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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. 2 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. 3 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