Download ECON366 - KONSTANTINOS KANELLOPOULOS

INSTRUCTOR: Mr. Konstantinos Kanellopoulos, MSc (L.S.E.), M.B.A.
COURSE: ECON-211-01-SUI13 Intermediate Macroeconomics
SEMESTER: Summer Session I, 2013
Tutorial 4 – for tutor
INSTRUCTIONS
Students are required to study the following questions and problems indicated and to be
able to solve them by themselves.
Although this is not a required part of a coursework, the purpose of the tutorial is
twofold: to help the student understand the methodology for solving the problems and to
help him/her prepare for the courseworks and/or exams. The utilisation of this resource
can be maximised depending on the time and effort each individual student devotes.
Konstantinos Kanellopoulos
7th June 2013
PART 1 SELF-TEST QUESTIONS
CHAPTER 2
1. How will each of the following events affect GDP and why?
a. Hurricane Katrina destroys large parts of New Orleans.
b. You sell your old macroeconomics textbook to another student.
c. You sell your holdings of IBM stock.
d. Your local car dealership decides to reduce its inventory by offering price
reductions.
a. When a hurricane destroys property, wealth is affected, not income (or GDP). However, if a
significant amount of the capital stock is destroyed and/or many people die, then less can be produced
later, leading to a decrease in GDP. On the other hand, the rebuilding of destroyed property results in
increased economic activity that will lead to a rise in GDP.
b. The sale of your textbook to another student will not constitute an official market transaction,
since you probably will not report your income to the IRS. In addition, the textbook has already been
used and is not part of current production. Therefore GDP will not be affected.
c. The sale of existing stock holdings is a transfer of wealth and, as such, does not affect GDP. Any
fees that you may have to pay your broker for his or her services, however, constitute payment for
services rendered. GDP will increase by that amount.
d. Inventory changes are counted as part of investment. A reduction in business inventories will
lower the level of investment (I) and thus GDP. However, the sales of the cars will count as
consumption (C) if consumers buy them, or investment (I) if firms buy them. Thus the net effect on
GDP depends on the value added, that is, the difference between the cost of the cars to the dealership
and the sales price of the cars.
2. If nominal GDP in Germany increased by 2.8% last year, but U.S. GDP increased by
4.2%, can we conclude that the welfare of U.S. citizens increased by more than that of
German citizens? Why or why not?
A country's nominal GDP is not a good measure of the economic welfare of its people, since nominal
GDP can change solely due to inflation. Only if real GDP grows faster than population, will real
income per capita increase. But real GDP per capita still does not take into account changes in income
distribution, changes in environmental quality, or leisure, all of which influence the economic welfare
of the people in a country. Therefore we cannot say whether the welfare of the people in the U.S. has
increased more than that of the people in Germany.
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3. Assume a Hyundai dealership in Chicago bought 30 Hyundais from Korea at a cost
of $15,000 per car in September of 2006. By December 31, 2006 they had sold 20 of the
Hyundais at a price of $18,000 each. The remaining Hyundais were sold in January of
2007 at a price of $16,000 each. How exactly does this affect the GDP in the U.S. in 2006
and 2007, and which categories of GDP (C, I, G, or NX) are affected?
2006:
NX = - (30*15,000) = - 450,000
C = + (20*18,000) = + 360,000
I = + (10*15,000) = + 150,000
_____________________________
GDP
= + 60,000
Check: The value added in 2006 is 20*3,000 = 60,000.
C = + (10*16,000) = + 160,000
I = - (10*15,000) = - 150,000
____________________________
GDP
= + 10,000
2007:
Check: The value added in 2007 is 10*1,000 = 10,000
PART 2 EXAM-TYPE PROBLEMS
CHAPTER 2
From the information below (all variables are in billions of dollars) calculate the level of
private domestic investment (I), consumption (C), and national income (Y).
government purchases
G = 1,200
budget surplus
BuS = 60
disposable income
YD = 4,500
net exports
NX = -110
private domestic saving
S = 500
From YD = C + S ==> C = YD - S = 4,500 - 500 = 4,000.
From S - I = BuD - TD ==> 500 - I = - 60 - 110 ==> I = 670.
From Y = C + I + G + NX ==> Y = 4,000 + 1,200 + 670 - 110 = 5,760.
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CHAPTER 10
Assume the following IS-LM model:
expenditure sector:
Sp
C
YD
TA
=
=
=
=
C + I + G + NX
100 + (4/5)YD
Y - TA
(1/4)Y
money sector:
I
= 300 - 20i
G = 120
NX = -20
M = 700
P =2
md = (1/3)Y + 200 - 10i
a. Derive the equilibrium values of consumption (C) and money demand (md).
b. How much investment (I) will be crowded out if the government increases its purchases
by G = 160 and nominal money supply (M) remains unchanged?
c. By how much will the equilibrium level of income (Y) and the interest rate (i) change, if
the Fed responds to this increase in government purchases by increasing nominal
money supply to M' = 1,100?
a. Sp = 100 + (4/5)[Y - (1/4)Y] + 300 - 20i + 120 - 20
= 500 + (4/5)(3/4)Y – 20i = 500 + (3/5)Y - 20i
From Y = Sp ==> Y = 500 + (3/5)Y - 20i ==> (2/5)Y = 500 - 20i
==> Y = (2.5)(500 - 20i) ==> Y = 1,250 - 50i IS-curve
From M/P = md ==> 700/2 = (1/3)Y + 200 - 10i ==> (1/3)Y = 150 + 10i
==> Y = 3(150 + 10i) ==> Y = 450 + 30i
LM-curve
IS = LM ==> 1,250 - 50i = 450 + 30i ==> 800 = 80i ==> i = 10
==> Y = 1,250 - 50*10 ==> Y = 750
C = 100 + (4/5)(3/4)750 = 100 + (3/5)750 ==> C = 550
Since ms = md ==> M/P = 700/2 = 350 = md
Check: md = (1/3)750 + 200 - 10*10 = 350
i
25
ISo
LMo
10
0
450
750
1,250
Y
4
b. Since G = 160, the IS-curve will shift to the right by
IS = (2.5)160 = 400 ==> so the new IS curve is of the form: Y = 1,650 - 50i
IS1 = LM ==> 1,650 - 50i = 450 + 30i ==> 1,200 = 80i ==> i = 15
==> Y = 1,650 - 50*15 ==> Y = 900
Since i = + 5 ==> I = - 20*5 ==> I = - 100
Check: Sp = G + I = 160 – 100 = 60 ==> Y = (Sp) = 2.5*60 =150
i
33
25
IS1
LMo
15
10
0
450
750 900
1,250 1,650
Y
c. If money supply is increased, then the LM-curve will shift to the right.
From M1/P = md ==> 1,100/2 = (1/3)Y + 200 - 20i
==> (1/3)Y = 350 - 20i ==> Y = 3(350 - 20i) ==> Y = 1,050 + 30i
IS1 = LM1 ==> 1,650 - 50i = 1,050 + 30i ==> 600 = 80i ==> i = 7.5 ==> Y = 1,275.
When we compare this result with the result in b., we can see that i = - 7.5 and Y = 375
i
25
IS1
LMo
LM1
10
7.5
0
450
900 1,050 1,275
1,650
Y
5