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 firm’s sales, costs and profits are described below.
Sales (€)
Costs (€)
Profits (€)
Steel Producer
Car Producer
Computer Manufacturer
100000
300000
200000
Labour
50000 Steel
100000 Labour
120000
Purchases
Labour
100000
50000
100000
80000
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
A
100
120
110
B
1000
1000
1000
C
50
60
70
D
70
60
50
A
10
11
12
B
1
1.2
1.1
C
7
6
5
D
5
6
7
Prices
2002
2003
2004
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
Quantity
3000 bags
6000 bunches
8000 bags
Price
$2 per bag
$3 per bunch
$4 per bag
2005
Fruit
Apples
Bananas
Oranges
Quantity
4000 bags
8000 bunches
10000 bags
Price
$3 per bag
$2 per bunch
$5 per bag
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;
I = 50;
G = 100;
T = 100
Solve for:
a. Equilibrium income (Y)
b. Disposable income (Yd)
c. Consumption spending (C)
d. Private saving
e. Public saving
f.
The multiplier
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 )
c0 > 0
0 ≤ c1 ≤ 1
I = d 0 − d 1i
d0 > 0
0 ≤ d1
G = 1000
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?