EXERCISES

CHAPTER 2: THE DATA OF MACROECONOMICS

Question 1
A farmer grows a bushel of wheat and sells it to a miller for $1. The miller turns the wheat
into flour and then sells the flour to the baker for $3. The baker uses the flour to make bread
and sells the bread to an engineer for $6. The engineer eats the bread. What is the value
added by each person? What is the bread’s contribution to GDP?

ANSWER: Value added by each person is the value of the good produced minus the amount the
person paid for the materials needed to make the good. Therefore, the value added by the farmer is
$1.00 ($1 – 0 = $1). The value added by the miller is $2: she sells the flour to the baker for $3 but
paid $1 for the flour. The value added by the baker is $3: she sells the bread to the engineer for $6
but paid the miller $3 for the flour. GDP is the total value added, or $1 + $2 + $3 = $6. Note that
GDP equals the value of the final good (the bread).

Question 2
Place each of the following transactions in one of the four components of expenditure:
consumption, investment, government purchases, and net exports.
a. Boeing sells an airplane to the Air Force.

b. Boeing sells an airplane to American Airlines.

c. Boeing sells an airplane to Air France.

d. Boeing sells an airplane to Michael Jackson.

e. Boeing builds an airplane to be sold next year.

ANSWER:
a. The airplane sold to the Air Force counts as government purchases because the Air Force
is part of the government.
b. The airplane sold to American Airlines counts as investment because it is a capital good
sold to a private firm.
c. The airplane sold to Air France counts as an export because it is sold to a foreigner.
d. The airplane sold to Amelia Earhart counts as consumption because it is sold to a private
individual.
e. The airplane built to be sold next year counts as investment. In particular, the airplane is
counted as inventory investment, which is where goods that are produced in one year and
sold in another year are counted.
Question 3
Consider an economy that produces and consumes bread and automobiles. In the following
table are data for two different years.

2000 2010
Good Quantity Price Quantity Price
Automobiles 100 $50,000 120 $60,000
Bread 500,000 $10 400,000 $20

Using 2000 as a base year, compute the following statistics for each year: nominal GDP, real
GDP, the implicit price deflator for GDP, and a fixed-weight price index such as the CPI.

i. Nominal GDP is the total value of goods and services measured at current prices.
Therefore,

Nominal GDP2000 = Pcars,2000 x Qcars,2000 + Pbread,2000 x Qbread,2000

= ($50,000 × 100) + ($10 × 500,000)

= $5,000,000 + $5,000,000

= $10,000,000.

Nominal GDP2010 = Pcars,2010 x Qcars,2010 + Pbread,2010 x Qbread,2010

= ($60,000 × 120) + ($20 × 400,000)

= $7,200,000 + $8,000,000

= $15,200,000.

ii. Real GDP is the total value of goods and services measured at constant prices.
Therefore, to calculate real GDP in 2010 (with base year 2000), multiply the quantities
purchased in the year 2010 by the 2000 prices:

Real GDP2010 = Pcars,2000 x Qcars,2010 + Pbread,2000 x Qbread,2010

= ($50,000 × 120) + ($10 × 400,000)
= $6,000,000+ $4,000,000
= $10,000,000
Real GDP for 2000 is calculated by multiplying the quantities in 2000 by the prices in 2000. Since
the base year is 2000, real GDP2000 equals nominal GDP2000, which is $10,000,000. Hence, real
GDP stayed the same between 2000 and 2010.

iii. The implicit price deflator for GDP compares the current prices of all goods and

services produced to the prices of the same goods and services in a base year. It

is calculated as follows:

Implicit Price Deflator2010 = Nominal GDP2010 / Real GDP2010

Using the values for Nominal GDP2010 and real GDP2010 calculated above:

Implicit Price Deflator2010 = $15,200,000 / $10,000,000 = 1.52

This calculation reveals that prices of the goods produced in the year 2010 increased by 52
percent compared to the prices that the goods in the economy sold for in 2000. (Because 2000 is
the base year, the value for the implicit price deflator for the year 2000 is 1.0 because nominal
and real GDP are the same for the base year.)

iv. The consumer price index (CPI) measures the level of prices in the economy. The CPI is called
a fixed-weight index because it uses a fixed basket of goods over time to weight prices. If the
base year is 2000, the CPI in 2010 is an average of prices in 2010, but weighted by the
composition of goods produced in 2000. The CPI2010 is calculated as follows:

This calculation shows that the price of goods purchased in 2010 increased by 60 percent
compared to the prices these goods would have sold for in 2000. The CPI for 2000, the base
year, equals 1.0.
Question 4

The economy of country A, in which two final goods (cars and motorcycles) and one
intermediate good (engines) are produced, can be described as follows:

Year Goods produced Price of goods Quantity

1998 Engines 5 150
1998 Cars 20 100
1998 Motorcycles 10 50
1999 Engines 10 230
1999 Cars 20 110
1999 Motorcycles 12 120

(a) Calculate the total GDP in nominal terms for year 1998

$GDP98 = Qcar, 98 x Pcar,98 + Qmotor,98 x Pmotor, 98

= 100 x 20 + 50 x 10
= $2,500

(b) Assume that the price for cars and engines does not change, while the price of motorbikes
increases by 20%. What is the nominal GDP in 1999? What is the real GDP in 1999 (base
year = 1998)?

Pmotor,99 = Pmotor,98 (1 + 0.2)

= 12

$GDP99 = Qcar, 99 x Pcar,99 + Qmotor,99 x Pmotor,99

= 110 x 20 + 120 x 12

= $3,640

GDP99 (base98) = Qcar,99 x Pcar,98 + Qmotor,99 x Pmotor,98

= 110 x 20 + 120 x 10

= $3,400
(c) Compute nominal GDP growth and real GDP growth. Are they different? Why?
The nominal GDP growth rate is = $GDP1999 - $GDP1998 / $GDP1998
= 3,640 – 2,500 / 2500
= 0.456
= 45.6% growth rate

The real GDP growth rate is = GDP1999 – GDP1998 / GDP1998

= 3,400 – 2,500 / 2,500
= 0.36
= 36%

The growth rate of nominal GDP is higher than the growth rate of real GDP. This is
because the price of the motorcycles has increased from 1998 to 1999.

(d) Calculate the inflation rate (the GDP deflator) between 1998 and 1999 using 1998 as base
year.

The GDP deflator is defined as (Nominal GDP99 / Real GDP). Taking 1998 as base year,
then we can get:

GDP deflator = Qcar,99 x Pcar,99 + Qmotor,99 x Pmotor99

Qcar,99 x Pcar,98 + Qmotor,99 x Pmotor98

= $3,640 = $1,071

$3,400

Which implies the inflation rate of 7.1%

Question 5

Suppose the following describes the economy (all figures in billions):

GDP $9,000
Investment $1,500
Consumption $5,000
Government purchases of goods & services $1,000

What is the value of net exports?

GDP = C + I + G + NX

NX = GDP – C – I – G

NX = 9000 – 5000 – 1500 – 1000

NX = 1500

Question 6

Consider the following data for a college student, Natalia. “P” is the price of each good. “Q” is the
quantity Natalia purchased during a year. “Share” will be the share of total spending accounted for
each of the five products.

Books Coffee Lattes Phone cards CDs

year P Q Share P Q Share P Q Share P Q Share P Q Share
1 80.00 8 0.252 1.00 250 0.098 2.50 500 0.492 20.00 12 0.094 16.00 10 0.063
2 84.00 8 0.248 1.05 275 0.107 2.85 475 0.5 19.20 12 0.085 16.16 10 0.06
3 88.20 8 0.272 1.10 450 0.191 3.30 300 0.382 18.40 13 0.092 16.32 10 0.063
4 92.60 8 0.293 1.15 550 0.25 3.80 200 0.301 17.70 13 0.091 16.48 10 0.065

For each year, calculate Natalia’s total spending and the share of her spending accounted for by
each of the five products. Write your answers in the table above.

Exm; Total spending in year 1 is :

(80 x 8) + (1 x 250) + (2.5 x 500) + (20 x 12) + (16 x 10) = 2540

The share spent on books is : 80 x 8 / 2540 = 0.252

Question 7

2002 2006
Product Quantity Price Quantity Price
Pizzas 100 $10 120 $12
Haircuts 50 $15 45 $20
Backpacks 200 $40 210 $45

Suppose that a very simple economy produces three goods: pizzas, haircuts, and backpacks.
Suppose the quantities produced and their corresponding prices for 2002 and 2006 are shown in
the table above. Use the information to compute real GDP in the year 2002 and 2006. Assume that
2002 is the base year. Is output higher in 2006 or 2002? Why?

ANSWER:
Recall that real GDP is found by valuing GDP in a particular year using base year prices. Since
2002 is the base year, real GDP for 2002 is found by multiplying 2002 prices by 2002 quantities
and then adding the values up. The individual values for 2002 are calculated in the following
table:
Question 8
Graph the market for foreign exchange (fx) at the right. The demand and supply curves are already
drawn but need to be labelled. Draw in an additional curve showing an increase in demand for
foreign exchange. What effect does an increase in demand for foreign exchange have on the price
of foreign exchange, e?

Pfx = e

Qfx

Question 9
For each activity listed below, indicate where the activity would be recorded on the expenditure
side of GDP accounting. Your choices are C, I, G, X, M, and (NR) not recorded. Give a brief
explanation for each answer.

a) You buy a new CD, manufactured in California, at BMG Tower Records.

C = You are (part of) a household, buying final good.

b) You buy a used CD at a local music shop

Mostly NR, but there is an entry in consumption. The markup of the used CD is in C. The
rest is not recorded. If the shop bought the CD for $5 for Rita and sold it for $8 to Iman,
then $3 ($8-$3) is in consumption and $5 is not recorded.

c) You buy a used bookcase at a garage sale

NR. This is just a transfer of assets between two households, nothing was produced.

d) BMG Tower Records buys a new permanent CD display racks that were manufactured in
North Carolina.
 I = the racks are permanent; they are not used up in the process of producing the final
product CDs for sale to consumers.

e) BMG Tower Records buys paint with which to paint sale signs on the windows
NR = the paint is an intermediate good; it is an input that is used up in the process of
producing the final product, CDs for sale to consumers. Look inside the paint can at the
end of the day and the paint can will be empty. It was used up.

f) You buy a new Toyota that was manufactured in Kentucky.

C = You are (part of) a household, buying a final good. If you were a business, this would
be investment spending because the car is not used up when it is driven. But assuming
you’re a person (and it’s hard to imagine a business doing all these questions, now isn’t
it?), this is consumption. The fact that the Toyota Motor Corporation is a Japanese-owned
corporation is irrelevant to the determination of GDP; what matters is the location of the
factory not its ownership. The Toyota factory in Georgetown, Kentucky, generates
employment in the U.S and so its product is counted as part of US GDP. If we were
discussing GNP (gross national product), then the ownership of the factory would matters.

Question 10

households export equilibrium CPI

GDP deflator GDP import Investment
decrease cyclical

a) GDP measures final goods and services produced in one year in a nation’s economy.

b) Export is/ are the value of goods and services sold to residents and businesses of other
countries.

c) The CPI measures average prices of consumer goods, using a fixed market basket of goods and
services.

d) The GDP deflator equals nominal GDP / real GDP * 100

e) C of the equation GDP= C + I + G + NX measures spending by households on foreign and
domestically produced goods and services.

f) Import is / are the value of goods and services sold to residents of the U.S. by residents and
businesses of other countries.

g) Conditions that must be true for the economy to be in balance are called equilibrium
conditions.

h) Investment refers to purchase of machinery, buildings, and infrastructure.

i) Cyclical unemployment is closely related with short-run ups and downs of the economy.

j) Increase in the number of people who are unemployed is associated with a decrease in real
GDP.

Question 11
U.S adult population by group, April 2002
Number employed : 134.0 million
Number unemployed : 8.6 million
Adult population : 213.5 million

Use the above data to calculate:

a) The labor force
b) The number of people not in the labor force
c) The labor force participation rate
d) The unemployment rate

Answers:
a) L = E + U = 134.0 + 8.6 = 142.6 million
b) NILF = POP – L = 213.5 – 142.6 = 70.9
c) U / L = 8.6 / 142.6 = 0.06 = 6%
d) L / POP =142.6 / 213.5 = 0.668 = 66.8%
Question 12

The following are the assumed supply and demand schedules for hamburgers in Collegetown:

Quantity Quantity
Price Demanded Supplied
$2.00 6,000 15,000
1.75 8,000 14,000
1.50 10,000 13,000
1.25 12,000 12,000
1.00 14,000 11,000
0.75 16,000 10,000

a) Plot the supply and demand curves and determine the equilibrium price and quantity.

2.0 Supply
0
1.7
5
1.5
0
1.2
5
1.0
0
0.7 Demand
5
0.5
0
0.2
5
2 4 6 8 10 12 14 16

b) What effect would a decrease in the price of beef (a factor of production) have on the
equilibrium price and quantity of hamburgers, ceteris paribus? Explain referring to the
graph.
A decrease in the price of an input shifts the supply curve to the right.

c) What effect would an increase in the price of pizza (a substitute commodity) have on the
equilibrium price and quantity of hamburgers, again ceteris paribus? Explain referring to
the graph
A rise in the price of a substitute good increases the demand. This shifts the demand curve
to the right.
Question 13
In the tiny island of Papaya Republic they once again need your help. You have been called to act
as a consultant to the government. The economy of Papaya Republic produces and consumes
papayas and laptop computers only. In the following table you can find data for two different
years:
Year 2000 Year 2007
Price of a laptop $5,000 $6,000
Price of papaya $10 $20
Number of laptops produced 100 200
Number of papayas produced 500,000 400,000

a) Using the Year 2000 as the base year, compute the following statistics for each year:
Nominal GDP; Real GDP; Real GDP growth rate; the price deflator for GDP; and a fixed-
weight price index like the CPI assuming that the typical Papayan consumer buys 125
papayas and 0.5 laptops every month.

b) What were the inflation rates according to the GDP Deflator and the CPI between year
2000 and year 2007?