but Mr. Lynch disinvests $5 million and

overall investment from this transaction is zero. No additionalproduction occurred. On the contrary, GM buys a new carfactory for $10 million, which adds to nonresidential fixedinvestment. Hence the addition to current GDP is $10 million.

5. A farmer grows a bushel of wheat and sells it to a miller for $1.00. Themiller turns the wheat into flour and then sells the flour to a bakerfor $3.00. The baker uses the flour to make bread and sells the breadto an economist for $6.00. What is the value added by each person?What is GDP (if these were the only transactions in the economy)?Answer: The value added of the farmer is $1, the value added

of the miller is $3-$1=$2, and the value added by the bakeris $6-$3=$3. The value added of the economists is $0!! TotalGDP is equal to the sum of all the value added. Thus GDPis $6.

2 Calculating GDP (5 points)

Go to the BEA website (http://www.bea.gov) and reconstruct TABLE 2,titles ”Spending Components of Nominal GDP” using more recent data. Theinformation you need can be found in TABLE 1.1.5 of the NIPA tables. This

table will allow you to reconstruct GDP using the spending approach. Usethe most recent quarter that is available.

Answer: Here are the updated numbers up to the second quar-ter of 2009.

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Table 2: Spending Components of Nominal GDP

Component Billions US$ % Total Nom. GDPTotal Nom. GDP 14,143.3 100.0%Consumption (C) 9,996.6 70.7%

Durable Goods 1,011.0 7.2%Nondurable Goods 2,180.2 15.4%

Services 6,805.3 48.1%Gross Investment (I) 1,558.6 11.0%Nonresidential Fixed 1,387.3 9.9%

Residential Fixed 346.2 2.4%Inventory Investment --175.0 --1.2%

Government Purchases (G) 2,926.8 20.7%Federal Government 1,137.0 8.0%

State and Local Government 1,789.8 12.7%Net Exports (X-M) -338.7 -2.4%

Exports 1,492.2 10.6%Imports -1,830.8 -12.9%

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