Tutorial Sheet 1

Economics 2
University of Edinburgh

Week 2, Fall 2023

Required Reading
– Recent lecture notes
– Nils Gottfries, Macroeconomics, Chapter 1
(Note: it is assumed here and will be assumed in the exam that you are familiar with the terminology
laid out on pages xxvi - xxvii of Gottfries’ text.)
– Renshaw Ch. 11

Homework
– Submission of homework this semester works like Econ 1 last year, but there is now one additional
component – you must also submit a graph.
– The submission must be done via Learn by 5pm on the Sunday before the tutorials occur.
– The written homework should be equivalent to at least two sides of handwritten A4 and should be
clear enough to read. It does not need to be complete, and indeed it does not even need to be correct.
You just need to show that you have made an honest attempt. As long as you have shown an honest
attempt, you will get credit, and as long as you do this for 14 of the 18 tutorials during the year, you
will get full credit.
– NEW FOR ECON 2: you must also submit an additional page with a ‘looking at the data’ graph (this
will be different each week, and relevant information will be on each tutorial sheet)

Further Resources
– Gottfries on YouTube: the textbook author (Nils Gottfries) has put 15-40 minute videos from most
chapters of the book on YouTube
– FRED: Most of the tutorial sheets this semester contain graphs generated by the St. Louis Fed’s Federal
Reserve Economic Data (FRED). This is a surprisingly easy-to-use, free site for exploring hundreds of
thousands of economic data series. You are strongly encouraged to visit the site whenever you feel the
need to find out what’s happened lately to GDP growth, or inflation, or infant mortality, etc.

Recordings
– Questions marked with an asterisk* have video solutions recorded by Sean Brocklebank, which will be
released after the Sunday 5pm submission deadline. Because the asterisk questions are covered in video,
they will mostly not be covered within the tutorials themselves.

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Priority Questions
We strongly recommend attempting every question on this tutorial sheet.1 However, if you find yourself
lacking for time and need to prioritize, you should start by focusing on: Q1, Q5, Q9, Q10, Q15, Q16, Q21,
Q22, Q23, Q24, and Q25.

Looking at the data

This semester, along with each week’s tutorial sheet, you’ll be required to download a graph with data relating
to the material that week and submit these along with your tutorial sheet in order to earn credit. At some
point in the tutorial, your tutor may ask you to comment on the graph that you brought in. You can find all
of the data that you need from the FRED website mentioned earlier (https://fred.stlouisfed.org/). This week,
the task is:
Using FRED (or another data source) find and print a graph of GDP growth over time for a country of your
choice. Include comments on any trends or features in the data and bring the printed graph and comments to
your tutorial.

Tutorial Questions
Q1. Exo/Endogeneity. Explain the difference between exogenous and endogenous variables, and explain why
a variable might be considered exogenous in one context and endogenous in another.

Q2. Marrying the butler. Suppose a woman marries her butler. After they are married, her husband continues
to wait on her as before, and she continues to support him as before (but as a husband rather than as an
employee). How does the marriage affect GDP? How do you think it should affect GDP?

Q3. “Hiring” the unemployed. What would happen to GDP if the government hired unemployed workers,
who had been receiving £B in unemployment benefits, as government employees and now paid them £B
to do nothing? Explain.

Q4. Classifying expenditure. Place each of the following transactions in one of the four components of
expenditure: consumption, investment, government purchases, and net exports (note that the question
assumes an American perspective).

(a) Boeing sells an airplane to the US Air Force.

(b) Boeing sells an airplane to American Airlines.

(c) Boeing sells an airplane to Air France.

(d) Boeing sells an airplane to an American billionaire (he plans to throw lavish parties on it).

(e) Boeing sells an airplane to a Saudi billionaire (he also plans to throw lavish parties on his plane).

(f) Boeing builds an airplane to be sold next year.

Q5. Optimization. Consider the function z = x2 + 0.5xy + y 2 . Find the optimum value of z (that is maximum
or minimum), subject to the constraint y = 90 − 2x. First do this by direct substitution, and then by
setting the slope of the iso-z section equal to the slope of the constraint. Attempt to assess informally
the shapes of the two surfaces, and discuss whether the optimum is a maximum or minimum of z.

Q6. Value added for wheat. A farmer grows a bushel of wheat and sells it to a miller for £1. The miller turns
the wheat into flour and then sells the flour to a baker for £3. The baker uses the flour to make bread
1 And you should note that all of the content here is potentially examinable

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 and sells the bread to an engineer for £6. The engineer eats the bread. What is the value added by each
person? What is the bread’s contribution to GDP?

Q7. GDP calculations. GDP at market price is 200 billion, taxes on production are 22 billion, compensation
of employees is 120 billion and subsidies to production are 2 billion. How large is:

(a) GDP at basic prices?

(b) The labour share of income?

Q8. More GDP calculations. The capital stock is 2.5 times as large as GDP at market price in one year and
the depreciation rate is 6 percent per year. Net primary income from the rest of the world is 4 percent of
GDP and net transfers from the rest of the world are negative and equal to minus 2 percent of GDP at
market price. Calculate as a percent of GDP at market price:

(a) Net domestic product at market price.

(b) Net national income at market price.

(c) Net national disposable income at market price.

Q9. Even more GDP calculations. Data for Smalland can be found in the table below.

Variable Amount
Private consumption 50
Government consumption 23
Private investment 20
Government investment 3
Exports 36
Imports 32
Primary income from RoW 5
Primary income to RoW 2
Taxes less subsidies on products 10
Net transfers from RoW 0
Capital stock 200
Depreciation rate 7.5%
Labour income 60
Net interest paid from gov't to private sector 1
Gov't income from private sector (taxes, etc.) minus transfers 24

Use the data to calculate the following:

(a) GDP (Hint: use the balance between sources and uses)

(b) Net domestic product at market price

(c) Net national disposable income at market price

(d) Labour income as a share of gross value added at basic price

(e) Gross and net capital income as a share of gross value added at basic price

Q10. Further GDP calculations. Use the data from the previous question to calculate the following:

(a) Private gross saving and net lending

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 (b) Government gross saving and net lending

(c) The current account balance

What is the relationship between the three numbers that you just calculated?

Q11. Goods and services. In the textbook, there is not much of a distinction made between physical goods
and services. Discuss the similarities and differences between services (haircuts, meals in restaurants,
transports) and physical goods (milk, cars, machines). Do you think goods or services prices are more
likely to vary internationally? What kind of international variation do you expect to see (i.e. where
would prices be high or low)?

*Q12. PPP adjustments. What is the PPP adjustment to GDP? For each of the following countries, explain
whether you think the PPP adjustment will raise or lower the value of GDP per capita:

(a) India

(b) Switzerland

(c) The United States

*Q13. Ethiopian PPP. In 2019, one unit of the Ethiopian currency (the Birr) was worth about $0.025 (in
USD). But estimates are that 40 Birr spent within Ethiopia can buy about as many goods and services
as $2.70 spent within the United States. GDP per capita in Ethiopia is about 1.3% of US GDP per
capita when evaluated at the market exchange rate ($65 000 vs $860). How large is it relative to the US
if we use purchasing power parity to compare incomes?

*Q14. PPPs in high income countries. As noted above, many of the richest countries in the world, such as
Norway, Luxembourg, or Switzerland, have higher price levels than the United States. But there are some
other very high income countries with very low price levels, particularly around the Persian/Arabian
Gulf. How might you explain this latter group in terms of the model in the textbook? How does this
variation in PPPs change the ranking of countries GDP per capita in nominal vs. purchasing power
adjusted terms?

GDP per capita PPP

(2018, nominal, IMF) (2018, World Bank)
Switzerland $82,950 1.2
Norway $81,695 1.2
Iceland $74,278 1.3
United States $62,606 1.0

Qatar $70,780 0.5

UAE $40,711 0.6
Kuwait $30,839 0.5
Bahrain $25,851 0.5

Q15. British PPP. The Office for National Statistics reports that GDP per capita in the UK was about £26
000 in 2013, whereas GDP per capita in the United States in 2013 was about $53 000. On a purchasing
power parity (PPP) basis, GDP per capita is listed as about $36 000 in the UK, and $53 000 in the USA.
The average exchange rate in 2013 was about $1.58 per pound.

(a) What is US GDP per capita at market exchange rates (expressed in dollars)? Is this higher or lower
than the PPP measure?

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 (b) What is UK GDP per capita at market exchange rates (expressed in dollars)? Is this higher or lower
than the PPP measure?

(c) Based on your answers above, do you think that the price level is higher or lower in the UK? By
how much?

(d) In percentage terms, how much poorer are Brits than Americans when measured at market exchange
rates? What about at PPP? Which measure do you think is better?

Q16. Real & nominal calculations. Assume consumers only spend their money on three things: clothes, cars,
and (rental) housing. The prices and outputs of the three goods in 1996 and 2013 are shown below.

Pclothing Yclothing Pcars Ycars Phousing Yhousing

1996 £100 120 £10 000 10 £400 100
2013 £49 150 £11 200 10 £636 100

(Note: the ‘Y’s in this question are made up, but the ‘P’s represent the actual nominal price movements
in the UK between 1996 and 2013—clothing declined in price by 51%, new cars went up by 12%, and
rent went up by 59%.)2

(a) Calculate the total & annual % increase in nominal expenditure from 1996 to 2013

(b) Calculate the total & annual inflation from 1996 to 2013

(c) Calculate the total & annual increase in real consumption (real GDP)

(d) Compare the numbers in (a), (b) and (c) and explain the relations between them.

(e) Suppose a person’s nominal income has been growing in line with the overall inflation rate. Over
time, is this person: better off, worse off, or just as well off?

*Q17. Exports > GDP. According to the CIA World Factbook, in 2013, Singapore had exports equal to
195.8% of GDP.3 Given that exports are just one component of GDP, how is this possible?

*Q18. CA vs NX. Define the current account and net exports and explain the difference between them.

*Q19. Current account deficits. When could it be rational for a country to have a deficit in the current
account?

*Q20. Elderly Germans. The table below (from Eurostat) shows the percentage of the population of each
EU country which is expected to be 65+ years old at the beginning of each decade from 1960 to 2060.
The largest number in each column is noted in bold. Note that Germany (DE) is expected to have the
highest proportion of pensioners for the next 40 years or so.
2 http://www.ons.gov.uk/ons/datasets-and-tables/data-selector.html?table-id=1.1&dataset=mm23
3 https://www.cia.gov/library/publications/the-world-factbook/geos/sn.html
4 http://www.bbc.co.uk/news/business-14486465

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 The graph below (from FRED) shows the current account balance of Germany as compared to the
Eurozone as a whole since 1997.

Can you use the table above to help understand what is happening in the graph?

Q21. Cost minimization. A firm’s production function is given by: Q = K 1/2 L1/4 where Q is output in
thousands of units, K is capital input measured in machine-hours and L is labour input measured
in worker-hours. The firm is perfectly competitive and the factor prices are r = £2.50 per hour and
w = £7.50 per hour. The total costs are given by T C = rK + wL.

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 Use the method of Lagrange multipliers to find the combination of K and L that minimises the cost of
producing Q = 4.5.

Q22. Woodwork. A carpenter plans to make a rectangular wooden box with no lid (that is, open on its top
side) and with a capacity of 108 cubic metres. The necessary wood costs £25 per square metre. Find the
dimensions of the box that will minimize the cost of wood. Find also the minimized cost.

Q23. Functions and their inverses.

Sketch the graphs of each of the following functions. In each case, write down the inverse function.

(a) y = (25)100.05x ,
1
(b) y = 10 x .

Q24. Logs and Exponents Attempt the following without using a calculator. Then use a calculator to check
your answers.

(a) Given log 30 = 1.4771, what is log 900?

(1+x)2
(b) If y = 1 , find an expression for log y as a function of x.
(x−1) 3

(c) Given log 3 = 0.4771, what is log 10

9
?

Q25. Breeding rabbits. A person decides to set up a business breeding rabbits. She starts with one pair,
which will produce one male and one female offspring every 6 months. The offspring in turn will produce
one male and one female offspring every 6- months. Assuming that none of the rabbits die, and that
incest is not a problem, how long will it be before the stock of rabbits reaches (a) 1 000; (b) 10 000?

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