Chapter 2 Problems 1. Look at the newspapers for the past few days. What new economic statistics have been released? How do you interpret these statistics? Poverty levels in the US will continue to rise as long term unemployment numbers continue to increase. The societal problems that are associated with high unemployment will continue to increase.

2. A farmer grows a bushel of wheat and sells it to a miller for $1.00. The miller turns the wheat into flour and then sells the flour to a baker for $3.00. The baker uses the flour to make bread and sells the bread to an engineer for $6.00. The engineer eats the bread. What is the value added by each person? What is GDP?
Farmer’s VA = $1 Miller’s VA = $2 Baker’s VA = $3 GDP = $6

3. Suppose a woman marries her butler. After they are married, her husband continues to support him as before (but as a husband rather than as an employee). How does the marriage affect GDP? How should it affect GDP? GDP is affected because the husband is no longer employed and GDP will be reduced minus his salary.

4. Place each of the following transactions in one of the four components of expenditure: consumption, investment, government purchases, and net exports. a. Boeing sells an airplane to the Air Force. Government purchases b. Boeing sells an airplane to American Airlines. Investment c. Boeing sells an airplane to Air France. Net exports d. Boeing sells an airplane to Amelia Earhart. Consumption e. Boeing builds an airplane to be sold next year. Investments

5. Find data on GDP and its components, and compute the percentage of GDP for the following components for 1950, 1980, and the most recent year available.

50 80 10 a. Personal consumption expenditures 183.4 1670.1 10,351.9 b. Gross private domestic investment 42.2 395.1 1,821.4 c. Government purchases 41.4 132.0 3,002.3 d. Net exports 329 27.5 -515.5 e. National defense purchases 12.0 132.0 817 State and local purchases 19.2 335.9 1,788.0 f. Imports 20.2 313.6 2,352.6
Do your see any ant stable relationships in the data? Do you see any trends? (Hint: A good place to look for data is the statistical appendices of the Economic report of the President, which is written each year by the Council of Economic Advisers. Alternatively, you can go to www.bea.doc.gov, which is the Web site of the Bureau of Economic Analysis. ) All trends are going up except exports which have decreased dramatically.

6. Consider an economy that produces and consumes bread and automobiles. In the following table are data for two different years. | Year 2000 | Year 2010 | Price of an automobile | $50,000 | $60,000 | Price of a loaf of bread | $10 | $20 | Number of automobiles produced | 100 cars | 120 cars | Number of loaves of bread produced | 500,000 loaves | 400,000 loaves |

a. Using the year 2000 as the base year, compute the following statistics for each year: nominal GDP, real GDP, the implicit price deflator for GDP, and a fixed-weight price index such as the CPI.
Year Nom GDP Real GDP GDP Deflator Inflation rate
2000 10,000,000 10,000,000 100 0
2010 15,200,000 10,000,000 105.2 1.52

b. How much have prices risen between year 2000 and year 2010? Compare the answers given by the Laspeyres and Paasche price indices. Explain the difference.

c. Suppose you are a senator writing a bill to index Social Security and federal pensions. That is, your bill will adjust these benefits to offset changes in the cost of living. Will you use the GDP deflator or the CPI? Why?

7. Abby consumes only apples. In year 1, red apples cost $1 each, green apples cost $2 each, and Abby buys 10 red apples. In year 2, red apples cost $2, green apples cost $1, and Abby buys 10 green apples. a. Compute a consumer price index for apples for each year. Assume that year 1 is the base year in which the consumer basket is fixed. How does your index change from year 1 to year 2?
b. Compute Abby’s nominal spending on apples in each year. How does it change from year 1 to year 2? c. Using year 1 as the base year, compute Abby’s real spending on apples in each year. How does it change from year 1 to year 2? d. Defining the implicit price deflator as nominal spending divided by real spending; compute the deflator for each year. How does the deflator change from year 1 to year 2? e. Suppose that Abby is equally happy eating red or green apples. How much has the true cost of living increased for Abby? Compare this answer to your answers to parts (a) and (d). What does this example tell you about Laspeyres and Paasche price indices?

8. Consider how each of the following events is likely to affect real GDP. Do you think the change in real GDP reflects a similar change in economic well-being? a. A hurricane in Florida forces Disney World to shut down for a month. Tourism will decrease causing tourist dollars to stop flowing to region.

b. The discovery of a new, easy-to-grow strain of wheat increases farm harvests. Farmers will increase their yields and GDP will increase.

c. Increased hostility between unions and management sparks a rash of strikes. GDP will decrease because production has stopped.

d. Firms throughout the economy experience falling demand, causing them to lay off workers. GDP will decrease because of lost wages and people not buying goods.

e. Congress passes new environmental laws that prohibit firms from using production methods that emit large quantities of pollution. GDP will decrease since companies will move to other countries that will allow them to produce goods however they want to.

f. More high-school students drop out of school to take job mowing lawns. GDP will initially increase due to wages but long term the lack of these people having meaningful high paying jobs will be a negative for GDP.

g. Fathers around the country reduce their work weeks to spend more time with their children. Wages and the goods that they normally would have produced will decrease causing GDP to decrease

9. In a speech that Senator Robert Kennedy gave when he was running for president in 1968, he said the following about GDP:
[It] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.

Was Robert Kennedy right? If so, why do we care about GDP?

Robert Kennedy was correct in that GDP measures none of the things that he talks about in his speech but without the things that are measured in GDP nothing that he talks about in his speech can be possible.