Econ 116 I.

True/False/Uncertain:

Problem Set 1 Solutions

1. True: The expenditure approach and the income approach to measuring GDP yield the same result. When money is spent for a good or service, this is also income which is received by the firm. This, in turn, goes towards paying wages or other expenses such as interest or taxes, and what remains is corporate profit. 2. True: GDP is the total value of all goods produced and services provided in a given year. The child provided a service worth $20 and, assuming this is reported, is thus counted in GDP. False: A simple unilateral money transfer does not change the total value of goods or services produced that year. 3. False: Fords contribution to GDP is the value of all the products that is produces. However, this can be different from the amount that Ford actually sells, and any difference will be reflected in its inventory. If it produces more than it sells, its inventory will increase, and if it sells more than it produces, its inventory will decrease. 4. True: Inventories are finished goods which are produced by a firm, but not yet sold. Holding all else constant, an increase in inventories means that more goods were produced than sold in a given year. However, GDP measures the production, not sales, of goods and services, and therefore an increase in inventories, assuming everything else is unchanged, amounts to an increase in GDP. 5. True: The unemployment rate is the fraction of people who are in the labor force but do not have a job. However, if you do not have a job, to be counted in the labor force you must be actively looking for a job. So, if the number of employed people increases and the number of people looking for a job substantially increases, then it is possible for the unemployment rate to increase. 6. False: The measure of unemployment includes all individuals who are actively looking for a job, but do not have a job. Cyclical unemployment, caused by fluctuations in economic activity, is not the only reason for unemployment. The measure of unemployment also includes frictional unemployment and structural unemployment. Frictional unemployment is the unemployment that results from short run matching problems. It takes time and effort for workers to search for a job and employers to search for workers, and this friction in the labor market results in short run unemployment. Structural unemployment refers to the long run adjustment problems resulting from changes in the structure of the economy, but is not related to economic fluctuations. For example, increases in international trade have caused structural unemployment domestically when firms, and therefore jobs, have moved overseas. II.

1. 2010 IV to 2011 I: (13,227.9 13,216.1)/ 13,216.1 = 0.09% Quarterly Rate: 13,138.8 13,019.0 = 0.0092 = 0.92% 13,019.0 (1 + 0.00089)4 1 = 0.36% Annual Rate: (1 + .0092) 4 1 = 0.037 = 3.7%

2011 I to 2011 II (13,260.5 13,227.9)/ 13,227.9 = 0.25% Quarterly Rate: 13,191.5 13,138.8 = .004 = 0.4% 13,138.8 (1 + 0.00089)4 1 = 0.99% Annual Rate: (1 + 0.004) 4 1 = 0.016 = 1.6%

State and local government spending fell from $1.517 trillion in 2009 I to $1.456 trillion in 2011 II, then, the percentage decrease overall is: (1.456 - 1.517) / 1.517 = - 4.02 % this overall and then at an annual rate? Note that this decrease is over 9 quarters, whereas an annual rate is over 4 quarters. Therefore, the exponent you want to use is 4/9. (1 - 0.0402)4/9 1 = -1.81 % (1 0.272) 1 = 0.132 = 13.2% 2. The increase in the deficit reflects both a decrease in receipts from taxes and massive government spending increases that reflect several federal stimulus plans and projects. III 1. In July 2011, the value of the CPI was 225.992. One year earlier, the CPI was 218.011. So the percentage change was: (225.992 218.011) / 218.011 = 0.0366 = 3.66% In July 2010, the value of the CPI was 218.011. One year earlier, the CPI was 215.351. So the percentage change was:
4 9

218.011 215.351 = 0.012 = 1.2% 215.351

IPC 218.011 218.312 218.439 218.711 218.803 219.179 220.223 221.309 223.467 224.906 225.964 225.722 225.922 Inflation rate 0.14% 0.06% 0.12% 0.04% 0.17% 0.48% 0.49% 0.98% 0.64% 0.47% -0.11% 0.09%

Jul 2010 Aug 2010 Sep 2010 Oct 2010 Nov 2010 Dec 2010 Jan 2011 Feb 2011 Mar 2011 Apr 2011 May 2011 Jun 2011 Jul 2011

Therefore, there was deflation between May and June 2011. The annual deflation rate of that month was: (1 + 0.0011)12 = 0.0133 = 1.33 % IV 1. To find the price level in a given year using 2010 quantity weights, multiply the price of each good in that year times the quantity purchased in 2010, and sum across goods: 2009 Price Level = (5 x 100) + (4 x 80) + (10 x 200) + (13 x 50) + (20 x 20) = 3870 2010 Price Level = (7 x 100) + (4 x 80) + (15 x 200) + (15 x 50) + (22 x 20) = 5210 Percent Change: 5210 3870 = 0.346 = 34.6% 3870

To find the price level in a given year using 2011 quantity weights, multiply the price of each good in that year times the quantity purchased in 2011, and sum across goods: 2009 Price Level = (5 x 75) + (4 x 100) + (10 x 200) + (13 x 50) + (20 x 25) = 3925 2010 Price Level = (7 x 75) + (4 x 100) + (15 x 200) + (15 x 50) + (22 x 25) = 5225 Percent Change: 5225 3925 = 0.3312 = 33.12% 3925

Since the price change of each good is weighted differently, the inflation rates will be different depending on the base year used.

To find nominal GDP for a given year, multiply the price of each good times the quantity produced, and sum across goods: 2009 GDP = (5 x 100) + (4 x 80) + (10 x 200) + (13 x 50) + (20 x 20) = 3870 2010 GDP = (7 x 75) + (4 x 100) + (15 x 200) + (15 x 50) + (22 x 25) = 5225