Test 4 – Sections 3 & 4
Section 3
5. You are given the following information about the small economy of Hyattville.
Hyattville’s economy is composed of three firms: Hyattville forest, Inc., which harvests
trees used by Hyattville Lumber Products, Inc., to manufacture various lumber products
used by Hyattville Houses Inc., to produce houses. Assume lumber is the only raw
material used to produce the houses in Hyattville.
Value of sales
Intermediate goods
Wages
Interest Payments
Rent
Profit
Total expenditures by
firm
Value added per firm
Hyattville
Forest,
Inc.
$15,000
(b)
6,000
1,000
3,000
5,000
15,000
(c)
Hyattville
Lumber
Products, Inc.
(a)
$15,000
15,000
3,000
(d)
4,000
40,000
(e)
Hyattville
Houses,
Inc.
$100,000
40,000
35,000
6,000
3,000
(f)
100,000
Total
Factor
Income
(g)
(h)
(i)
(j)
60,000
a. Fill in the missing entries [(a)-(j)] in the above table (1) by measuring GDP as the
value of the production of final goods and services in an economy as measured by
the value added by each firm; (2) by measuring GDP as the sum of aggregate
spending on domestically produced final goods and services in an economy; and
(3) by measuring GDP a the sum of factor income earned by households in the
economy.
b. Use the value-added approach to calculate the value of GDP? Explain.
c. Use the factor income approach to calculate the value of GDP? Explain.
d. Use the aggregate spending on domestically produced final goods and services
approach to calculate the value of GDP? Explain.
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5.a.
Value of sales
Intermediate goods
Wages
Interest Payments
Rent
Profit
Total expenditures by
firm
Value added per firm
Hyattville
Forest,
Inc.
$15,000
0
6,000
1,000
3,000
5,000
15,000
Hyattville
Lumber
Products, Inc.
$40,000
$15,000
15,000
3,000
3,000
4,000
40,000
Hyattville
Houses,
Inc.
$100,000
40,000
35,000
6,000
3,000
16,000
100,000
15,000
25,000
60,000
Total
Factor
Income
$56,000
10,000
9,000
25,000
b. To find GDP using the value added approach requires summing the horizontal
entries that are found in the row labeled “Value added per firm” in the above table.
From your answer in part (a) you know that the sum of these entries is equal to
$15,000 + $25,000 +$60,000 or $100,000.
c. To find GDP using the factor income approach requires first summing horizontally
the entries of the amount of wages paid, the amount of interest payments, the amount
of rent, and the amount of profit, which corresponds to finding the values of (g), (h), (i),
and (j) in the above table. Then, once these amounts have been calculated, these fourvalues must be summed to find the total factor income in the economy thus, from part
(a) of this question we have $56,000 (the amount of total wages paid in the economy) +
$10,000 (the total amount of interest payments in the economy) + $9,000 (the total
amount of rent payments in this economy) + $25,000 (the total amount of profits in this
economy) for a total of $100,000.
d. To find GDP using the aggregate spending on domestically produced final goods
and services approach, first recognize that Hyattville produces only one type of final
good or service: houses. The value of the houses produced in Hyattville is $100,000.
6. Suppose there are 12,000 people living in Macroland. Of these 12,000 people, 1,000
are either to old or too young to work. Of the remaining individuals, 5,000 are employed
full time; 3,000 are employed part time, but wish to work full time; 1,000 are
underemployed, but working full time; 1,000 are currently not working but are looking
for work; and the remainder are discouraged workers.
a. What is the size of the labor force in Macroland?
b. What is the employment rate in Macroland?
c. What is the unemployment rate in Macroland?
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d. What percentage of the population are discouraged workers?
e. Suppose you are told that 100 people find jobs for every $10,000 increase in the
level of aggregate output in Macroland. If you wanted the unemployment rate to
equal 8%, what would the change in output need to be? Assume no changes in
the number of young or old in the population, nor in the number of discouraged
workers.
f. Suppose the government department in Macroland responsible for compiling
unemployment statistics redefines the employed as including only those with fulltime jobs. How does this change the unemployment rate, given the initial
information?
6.a. The labor force is defined as the number of employed workers plus the number of
unemployed workers. The number of employed workers equals the sum of full-time
workers, part-time workers, and underemployed workers, or, in this example 9,000
workers. The number of unemployed workers is the 1,000 workers who are currently
not working, but who are actively looking for work. Thus, the labor force equals
10,000 workers.
b. Employment rate = [employed/labor force] x 100 = (9,000/10,000) x 100 = 90%.
c. Unemployment rate = [unemployed/labor force x 100 = (1,000/10,000 x 100 = 10%
d. Percentage of discouraged workers in population = [(discouraged
workers)/population] x 100 = (1,000/12,000) x 100 = 8.83%.
e. The current unemployment rate is 10%. To reduce the unemployment rate to 8%
requires that 200 of the currently unemployed workers find jobs. If output increases by
$10,000 for every 100 people who find jobs, then output must increase by $20,000 for
200 people to find unemployment.
g. Using the new definition of employment, the number of employed now is 6,000,
and the unemployed would increase by 3,000 for a total of 4,000 unemployed.
This change in definition results in a much higher unemployment rate (40%)
and a much lower employment rate (60%). The definition underlying
calculations do matter.
Section 4
2. Suppose you are given the following information about Macroland, a small, closed
economy where Y is real GDP, T is Taxes, and C is consumption spending, and I is
planned investment spending. Assume that government spending is currently $0, taxes
are constant at $50, and the aggregate price level is originally fixed at $100.
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Year
Y
T
C
I
1
$100 $50 $40 $50
2
150 50 80 50
3
300 50 200 50
a. Fill in the following table, using the information given above.
Year Disposable Income
1
2
3
b. What is the MPC for this economy?
c. What is the MPS for this economy?
d. What is the value of the spending multiplier for this economy?
e. What is the consumption function for this economy?
f. Given the above information, what is the equilibrium output level for this
economy?
2. a.
Year Disposable Income
1
$50
2
100
3
250
b. The MPC is defined as the change in consumption spending divided by the change
in disposable income. Using the information given to you and your calculations in part
(a), you can calculate the MPC as 0.8 (since the change in consumption from year 1 to
year 2 is 40 and the change in disposable income from year 1 to year 2 is 50.
c. The MPS plus the MPC equals one. Since the MPC equals 0.8, the MPS equals 0.2.
d. The value of the multiplier for this economy equals [1/(1-MPC)], or 5.
e. The consumption function for this economy can be written as C = A + MPC x (Y –
T). But, from part (b) you know the MPC is 0.8, and the taxes are constant at $50.
Thus, C = A + 0.8 (Y – 50). Using one of the disposable income and consumption pairs
from the table, you can solve this equation for the value of A, the autonomous level of
consumption spending. Thus, 40 = A + 0.8 (100 – 50), or A = 0. The consumption
function is therefore C = 0.8 x (Y – Y).
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f. The equilibrium level of output is where planned aggregate expenditure equals
production, or where planned AE equals Y. Planned AE is the sum of consumption
spending and investment spending because there is no government spending nor
foreign trade. Thus, AE = 0.8 x (Y – T) + 50. Substituting 50 for taxes, we get AE =
0.8 x(Y – 50) + 50 or AE = 0.8Y + 10. Recall that in equilibrium planned AE equals Y
so Y = AE = 0.8Y + 10. Solving for Y, the equilibrium level of real GDP, we get Y
equals 50.
4. Macroland is a small, closed economy that is currently operating at the long-run
equilibrium level of output. It is therefore producing Yp where Yp is potential output. Its
aggregate price level is P1.
a. Draw a graph of long-run equilibrium for Macroland depicting the AD, SRAS,
and LRAS curves. Label both axes, and identify Yp and P1 on the graph.
b. Suppose that Macroland experiences a negative demand shock. Draw a new
graph depicting the short-run changes in the original equilibrium that will occur
because of this demand shock. On your graph, identify the new short-run
equilibrium level of output Y2 and the new short-run equilibrium aggregate price
level P2. Label any shifts in AD or AS clearly.
c. Given the change in part (b), draw a third graph illustrating the long-run
adjustment to the negative demand shock. Label any shifting curves clearly and
identify the new long-run equilibrium level of aggregate output Y3 and the new
long-run price level P3
d. Given the change in part (b), suppose the government wishes to engage in activist
fiscal policy in order to restore the economy to its initial equilibrium. Provide
two fiscal policies that would accomplish this.
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4.
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d. To offset a negative demand shock, the government needs to shift the AD curve to
the right. Monetary policy that increases the money supply will shift the AD curve to
the right and return the economy to P1 and Yp.
7. The following graph depicts the economy of Macroland’s short-run aggregate supply
curve (SRAS), its long-run aggregate supply curve (LRAS), and its aggregate demand
curve (AD), Macroland is currently producing at Point E.
a. Is potential GDP for Macroland equal to Y1 or Y2? Describe Macroland’s current
production relative to its potential production.
b. Does Macroland have a recessionary gap or inflationary gap? Explain your
answer.
c. Holding everything else constant, which of the following policy initiatives might
help Macroland produce at its potential output? Explain how each would help.
i. The government initiates policies that encourage private
investment spending.
ii. The government increases taxes on consumers and corporations.
iii. The government authorizes new spending programs.
d.What is the current price level in Macroland? If Macroland engages in
expansionary fiscal policy so that AD shifts and actual output equals potential output,
what will happen to the price level?
7. a. The potential output level for Macroland is Y2. Currently, Macroland is
producing Y1 at price level P2: this is a recessionary gap because Macroland has the
potential to produce a higher level of output than it is currently producing.
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b. Macroland has a recessionary gap because its current level of production, Y1, is less
than its potential level of production, Y2.
c. Any policy initiative that shifts AD to the right will help Macroland move toward its
potential output level. Items (i) and (iii) will both shift AD to the right; government
policies that stimulate private investment spending lead to higher levels of aggregate
spending and a rightward shift in AD. New spending by government will also lead to
higher levels of aggregate spending and a rightward shift in AD. Item (ii) will reduce
disposable income and lead to lower levels of aggregate spending AD will shift to the
left.
d. The current price level in Macroland is P2. If the government engages in fiscal
policy that results in a shift of AD to the right, returning to the potential level of output,
and leading to an increase in the price level from P2 to P3.
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