Problem_Set_1_JustinGreen

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Problem Set 1 Note: The following questions are from “Problems and Applications” at the end of chapter in Mankiw textbook. Chapter 5. Measuring A Nation’s Income 1. What components of GDP (if any) would each of the following transactions affect? Explain. a. Uncle Fester buys a new refrigerator from a domestic manufacturer. Because a refrigerator is a good purchased by a household, consumption rises. b. Aunt Dolly hires a local contractor to build her a new house. Because a house is an investment good, investment rises. c. The Huang family buys an old Victorian house from the Ellis family. GDP is unaffected since no new goods are produced. d. You pay a hairdresser for a haircut. Because a haircut is a service purchased by a household, consumption rises. e. Ford sells a Mustang from its inventory to the Martinez family. Consumption rises because a car is a household product, while investment falls because the automobile in Ford's inventory was considered as an investment item until it was sold. f. Ford manufactures a Focus and sells it to Avis, the car rental company. Investment rises as a result of a car being a profitable investment for the car rental business. g. California hires workers to repave Highway 66. Because the government invested money to give a benefit to the public, government purchases have increased. h. The federal government sends your grandmother a Social Security check. A Social Security check is a transfer payment, not a government purchase, hence GDP is unaffected. i. Your parents buy a bottle of French wine. Since households buy the bottle, consumption rises; yet because the bottle was imported, net exports fall. j. Honda expands its factory in Ohio. Investment grows as a result of the construction of new facilities and machinery.

5. Below are some data from the land of milk and honey. a. Compute nominal GDP, real GDP, and the GDP deflator for each year, using 2020 as the base year. 2020 2021 2022 Nominal GDP 200 400 800 Real GDP 200 400 400 GDP Deflator 100 100 200 b. Compute the percentage change in nominal GDP, real GDP, and the GDP deflator in 2021 and 2022 from the preceding year. For each year, identify the variable that does. not change. Explain why your answer makes sense. For nominal GDP the percent change in 2021 is 100% all variables double so the increase was 100%. For nominal GDP the percent change in 2022 is also 100%. Again, all variables doubled so the increase was 100%. The real GDP in 2021 had a 100% increase as it doubled from 2020. The real GDP in 2022 had a 0% increase as it stayed the same. The deflator percent change in 2021 was 0% because prices didn’t change. The deflator percent change in 2022 was 100% because prices doubled. c. Did economic well-being increase more in 2021 or 2022? Explain. It increased more in 2021 because there was an increase in real GDP. 7. Consider the following data on U.S. GDP: (Note: as we did in our class, GDP deflator = Nominal GDP ÷ Real GDP) a. What was the growth rate of nominal GDP between 1998 and 2018? (Hint: The

(annualized) growth rate of a variable X over a N-year period is calculated as: 100×[( 𝑋𝑓𝑖𝑛𝑎𝑙 / 𝑋𝑖𝑛𝑖𝑡𝑖𝑎𝑙 )^1/ 𝑁 − 1].) b. What was the (annualized) growth rate of the GDP deflator between 1998 and 2018? c. What was real GDP in 1998 measured in 2012 prices? d. What was real GDP in 2018 measured in 2012 prices? e. What was the (annualized) growth rate of real GDP between 1998 and 2018? f. Was the growth rate of nominal GDP higher or lower than the growth rate of real GDP? Explain. 9. A farmer grows wheat, which she sells to a miller for $100. The miller turns the wheat into flour, which she sells to a baker for $150. The baker turns the wheat into bread, which she sells to consumers for $180. Consumers eat the bread. a. What is GDP in this economy? Explain. The GDP is the value added to the item so 100+50+30=180. b. Value added is defined as the value of a producer’s output minus the value of the intermediate goods that the producer buys to make the output. Assuming there are no intermediate goods beyond those described above, calculate the value added of each of the three producers. The farmer added $100 of value. The miller added $50 of value. The baker added $30 of value.

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Chapter 6. Measuring the Cost of Living (Mankiw textbook, pp. 127-128) 5. A small nation of ten people idolizes the TV show American The Voice. All this small nation produces and consumes are karaoke machines and CDs, in the following amounts: Karaoke machines CDs year Quantity price($) Quantity price($) 2020 10 40 30 10 2021 12 60 50 12 a. Using a method similar to the CPI, compute the percentage change in the overall price level. Use 2020 as the base year and fix the basket at 1 karaoke machine and 3 CDs. 2020(40+30=70) 2021(60+36=96) b. Using a method similar to the GDP deflator, compute the percentage change in the overall price level. Again, use 2020 as the base year. 2020 nominal(10*40+30*10=700) 2020 real=700 2020 deflator = 100 2021 nominal(12*60+50*12=1320) 2021 real (12*40+50*10=980 2021 deflator = 134.69 2021 inflation is 34.69% c. Is the inflation rate in 2021 the same using the two methods? Explain why or why not. No because in the CPI we used a fixed basket but the deflator accounts for outliers.

8. The chapter explains that Social Security benefits are increased each year in proportion to the increase in the CPI, even though most economists believe that the CPI overstates actual inflation. a. If the elderly consumer the same market basket as other people, does Social Security provides the elderly with an improvement in their standard of living each year? Because Social Security payments are based on the CPI and the CPI overstates inflation, if seniors consumed the same market basket as everyone else, their quality of living would increase every year. b. In fact, the elderly consumes more healthcare compared to younger people, and healthcare costs have risen faster than overall inflation. What would you do to determine whether the elderly is actually better off from year to year? It's probable that the elderly is worse off because they utilize healthcare services more frequently than younger people do and because healthcare expenditures have increased more quickly than general inflation. You would need to put together an aged market basket with a heavier emphasis on healthcare in order to investigate this. The cost increase for the "elderly" basket would then be compared to the overall basket's increase for the CPI.

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