ECON 162B-A0, A1 Kenny Christianson

Fall 2010 due: October 29

ANSWER KEY – PROBLEM SET NUMBER FIVE

1. a. GDP = C + I + G + (X - M) = 17,500 + 6,250 + 7,500 + (-750) = 30,500

b. NI = W + i + R + profits = 22,500 + 2,500 + 750 + 3,750 = 29,500

c. NNP = GNP - depreciation = 30,500 - 250 = 30,250

d. Statistical Discrepancy = NNP - NI = 30,250 - 29,500 = 750

2. a. No, the Friends of the Earth does not feel that GDP is a good measure of economic
welfare. GDP is a brute measure of progress which doesn’t take into account how the
side-effects of economic growth can make us worse off.

“GDP takes no account of increasing inequality, pollution or damage to people’s health

and the environment. It treats crime, divorce, and other elements of social progress as
economic gains.”

b. The Index of Sustainable Economic Welfare attempts to adjust GDP to include

better indicators of the quality of life. It tries to measure increases in the quality of life,
not just increases in output. Overall, there are 19 adjustments which the ISEW makes to
GDP calculations. The Index is calculated by the Centre for Environmental Strategy and
the New Economics Foundation, in collaboration with the Friends of the Earth and other
groups, mostly British. It has been calculated for 8 countries.
The ISEW adjusts GDP in several ways. It includes calculations for such
indicators as income inequality, domestic labor, health, education, services from
consumer durables, air pollution, climate change and ozone depletion, and other factors
such as the costs of commuting, car accidents, the costs of noise and water pollution, and
loss of habitat and farmlands. In this way, ISEW provides a better measure of the quality
of life in an economy.

3. After doing the exercise, you should find that everyone in the world can’t live like
you. Most of us take about 10 – 30 acres per year to support ourselves, and we would
need 3 – 5 planets if everyone on the planet lived like us. There are many ways to reduce
our global footprint. We could eat less meat, drive less, take trains rather than planes,
buy second hand clothing, or live in New York City.

4. a. According to the news release of September 16, 2010 for the second quarter of
2010, the U.S. current-account deficit increased to $123.3 billion in the second quarter of
2008 from $109.2 billion in the first quarter. “The increase was more than accounted for
by an increase in the deficit on goods.”
Econ 162B-A0, A1 Fall 2010 Answer key 5 2

b. The major components of the Balance of Payments discussed are:

Current Account:
Goods – The deficit on goods increased.
Services – The surplus on services increased.
Income – The surplus on income increased.
Unilateral current transfers – net unilateral current transfers decreased.
Capital and Financial Accounts:
Capital Account – net outflows remained close to zero.
Financial Account –
U.S.-owned assets abroad increased.
Foreign-owned assets in the U.S. increased.

5. Trade one dollar for 100 yen, then trade 100 yen for ½ euro, then trade ½ euro for one
dollar. Since you started with a dollar and ended up with a dollar, you can’t get rich in
this market. This is an example of purchasing power parity for currency.

6. To calculate which bond you should purchase, consult the following table:

today next year

Buy U.S. bond pay $10,000 receive $10,000(1 + 0.1) = $11,000

Buy French bond trade $10,000 for

$10,000 x 0.8 =
8,000 euros worth
of French bonds receive 8,000(1 + 0.08) = 8,640 euros

trade 8,640 euros for 8,640/0.5 =

$17,280

Since the U.S. bonds pay a total of $11,000 (10% return) and the French bonds pay a total
of $17,280 (72.8% return), you would be better off purchasing the French bonds, unless
you really hate France.