METU

Department of Economics
Econ 202 Macroeconomic Theory
Instructors: Şirin Saraçoğlu – Ebru Voyvoda
2010-2011 Spring Semester

Problem Set 1

Question 1:

Consider an economy with three companies A, B, C. Company A produces cardboard,

which is used by Company B to produce boards and cards, which is used by Company C
to produce board games. Company A’s revenues (from sales to Company B) amount to
100 TL, and its expenses on labor amount to 30 TL. Company B’s revenues amount to
250 TL, while its expenses on labor amount to 80 TL. Company C’s revenues amount to
400 TL, while its expenses on labor amount to 90 TL. Show three different ways to
compute this economy’s GDP.

Question 2:

Suppose that the country of Macronia has three industries: bananas, tires, and cars.
(Macronia is a closed economy, both with respect to capital and goods flows.) Macronia's
population is 10,000. Bananas are produced by independent farmers, and the country
produces 17 million bananas in a year, all of which are consumed by Macronia's banana-
loving households. Tires are made by independent entrepreneurs from worthless junk.
The total value of tires produced in a year is 38 million TRY. These tires are in turn
purchased entirely by Macronia's car assembly plant. The car assembly plant turns out 62
cars a year, hiring workers and paying a total of 10 million TRY per year in wages. The
market price of a car is 3 million TRY and the market price of a banana is 2 TRY.
a) Calculate Macronia's GDP using the final sales definition of GDP
b) What is Macronia's GDP per capita?
c) Compute value-added in each industry, and in the economy as a whole. Does
your answer make sense? Why?

Question 3:

Compute the GDP and its components as measured by expenditure, income and
production in each case given below. For the production side, make sure you compute
value-added for each firm. Make sure that you arrive at the same number with each way
of computing GDP!

Imagine that there are two firms in the economy. One of them is a brewery,
the other one produces computers. The brewery produces 10000 bottles of beer, sells
6000 of them to consumers, 2000 to the computer factory and 2000 are still unsold at the
end of the year. The price per bottle sold is $2. The brewery buys two computers from the
computer company for $3000 and pays wages amounting to $4000. The brewery also
delivers additional 10 kegs to the computer factory for $200 each and pays indirect taxes
in the amount of $500. Depreciation of capital amounts to $1000. The computer company

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builds 10 computers, two of which are sold to the brewery, six are sold to consumers for
$1500 each and two are unsold at the end of the year. The computer company also buys
beer as mentioned above for the annual company picnic. The total amount of wages in the
economy is $10000 and depreciation of capital is $2000. There are no other transactions
in the economy apart from those mentioned above.

Question 4:

In Orangeland, a closed economy, Orangelanders live only on orange juice. There is a

farm that produces oranges and a factory that produces Orange Juice (OJ). In 2006, the
orange farm produced 10 oranges, and sold them to the orange juice company at 1 TL
each. The orange juice company produced 3 bottles of orange juice, and sold them all at a
unit price of 10 TL plus 10% indirect tax collected by government (so the price paid was
actually 11 TL). The orange farm paid total wages of 6 TL. The orange juice company
paid total wages of 10 TL. Both companies retained 50% of their net profits and paid the
rest of it as dividends to the households. After receiving their wage income and their
dividends, the households paid a 10% direct tax on their total income to the government.
The government bought one orange juice bottle (for 11 TL). The government made no
social transfers. (Notice that the firms are not paying any direct taxes on their retained
profits)
a) Compute the GDP of Orangeland using (a) income approach, (b) the value
added approach, and (c) the final goods approach.
b) What is the total income of the government from taxes?
c) What is the disposable income of the households?
The above information holds also for 2007, except that in 2007, the prices of all the goods
(oranges and orange juice bottles) go up by 10%.
d) Would you say that the economy experience a real economic expansion
between 2006 and 2007? Explain.
e) What was the nominal GDP in 2007?

Question 5:

Consider the following labor force statistics for an economy:

Total population (000s): 1000

Number of adults employed (000s): 600
Number of adults unemployed and looking for work (000s): 50
Number of adults unemployed and not looking for work (000s): 100
Number of elderly and children [none of whom work or look for work] (000s):250

a) Calculate the unemployment rate for this economy.

There is an economic boom, and 20000 new jobs are created, all of which are
filled by adults who were previously unemployed but looking for work.
b) Calculate the new unemployment rate.
Now the stock market crashes, and the boom turns into a deep recession. Total
employment falls to 520000. All the laid off workers give up hope of finding
another job, and decide to retire and move to Florida. So the number of
people unemployed but looking for work remains at 30000 as in Part (b).

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 c) What is the new unemployment rate? Compare your answer to the answers
you found in parts (a) and (b). Thinking about this comparison, comment on
the strengths and weaknesses of the unemployment rate as a measure of the
strength of the labor market.
d) If 200000 migrate to a neighboring country, what happens to the
unemployment rate?
e) If this country’s unemployment rate decreases, what do we know about its
real GDP?

Question 6:

An economy has the following real GDP and nominal GDP in 2006, 2007, and 2008.
the currency units are denoted in Euros and the numbers are in billions of euro.

Year Real Nominal

GDP GDP
2006 1,000 1,000
2007 1,050 1,200
2008 1,200 1,500

a) What was the GDP deflator in 2006?

b) What was the GDP deflator in 2007?
c) What is the inflation rate as measured by the GDP deflator between 2007
and 2008?
d) What is the percentage increase in the price level between 2006 and 2007
as measured by the GDP deflator?
e) What is growth rate of nominal GDP between 2006 and 2007, and 2007
and 2008?
f) What is growth rate of real GDP between 2006 and 2007, and 2007 and
2008? Why are your answers to parts (e) and (f) different?
g) What is the inflation rate between 2006 and 2007? and between 2007 and
2008?

Question 7:

The following table shows the price and quantities of goods consumed in a typical
consumption basket for a representative consumer in a country called Macroland.

Year Price Quantity Price Quantity Price of Quantity Price of Quantity

of of of of Orange of Tomato of
Pens Pens Pencils Pencils Juice Orange Soup Tomato
Juice Soup
2007 5 14 3 5 10 5 14 4
2008 10 5 3 15 11 6 14 5

a) Using 2007 Quantities as the official consumption basket and 2007 as the
base year, calculate the CPI for both years.

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b) Using 2008 Quantities as the official consumption basket and 2008 as the
base year, calculate the CPI (note that the CPI for 2007 may be in this case
less than 100).
c) Calculate the inflation rate from the CPI in a) (that is, using 2007 as the
base year) and in b) (using 2008 as the base year).
d) Are the inflation rates you calculated equal? Which one is bigger? Why?
e) What does this exercise tell you about the problems of using the inflation
rate as calculated here as reflecting the increase in the cost of living?
f) Calculate the GDP deflator and the inflation rate implied by it using 2007
as the base year and assuming that the quantities in the table above are the
output levels of each of the goods.
g) Calculate the GDP deflator and the inflation rate using 2008 as the base
year and assuming that the quantities in the table above are the output
levels of each of the goods.