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Universidad Carlos III de Madrid – Department of Economics

Principles of Economics - Problem Set 9

Conceptual Questions

Write down a short and concise answer. When you are asked to solve the question in class,
explain the concept clearly and give examples or pieces of evidence.

1. Why we say that national savings are equal to investment? What assumption
is crucial for the statement being true?
We say national savings are equal to investment because of the mathematical equality.
Y=C+I+G I=Y-C-G
Is crucial for the assumption of being a closed economy without NX for these statements to
be true.

2. Why the supply of loanable funds has a positive slope and the demand for
loanable funds has a negative slope?
The supply of loanable funds is positive because of the interest rate being treated as the
price, so the bigger the interest rate the more people will want to supply loanable funds.
Whereas, in the demand side when the interest rates are high less people will want to ask
for loanable funds making them negative.

3. What is the difference between the natural rate of unemployment and the rate
of unemployment during a recession?
The natural rate of unemployment refers to the rate of unemployment when the market is
in balance. Different from the rate of unemployment when a recession is hit which is
higher and the market gets unbalanced.

4. Is true that if a person losses her/his job, unemployment rate always

increases?
No, if:
The person finds another job within 4 weeks
The person decides not to look for a job
The job is given to an unemployed person

5. Explain why it is the case that some prices increase but the CPI does not
increase.
This can be the case when the prices that increased do not take part of the CPI or other
products within the basket decrease at the same time.

6. Why an increase of 10% in the price of bread will have a larger impact in the
CPI than an increase of 10% in the price of salt.
The price of bread has more weight than the price of salt in the basket. This will be
subjective depending on the basket being referred to.

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 Problems

1. In an economy, two goods are produced in: orange juice and

sandwiches with the following prices
a) Calculate the price index for this economy if the basket is 1 liters of orange
juice and 1 sandwich and the base year is 2012.
b) Calculate the price index for this economy if the basket is 1 liter of orange
juice and 15 sandwiches and the base year is 2012.
GOODS Orange juice Sandwiches Cost of Basket CPI Cost of Basket CPI
$(per liter) $ 1&1 1 & 15
2012 3 2 5 100 33 100
2013 6 2 8 160 36 109.9
2014 6 4 10 200 66 200
c) Compare the evolution of the price indexes and explain why they behave
differently.
Use the inflation between year 2013 and 2014 for basket a and b.
Basket A inflation 2013 = 60%
Basket A inflation 2014: 100x (200-160)/160=25%
Basket B inflation 2013 = 9%
Basket B inflation 2014: 100x (200-109)/109=9%

Fluctuation varies in a lower degree. Basket A suffers a higher inflation rate than basket B.

2. Explain what happens to savings, investments and interest rate if

a) The government decides to reduce public expenditure (G) but it does not
change tax revenues (T)
If the Government decides to reduce public expenditure and keep taxes at the same rate the
total savings will increase. Then the supply of funds curve will shift to the right and the
new equilibrium will have lower interest rates and a higher investment.

b) What would be the impact of such a measure in the prospective for economic
growth in the long run?
In the long run it will have a positive impact on the economic growth, there will be an
increase in the accumulated capital.

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3. According to the EPA (Encuesta de Población Activa) in the second
quarter of 2018 in Spain there were 22,834.2 thousand active people,
19,344.1 thousand occupied and 3,490.1 thousand unemployed.
Activity rate was 58.80%.
a) Calculate unemployment rate and population older than 16
Adult population: 22,834.2/0.588 = 38,833.7
Unemployment rate: (unemployed people/active people) x 100 =15.3%
b) Recalculate unemployment rate if 1,000 thousand individuals lose their job
and become immediately non-active.
Unemployment rate”: 19.66%

Other questions

1. Suppose that in a closed economy GDP is 10,500, consumption is 7,500, and taxes
are 500. What value of government purchases would make national savings equal
to 2,000 and at that value would the government have a deficit or surplus?
a. 1,500, deficit
b. 1,500, surplus
c. 1,000, deficit
d. 1,000, surplus

2. If the government currently has a budget deficit, then

a. the current level of public debt must be above zero.
b. its debt is increasing.
c. government expenditures are lower than taxes.
d. All of the above are incorrect.

3. If there is a sudden increase in the oil price (not produced in Spain). What will be
the behavior of the GDP deflator in relation to the CPI?
The GDP deflator will not record the information of the oil going up but the CPI will see
an increase in the total value of the basket.

4. The inflation rate is defined as the

a. price level in an economy.
b. change in the price level from one period to the next.
c. percentage change in the price level from the previous period.
d. price level minus the price level from the previous period.

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5. Suppose that the adult population in the town of Springfield is 225 million. If 40
million are unemployed and 100 million are employed, then the unemployment
rate is approximately
a. 29%.
b. 18%.
c. 24%.
d. 6%.

6. Which of the following helps to reduce frictional unemployment?

a. government-run employment agencies
b. public training programs
c. the Internet
d. All of the above are correct.

7. Assume an economy experienced a positive rate of inflation between 2003 and

2004 and again between 2004 and 2005. However, the inflation rate was lower
between 2004 and 2005 than it was between 2003 and 2004. Which of the following
scenarios is consistent with this assumption?
a. The CPI was 100 in 2003, 110 in 2004, and 105 in 2005.
b. The CPI was 100 in 2003, 120 in 2004, and 135 in 2005.
c. The CPI was 100 in 2003, 105 in 2004, and 130 in 2005.
d. The CPI was 100 in 2003, 90 in 2004, and 88 in 2005.

Edx courses macro micro