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BASIC MACROECONOMICS - BMAK

Problem Set 1
Monday, April 5th, 2021.

Question 1
Measuring GDP: Nettel and Cabell are two firms located in the country of Digiland. In 2017, Nettel won a contract
with the government of Digiland to build a free Wifi service system which was worth 17 million USD. To complete this
project, Nettel spent 5 million USD to buy the cable from Cabell, and employed 250 workers from Digiland, which it paid the
annual wages and salaries of $ 20,000 per person. Nettel also employed 100 manual workers from the neighboring country of
Agriland, to whom it paid a compensation package of $10,000 per person. Nettel paid 4 million USD in dividends, 1 million
USD in taxes, and invested in a new internet service center which cost 2 million USD. In 2017, Nettel also made a 2.5 million
USD profit from operating an internet firm in Agriland. It remitted half of the income to Digiland and reinvested the other
half.

At the beginning of 2017, Cabell had 4 million USD of cable in inventory, which was later in 2017 sold to the households in
Digiland for a total revenue of 6 million USD. During the year, it imported 10 million USD of copper from Agriland, employed
500 workers from Digiland and 500 workers from Agriland, to all of whom it paid a package of $8,000 per year. It exported 4
million USD of cable to Agriland, and sold 10 million USD of cables and home equipment to the residents of Digiland. At the
end of 2017, Cabell had 7 million USD of cable in its inventory. Besides paying 1 million in taxes, Cabell paid all of the re-
maining profit to its owners in the forms of dividends. Labor income taxes in Digiland is 15%, and capital income taxes are 5%.

a) Compile the 2017 GDP for the country of Digiland using the expenditure, product and income approaches. Show your
work. What is the value of dividends that Cabell paid to its owners in 2017?

b) Compile the GNP for Digiland in 2017. Show your work.

c) Explain the implication of the statement "Good measurement is the prelude to sensible analysis".

d) Governments and organizations have spent a substantial amount of money on finding alternative measures of well being
instead of GDP. What are the limitation of these alternative measures in comparison with GDP as a measure of the standard
of living?

Question 2
In the year 2016, Kiel-based Pausenlos produces 50,000 lawn mower engines. The market value of each lawn mower engine
is 50 Euro. In producing these 50,000 lawn mower engines, Pausenlos incurs the following costs of production for each lawn
mower engine produced: labor cost: 10 Euro; imported components from Vietnam: 5 Euro; interest payment on debt: 5 Euro.
Pausenlos sells 35,000 of the lawn mower engines it produced to Rostock-based Grünland and 5,000 of these lawn mower
engines to private customers in Sweden. Finally, Pausenlos places the remaining 10,000 lawn mower engines it produced into
its inventory.
In the year 2016, Grünland produces 35,000 lawn mowers. The market value of each lawn mower is 150 Euro. In producing
these 35,000 lawn mowers, Grünland incurs the following costs of production for each lawn mower produced: labor cost: 25
Euro; imported components from Slovakia: 20 Euro; lawn mower engines purchased from Pausenlos: 50 Euro; tax payments:
5 Euro. Grünland sells 25,000 of the lawn mowers it produced to private customers in Germany and 5,000 to private customers
in Denmark. Finally, Grünland places the remaining 5,000 lawn mowers it produced into its inventory.
Suppose that in the year 2016 there are no further transactions of relevance in the German economy comprising the two
firms Pausenlos and Grünland. Using the income and expenditure approaches, calculate the year 2016 GDP of the German
economy.
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Question 3
For this problem, consider two companies: Noisy Music GmbH (which is located in country Sunny), and Plain Pictures AG
(which is located in country Windy).
Noisy Music enters the year 2016 with a capital stock worth 2,000,000 Euro. During 2016, Noisy Music produces 30,000
headphones. Noisy Music’s costs for the production of each headphone are as follows: cost of labor from workers who are
nationals of Sunny: 15 Euro; cost of labor from workers who are nationals of Windy: 15 Euro; depreciation of capital stock:
5 Euro. Noisy Music in 2016 sells 25,000 headphones at a price of 100 Euro per headphone (of the 25,000 headphones sold,
15,000 are sold to private households in Sunny, 5,000 to private households in Windy and 5,000 to private households in a
third country, Rainy). Finally, Noisy Music places the remaining 5,000 headphones produced but not sold in 2016 into its
inventory. Also during 2016, the owners of Noisy Music on the stock exchange of Windy purchase 6,000 newly issued shares
of the stock of Plain Pictures AG, at a price of 10 Euro per share.

Plain Pictures enters the year 2016 with a capital stock worth 5,000,000 Euro. During 2016, Plain Pictures produces
50,000 blu ray players at a cost of 100 Euro each (imported components from Rainy: 20 Euro; cost of labor from workers
who are nationals of Windy, 50 Euro; cost of labor from workers who are nationals of Sunny, 20 Euro; depreciation of capital
stock: 10 Euro). Plain Pictures sells 25,000 of the blu ray players it produced in 2016 at a price of 200 Euro each to private
households in Windy; it sells 10,000 of the blu ray players produced in 2016 at a price of 250 Euro each to private households
in Sunny; and puts all remaining 15,000 blu ray players produced but not sold in 2016 into its inventory. Those workers of
Plain Pictures who are nationals of Windy transfer 25,000 Euro of their 2016 income to private households in Sunny.
Suppose that in 2016 there are no further contributions involving Noisy Music or Plain Pictures to the GDP, national saving
and/or national wealth of Sunny and/or Windy.

a)
Using the product approach, calculate the year 2016 contributions of Plain Pictures to the GDP of Windy.

b)
) Calculate the year 2016 contributions of Noisy Music and Plain Pictures to the level of (i) national saving of Sunny and of
Windy and (ii) national wealth of Sunny and of Windy.

Question 4
For the following transactions, determine the contribution to Germany’s GDP. Use the product, income and expenditure
approaches.

a)
A Japanese computer company builds a factory in Dresden for 20 million Euro, using only local labor and materials.

b)
Frankfurt Pizza, a local restaurant, serves 500,000 Euro worth of pizza, using 150,000 Euro worth of ingredients imported
from Italy. It pays 120,000 Euro in wages to its employees, 80,000 Euro in interest to its bank and 70,000 Euro in taxes to
the government.

c)
A German household buys a laptop for 2,000 Euro via an online retailer from Ireland.

Question 5
The table above illustrates the production per capita and prices of goods and services in two fictitious
countries, AAA (a rich country) and BBB (a poor country).
An international survey has recently found that a basket of 12 haircuts and 1 computer is the best representation of
production and consumption across countries. In the following questions, please use this information in your calculation.
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Computer Hair cuts

Production per Price Production Price
Capita (Local currency) per Capita (Local currency)
AAA 65 100 200 30
BBB 5 2,800,000 100 40,000

a)
As of May 2018, the market exchange rate is that 1 unit of AAA’s currency (AAA$) can be converted to 28,000 units of
BBB’s currency (BBB$). Compute BBB’s GDP per capita in AAA$ using the market exchange rate. Show your work.

b)
Computing the PPP-based exchange rate between AAA$ and BBB$. Show your work. Compare this PPP-based exchange
rate with the market exchange rate. Please explain why there exists such a difference.

c)
Vietnam’s GDP in 2014 was 216 billion in current USD, and 500 billion in PPP dollar. Please give the explanation for this
deviation in terms of purchasing power parity.

Question 6

Product and Price

Year Chicken Beef Noodle
Quantity Price Quantity Price Quanity Price
2014 2000 3 500 6 2500 2
2015 1500 2.5 1000 5.5 2560 1.8
2016 1000 4 2000 8 2800 2.3

The table above presents the development of price and quantities produced in a fictitious country.

a) Compute the real GDP for the years 2014, 2015, 2016 using the Laspeyres method. What is the limitation of this
approach?

b) Compute the real GDP for the years 2014, 2015, 2016 using the Paasche method. What is the limitation of this approach?

c) Compute the real GDP for the years 2014, 2015, 2016 using the annual chain weight method. What is the reason to
employ this approach?