Practice Questions National Income

1. National accounts in Margaritaville (40 points). Jimmy Buffett has decided to apply for
membership in the European Union on behalf of his newly sovereign nation, Margaritaville.
As part of his application, he must provide the EU technocrats with a complete set of
national accounts. You have been hired as the Chief National Accountant. Your first day on
the job, you receive an official Coral Reefer CrewTM t-shirt and the following information
about local economic activity:

• Local Cheeseburger in ParadiseTM cafes sold $63,000 worth of cheeseburgers to local

consumers. Their expenses were: imported beef and sesame seeds ($10,000), locally produced
catsup ($12,000), wages and benefits ($22,000), and rent ($3,000). Hint: you will need to
compute the profit earned by the cafes.

• Local tomato growers sold $8,000 worth of tomatoes to domestic catsup producers and
exported another $3,000 to the US. They paid land rent ($1,000) and wages ($9,000).

• Local producers of the Margaritaville Frozen Concoction MakerTM sold $100,000 worth of
blenders; $50,000 were exported to Europe, the remainder were sold to local consumers. Their
expenses were $15,000 worth of imported metal, $20,000 for a new CNC machine imported
from Germany, and $90,000 in wages.

• The domestic catsup industry sold $12,000 worth of product to local cafes. They purchased
$8,000 worth of tomatoes from domestic growers and paid $4,000 in wages.

• The newly-formed government collected $10,000 in taxes from its citizens and paid $10,000 to
government regulators, who oversee food and beverage safety. You mission is to use this raw
data to construct national income and product accounts for Magaritaville.

Specifically:

(a) Compute the value-added of each production unit. What is GDP? (10 points)

(b) Compute GDP and its expenditure components (consumption, investment, government
purchases of goods and services, exports, and imports). (10 points)

(c) What are saving and investment? Why are they different? Where does the difference go? (10
points)

2. This question is designed to see if you understand how Gross Domestic Product (GDP) is
measured. For each transaction answer the following questions:
• How is the GDP of the countries mentioned affected?
• In which component of each country’s GDP (C, I, G, or NX) will the transaction appear?
Before you begin, you should define exactly what GDP is. This definition should help you
answer the question. Each one of your answers should be able to satisfy this definition.
i. Households in the U.S. go on a binge of buying and eating U.S.-produced popcorn.
ii. J.B., who is a Canadian citizen living in Canada, buys a new car in Ann Arbor which
was built by a firm based in Michigan.
 iii. US Steel Corporation purchases a new $10 million steel rolling machine for its
factory. Assume the steel rolling machine was produced in Japan.
iv. The city of Ann Arbor purchases a new, German-made bus for $150,000.
v. The University of Michigan, a public school, builds a new library for $20 million.
vi. Aunt Jane buys a new home in Ann Arbor, MI in 2003 for $600,000. The home has
been built in 2003 from $40,000 worth of bricks produced in Canada in the same
year.
vii. A TV assembly plant in Mexico buys $100 worth of components from US factories,
assembles a TV, and sells it to the Ann Arbor Best Buy store for $350. A Canadian
buys it in Ann Arbor for $400 while on his vacation.
viii. Due to the current favorable exchange rate, EU citizens start purchasing shares on
the US stock market.
ix. You sell your copy of Mankiw’s Brief Principles of Macroeconomics back to Ulrich’s
for $15 after a very successful semester.
x. Your friend spends 5 hours fixing the broken wheel on his car; a job that would have
cost him $300 at the local service station.

3. There are an orange farm and an orange juice company in a country called Orangeland.
Orangelanders live only on orange juice. In 1992, the orange farm produced 10 oranges, and sold
them to the orange juice company at $1 each. The orange juice company produced 3 bottles of
orange juice, and sold them all at a unit price of $10 plus 10% indirect tax collected by government
(so the price paid was actually $11). The orange farm paid total wages of $6. The orange juice
company paid total wages of $10. The orange juice company also had to pay $4 to replace the orange
juice extractor that was not working properly due to its use during 1992 (depreciation). Both
companies retained 50% of their profits and paid the rest of it as dividends to the households. After
receiving their wage income and their dividends, the households paid a 10% direct tax on their total
income to the government. The government bought one orange juice bottle. (Notice that the firms
are not paying any direct taxes on their retained profits)

1. Compute the GNP of Orangeland using the value added approach or the final goods approach.
2. What is NNP? What is National Income?
3. What is the total income of the government?
4. What is government budget deficit (or surplus)?
5. What is the disposable income (income available for consumption) of the households?

In 1993, the price of all the goods (oranges and orange juice bottles) went up by10%.

6. Would you say that the economy experience a real economic expansion between 1992 and 1993?
Explain.
7. What was the nominal GNP in 1993? What is the inflation rate?
8. What was the real GNP in 1993 measured at 1992 prices?