Homework #1 Answers

ECO 310
20 points possible

National Income Accounting (15 points)

Consider an economy that produces and consumes bread, coffee, and automobiles. In the following table, we have data for two different years. The
first 2 questions refer to this table.

Price of 1 Automobile
Price of 1 loaf of Bread
Price of 1 cup of Coffee
Number of Automobiles Produced
Number of Cups of Coffee Produced
Number of Loaves of Bread Produced

Year 2007 Year 2008

$20,000
$21,000
$1.25
$1.50
$2.00
$2.10
100
120
100,000
115,000
400,000
380,000

1. Using the year 2007 as the base year, compute the following
statistics for each year: nominal GDP, real GDP, the GDP deflator
(a Paasche price index) and the CPI (a Laspeyres price index). For the
CPI, assume that the representative basket of goods is exactly the one
produced in the year 2007
Answer: To calculate nominal GDP for 2007 is
$20, 000 100 + $1.25 400, 000 + $2 100, 000 =
$2, 000, 000 + $500, 000 + $200, 000 = $2, 700, 000
for 2008
$21, 000 120 + $1.50 380, 000 + $2.1 115, 000 =
$2, 520, 000 + $570, 000 + $241, 500 = $3, 331, 500
To calculate real GDP for 2007, since 2007 is the base year
real GDP 2007 equals $2,700,000

for 2008 just use the 2007 prices

$20, 000 120 + $1.25 380, 000 + $2 115, 000 =
$2, 400, 000 + $475, 000 + $230, 000 = $3, 105, 000
The amount of stuff produced in 2008, at 2007 prices is the
real GDP in 2008
To calculate the GDP deflator in both years simply divide
Nominal GDP by Real GDP, so for 2007
GDP def lator 2006 = $2.7 million/$2.7 million = 1
and for 2008
GDP def lator 2007 = $3, 331, 500/$3, 105, 000 = 1.073
For the CPI , just calculate it as a Laspeyres price index so
that
a0 pat + b0 pbt + c0 pct
CP It =
a0 pa0 + b0 pb0 + c0 pc0
where a stands for autos and b stands for bread. Since 2007
is the base year the CPI equals one. For 2008,
100 $21, 000 + 400, 000 $1.5 + 100, 000 $2.1
100 $20, 000 + 400, 000 $1.25 + 100, 000 $2
$2, 100, 000 + $600, 000 + $210, 000
$2, 910, 000
=
=
= 1.078
$2, 000, 000 + $500, 000 + $200, 000
$2, 700, 000

CP I2010 =

2. How high was the inflation rate between 2007 and 2008, based on the
GDP deflator, and based on the CPI? Answer: Based on the GDP
deflator, the inflation rate between 2007 and 2008 would be
7.3%, based on the CPI it is 7.8%.
3. Consider the following events: Mr. Jordan buys for himself a hundred
year old Victorian house for $US 10 million, and Mr. ONeal builds for
himself a brand-new villa for $US 15 million. How much do these events
together add to current GDP? $10 million, $15 million, or $25 million.
Justify your answer. Answer: Since the Victorian house is not
2

newly built, it is not included in GDP. Mr. ONeals house

is newly built, hence it counts as residential fixed investment
in current GDP. Thus, the addition to current GDP is $15
million.
4. Consider the following events: Mr. Merrill buys $5 million in IBM stock
from Mr. Lynch on the New York Stock Exchange and General Motors
sells $10 million in new stock to the public and uses the proceeds to
build a new car factory. How much do these events together add to
current GDP? $0, $5 million, $10 million, or $15 million. Justify your
answer. Answer: When Mr. Merrill buys $5 million in stock
he invests $5 million, but Mr. Lynch disinvests $5 million and
overall investment from this transaction is zero. No additional
production occurred. On the contrary, GM buys a new car
factory for $10 million, which adds to nonresidential fixed
investment. Hence the addition to current GDP is $10 million.
5. A farmer grows a bushel of wheat and sells it to a miller for $1.00. The
miller turns the wheat into flour and then sells the flour to a baker
for $3.00. The baker uses the flour to make bread and sells the bread
to an economist for $6.00. What is the value added by each person?
What is GDP (if these were the only transactions in the economy)?
Answer: The value added of the farmer is $1, the value added
of the miller is $3-$1=$2, and the value added by the baker
is $6-$3=$3. The value added of the economists is $0!! Total
GDP is equal to the sum of all the value added. Thus GDP
is $6.

Calculating GDP (5 points)

Go to the BEA website (http://www.bea.gov) and reconstruct TABLE 2,

titles Spending Components of Nominal GDP using more recent data. The
information you need can be found in TABLE 1.1.5 of the NIPA tables. This
table will allow you to reconstruct GDP using the spending approach. Use
the most recent quarter that is available.
Answer: Here are the updated numbers up to the second quarter of 2009.

Table 2: Spending Components of Nominal GDP

Component
Billions US$ % Total Nom. GDP
Total Nom. GDP
14,143.3
100.0%
Consumption (C)
9,996.6
70.7%
Durable Goods
1,011.0
7.2%
Nondurable Goods
2,180.2
15.4%
Services
6,805.3
48.1%
Gross Investment (I)
1,558.6
11.0%
Nonresidential Fixed
1,387.3
9.9%
Residential Fixed
346.2
2.4%
Inventory Investment
--175.0
--1.2%
Government Purchases (G)
2,926.8
20.7%
Federal Government
1,137.0
8.0%
State and Local Government
1,789.8
12.7%
Net Exports (X-M)
-338.7
-2.4%
Exports
1,492.2
10.6%
Imports
-1,830.8
-12.9%