Homework in Macroeconomics
D. Andolfatto
July 2, 2015
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Questions
1. Define the GDP and GNP.
2. A family decides to invest in local real estate, purchasing some property
with an old home on it. Is this purchase, or any part of it, counted toward
the period’s GDP? (Hint: think of the services that are typically involved
in real estate transactions).
3. A family decides to renovate their existing home. They spend $30,000
on renovations. The $30,000 expenditure involved $20,000 in labor costs
and $10,000 in materials drawn from their contractor’s inventory. How do
these expenditures and costs contribute to the GDP?
4. Explain why the GDP is equivalent to gross domestic expenditure, and
why gross domestic expenditure is equivalent to gross domestic income.
5. The income-expenditure identity  ≡  +  +  +   implies that an
increase in  must lead to an increase in  (TFU and explain).
6. A private firm produces investment services that cost $8,000 in labor,
selling $7,000 its output to the private sector and $3,000 to the government
sector. Compute this firm’s contribution to GDP and divide it into its
expenditure and income components.
7. A government agency produces a consumer service that it provides for free.
The service costs $8,000 in labor and $2,000 in rental costs. Compute this
agency’s contribution to the GDP and divide it into its expenditure and
income components (state what assumptions need to be made here). What
if consumers are in fact willing to pay only $5,000 for the services provided.
What sort of issue does this imply for the way government services are
measured in the GDP? Does the same issue apply to the private sector?
Explain why or why not.
8. Bob and Joe each spend one hour every Sunday doing yardwork. How
are these “yard maintainance services” valued in the NIPA? Imagine instead that Bob and Joe hire each other at $20/hr to do their respective
yardwork. Assuming that this income is reported and measured, how are
these same services valued in the NIPA? (NIPA = National Income and
Product Accounts). What sort of caveat does this thought experiment
suggest for what the GDP actually measures?
9. A firm charges $100,000 for excavation services. $60,000 of this cost is
paid to labor (including the owner of the firm) and $40,000 is paid to
rent a bulldozer. In the process of excavation, the wear and tear on the
bulldozer depreciates its value by $10,000. How much does this activity
contribute to the gross domestic product and the net domestic product.
Explain the difference (if any).
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10. Start at zero. Now flip a coin. If it comes up “heads,” add one to zero. If
it comes up “tails,” subtract one from zero. Now flip the coin again. If it
comes up “heads,” add one to your total, if it comes up “tails,” subtract
one from your total. Repeat this exercise ten times. Before the first
toss of the coin, what is the expected value of the total after ten tosses?
Suppose that after ten tosses, your total is three. Draw a linear “trend”
line through the data. What does the trend suggest the total will be after
another ten tosses? What is the actual expected value of your total after
another ten tosses? What does this exercise tell us about the pitfall of
drawing trend lines through the data?
11. What does it mean for an outcome to be “individually rational,” but
“collectively irrational?”
12. Consider the “Schumpeterian” and “Keynesian” business cycle models
studied in class. For each model, make a list of the exogenous and endogenous variables. Express in plain language the interpretation of the
business cycle offered by each model. What do these models have to
say about the desirability of “stabilization policies?” Is there any way for
an econometrician to distinguish between these two competing models?
Would cross country evidence help (where different countries have different policies)?
13. Explain the substitution and wealth effects associated with a change in
the real wage. Explain how the relative strength of these two effects is
likely to depend on whether the wage change is expected to be transitory
or permanent.
14. Consider a person with preferences for consumption () and home production () are given by  ( ) = ln() +  ln() where   0 is a preference
parameter. These preferences imply a MRS function   =  Suppose that this person faces the real wage  Explain how labor supply
 = 1 −  changes over time as  increases. Depict this on a diagram
with indifference curves and budget lines. What does this imply about
the relative strength of the substitution and wealth effects?
15. Consider the same person as in the question above, but now suppose that
they face a tax 0 ≤  ≤ 1 on labor earnings. Assume that the government takes the tax revenue it raises ( ) to finance a lump-sum transfer
 to all individuals. For simplicity, assume a representative agent economy. Derive the labor supply schedule ( ) and explain how employment
depends on   Redo this exercise assuming that the government instead
takes the tax revenue and consumes it (instead of redistributing it back to
individuals). How does labor supply depend on  in this case? Explain.
16. Explain why the marginal propensity to consume (MPC) out of income is
likely to depend on whether the income change is perceived to be transitory
or permanent. (First define MPC).
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17. Imagine that there is an event that leads a country into running a trade
deficit. Would it be correct to assume that the people of this economy are
now worse off because of the trade deficit? Even if the event in question
makes people worse off, can a case be made that a rising trade deficit
actually makes people better off than they would otherwise be? Explain.
18. Consider the problem max (1  2 ) subject to 1 + 2  ≤ 1 + 2 .
Explain how the desired saving function  = 1 − 
1 depends on  1 
and 2  (By "explain" I mean provide economic intuition—I do not mean
"describe.")
19. Explain why the consumption function 
1 in question 18 depends on
wealth and not on income per se (hint: show that there many different income profiles consistent with the same level of desired consumer
spending).
20. The permanent income hypothesis assumes that people can borrow freely
at the market rate of interest. Suppose, however, that creditors do not
believe that debtors will repay. In this case, borrowers face an additional
constraint: 1 ≤ 1  If this borrowing constraint binds, current consumer
demand no longer depends on wealth—it is instead sensitive to current
income. Explain.
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