CHAPTERS 1-5 (Blanchard)

National Accounts

Question 1: In Economics, GDP per capita is often used as a measure of the welfare of an economy. Discuss its advantages and disadvantages.

Question 2: a) Discuss the Paasche and Laspeyres Prices Indices b) The GDP Deflator is a Paasche Price-Index (which, by the way, is true). Prove its validity.

Question 3 Discuss the following: a) Measurement of GDP

b) Nominal and real GDP c) Measurement of inflation

Question 4:

Consider an economy comprising households, a government, a tomato producer, and a pizza bakery. The government levies no taxes, but consumes tomatoes for 100. The tomato producer sells tomatoes to the government (100), to households (300), to the rest of the world (150) and to the pizza bakery (450), and he pays to his workers 500 wage income. The pizza bakery buys tomatoes for 450, pays to its workers 300 and sells pizzas to households for 1000. 1. Compute GDP according to the final goods approach (itemizing private consumption, investment, government consumption and net exports). 2. Compute GDP according to the value added approach (itemizing value added in the production units). 3. Compute GDP according to the income distribution approach (itemizing compensation of employees and corporate profits). 4. Suppose that the pizza bakery is owned by a foreign firm, and that domestic households receive 100 income from rent abroad. Compute GNI. 5. Compute the current account balance, compute the government budget deficit/surplus and net savings of the private sector. Show that the current account balance is equal to total net savings of the economy (private net savings plus government budget surplus).

Question 5: An economy consists of three firms; a car firm, a steel producer and a computer manufacturer. The firms sales, costs and profits are described below.

Sales () Costs ()

Steel Producer Car Producer Computer Manufacturer 100000 300000 200000 Labour 50000 Steel 100000 Labour 120000 Purchases Labour 100000 50000 100000 80000

Profits ()

You are also provided with the following information - The owners of the computer manufacturer are located abroad - Domestic workers travel across the border to work each day earning 20000 - VAT on steel and cars is 10% and on computers 15% - Depreciation of fixed capital in the year was 40000 Given all the above information calculate a. GDP according to the three methods (show all workings) b. Net Domestic Product c. Gross National Income (formerly Gross National Product) d. Net National Income (formerly Net National Product)

Question 6 You are given the following information on prices and quantities for four goods (Goods A, B, C and D) and for three years (2002, 2003 and 2004). Quantities 2002 2003 2004 Prices 2002 2003 2004 A 10 11 12 B 1 1.2 1.1 C 7 6 5 D 5 6 7 A 100 120 110 B 1000 1000 1000 C 50 60 70 D 70 60 50

Goods A, B and C are produced domestically, while good D is produced abroad. All of good C is exported abroad while all of good D is imported into the domestic economy. a) Calculate nominal GDP for all three years b) Using 2003 as the base year calculate real GDP for all three years c) Calculate for each year the GDP deflator. Using this, calculate the inflation rate for the years 2003 and 2004. d) Using quantities from 2003 calculate for each year the CPI index. Using this, calculate the inflation rate for the year 2003 and 2004. e) Assume now that the firm producing good D relocates to the domestic economy, producing all of its output in the domestic economy. What is the impact on domestic GDP and the inflation rate according to both the GDP deflator and the CPI index? Calculate all changes.

Question 7
Consider an economy that produces only three types of fruit: apples, oranges and bananas. The production and price data for 2004 and 2005 are reported below. (30 Marks) 2004 Fruit Apples Bananas Oranges Fruit Apples Bananas Oranges Quantity 3000 bags 6000 bunches 8000 bags Quantity 4000 bags 8000 bunches 10000 bags Price $2 per bag $3 per bunch $4 per bag Price $3 per bag $2 per bunch $5 per bag

2005

a) Calculate nominal GDP for 2004 and 2005. What is the percentage increase in nominal GDP between 2004 and 2005? b) Using 2004 as the base year, calculate real GDP for 2004 and 2005. What is the percentage increase in real GDP between 2004 and 2005? c) Calculate the GDP deflator for 2004 and 2005. What is the inflation rate for 2005 as measured by the GDP deflator? d) Suppose a Consumer Price Index (Laspeyres index) is constructed using weights corresponding to 2004, what is the rate of inflation in 2005 as measured by the CPI index? e) If all bananas were exported, how would the answers to parts c and d change? Calculate the changes.

Chapters 3-5

Question 8 Suppose that an economy is characterized by the following behavioral equations: C = 100 + 0.6Yd; Solve for: a. Equilibrium income (Y) b. Disposable income (Yd) c. Consumption spending (C) d. Private saving e. Public saving f. The multiplier I = 50; G = 100; T = 100

Verify from the above that in equilibrium: g. Production equals demand. h. Total saving equals investment.

Question 9 Consider the economy of the exercise above and suppose that the government wishes to increase equilibrium income by 100. a. Which change in government spending is required? b. If government spending cannot change, which change in taxes is required?

Question 10

(a) Using the IS-LM model describe graphically and verbally the impact of a contractionary fiscal policy on output and the interest rate. What is the impact on consumption and investment? (b) Using the IS-LM model describe graphically and verbally the impact of an expansionary monetary policy on output and the interest rate. What is the impact on consumption and investment? (c) The government needs to reduce the budget deficit while at the same time keeping output constant. What combination of policies would achieve this outcome? Show using the IS-LM model the impact of such a policy. What is the impact of the policy on the interest rate, consumption and investment?

Question 11

Discuss the following (a). Autonomous spending and the income multiplier. (b). Implication of the income multiplier? (c). The money multiplier. What does it imply?

(d). Discuss the paradox of thrift

(e). The marginal propensity to consume and save (f). A fiscal expansion and contraction (g). Open market operations (h). The IS curve and explain graphically its derivation. (i). The LM curve? How do we construct it? What does a point on the LM curve mean?

(j) The relationship between bond prices and the interest rate
(k) The demand for money

Question 12 Suppose that a person with wealth of $25,000 and a yearly income of $50,000 has a demandfor-money function given by Md = $Y ( 0.5 - i ) with i<0.5.

a. What is the person's demand for money when the interest rate is 5 percent? 10 percent?

b. What is the person's demand for bonds when the interest rate is 5 percent? 10 percent?

c. Summarize your results by stating the impact of a rise in the interest rate on the demand for money and the demand for bonds.

d. Assuming that the demand for money is equal to the supply of money (M), find an expression for velocity at any given interest rate. Use the expression to determine the impact on velocity of a rise in the interest rate.

Question 13 Suppose the public holds no currency, the ratio of reserves to deposits is 0.2, and the demand for money is given by Md = $Y (0.2 - 0.8 i ). Initially, the monetary base is $100 billion and nominal income is $5,000 billion.

a. Determine the value of the money supply.

b. Determine the equilibrium interest rate.

c. Determine the impact on the interest rate if the central bank increases the monetary base to $150 billion.

d. With the original money supply, determine the impact on the interest rate if nominal income increases from $5,000 billion to $6,250 billion.

Question 14

Consider the following numerical version of the IS-LM model: C = 296 + 0.6YD YD = Y T T = tY t = 0.4 I = 200 + 0.2Y 1000i G = 200 (M/P)d = 0.5Y 2500i (M/P)s = 500 a) Find the equation for the IS curve b) Find an equation for the LM curve c) Solve for equilibrium output (Y) and the equilibrium interest rate (i). d) Solve for the equilibrium levels of consumption (C) and investment (I). f) Now assume that the government decides to increase the tax rate (t) to 60%, calculate what happens to the equilibrium values of Y, i, C, and I. g) Using diagrams show graphically the impact of this policy on output and the interest rate. Explain in words how this policy affects output, interest rates, investment and consumption. h) Setting all variables back to their original levels, what would happen to the equilibrium values of Y, i, C and I if the Central Bank increased the money supply from 500 to 600? j) Using diagrams show graphically the impact of this policy on output and the interest rate. Explain in words how this policy affects output, interest rates, investment and consumption.

Question 15 Consider the following equations which describe an economy. (30 Marks)

C = c0 + c1 (Y T ) I = d 0 d 1i
G = 1000

c0 > 0 d0 > 0

0 c1 1 0 d1

Md = e1Y e2 i P

Ms = 2000 P

a) Derive an expression for equilibrium output and the equilibrium interest rate b) Given the following values for parameters and assuming that the government runs a balanced budget solve for the equilibrium values of output, the interest rate, consumption and investment. c0 = 1000; c1 = 0.8; d0 = 1000; d1 = 3000; e1 = 0.4; e2 = 4000 c) The government decides that it wants to increase the level of output. It considers two options: i) To allow the budget deficit to increase by reducing the level of taxes by 200 ii) To maintain a balanced budget increasing both taxes and government spending by 200 What is the impact on output, the interest rate, consumption and investment of the two policies? Explain why balanced budget changes in fiscal policy impact on output. d) Rather than use fiscal policy the central bank decides to increase output using monetary policy. What change in the money supply would be required to increase output by 400? Describe and explain the impact on consumption, investment and the interest rate?

Question 16

Part A: The Goods Market You are provided with the following information on the goods market, Y = C(Y-T) + I + G C = C(Y-T) = c0 + c1(Y-T) Z=C+I+G C = 400 + 0.6(Y-T) I = 200 T = G = 0.2Y Where Z is aggregate demand, Y is output, C is consumption, I is investment, c0 is autonomous consumption and c1 is the marginal propensity to consume. (a) Given this information calculate the value for equilibrium income. (b) What are the values for consumption and saving in each of the above cases? (c) Show that production equals demand and that investment equals total (private plus public) saving. (d) Consumers decide that they want to save more by reducing autonomous consumption to 200. What is the impact of this change on output, consumption and savings?

Part B: Financial Markets Assume that the public holds 20% of its money as currency and the ratio of reserves to deposits is 10%. The money demand function is given by,
M d = Y (0.6 2i ) with Y = 200 in equilibrium. Moreover, let the monetary base be 28. What is the total supply of money and the interest rate in equilibrium?