Universidad Carlos III de Madrid – Department of Economics

Principles of Economics - Course 2020-2021 - Problem Set 1

Conceptual Questions

Write down a short and concise answer. When you are asked to solve the question in
class, explain the concept clearly and give examples or pieces of evidence.

1. While campaigning for the US presidency on 18 March 1968, Senator Robert

Kennedy gave a famous speech questioning ‘the mere accumulation of material things’ in
American society. He said that GDP “counts the destruction of the redwood and the loss of
our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and
armoured cars for the police to fight the riots in our cities. It counts Whitman's rifle and
Speck's knife, and the television programs which glorify violence in order to sell toys to
our children. Yet the gross national product does not allow for the health of our children,
the quality of their education or the joy of their play. It does not include the beauty of our
poetry or the strength of our marriages, the intelligence of our public debate or the
integrity of our public officials. It measures neither our wit nor our courage, neither our
wisdom nor our learning, neither our compassion nor our devotion to our country, it
measures everything in short, except that which makes life worthwhile. And it can tell us
everything about America except why we are proud that we are Americans.” (Underline
has been added). Please read the full text available in
https://www.jfklibrary.org/learn/about-jfk/the-kennedy-family/robert-f-kennedy/robert-f-
kennedy-speeches/remarks-at-the-university-of-kansas-march-18-1968.

What statements of Senator Robert Kennedy do you agree with and what statements
you don’t agree with? For instance, do you think that GDP “counts the destruction of the
redwood and the loss of our natural wonder…” and that GDP “…does not allow for the
health of our children, the quality of their education or the joy of their play”? – I partially
agree with Kennedy’s statement, particularly with the part where he refers to the data
gathered through the use of GDP – this data is valuable and could be used to estimate not
solely the status of a country’s economic development, but also how the values of the
people who live there are formed. I, however, disagree with the second part of the
statement because GDP is a tool to measure the ‘value of all goods and services in the
economy’ and with its help, there could be drawn conclusions about the living patterns of
the people in a certain country and there could be discussed solutions, based on the GDP
and compatible with this same lifestyle, as well.

2. Use one of the following figures to answer the questions:

Figure 1.1a: https://ourworldindata.org/grapher/historys-hockey-stick-worldwide-

historical-gross-domestic-product-percapita-1990 (linear scale and ratio scale or
logarithmic)
Figure 1.1b: https://ourworldindata.org/grapher/historys-hockey-stick-gross-domestic-
product-per-capita-using-the-ratio-scale-1990?yScale=linear (linear scale and ratio scale or
logarithmic)

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 1) For Britain, identify a period of time when its growth rate was increasing and
another period in which its growth rate was roughly constant. Which figure did you use,
and why?  The rate in Britain was roughly constant between 1000 and 1800. Then, from
1800 up until 2006, it was increasing. (first one)
2) Identify a period during which GDP per capita was shrinking (a negative growth
rate) faster than in India. Which figure did you use and why?  between 2006 and 2009
(second one)

3. Suppose you build a model of the market for umbrellas, in which the predicted
number of umbrellas sold by a shop depends on their colour and price, ceteris paribus.
1) The colour and the price are variables used to predict sales. Which other variables
are being held constant? Which of the following questions do you think this model might
be able to answer? In each case, suggest improvements to the model that might help you to
answer the question (resistance to conditions, .
2) Why are annual umbrella sales higher in the capital city than in other towns? –
Because more people live in the capital city. (Demography)
3) Why are annual umbrella sales higher in some shops in the capital city than others?
– Location.
4) Why have weekly umbrella sales in the capital city risen over the last six months? –
Weather conditions.

Problems

1. Download the spreadsheet data used to create Figure 1.2 that is in the text
(https://jackblun.github.io/Globalinc/html/fig_2014.html). Choose five countries to
calculate their 90/10 ratio for income in 1980, 1990 and 2014. Describe the differences
between countries and the changes over time that you find. Can you think of any
explanations for observed changes or patterns?

2. Suppose the price of one unit of labour (the wage) is 10 euros and the price of one
unit of coal is 5 euros.
1) What is the relative price of labour?  -10/5 = -2
2) Using the method explained in the text, write down the equation of the iso-cost line
for a cost of 60 euros, and write it in the standard form, y = a + b x.  60 = 10*L + 5*R;
12 = 2*L + R; R = 12 – 2L
3) Write down the iso-cost line in both forms when the cost is 30 euros and when the
cost is 90 euros. Represent all the iso-cost lines in a graph. What happens to the iso-cost
line when the price of coal rises to 20 euros and the wage remains equal to 10 euros?
Compare the initial iso-cost line and the new iso-cost line using the same diagram for a
total cost of 60 euros.
30 = 10*L + 5*R; 6 = 2L + R; R = 6 – 2L
90 = 10*L + 5*R; 18 = 2L + R; R = 18 – 2L
P = 20; w = 10
60 = 10*L + 20*R
6 = L + 2R
2R=6-L
R = (6-L)/2

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 First, we define the maximum cost of coal and of workers we could afford and we draw
the graph. Using the formula y = a + bx, we find a by solving the equation when x=0; then,
to find b, we solve the max cost for the y – 0, and divide it by 0 – the max. cost for x. We
can check if we’re right by doing it the other way round.
(draw all the graphs at home to practice)
Other Questions

1. The following table shows the nominal GDP (in 2015 US dollars) and the population
of Japan in 2013 and 2014 (source: The World Bank). Based on this information,
which of the following statements regarding GDP per capita is correct?

a. Japan’s GDP per capita in 2013 was $36,194.42.

b. Japan’s GDP per capita fell by 6.74% between 2013 and 2014.
c. The fall in the population was enough to offset the fall in GDP, for an overall
growth in GDP per capita between 2013 and 2014.
d. Japan’s GDP per capita fell by 6.31% between 2013 and 2014.

Solution:
GDP per capita for 2013: 4 919 563 108 372,5 / 127 338 621 = 38 633
GDP per capita for 2014: 4 601 461 206 888.1/ 127 131 800 = 36 194
36 194/ 38 633 – 1 = -6,31 % decrease  d)
Growth rate per population: - 0,016%

2. Capitalism is an economic system in which private property, markets, and firms

play an important role. Which of the following statements related to the terms in this
definition is correct?
a. An economic system is a way of organising the production and distribution of
goods and services in an entire economy.
b. The knowledge you attain from the CORE programme is considered private
property (private properties are things we can possess and then sell  knowledge doesn’t
fit this definition; we call knowledge ‘human capital’).
c. Forced labour where the workers receive some daily allowance is an example of a
market (markets require some degree of freedom, a place where goods are bought and
sold).
d. Employee-owned cooperatives are firms (search for a definition of firm; not true);
private individuals who invest money to employ others to work).

3. The following diagram depicts the production function of the farmers, where
diminishing average product of labour is assumed. At A the average product of labour is
500,000/800 = 625 kg of grain per farmer. At B the average product of labour is

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732,000/1,600 = 458 kg of grain per farmer. If you know that the grain output for 2,800
farmers is 894,000kg, then which of the following statements is correct?

a. When the
labour input is
2,800, the average
product of labour is
300 kg.
(894 000/ 2 800 =
319 kg)
b. The slopes
of the rays from
the origin to the

production function increase along the curve, indicating that the average product of labour
is decreasing. (The slope decreases – if we draw a straight line, the corner will be smaller –
the slope connecting A and 0 is higher than the slope connecting B and 0  the product of
labour is decreasing);
c. If the production function curve is an upward-sloping straight line, then there is no
diminishing average product of labour. (If the production curve is an upward-sloping
straight line, the average product of labour is constant; it’s the opposite of point b., check
explanation; if the production increases in parallel with the number of workers, then the
slope goes upwards and there is no diminishing average product of labour.)
d. It is possible that initially there are economies of scale (for example, when there are
two farmers instead of one, the average output increases as they efficiently share the
workload). (The average product of labour diminishes, so such possibility couldn’t be
possible – we need more land, grain and capital for this strategy to work);

On the graph (which shows a generic production function), we can observe that the
slope is increasing, instead of decreasing. With each worker hired, we get benefits in the
production  the average product per worker is increasing (output divided by the input).

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 The slope is measuring the average product – how much each worker is
producing.
4. The following figures show the real wage index in England from 1750 to 2000, and
the explanation of how England escaped the Malthusian trap in the period up to 1900.
Based on this information, which of the following statements are correct?
a. These figures show evidence that increased productivity of labour increases wages
immediately. (Were we to take a part of the graph, we observe a constant increase in labour
productivity, but not in wages, where the numbers are chaotic).
b. Throughout the 1800s, political developments led to a fall in the workers’
bargaining power, keeping the real wage low. (This increases the bargaining power of
workers because children and women were restricted to work (their productivity is higher,
they realised they deserved more and pushed the governments  they became more
organised and received higher salaries.)
c. England was able to escape from the Malthusian trap after the 1780s by being able
to increase the workers’ share of the rising output, due to an increase in the workers’
bargaining power. (Increases in workers’ bargaining power, which started in the 1830s, not
the 1780s, meant that wages rose, allowing workers to benefit from the permanent
technological revolution)
d. These figures demonstrate that the size of pie (the total output) does not determine
the wage rate, but it merely sets a limit on how high the wage could possibly be.
(Bargaining power determines the wage rate, but the range of possible wages depends on
the size of the pie. The increases of wages are related to the bargaining power more than to
productivity.)

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Exercise 1:
GDP, Spain, 2020: 1. 117. 989 million of euros
GDP, Spain, 2019: 1. 245. 513 million of euros
The difference between the two numbers is -127. 524 million
1. 245. 513/ -127. 524 = -0.0001024x 10000 = -10.24%
F = AxB; growth rate of F = growth rate of F + growth rate of B

GDP per capita, 2020 (Spain): 23.406

GDP per capita, 2019 (Spain): 26.441
-10.71%
GDP per capita = GDP/ population
Growth rate of GDP per capita = growth of GDP – growth of population
-10,71 = -10.24 – x
X = 10.71 – 10.24 = 0.47 growth of population

Exercise 2:
Average (gross) wage:
Men: 2.210,30 euros
Women: 1.851,98 euros
(M – W)/W = (2.210,30 – 1.851,98)/ 1.851,98 = 19.35%
or (W – M)/M = -16,21%  gender gap (gender inequality)
We should have in mind that women work less hours than men.

Exercise 3:
Decile: divides by pieces of 10% all the
population, telling us the earnings in the
poorest and richest parts of society;
Median = reaches the 50% of the
population (the 5th decile)

We take the income of the 9 th decile and

we divide it by the 1st decile: this is one
of the ways to measure inequality
(90/10 ratio)