Economics 102 Introductory Macroeconomics - Spring 2005, Professor J

Economics 102 Introductory Macroeconomics - Spring 2005, Professor J. Wissink Problem Set 3 – DUE at the start of class on Monday Feb 28, 2005 Boxes will be removed ten minutes after the start of class.

Remember: We will NOT accept problem sets late. Period. Thanks for minding this policy and not asking if you can hand it in late.

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.

1 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. Suppose 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. 2 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. Freestone 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: 3 Item Total Amount Spent ($’s) 1 loaves of bread 2.50 ½ pound of chicken 2.00 ½ gallon of milk 3.00 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) 3 loaves of bread 7.50 ½ pound of chicken 2.00 2 pounds of beef 5.00 1 bag of onions 2.50 1 bag of potatoes 3.00 ½ gallon of milk 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.