Principles of Macroeconomics Fall Answer Key - Problem Set 1

Transcription

1 EC132.01(02) Serge Kasyanenko Principles of Macroeconomics Fall 2005 Answer Key - Problem Set 1 1. Gross Domestic Product, 2004 (millions of current dollars) I. Personal consumption expenditures Compensation of employees Durable goods Proprietors' income Nondurable goods Rental income Services Corporate profits Net interest II. Gross private domestic investment Taxes on production Fixed investment Consumption of fixed capital Nonresidential (Depreciation) Residential Other income 88.1 Change in private inventories Statistical discrepancy 23.1 III. Net exports of goods and services Income payments to the rest Exports of the world Goods Income receipts from the rest Services of the world Imports Goods Personal taxes (including Services social security contributions) Taxes on corporate income IV. Government consumption 14. Net business saving and expenditure and gross investment statistical discrepancy 87.4 Federal Personal transfer receipts National defense Nondefense State and local Gross Domestic Product Gross Domestic Product a. Fill the empty fields in the table. b. What was the gross national product (GNP) in 2004? ANSWER: Gross National product is equal to the GDP plus the net income flow into the country. To get GNP take the difference between lines 11 and 10 in the second column of the table and add this difference to GDP. What was the national income (NI) in 2004? ANSWER: National Income (NI) is equal to the Gross Domestic Product less depreciation. You can calculate the depreciation by subtracting lines 1-9 from GDP, since under Earnings approach GDP is equal to the sum of lines 1-9.

2 What was the disposable income (DI) in 2004? ANSWER: Disposable income (DI) is equal to the national income (NI) plus personal transfers (line 15) less personal taxes (line 12), taxes on corporate income (line 13) and net business savings (line 14). c. Was the US a net exporter of goods/services in 2004? - net export of goods in 2004 was: ANSWER: Take the difference between exports and imports of goods: , therefore, US was a net importer of goods in net export of services in 2004 was: 53.8 ANSWER: Take the difference between exports and imports of services: 53.8, therefore, US was a net exporter of services in d. What percentage of GDP was spent on the national defense by the federal government in 2004? 4.7%

3 2. GDP in billions of current dollars Real GDP in billions of 2000 dollars , , , , , , , , , , , , a. Fill the empty fields in the table. GDP Deflator (GDP price index) b. Find the growth rates of the nominal GDP, real GDP and GDP price index (inflation): Nominal Real GDP GDP Inflation % 3.66% 2.04% % 0.75% 2.40% % 1.78% 1.56% % 2.81% 1.92% % 3.92% 2.92% c. Should the growth rate of nominal GDP be equal to the growth rate of the real GDP plus inflation? Explain your answer. Nominal Real GDP + Difference GDP Inflation % 5.70% % 3.15% % 3.34% % 4.74% % 6.84% 0.07 ANSWER: The rate of growth of nominal GDP is only approximately equal to the sum of the growth rates of inflation and Real GDP. When inflation is small the difference between two is small and close to zero (see last page for details). d. How would you describe (recession or boom) the performance of the economy in ? What is the picture behind the recent macroeconomic data (2004)? Please provide a detailed answer. Civilian unemployment rate (%)

4 ANSWER: As unemployment rate increased and real GDP growth slowed down, the economy was entering a recession in after a period of strong economic performance. This slowdown of the economy can be also associated with the consequences of the September 11th and the War in Iraq. In 2004 we can observe some signs of a recovery as unemployment rate drooped and real GDP growth rate accelerated. Yet, as the FED was using "loose" monetary policy (primarily by lowering interest rate) to push the economy out of the recession, inflationary pressure has built up and inflation rate increased.

5 3. Price a. Using the table plot the supply and New Supply demand graphs for oil and find the equilibrium price and quantity. 50 Supply b. Price Quantity Quantity 40 Demanded Supplied Demand Quantity Now suppose that a natural disaster limits the access to the oil wells which reduces the supply of oil by 30 for any given price. What are the new equilibrium price and quantity at the market? (Show the new equilibrium on the same graph.) ANSWER: Market supply shifts to the left - see graph. New equilibrium price is 50 and new equilibrium quantity is Suppose that the production of the ice-cream involves the following stages 1) raw milk from the farm 2) milk processing at the milk plant 3) ice-cream manufactured at the ice-cream factory 4) ice-cream is sold at the grocery store: Production Sales Value Stage Receipts Added Total - 6 Sale Tax Value Added Tax a. b. Find the value added at each stage of production. Is the total value added equal to the final sale price of the ice-cream? ANSWER: Yes, the total value added, which is 6, is equal to the final sale price of the ice-cream. A 5% sales tax generates the revenue for the government from every sale at any production stage. If a 5% sales tax is imposed on the production of ice-cream the government can raise 78 cents from every ice-cream sold. A value added tax take a fraction of the value added at each stage of ice-cream production. What value added tax should the government levy to generate the same amount of the tax revenue per ice-cream sold as with the 5% sales tax?

6 ANSWER: A revenue received from the value added tax is equal to the value added multiplied with this tax. Assume that the value added tax is equal to t, then the revenue received by the government at every stage of production of icecream is equal to: Production Value Tax Stage Added Revenue 1 2 2*t 2 1 1*t *t *t Total Therefore the total revenue from the value added tax is equal to 6* t. If the government wants to collect the same amount of money as with the 5% sale tax it just have to find t that solves the following equation: 6*t=0.78 As a result, t =13%. This example shows you that the government needs to impose a higher value added tax to get the same amount of revenue as with a smaller sales tax. It might give you an intuition why some countries that use value added tax have much higher rates (around 13-15%) of this tax than US sales tax, which is about (5-8%).

7 Problem 2.c We know that nominal GDP ( ) is equal to the real GDP (GDP R ) multiplied with a GDP deflator (P ). Let s show this relationship for the period t: Nominal GDP growth rate is equal to: %GDPt N = GDP t N t = GDP R t P t (1) = GDP t N 1 (2) GDP N From this equation you can deduce that the ratio of this year nominal GDP (real GDP, price deflator) to the previous year nominal GDP (real GDP, price deflator) is equal to: t = 1 + % t (3) Now, substitute equation (1) into the right hand side of the equation (2): %GDPt N = GDP t R = [ GDP R t GDP R P t GDP R P GDP R ] = GDP t R P t 1 = P GDP R P ] [ Pt P Thus using equation (3) we can show that (4) is equal to: 1 (4) %GDPt N = (1 + %GDPt R ) (1 + %P t ) 1 = 1 + %GDPt R + %P t + %GDP R Therefore: = %GDP R t t %P t 1 = + %P t + %GDPt R %P t (5) % t = %GDP R t + %P t + %GDP R t %P t (6) By equation (6) the growth rate of the nominal GDP, % t, is equal to the growth rate of the real GDP, %GDP R t, plus the growth rate of inflation %P t plus the growth rate of real GDP multiplied with the growth rate of inflation %GDP R t %P t. Thus, if we ignore this last component, the growth rate of nominal GDP is only approximately equal to the sum of the growth rate of real GDP and inflation. 1