Economics 120
Williams College
Spring 2022
Prof. Nafziger
Problem Set #1
Due on Friday, February 11 by 4 pm in the box outside of Schapiro 335
Please Show All Work and List Who You Worked With!
1. How would the following transactions affect U.S. GDP? Be sure to indicate what categories
of GDP (i.e. C, I, G, NX) are affected and by how much they change (and in what year, if
appropriate).
a) Manufacturing firms reduce their inventories by selling $20 billion worth of goods to
households.
b) A farmer in Tulsa Oklahoma buys a new $25,000 truck built by Toyota in Japan. In
addition, a farmer in Japan buys a $28,000 truck built by Ford in the U.S.
c) The value of existing houses falls by $500 billion.
d) An elderly woman in the U.S. starts working part-time as a substitute teacher and is
paid a salary of $20,000 by a local government. She also starts receiving $15,000 of Social
Security benefits from the federal government.
e) The government pays $100 billion in interest payments on Treasury bonds.
f) In 2008, a Korean firm builds a tractor engine and sells it to a U.S. firm for $10,000. The
U.S. firm puts it in storage. In 2009, the U.S. firm builds a tractor in the U.S., installs the
Korean engine in it, and sells the tractor (with engine) to a firm in China for $25,000.
Calculate changes in GDP in both years.
2. Below are data on GDP in the United States in the 2000s. The GDP deflator is a price index
that works just like the CPI, but applies to all of the items in GDP, not just consumption.
Nominal GDP (billions, 1st-quarter)
GDP deflator
2005
$12154
1.117
2006
$12965
1.154
2007
$13552
1.187
a) Calculate real GDP for each of the years (in constant dollars of the base year 2000, when
the price index is 1.00).
b) Calculate the percentage growth rate in real GDP in 2006 (that is, the percentage increase
between 2005 and 2006) and in 2007 (similarly).
c) Calculate the inflation rate, as measured by the GDP deflator, for 2005-6 and 2006-7.
3. A farmer owns 8 sheep at the beginning of 2021. She shears the sheep and sells the wool
to a yarn manufacturer for $350. The yarn manufacturer uses this wool to produce 50
balls of yarn, priced at $9 per ball. 40 balls of yarn are sold to a clothing production
company and 10 are sold to consumers who enjoy knitting. The clothing production
company uses the yarn to produce 12 sweaters, each with a retail price of $60. At the end
of 2021, the farmer decides she wants to retire and she sells her sheep to a neighbor at a
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price of $100 per sheep.
a. What is the value added by the yarn manufacturer?
b. What is the net contribution of all of these transactions to 2021 GDP?
c. If only 10 of the sweaters produced are sold in 2021, with the remaining 2 sweaters
sold in January 2022, how does your answer to part b change?
4. Suppose the librarians of Williams College have negotiated a wage contract specifying
that their nominal wage will rise by 10% each year, relative to the previous year. The
nominal wage is $20 in the first year of the contract. Additional information is shown in
the chart below:
Year
CPI
Real Wage, in
Nominal Wage
Year 1 Dollars
1
1.00
2
1.02
3
1.05
4
20
24.20
a. Fill in the missing entries in the above chart.
b. What is the rate of inflation between year 3 and year 4?
5. Consider an economy in which the 2010 CPI was equal to 1000 and Joyce’s salary was
$60,000. If her real salary was held constant, she would have earned $69,300 in 2014.
What was the 2014 CPI? And if the 2015 CPI was 1247.4, what was the rate of inflation
from 2014-15?
6. You’re working as a summer intern at Entertainment Weekly magazine, and your editor
gives you the following assignment for an article. Listed below is the total revenue from
ticket sales for each of five blockbuster movies, expressed in nominal dollars. Your task is to
calculate how much money each film made in constant year dollars, and then to rank them
on that basis. Present your findings in tabular form.
 Titanic made $645 million in 1997
 Star Wars made $323 million in 1977 and another $138 million when re-released in 1997.
 E.T. made $400 million in 1982
 Jaws made $260 million in 1975
 Zootopia made $1.02 billion in 2016
Since you’re an intern, you have to track down the relevant price index yourself. Use the
annual average of the Consumer Price Index for all Urban Consumers (CPI-U) for all cities.
(Hint: the U.S. Bureau of Labor Statistics maintains the CPI. Use the Data Tools function on
their web site. Feel free to take a rough average over months in a year. You may also find
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these data in FRED, a service maintained by the Sty. Louis Fed:
https://fred.stlouisfed.org/series/CPIAUCSL)
7. Suppose that a borrower and a lender agree on the nominal interest rate to be paid on a
loan. Then inflation turns out to be higher than they both expected.
a) Is the real interest rate on this loan higher or lower than they had expected?
b) Does the lender gain or lose from this unexpectedly high inflation? Does the borrower
gain or lose?
c) Inflation during the 1970s was much higher than most people had expected when the
decade began. How did this affect homeowners who obtained fixed-rate mortgages at
the beginning of the decade? How did it affect the banks that lent the money?
8. In each of the following examples, show what happens on supply-demand diagram(s) of the
particular labor market described, indicate what would happen to the equilibrium wage(s)
and the equilibrium quantity(ies) of labor in that market(s), and briefly explain why.
a. The prices of goods made by low skill workers in the U.S. fall because we can now get
those goods more cheaply from other countries. Analyze the effect on the market for low
skill workers in the U.S.
b. The invention of computers and word processing programs enables authors to write
books more quickly. Analyze the effect on the labor market for authors.
c. Suppose that low-skilled immigrants are complementary to high-skilled native U.S.
workers in production (in other words, having lots of low-skilled workers around makes
high-skilled workers more productive at what they do). The U.S. suddenly changes
immigration policy to restrict low-skilled immigration. What happens in both the low
and high-skilled labor markets in the U.S.?
Complete Question 9 on Separate Sheets from Questions 1-8
Pick a country other than the U.S., and find this country in the World Economic Outlook
database (https://www.imf.org/en/Publications/WEO/weo-database/2021/October ), compiled
by the International Monetary Fund. Using Excel, Google Sheets, or some other program,
construct a figure showing the annual inflation rate in your country for the years 2000 to 2020
[if not all years are available, that is ok, although you might consider switching countries]. Put
years on the horizontal axis and inflation rates on the vertical axis and make sure everything is
well labelled. Write a paragraph in which you speculate as to what has driven changes in
inflation over time, and in which you compare this country’s recent inflation experience to the
inflation experience in the United States (you may wish to also graph the U.S.’s inflation rate).
Alternatively, focus on a specific change in the rate of inflation (relative or parallel to the United
States rate) and discuss why this happened. Please cite/reference any other external sources that
you draw on.
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