Answer to Assignment One

1. Suppose that the annual rates of growth of real GDP of Econoland over a five-year period were as follows: 3 percent, 1 percent, -2 percent, 4 percent, and 5 percent. What was the average of these growth rates in Econoland over these 5 years? What term would economists use to describe what happened in year 3? If the growth rate in year 3 had been a positive 2 percent rather than a negative 2 percent, what would have been the average growth rate? Answers: 2.2 percent; recession; 3 percent. Consider the following example. Suppose that the annual rates of growth of real GDP of Econoland over a five-year period were sequentially as follows: 3 percent, 1 percent, -2 percent, 4 percent, and 5 percent. What was the average of these growth rates in Econoland over these 5 years? What term would economists use to describe what happened in year 3? If the growth rate in year 3 had been a positive 2 percent rather than a negative 2 percent, what would have been the average growth rate? To calculate the average annual rate of growth for this economy add each year's rate of growth then divide by the number of years. The average annual growth rate is 2.2% (= (3 + 1 + (-2) + 4 + 5) / 5). The negative rate of growth in year 3 would be considered a recession. If growth had been a positive 2% in year 3 the average growth rate would have been 3% (= (3 + 1 + 2 + 4 + 5) / 5). 2. Suppose that Glitter Gulch, a gold mining firm, increased its sales revenues on newly mined gold from $100 million to $200 million between one year and the next. Assuming that the price of gold increased by 100 percent over the same period, by what numerical amount did Glitter Gulchs real output change? If the price of gold had not changed, what would have been the change in Glitter Gulchs real output? Answers: 0; $100 million. Consider the following example. Suppose that Glitter Gulch, a gold mining firm, increased its sales revenues on newly mined gold from $100 million to $200 million between one year and the next. Assuming that the price of gold increased

by 100 percent over the same period, by what numerical amount did Glitter Gulchs real output change? If the price of gold had not changed, what would have been the change in Glitter Gulchs real output?Since the price doubled and the sales revenue doubled between one year and the next, this implies that the company sold and mined the same amount of gold over the period. The change in real output is zero. If the price of gold did not change and sales revenue doubled, the amount of gold sold and mined must have doubled. The change in real output is $100 million (= $200 million (new revenue) - $100 million (old revenue)). 3. A mathematical approximation called the rule of 70 tells us that the number of years that it will take something that is growing to double in size is approximately equal to the number 70 divided by its percentage rate of growth. Thus, if Mexicos real GDP per person is growing at 7 percent per year, it will take about 10 years (= 70/ 7) to double. Apply the rule of 70 to solve the following problem. Real GDP per person in Mexico in 2005 was about $11,000 per person, while it was about $44,000 per person in Canada. If real GDP per person in Mexico grows at the rate of 5 percent per year, about how long will it take Mexicos real GDP per person to reach the level that Canada was at in 2005? (Hint: How many times would Mexicos 2005 real GDP per person have to double to reach Canadas 2005 real GDP per person?) Answer: 28 years Consider the following example. Apply the rule of 70 to solve the following problem. Real GDP per person in Mexico in 2005 was about $11,000 per person, while it was about $44,000 per person in Canada. If real GDP per person in Mexico grows at the rate of 5 percent per year, about how long will it take Mexicos real GDP per person to reach the level that Canada was at in 2005? (Hint: How many times would Mexicos 2005 real GDP per person have to double to reach Canadas 2005 real GDP per person?) Using the rule of 70 Mexico's Real GDP per person will double every 14 years (= 70 / 5 or 70 divided by the rate of growth in Mexico). This implies that in 14 years Mexico's Real GDP per person will be $22,000. This is still only half of the $44,000 Real GDP per person in Canada. If we move ahead another 14 years Mexico's Real GDP per person will double again to $44,000 (from $22,000). Thus, after 28 years Mexico's Real GDP per person will reach the level of Canada in 2005. Mexico's Real GDP per person will need to double twice.

4.What is the value added by all the firms AE from the production of a product as described below? What did each firm add separately in value and what does it total? Stage of production Firm A Firm B Firm C Firm D Firm E Sales value of product $1,600 2,500 3,700 5,200 7,600

The value added by all firms is $7,600, or the final sales value. Firm A: added $1,600. Firm B: added $900. Firm C: added $1,200. Firm D: added: $1,500. Firm E: added $2,400. The value added by all firms totals $7,600 and equals the final sales value by Firm E ($7,600). 5. Which of the following are included and which are excluded in calculating this years GDP? Explain in each instance. (a) A monthly scholarship cheque received by an economics student (b) The purchase of a new corncrib by a farmer (c) The purchase of a used tractor by a farmer (d) The cashing in of a savings bond (e) The services of a mechanic in fixing the radiator in his own car (f) Social security cheques received by a retired person (g) An increase in business inventories (h) Government purchase of missiles (i) A barbers income (j) Income received from interest on a corporate bond (k) Cash received from selling a corporate bond (a) Scholarships are viewed as awards for past performance and would not be included in current production. They dont represent income earned by providing a productive resource as defined in the GDP accounts. (b) Is included because it represents investment. It is a final good that was produced in the current year.

(c) Not included because it was counted when it was new. (d) Not included because it represents a financial transaction only. (e) Not included because it is not a market transaction. (f) Not included because it is a transfer payment, not payment for current productive services. (g) Is included as part of business investment. (h) Is included as part of government spending on goods. (i) Is included because it is payment for productive services (barbering). (j) Is included because it is payment for use of capital resources during that year. (k) Not included because it represents a financial transaction only. 6. The following table shows the price of a specific stereo receiver for a five-year period. Using year 3 as the base year, calculate the price index for each year. Year Price Price index 1 $88 ___ 2 $100 ___ 3 $120 ___ 4 $132 ___ 5 $140 ___ Year 1 2 3 4 5 Price $88 $100 $120 $132 $140 Price index 73 83 100 110 117

To get the price index numbers, one would divide the given years price by the year 3 price and multiply the result by 100 to express as a percentage in index form. So the year 5 index is $140 divided by $120 or 1.17. Multiply 1.17 100 to get 117 expressed in percentage. 7. The following data show nominal GDP and the appropriate price index for several years (also referred to as GDP deflator). Compute real GDP for each year and indicate whether you have inflated or deflated nominal GDP in finding real GDP. All GDP are in billions. Year 1 2 3 4 5 6 Nominal GDP $117 124 143 149 178 220 Price level index 120 104 85 96 112 143 Real GDP ___ ___ ___ ___ ___ ___ Inflated (I) Deflated (D) ___ ___ ___ ___ ___ ___

NominalPrice level Year GDP 1 $117 2 124 3 143 4 149 5 178 6 220

index 120 104 85 96 112 143

Inflated (I) Real GDP $ 98 119 168 155 159 154

Deflated (D) D D I I D D

To get the answers for real GDP change the price index to percent (divide each index by 100), then divide nominal GDP by the percent price index. For example, in year #1, divide $117 by 1.20 to get $98 in real GDP. If the real GDP is less than the nominal it has been deflated; if the real GDP is more than the nominal GDP it has been inflated.