Marcoeconomic Practice

Economics 102 Introductory Macroeconomics - Spring 2005, Professor J.
Wissink
Problem Set 3
Multiple Choice/True and False
1. Tom just bought shares of Google stock for $2,000 and paid a $30 commission to his broker. How did
this affect GDP?
a) GDP increased by $2030.
b) GDP increased by $2000.
c) GDP increased by $1970.
d) GDP increased by $30.
2. An economy which is experiencing rising rates of unemployment and inflation would be said to be in a
period of:
a) inflation
b) recession
c) stagflation
d) hyperinflation
3. Which of the following are examples of intermediate goods? (There is more than one in this list.)
a) a book written by your favorite author purchased by you
b) dough bought by a housewife to bake a cake for her daughter’s birthday
c) dough bought by a chef to bake a cake at his restaurant
d) a set of screwdrivers purchased by a small firm
e) wood purchased by a professional carpenter
4. True or False and EXPLAIN: The $15,000 spent by a furniture firm in replenishing their inventories is
not counted in GDP since it is neither consumption, nor investment, nor government expenditures.
5. True or False and EXPLAIN: The income of foreigners working in the U.S. is counted in the U.S. GNP as
long as those foreigners work for a U.S. company.
6. True or False and EXPLAIN: Final sales of $10,000 worth of cocaine are counted in the GDP
calculations because its production involved the 4 factors of production.
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Long Questions
7. The small and isolated island of Bithaca has no contact with the outside world. Only two firms operate in
this economy: Joe & Bros. Farm which produces wheat, and Big Bakery, which makes bread (the only
final product in the economy) using the wheat provided by Joe & Bros. Farm. The following data are
given for the year 2005.
Joe & Bros. Big Bakery

($) ($)
Total output 50,000 150,000

Total Expenses
Wages 27,000 51,500
Rent & Interest 4,000 9,000
Intermediate Goods Purchased 0 ?
a) Answer the following questions:

i. What is the value of the intermediate goods purchased by Big Bakery?
ii. What is the value added to GDP by Joe & Bros.?
iii. What is the value added to GDP by Big Bakery?
iv. What is the GDP for Bithaca? Show your calculations.
v. What is the GNP for Bithaca? Show your calculations.
b) Assume that although Big Bakery produces $150,000 worth of bread it is only able to sell
$125,000. The remaining $25,000 thousands worth of bread is stored. What is the GDP of
Bithaca now?
c) Suppose that the owners of Joe & Bros. Farm inherit 10,000 shares in AT&T. In 2005 they
receive $5,500 in the form of dividends. How does this change the GDP of Bithaca?
8. 1Suppose the following data apply to the United States for the year 2004 (all figures are in billion of
dollars).
(1) Personal Income 9,675

(2) Depreciation 1,500
(3) Personal consumption expenditures 8,231
(4) Rental income 163
(5) Government expenditures on goods and services 2,183
(6) Personal taxes 1,045
(7) Net interest 546
(8) Compensation of employees 6,765
(9) Proprietors’ Income 946
(10) Indirect taxes less subsidies 803
(11) Corporate profits 1,118
(12) Gross private investment 1,922
(13) Net exports -609
(14) Net factor payments to the rest of the world -114
Assume that all income and expenditure data not listed above is equal to zero.
a) Compute gross domestic product (GDP) using the expenditure approach.
b) Compute national income.
c) Compute gross domestic product (GDP) using the income approach.
d) Compute personal saving.
9. 1Freestone is an isolated community that produces only three final goods: pizza, notebooks, and tonic
water. Information on population, nominal prices and total output for each good in the years 1980 and
2004 is given below.
1980 2004
per unit Price Output per unit Price Output
($’s) (in millions) ($’s) (in millions)
pizza 1.00 1 2.75 3
notebooks 4.00 4 7.00 10
tonic water (bottle) 1.50 2 2.50 4
NOTE: THE POPULATION IN 1980 IS 10,000 AND IN 2004 IS 15,000
a) Calculate nominal GDP for 1980 and 2004.

b) Calculate real (in 1980 dollars) GDP for 1980 and 2004.
c) What is the GDP deflator for 2004? (Use 1980 as the base year.)
d) By what percent has the price level increased between 1980 and 2004?
e) Has the standard of living increased or decreased since 1980? Explain.
10. Suppose that the Consumer Price Index (CPI) in a given economy is calculated using the following
weekly basket of goods:
2 loaves of bread
3 pounds of chicken
½ gallon of milk
1 dozen (12) oranges
1 dozen (12) eggs
Suppose further that the average family's weekly grocery bill is as follows in 1980:
Item Total Amount

Spent ($’s)
2 loaves of bread 2.50
3 pounds of chicken 9.00
½ gallon of milk 2.00
12 oranges 1.20
1 dozen eggs 1.50
And in 2004:
Item Total Amount

Spent ($’s)
½ pound of chicken 2.00
1 dozen oranges 1.20
1 dozen eggs 2.60
a) What is the CPI for 1980 and 2004? (Use 1980 as the base year.)
b) Using this 1980-base CPI, calculate the average annual inflation rate between 1980 and 2004.
c) What is the CPI for 1980 and 2004? (Use 2004 as the base year.)
d) Using this 2004-base CPI, calculate the average annual inflation rate between 1980 and 2004.
e) Compare your results from parts b) and d). Are they similar? If so why? If not, why not?
Now you learned from your economist friend that the previous basket of goods you considered for 2004 is
wrong, and that instead an average household is consuming the following basket of goods:
Item Total Amount

Spent ($’s)
½ pound of chicken 2.00
2 pounds of beef 5.00
1 bag of onions 2.50
1 bag of potatoes 3.00
1 lettuce 0.80
1 dozen oranges 1.20
½ dozen apples 1.50
1 dozen eggs 2.60
f) Given the changing tastes of consumers between 1980 and 2004, is the CPI an accurate measure
of the change in the cost of living? Explain. No calculations are required here, just a verbal
explanation.
ANSWERS
Multiple Choice/True and False
1. Tom just bought shares of Google stock for $2,000 and paid a $30 commission to his broker. How did
this affect GDP?
a) GDP increased by $2030.
b) GDP increased by $2000.
c) GDP increased by $1970.
d) GDP increased by $30.
The purchase of stock does not count for GDP because is just a paper transaction that doesn’t involve the 4
factors of production. The $30 commission though is a payment to labor (broker’s service), hence it counts
for GDP.
2. An economy which is experiencing rising rates of unemployment and inflation would be said to be in a
period of:
e) inflation
f) recession
g) stagflation
h) hyperinflation
3. Which of the following are examples of intermediate goods? (There is more than one in this list.)
i) a book written by your favorite author purchased by you
j) dough bought by a housewife to bake a cake for her daughter’s birthday
k) dough bought by a chef to bake a cake at his restaurant
l) a set of screwdrivers purchased by a small firm
m) wood purchased by a professional carpenter
These are the only two goods in the list that will be transformed in order to produce a final good.
4. True or False and EXPLAIN: The $15,000 spent by a furniture firm in replenishing their inventories is
not counted in GDP since it is neither consumption, nor investment, nor government expenditures.
False. Inventories is one of the 3 components of investment.
5. True or False and EXPLAIN: The income of foreigners working in the U.S. is counted in the U.S. GNP as
long as those foreigners work for a U.S. company.
False. US GNP will only count the income of US citizens irrespectively of where this income is generated.
6. True or False and EXPLAIN: Final sales of $10,000 worth of cocaine are counted in the GDP
calculations because its production involved the 4 factors of production.
False. It is an illegal transaction.
Long Questions
7.
d)
(ii) The value of the intermediate goods purchased by Big Bakery is $50,000 (the value of Joe
& Bros production).
(iii) The value added to GDP by Joe & Bros. is $50,000 (i.e. VA= Sales – IGoods= $50,000-$0)
(iv) The value added to GDP by Big Bakery is $100,000 (i.e. $150,000-$50,000)
(v) The GDP for Bithaca is $150,000, which equals the sum of value added by each firm, and
also is equal to the value of final sales in the economy (inventories are assumed to be $0)
(vi) The GNP for Bithaca is equal to GDP (i.e. $150,000) since the island is assumed to be
completely isolated from the outside world.
e) The GDP of Bithaca still is $150,000, since

GDP = Final sales + Change in business inventories = $125,000 + $25,000
f) The GDP of Bithaca still is $150,000 since AT&T is an American firm (remember Bithaca only
has the two aforementioned firms) and hence these dividends are not a payment to a factor of
production located within Bithaca, so it won’t count in its GDP.
10. 1
a) Expenditure Approach
GDP = C + I + G + NX = (3) + (12) + (5) + (13) = $11,727 billions
b) National income = Compensation of Employees + Proprietors’ Income + Corporate Profits + Net
Interest + Rental Income = (8) + (9) + (11) + (7) + (4) = $9,538 billions
c) Income Approach
GDP = National Income + Depreciation + (Indirect Taxes – Subsidies) + Net Factor
Payments to the Rest of the World + Other = $9,538 + (2) + (10) + (14) + 0
= $11,727 billions
d) Personal saving = Disposable Personal Income – Personal Consumption Expenditures – Interest
paid by Consumers to Business – Personal Transfer Payments to Foreigners.
But since Disposable Personal Income = Personal Income – Personal Taxes, and in this example
Interest paid by Consumers to Business = Personal Transfer Payments to Foreigners = 0, then
Personal saving = (1) – (6) – (3) = $399 billions
6
11. 1
f) Nominal GDP for 1980 = (1.00)*1 + (4.00)*4 + (1.50)*2 = $20 millions
Nominal GDP for 2004 = (2.75)*3 + (7.00)*10 + (2.50)*4 = $88.25 millions
g) Real GDP for 1980 is equal to Nominal GDP for 1980 since 1980 is the base year.
Real GDP for 2004 = (1.00)*3 + (4.00)*10 + (1.50)*4 = $49 millions.
h) The GDP deflator index for 2004 is

Deflator GDP2004 = [(Nominal GDP2004) / (Real GDP2004)] *100 = (88.25/49)*100 = 180
i) Inflation Rate = [(Deflator GDP2004) - (Deflator GDP1980)/ (Deflator GDP1980)] *100

= [(180 – 100)/ 100] *100 = 80 %
j) One approximation to the standard of living can be obtained by comparing Real GDP per capita
for 1980 and 2004.
Real GDP Per capita 1980 = Real GDP1980/ Population1980 = $20 million/10,000 = $2,000
Real GDP Per capita 2004 = Real GDP2004/ Population2004 = $49 million/15,000 = $3,266
In principle the standard of living improved between 1980 and 2004. However, we need to keep
in mind that Real GDP per capita is just a crude approximation to the standard of living. There
are many other factors affecting it, for instance, income distribution, crime rates, pollution, etc.
and these factors go unaccounted by just comparing Real GDP per capita.
11.
f) Using 1980 as the base year
CPI 1980 = (bundle price 1980 / bundle price 1980 ) *100 = 100
CPI 2004 = (bundle price 2004 / bundle price 1980 ) *100
= [2*$2.50 + 3*$4.00 +1/2*$6.00 + 1*$1.2 + 1*$2.6] *100 / [$2.5 + $9 + $2 + $1.2 + $1.5]
= 146.91
g) Let π be the inflation rate between 1980 and 2004, then

CPI 2004 − CPI 1980
π= *100 = 46%
CPI 1980
and the average annual inflation rate is π /No. of years over which you’re averaging
Average annual inflation rate = 46%/24 = 1.91 %
h) Using 2004 as the base year
CPI 1980 = (bundle price 1980 / bundle price 2004 ) *100
= [1*$1.25 + 1/2*$3.00 +1/2*$4.00 + 1*$1.2 + 1*1.5] *100 / [$2.5 + $2 + $3 + $1.2 + $2.6]
= 65.92
CPI 2004 = (bundle price 2004 / bundle price 2004 ) *100 = 100
i) Using this 2004-base the average annual inflation rate between 1980 and 2004 equals
CPI 2004 − CPI 1980
π= *100 = 51.67%
CPI 1980
and the Average annual inflation rate = 51.67%/24 = 2.15 %
j) The answers from parts b) and d) are different. That is, depending on which base year you
choose you will get different rates of inflation for the same calendar period. This is one of the
common problems associated with indexes calculated using fixed-weights.
g) The CPI has many problems as a measure of the cost of living. It doesn’t account for changes in
the consumer preferences, nor does it account for possible substitutions between goods when one
specific good becomes relatively more expensive. The consequence of this is that inflation might
be calculated over a bundle of goods that is not representative of what a current household
actually consumes.
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Economics 102 Introductory Macroeconomics - Spring 2005, Professor J.

Multiple Choice/True and False

Joe & Bros. Big Bakery

Total output 50,000 150,000

a) Answer the following questions:

(1) Personal Income 9,675

NOTE: THE POPULATION IN 1980 IS 10,000 AND IN 2004 IS 15,000

a) Calculate nominal GDP for 1980 and 2004.

Item Total Amount

Item Total Amount

Item Total Amount

Multiple Choice/True and False

False. Inventories is one of the 3 components of investment.

e) The GDP of Bithaca still is $150,000, since

h) The GDP deflator index for 2004 is

i) Inflation Rate = [(Deflator GDP2004) - (Deflator GDP1980)/ (Deflator GDP1980)] *100

g) Let π be the inflation rate between 1980 and 2004, then

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