Download ECON 102 Tutorial 2

ECON 102
Tutorial 2
TA: Iain Snoddy
18 May 2015
Vancouver School of Economics
Questions
What is Gross Domestic Product?
Gross Domestic Product
The value of all final goods and services produced within a
country in a given year. There are three ways to calculate GDP.
By summing either total expenditure, income or production.
Typically we think of GDP=C+I+G+NX, ie, the Expenditure
approach.
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Question 1
In calculating GDP, economists use the value of final goods and
services because
(a) by using final goods and services, they avoid double counting.
(b) final goods can be exported to other countries.
(c) intermediate goods are imported from other countries.
(d) GDP is underestimated if intermediate goods are used instead.
(e) none of the above.
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Question 1
In calculating GDP, economists use the value of final goods and
services because
(a) by using final goods and services, they avoid double counting.
(b) final goods can be exported to other countries.
(c) intermediate goods are imported from other countries.
(d) GDP is underestimated if intermediate goods are used instead.
(e) none of the above.
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Double Counting
The problem of Double Counting
Essentially the problem of double counting arises because goods
used in the production of another good add value to that new
good. Intermediate goods add value to final goods.
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An example
Perhaps the easiest example to think of is car tires. A car
manufacturer buys tires from a tire manufacturer, which increases
the value of the car produced. If both the car and the tires were
included in the calculation of GDP, it would overstate total
production.
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Another example
Let’s think of a numerical example. Consider a basic computer made up of
Component
Price
CPU
RAM
Heatsink
Cables
Software
Battery
$125
$75
$25
$7
$85
$65
The Computer costs $490. $382 on components and an extra $108 for
construction etc. Clearly the Computer derives its value to some degree from
its components. If we included intermediate goods the contribution to GDP
here would be $872 (490+382). But clearly some of the computers value ($382
here) is made up of the value of the intermediate goods.
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Question 2
Of the following items, which one would be considered as
investment in the National Income and Expenditure Accounts?
(a) The purchase of a new van by a potter who packs it with his wares
and travels to art shows on weekends.
(b) The purchase of 100 shares of Bell Canada stock on the Toronto
Stock Exchange.
(c) The purchase of a 100-year-old house that was put on the protected
historic sites list.
(d) The purchase of a Canadian government bond.
(e) All of the above.
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Question 2
Of the following items, which one would be considered as
investment in the National Income and Expenditure Accounts?
(a) The purchase of a new van by a potter who packs it with his
wares and travels to art shows on weekends.
(b) The purchase of 100 shares of Bell Canada stock on the Toronto
Stock Exchange.
(c) The purchase of a 100-year-old house that was put on the protected
historic sites list.
(d) The purchase of a Canadian government bond.
(e) All of the above.
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Investment
Investment
Economists think of investments as expenditure on physical
capital, basically on machines, equipment and buildings.
Inventories are also included. Financial transactions are not
considered to be investment.
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Question 3
Which of the following would be an example of a consumption
expenditure?
(a) More spending by the government on children’s programs.
(b) An increase in welfare payments to single mothers.
(c) The purchase of a new car by the IPSCO steel company.
(d) The purchase of a new car by the Singh household.
(e) All of the above.
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Question 3
Which of the following would be an example of a consumption
expenditure?
(a) More spending by the government on children’s programs.
◦ This is government expenditure
(b) An increase in welfare payments to single mothers.
◦ This is a government transfer
(c) The purchase of a new car by the IPSCO steel company.
◦ This is investment
(d) The purchase of a new car by the Singh household.
◦ This is consumption expenditure
(e) All of the above.
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Consumption Expenditure
Consumption Expenditure
This is private spending on final goods and services by
households. The selling of used/second-hand goods are not
included in this measure.
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Question 4-7: Circular Flow
◦ A=$100
◦ B=$50
◦ C=$30
◦ D=$10
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Question 4
How much is GDP?
(a) $75
(b) $50
(c) $90
(d) $100
(e) None of the above
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Question 4
How much is GDP?
(a) $75
(b) $50
(c) $90
(d) $100
(e) None of the above
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Arriving at the Answer
To calculate GDP we use the income approach. GDP is equal to
the income paid to households in the factor market. This is $100
here.
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Question 5
How much is Net Exports?
(a) $10
(b) $25
(c) $30
(d) $50
(e) None of the above
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Question 5
How much is Net Exports?
(a) $10
(b) $25
(c) $30
(d) $50
(e) None of the above
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Arriving at the Answer
Remember that Yi nc = Yp rod = Ye xp. We already know that
GDP is $100 using the income approach. From the expenditure
approach we know that 100=C+G+I+NX. We know the value of
investment, consumption and government expenditure. C=50,
I=10, G=30. So NX=10. Meaning exports are greater than
imports.
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Question: Openness to Trade
Is Net exports useful in telling us how open an economy is to trade?
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Question 6
How much is Aggregate Expenditure?
(a) $50
(b) $75
(c) $90
(d) $100
(e) None of the above
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Question 6
How much is Aggregate Expenditure?
(a) $50
(b) $75
(c) $90
(d) $100
(e) None of the above
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Question 7
How much is Aggregate Income?
(a) $25
(b) $50
(c) $75
(d) $90
(e) $100
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Question 7
How much is Aggregate Income?
(a) $25
(b) $50
(c) $75
(d) $90
(e) $100
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Question 8
In the Canadian economy, market prices and factor costs would be
the same except for
(a) Depreciation
(b) Exports
(c) Personal Taxes
(d) Indirect Taxes and Subsidies
(e) Capital Consumption
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Question 8
In the Canadian economy, market prices and factor costs would be
the same except for
(a) Depreciation
(b) Exports
(c) Personal Taxes
(d) Indirect Taxes and Subsidies
(e) Capital Consumption
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Factor Costs
Factor Cost
Factor Cost is the revenue received by producers from the sale
of a good. It includes the cost of factors of production
plus a mark-up. The market price paid by consumers is equal
to this amount plus sales taxes.
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Question 9
Given that pollution is a by-product of some production processes,
(a) GDP accountants adjust GDP downward.
(b) GDP accountants adjust GDP upward.
(c) GDP accountants do not adjust GDP unless pollution is a serious
problem.
(d) GDP tends to overstate economic well-being
(e) GDP tends to understate economic well-being.
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Question 9
Given that pollution is a by-product of some production processes,
(a) GDP accountants adjust GDP downward.
(b) GDP accountants adjust GDP upward.
(c) GDP accountants do not adjust GDP unless pollution is a serious
problem.
(d) GDP tends to overstate economic well-being
(e) GDP tends to understate economic well-being.
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Other problems with GDP
Beyond the exclusion of externalities that are many limitations of
GDP. Here are just a few:
◦ It does not account for the Distribution of Income
◦ Does not account for hours worked
◦ It does not provide information on the structure of the
economy
◦ Home Production is not included
◦ Underground economy is not included
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Questions 10-12
Disposable Income
(dollars)
Consumption Expenditure
(dollars)
325
400
475
550
625
325
375
425
475
525
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Question 10
When saving is zero, what is the level of disposable income?
(a) $325
(b) $400
(c) $475
(d) $550
(e) $625
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Question 10
When saving is zero, what is the level of disposable income?
(a) $325
(b) $400
(c) $475
(d) $550
(e) $625
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The Answer
Put simply, saving is zero when all income that is consumed is
spent.
Here’s a tricky question: If total consumption expenditure equals
total disposable income in the economy does that mean that
nobody has saved any money?
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The Answer
The answer is no! Some people could have saved. But it means
that others also borrowed to finance consumption. Typically when
we talk about savings at the macro level we are thinking about net
savings. Or the amount of savings available for investment.
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Question 11
What is the value of the marginal propensity to consume?
(a) 0.75
(b) 0.25
(c) 1.33
(d) 0.34
(e) 0.67
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Question 11
What is the value of the marginal propensity to consume?
(a) 0.75
(b) 0.25
(c) 1.33
(d) 0.34
(e) 0.67
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The Marginal Propensity to Consume
The MPC
The MPC is the proportion of the increase in income that
an individual consumes.
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Calculating the MPC
To calculate the MPC you calculate the fraction of the increase in
income that is spent on consumption. In this case income is
increasing by $75 dollars between each row. Expenditure is
increasing by $50. The MPC is therefore 50/75=0.67.
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Autonomous Versus Induced Expenditure
The MPC captures induced consumption, the level of consumption
that depends upon the amount of income you are earning.
Autonomous consumption is the amount of consumption you
would have if you had an income of zero.
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Calculating Autonomous Consumption
In this example we can actually calculate autonomous
consumption. We are assuming that the MPC here is linear at all
points and takes the form C = a + M P C × Income where the
MPC is 0.67. We know that at an income level of $325, spending
is $325, and so 325 = a + 0.67 × 325. Autonomous spending is
$107.25
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Plotting the Marginal Propensity to consume
500
400
Consumption
300
200
100
0
0
100
200
300 400
Income
500
600
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A side note
You will always work with linear Consumption functions. Meaning
that the marginal propensity to consume is constant. As income
increase you will always consume the same fraction of income. But
of course this is unlikely to be true! A person earning $100,000
and a person earning $1,000 are likely to act very differently to an
increase in income of $100.
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MPC possibility
It could be that the MPC looks like this
Consumption
Income
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MPC possibility
Or maybe this:
Consumption
Income
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Question 12
What is the value of the marginal propensity to save?
(a) 0.27
(b) 0.25
(c) 0.67
(d) 0.33
(e) 1.33
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Question 12
What is the value of the marginal propensity to save?
(a) 0.27
(b) 0.25
(c) 0.67
(d) 0.33
(e) 1.33
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The Answer
The Marginal Propensity to save is 1-MPC. Or it is the proportion
∆S
of additional income that is saved: ∆Y
. Here it is given by
25
75 = 0.33
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What the hell is the AE model anyway?
Let’s try to put some context on the AE model. The AE model is
a short run model used to explain fluctuations in the economy.
The basic intuition of the model is this: Desired Expenditure drives
production. Or put another way, demand is key. Demand actually
drives supply here.
AE = a + bY d
AE can then be written as: AE = a + bY d where Y d = Y − T .
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What the hell is the AE model anyway?
AE = a + bY d
From this equation we know the desired level of expenditure for all
output. If output is Y , how much is purchased. If output exceeds
expenditure then firms are producing too much.
If expenditure exceeds output then firms will run down inventories
and increase production.
In both cases desired expenditure drives actual output.
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What the hell is the AE model anyway?
This is the central tenet of the AE model. Actual output is driven
by expenditure choices. In fact the model implies that expenditure
is quite powerful in driving economic activity. There is a multiplier
effect.
The multiplier effect states that if autonomous consumption
increases, output increases by a greater amount. The reasoning
behind this is that output becomes income. A change in
expenditure in the model yields to a large change in actual output.
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