Homework 2-

1. GDP Measurement:

Suppose you are studying a macro economy and you know that the total level of output this economy can produce during a year is dependent on the level of technology and the available capital and labor. For this economy this relationship can be written as

Y = AK^1/2L^1/2

Where Y is real GDP or real production, A is a measure of technology, K is the amount of capital available to this economy and L is the amount of labor available to this economy. Furthermore, assume that this economy fully utilizes its capital and its labor. You know that the value of A is 10 in this economy and that this economy has 100 units of capital and 400 units of labor.

In addition you also know that the national income accounts define GDP with the following two equations:

(1) Y = C + I + G + (EX - IM)

(2) Y = C^d + I^d + G^d  + EX

Where Y = real GDP, C = consumption spending, I = investment spending, G = government spending, EX = exports, IM = imports, C^d = spending by households on domestically produced goods, I^d = spending by businesses on domestically produced goods, and G^d = spending by government on domestically produced goods.

a. Given this information, what is the level of real GDP in this economy?

b. If households buy both domestically produced goods and foreign produced goods, then this relationship can be expressed as Cd + Cf = C. Suppose you are told that C is 1000 and that households purchase of domestically produced goods is 700. What is the level of household expenditure on foreign produced goods?

c. Using the same reasoning as in part (b) complete the following table where the superscript "d" stands for domestically produced while the superscript "f" stands for foreign produced. Use the information about consumption from part (b) and your calculation of real GDP from part (a) to complete the table.

d. Spending on imports is equal to all the spending that households, businesses, and the government make on foreign produced goods. What is the value of imports equal to in this example? Provide a general equation with symbols for imports and then give a numeric answer for the level of imports in this economy.

e. What is the value of net exports in this economy?

f. Verify from your calculation that both equations (1) and (2) given above are true.

2. GDP Measurement:

For each of the following identify whether or not they are counted in this year's GDP and if so what method you are using to calculate GDP, and how the situation affects the particular method of GDP accounting. The first one is done for you as an example.

a. Mona sells her 2001 Camry to a neighbor for $3000. She does not get any help to make the sell.

b. Trevor lives in a house built in 1941. In 2010 Trevor sells the house for $150,000 and he pays his real estate agent a commission of $9,000 after the transaction occurs.

c. Barney manufactures erasers. In 2010 he made 40,000 erasers. 50% of these erasers he sold to the Pentel Corporation where they were sold as part of the basic Pentel mechanical pencil. The other 50% of these erasers were sold in the market as replacement erasers. Each eraser sold for $.50. What was the effect of this transaction on GDP for 2010?

d. Susie purchases $500 of clothing during 2010. All of this clothing was manufactured during 2010. In addition, she purchases $40 of cheese, $100 of legal services, and $250 of car repairs done on her Honda. The car repairs were done by her favorite Armenian mechanic that has a shop just down the street from her apartment. Susie lives in Ohio. Some of the clothing Susie purchased was manufactured in Thailand ($300 worth) and some of the clothing was manufactured in Mexico ($75 worth). The rest of the clothing was manufactured in the U.S. 50% of the cheese Susie purchased in 2010 was produced in France while the rest of the cheese was manufactured in Wisconsin.

3. CPI:

Suppose you are given the following information to answer this set of questions.

For this problem assume that the market basket is defined as 1 hammer, 1 lawn mower, 1 unit of groceries for the year, and 2 bicycles. Note in this problem you may want to use a calculator and round all numbers to the nearest hundredth.

a. Compute the cost of the market basket for each year.

i. Cost of market basket in 2005 = ______________________

ii. Cost of market basket in 2006 = ______________________

iii. Cost of market basket in 2007 = ______________________

iv. Cost of market basket in 2008 = ______________________

b. Calculate the CPI four times. Use 2005 as the base year the first time, then use 2006 as the base year, then 2007 as the base year, and finally 2008 as the base year. Complete the following table with your calculated values.

c. Calculate the inflation rate between each year using 2005 as the base year. Fill in the following table based on your calculations.

d. Calculate the inflation rate between each year using 2006 as the base year. Fill in the following table based on your calculations.

e. Calculate the inflation rate between each year using 2007 as the base year. Fill in the following table based on your calculations.

f. Calculate the inflation rate between each year using 2008 as the base year. Fill in the following table based on your calculations.

g. Compare your answers in parts (c), (d), (e), and (f) and explain the reasoning behind your results.

4. CPI:

Answer the following set of questions using this CPI information for an economy.

a. Joe's nominal income in 2006 is $100,000. What must his nominal income be in 2008 in order for his real income to be unchanged?

b. Mary's real income in 2007 was $80,000. What must her nominal income be in 2008 in order for her real income to be unchanged?

c. Mike borrows $1000 in 2005 and repays this loan in 2006. Mike pays the lender $1060 in 2006. What is the real value of this payment in 2006 using 2005 as the base year? What nominal interest rate is Mike paying for this loan? What real interest rate is Mike paying for the loan?

5. Employment:

Consider an economy that has 100,000 people that are 16 years old or older. 2,000 of this group are currently in the military. 1,000 are homemakers; 10,000 are retired; and 14,000 are full-time students that are not employed. 10,000 people are currently not working and are actively seeking jobs. 5,000 people are temporarily laid off and anticipate that their jobs will resume within the next two months. 5,000 people are currently not working and are not actively seeking jobs because they live in a community with a severely depressed economy (like Detroit today). All other adults in this economy can be assumed to be working: 80% of this group are fully employed and 20% are underemployed.

a. What is the civilian labor force in this economy?

b. What is the number of unemployed people in this economy?

c. What is the number of employed people in this economy?

d. What is the unemployment rate in this economy?

e. What is the civilian labor force participation rate in this economy?

f. Suppose the government statistics department changes its definition of unemployment so that discouraged workers are counted as unemployed workers. What is the new unemployment rate with this change in definition?

g. Suppose that the government in addition to the change in part (f) also decides to treat all underemployed workers as unemployed workers since their work situation is not an optimal allocation of resources. How will this policy change alter the unemployment rate?

h. Does the way employment and the civilian labor force are defined matter? Explain your answer.