Universitat Pompeu Fabra Introduction to Macroeconomics 2020-21

Instructor:

Problem set 1

All necessary readings can be found in Aula Global

1. Professor Sir Charles Bean discusses the measuring of economic activity in reading 1
and in the related video, https://voxeu.org/article/rethinking-measurement-economic-activity

1.1 Consider graph A, where technology is evolving but GDP appears to be falling. How
could you rationalize such a phenomenon?
1.2 Comment graph B, explain why measured GDP growth is likely to underestimate
the actual economic growth in UK over the years 2007-2015.
A B

GDP

Years

Hints for solution:

There are two features of the Digital Economy that we focus on here:
1. Free goods – E.g. Phonecalls, maps
2. New goods/services – E.g. Smartphones, facebook

Smartphones substituted
• Camera
• Alarm Clock
• Music Player
• Calculator
• Computer
• Game Machine
• Movie Player
• Recording Device
• Video Camera
• Data plan • GPS Map and directions
• E-book reader
• Fitness monitor
• Instant messaging
Free goods and new goods are poorly measured by GDP

- Downloading music or paying a flat rate subscription, whastapp, skype… versus CD,
phone calls.

- an increasing share of consumption is made up of digital products delivered at a zero

price or funded through alternative means such as advertising

- instead of visiting a travel agent, you use free online travel booking services, but by
convention, home production activities are not counted as part of GDP

- new form of digital communication appears to be largely absent in official statistics;

the last ten years has seen a tailing off in the growth rates of both consumption and
production of the telecommunication sector

- the current treatment of digital products in the national accounts inevitably tends to
result in the underestimation of the value generated by the digital economy.

Diane Coyle (2017): “The pace of change in the OECD countries is making the existing statistical
framework decreasingly appropriate for measuring the economy”

Charlie Bean (2016): “Statistics have failed to keep pace with the impact of digital technology”

Hal Varian (2015): “There’s a lack of appreciation for what’s happening in Silicon Valley,
because we don’t have a good way to measure it.”

2. The following statements are false. Explain why.

a/ Deflation means a decrease in the inflation rate

Deflation is a decrease in the general prices of goods and services. Deflation occurs when
the inflation rate falls below 0% (a negative inflation rate). This allows one to buy more goods
and services than before with the same amount of currency. Deflation is distinct
from disinflation, a slow-down or decrease in the inflation rate. (TERESA: I would add the
sentence in italics below, as the questions talks about “decrease in the inflation rate” and not
only “disinflation”: A decrease in the inflation rate could also occur when deflation becomes even
more negative over time. But we could have deflation without a decrease in the inflation rate if
the deflation this year is less negative than in the previous year.)

b/ In an economy you cannot simultaneously observe an increase in the price level and a
decrease in the inflation rate (both calculated using the CPI – Consumer Price Index). Propose a
numerical example to illustrate your answer.
False: prices may increase but at a lower rate than the previous period → higher price level +
lower inflation rate.
Example: an economy in which cars are consumed by individuals:
Year 2001 2002 2003
Quantity produced 10 12 14
Price 2000 3000 3500
The prices increase between 2001 and 2003 but π02=50% y π03=16.6%

c/ If nominal economic growth in a mature and developed economy is 10% we can affirm these
are good news since it implies a generous increase in production and its expected net creation
of jobs. Give an example (in very basic economy producing one good) showing why this may be
wrong.
Nominal GDP is the sum of the quantities of final goods produced multiplied by their current
prices. This definition just makes clear that nominal GDP can increase over time for two reasons:
● The production of most goods increases over time.
● The prices of most goods also increase over time.
If our goal is to measure production and its change over time, we need to eliminate the effect
of increasing prices on our measure of GDP. That’s why real GDP is constructed as the sum of
the production of final goods multiplied by constant (rather than current) prices.

d/ A HCPI Inflation higher than inflation measured by the GDP deflator could be explained by a
decrease in the price of imported consumption goods.
A decrease in the price of imported goods, consumed but not produced in the country, would
have the opposite effect: HCPI Inflation lower than that measured by GDP deflator

3.With the information from reading 2: BBVA Research, Spain Outlook 3Q20, from slide 20
onwards (https://www.bbvaresearch.com/publicaciones/situacion-espana-cuarto-trimestre-2020/) Expain

3.1 why In October 2020, the behavior of external demand helps the recovery of Spanish
GDP?

Solution:

EXPORTS:
A strong recovery in exports of goods is expected in 3Q20… ...mainly supported by the food
and automotive sectors… …despite the poor performance of foreign visitor spending in Spain.

IMPORTS:
Decrease in imports: atypical concentration of the expenditure on domestically produced
goods.

recovery in expenditure being concentrated in sectors that are more intensive in the use of
domestic inputs.

3.2 GDP growth is going to be lower than it was expected. Give three reasons sustaining the
downward revision of GDP growth
Spanish exports lower than expected
Decrease in private investment, up to now, investment hardey decreased due to existing
projects that now come to an end.
Deterioration in expenditure: C and X (tourism)

4. Explain, using the information from the graph below (source: BBVA Research), the impact of
the financial and the COVID crisis on the Spanish economy. Some key words you can use:
inequality, remote working, private sector, public sector.

Note that changes in social security affiliation reflect changes in employment: higher levels of
employment correspond to higher levels of social security affiliation.

08-09

Present crisis:
an unequal decrease in employment across sectors
Those companies where employees can work from home, suffered less
Employment linked to tourism suffers the most
Public employment hardly changes versus that of private sectors´
No sector shows increases in employment

Previous crisis:
Sharp contraction of employment in the construction sector
The possibilities of teleworking hardly influence employment: it seems that it does not matter if
you can do remote work
Public administration employment does not suffer.
No sector shows increases in employment

5. Let us go back in time now, to 2019. Go to reading 3: Economic Watch for The Spanish
Economy, Dec 2019, and answer:

a. “What is the relative contribution of each component of aggregate demand to its total
growth?? Using your notes from lectures, detail the components of the domestic demand in
an economy.
According to the article, “consumption supports the increase in domestic demand”. Domestic
demand for goods is given by the identity: DD = C + I + G. Therefore, the observed increase in Z
(total demand) is primarily being caused by an increase in C (consumption demand). C is
expected to grow 0.8%
Find below the weights of GDP components, Demand perspective, in 2018, very similar to
those in 2019. We do not expect students to have this information, however, showing the
table we can ask them, during the session, to put data from both sources together, and answer
the question.

Source: https://ec.europa.eu/economy_finance/forecasts/2020/spring/ecfin_forecast_spring_2020_es_en.pdf

b. Focusing now on the behavior of inflation: What is the difference between the headline and
core (underlying) inflation rates? Define and explain the different values in 2016 and 2019
shown in Figure 7
Headline inflation is a measure of the total inflation within an economy, including commodities
such as unprocessed food and energy prices, which tend to be much more volatile. On the
other hand, core inflation is calculated by subtracting changes in unprocessed food and energy
prices from headline inflation.

The reason prices of unprocessed food and energy are subtracted from headline inflation to
calculated core inflation is because headline inflation may not present an accurate picture of
an economy's inflationary trend. This is because inflationary spikes in the energy and
unprocessed food industries are unlikely to persist.
From Figure 7: headline inflation is negative (deflation) in the first three quarters of 2016 and
positive in the fourth quarter of 2016. As we can see this is driven by changes in energy prices
(a slump in oil prices). Core inflation was relatively constant while energy prices decreased
substantially in the first half of 2016 and increased substantially in the second half of 2016.
In 2019, core inflation is again relatively constant (in fact it is relatively constant for all of May-
2015 to November-2019). In the first half of 2019 there was moderate headline inflation
whereas in the second half there was near zero inflation. Again, this variation was driven
primarily by changes in energy prices.

c. In Figure 6 we see that in mid 2017 there is an increase in employment (shown through
“social security affiliation”) and a decrease in unemployment. However, in December 2019 the
increase in employment does not imply a decrease in unemployment. Explain why this
happens.
The employment rate is defined as the percentage of the population who have a job
(employment rate = % of people employed/working age population*100) whereas the
unemployment rate is the percentage of people in the labor force who do not have a job
(unemployment rate = # of unemployed/labor force*100).

A hypothetical example of how both the employment rate and unemployment rate could
increase simultaneously could be: suppose the working age population of Spain remains
constant at 45 million, the number of jobs increases from 20 million to 21 million and the
number of people in the labor force increases from 25 million to 30 million. Then the
employment rate would increase from 44% to 47% but the unemployment rate would also
increase from 20% to 30%

Note that:
• An increase in the number of people in the labor force along with no change in the
population increases the participation rate (participation rate = labor
force/population*100)
• An increase in the participation rate along with no change in employment increases
the unemployment rate but has no effect on the employment rate.
• An increase in the number of jobs along with no change in the participation rate,
increases the employment rate and decreases unemployment rate

So, in this example the employment rate unambiguously increases because of

- increases in the participation rate larger than the increase in the number of jobs.

6. Suppose you have the following information about the economy of a country. There are 10
million working age persons. Of those, 5 million are employed, 2 million are looking for a job, 1
million stopped looking for a job more than two months ago and the rest, 2 million, do not want
to work at all.

A/ Show the unemployment, participation and employment rates.

Working-age population (WAP) = 10

Employed: E =5 Unemployed: U = 2 Labor force: L = E + U = 7
!
Unemployment rate: u = U / L = !"" × 100 = 28.57 %
"
Participation rate: PR = L / WAP = !#$" × 100 = 70%
Employment rate e = E / WAP = ( 5/ 10) * 100 = 50 % be aware of this ratio, Employment rate
is calculated with respect to working age population, not Labour force!!
B/ Now suppose that of the 2 million individuals looking for work, 0,8 million stop looking for
work. Given this change, show the unemployment, participation and employment rates.

Employed: E = 5 Unemployed: U = 2-0.8=1.2 Labor force (active population): L = E + U =

5+1.2=6.2
#.!
Unemployment rate: u = U / L = !&.!" × 100 = 19.35 %
Employment rate e = E / WAP = (5 / 10 )*100 = 50 %
The unemployment rate is now lower, but not because people have found a job, but because
they were discouraged and went out of the labor force.