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PROBLEM SET 1
Problems for Chapter 2
1. Suppose nominal GDP in 1997 increased by 7% (over its level in 1996). Based on this information, what happened to the rate of inflation (as measured by the
GDP deflator) and real GDP between 1996 and 1997? Explain.
2.
Use the information provided below to answer the following questions.
Year
1984
Nominal GDP
(bil of $)
3777.2
GDP Deflator
(1987 = 100)
.91
Real GDP
(in 1987 $)
1985
1986
1987
1988
1989
1990
4268.6
4539.9
4900.4
5250.8
5546.1
.94
.969
1.00
1.039
1.085
1.133
4296.5
1991
1992
1993
5724.8
6020.2
6343.3
1.176
1.235
4979.5 a.
What is nominal GDP in 1985? What is the GDP deflator in 1992? b.
Using the GDP deflator (where 1987 = 1), calculate real GDP for the remaining years. In what years, if any, did real GDP fall? If reductions in real GDP did occur, what does this tell us about the level of economic activity during those years? c.
Based on your calculations in part (b), compare the levels of real GDP with the level of nominal GDP for each year. What does this comparison suggest about prices (in that year relative to 1987)? d.
Explain why economists focus on real rather than nominal GDP when analyzing the level of economic activity.
3. Briefly explain how nominal GDP can increase and real GDP can decrease during the same period.

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4. Suppose you are provided with the following information about an economy. There are 100 million working-age individuals in the economy. Of these 100 million, 50 million are currently working, 10 million are looking for work, 10 million stopped looking for work 2 months ago, and the remaining 30 million do not want to work. a. Calculate the number of unemployed individuals, the size of the labor force, the unemployment rate, and the labor force participation rate. b. Now suppose that of the 10 million individuals looking for work, 5 million stop looking for work. Given this change, calculate what will happen to the size of the labor force, the unemployment rate, and the labor force participation rate. Did the unemployment rate and participation rate move in the same direction? Explain. c. Ignore part b. Start with the original numbers. Suppose firms experience an increase in the demand for their products and they respond by increasing employment.
Specifically, 2 million of the previously unemployed individuals now have jobs. Given this change, calculate what will happen to (1) the size of the labor force; (2) the number of employed individuals; (3) the number of unemployed individuals; (4) the unemployment rate; and (5) the labor force participation rate.
5. The table below includes information about real GDP (measured in billions of 1987 dollars) for the United States in 1993 and 1994.
1993
Consumption (C)
Fixed Investment (I)
Nonresidential
3459
805
592
1994
3579
903
672
Residential
Government spending (G)
Exports (X)
Imports (Q)
Inventory Investment (Is)
213
930
603
676
15
231
923
655
769
52 a. Calculate the levels of real GDP for 1993 and 1994. Then calculate the
rate of GDP growth between 1993 and 1994. Based on your calculations, briefly explain what happened to economic activity between 1993 and 1994. b. Calculate the rate of growth/decline in each of the components of GDP between 1993 and 1994. Which of the components of GDP grew the fastest and slowest between those two years? c. Based on the information in these two tables, what happened, if anything, to the size of the trade deficit between these two years? If the deficit did change, did it occur primarily because of changes in exports or imports?

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6. The table below includes information about nominal GDP (in billions of dollars) for the U.S. in 2002.
CONSUMPTION (C)
GOVERNMENT SPENDING (G)
FIXED INVESTMENT (I)
2002
7,376
1,957
1,568
INVENTORY INVESTMENT (Is)
IMPORTS (Q)
11
1,430
EXPORTS (X) 1,005
Calculate GDP from the above information. Show work.
7. Suppose you are provided with the following information about an economy comprised of just two firms, a shrimp farm that produces raw shrimp and a
seafood restaurant:
SHRIMP FARM
Revenues (shrimp)
From Sales to Households $10,000
From Sales to Foreigners $10,000
From Sales to Seafood
Restaurant $10,000
SEAFOOD RESTAURANT
Revenues (fried shrimp)
From Sales to Households $50,000
Expenses (wages) $10,000 Expenses
Wages $15,000
Shrimp $10,000
Profits $20,000 Profits $25,000 a. Calculate GDP using the FINAL GOODS APPROACH. Show work. b. Calculate GDP using the VALUE-ADDED APPROACH. Show each step of your calculations. c. Calculate GDP using the INCOME APPROACH. Show each step of your calculations.
TEXTBOOK, p. 37: #3, 4, 5, 6

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SELECTED ANSWERS
1. Without more information, we can say nothing about inflation and real GDP. Nominal
GDP can increase because of changes in the price level and/or changes in real output.
2. a.
$Y in 1985
=
.
94(4296.5) = 4038.7. The GDP deflator in 1992 = (5020.214979.5) =
1.209.
. b. To obtain the following values, simply divide nominal GDP by the GDP deflator. 4150.8,
4405 .
2, 4539.9, 4716.5, 4839. 4, 4895.1, 4868, 5136.3. Real GDP fell in 1991. This indicates that aggregate output was lower in 1991 compared to 1990 .
c. Prior to 1987. the real GDP figure is always greater than the nominal GDP figure because prices in the base year (1987) are higher than prices in these years. After 1987. the real GDP figure is always less than the nominal GDP figure because prices in the base year (1987) are less than prices in these years.
" " d. Nominal GDP can change simply because the price level is changing. Economists are concerned about changes in aggregate output. Real GDP measures changes in aggregate output.
.
3. If the increase in the price level is greater (in a proportionate sense) than the reduction in real output, nominal GDP will increase.
4. a. Number unemployed = 10; number employed = 50; therefore the labor force = 60. U =
10/60 = 16.7%. The participation rate = 60/100 = 60%.
. b. The labor force drops to 55, u = 5/55 = 9.1 %. The participation rate falls to 55/100 =
55%. Both rates fell. As fewer people search, the number of unemployed (and u) falls and the participation rate falls.
.
- - -- __ -..
f remains constant at 60. u falls to 8/60 = 13.3%. The participation rate does not change.
5. a. Y in 1993: 5136. Y in 1994: 5343. Rate of growth: 4%.
.
The level of economic activity increased; that is, real aggregate output increased.
. . b. 'Rates of growth: C (3.5%). I (12.2%). G (-1 %). X (8.6%), Q (13.8%), Is (247%).
Fastest: inventory investment (though this is a. bit misleading since it is the smallest component of Y). Slowest: government spending fell. years, Q increased even more.
. -.

6.
7.
5 b. c. a.
C+G+I+Is-Q+X = 10,487
Final Goods: shrimp to households + shrimp to foreigners + fried shrimp
$10,000 + $10,000 + $50,000
= $70,000
Value Added: VA in shrimp + VA in fried shrimp
$30,000 + $40,000 = $70,000
Income in shrimp (wages+profits) + Income in fried shrimp (wages+profits)
$30,000 $40,000 = $70,000

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4.
3. a. b. c.
ANSWERS TO TEXTBOOK PROBLEMS:
$1,000,000 is the value of the silver necklaces = GDP
1 st stage: $300,000. 2 nd stage: $1,000,000 - $300,000 = $700,000
GDP = $300,000 + $700,000 = $1,000,000 = GDP
Wages: $200,000 + $250,000 = $450,000
Profits: ($300,000 - $200,000) + ($1,000,000 - $250,000 - $300,000) = $550,000
Wages+Profits = $450,000 + 550,000 = $1,000,000 = GDP c. a. b.
2006 GDP: 10x$2,000 + 4x$1000 + 1,000x$1 = $25,000
2007 GDP: 12x$3,000 + 6x$500 + 1000x$1 = $40,000
2006 Prices:
2006 real GDP: $25,000
2007 real GDP: 12x$2,000 + 6x$1000 + 1,000x$1 = $31,000
Real GDP has increased by 60%
2007 Prices:
2006 real GDP: 10x$3,000 + 4x$500 + 1000x$1 = $33,000
2007 real GDP: $40,000
Real GDP has increased by 21.2% d. The output growth rates are different because the base-year prices are different in part b than in part c. Neither is correct or incorrect. When prices change over time, it is a “fact of life” that estimates of real GDP using the constant dollar method will produce different growth rates depending on which year’s prices are selected as the “constant” prices.
5. a. 2006 base year: Deflator (2006) = 1
Deflator (2007) = $40,000/$31,000 = 1.29
 inflation rate = 29% b. c.
2007 base year: Deflator (2006) = $25,000/$33,000 = 0.76
Deflator (2007) = 1
 inflation rate = 32%
The GDP Deflator is not constructed from the value of a fixed market basket of
goods like the CPI is. The quantities of goods in GDP change from one year to the next so changes in the GDP deflator reflect not only changes in prices but changes in quantities as well.
6. a. Real GDP 2006: $2500x10 + $750x4 + $1x1000 = $29,000
Real GDP 2007: $2500x12 + $750x6 + $1x1000 = $35,500 b. c.
22.4%
Average prices
2006 GDP Deflator: $25,000/$29,000 = 0.862
2007 GDP Deflator: $40,000/$35,500 = 1.13 d.
 inflation rate = 31%
This is an attractive solution because the common prices used in real GDP will no longer have to periodically change so growth rates will not change (see #4 b and c).