Macroeconomics - Assignment I

Baranidharan Mohan and Robin Shourie

(Dated: November 1, 2012)

I.

QUESTION 1

A) This increase the GDP by increasing the consumption, because Smith pays $50000 for services and this is included during the calculation of the GDP. B) The purchase of goods worth $10000 for building the garage, which is included in consumption. D) The purchase of the new house by Jones family is included in the GDP in terms of investment, though the selling of the old house is not. F) Purchase of the new mainframe computer from IBM by the university for $25000 since it is included in consumption. J) Purchasing a book from the store increase GDP by $100, since it is included as consumption.
II. QUESTION 2

Consider the GDP at market price. This value of the GDP can be calculated by dierent methods, one of them being by summing the total values of the goods added to the market. This can be done by calculating the value added by each individual rm by the sales of their goods and subtracted from it, the value of the intermediate goods used by the rm. Given that rm A sells cotton bales at $1000 to the rm B, and at $750 to the consumers. In this process of sales by rm A, it purchases $600 worth of raw cotton. Since this has to be produced by someother rm, this is considered as an intermediate good. Hence, the total value added by the rm A =$1000 + $750 - $600 = $1150. Similarly, the total sales made by the rm B is $5000 (by selling)+ $200 (by production though unsold), and it uses the $1000 worth of cotton produced by the rm A, which should be counted as an intermediate good. Hence, the total value added by the rm B = =$5000 + $200 - $1000 = $4200. Total GDP = Value added by rm A + Value added by rm B = $1150 + $4200 = $5350 GDP at factor prices is dened as the GDP at market prices, with the government involvement(eg., indirect taxes and subsidies) subtracted from it. Since there is no such factor included in the problem. Hence the GDP at factor prices is the same as the GDP at the market prices,, which can be calculated by the value added method, which is equal to $5350.
III. QUESTION 3

Ination for a basket of goods at time t can be dened mathematically as, t = where Pt is the price of the good i at time t. During the course of year 1, 1 = 200 (10 10) + 50 (30 20) + 10 (40 30) = 0.1818 18.18% 200 10 + 50 20 + 10 30 i (Pi,t Pi,t1 )Qi,0 ; i Pi,t1 Qi,0

Similarly, during the course of the second year, 2 = 200 (5 10) + 50 (30 30) + 10 (40 40) = 0.2546 25.46%. 200 10 + 50 30 + 10 40

Consumer Price Index or the CPI, can be dened as i Pi,t Qi,0 ; i Pi,0 Qi,0

CP It = CP I0

2 Choose t = 0 as the base year, and the base CPI, CP I0 = 100. Hence the CPI after the rst and second years can be given as, 200 10 + 50 30 + 10 40 200 10 + 50 20 + 10 30 200 5 + 50 30 + 10 40 200 10 + 50 20 + 10 30
IV. QUESTION 4

CP I1 = 100

= 118.18;

CP I2 = 100

= 87.87.

The initial equilibrium condition prevailing is represented by the gure given the question. AD0 , SRAS0 and LRAS0 give the aggregate demand, short run aggregate supply, and long run aggregate supply curves. The point a corresponds to the equilibrium price of P0 and equilibrium demand of Y0 . Given that there is a sudden spurt of investment by rms, increases the demand for the goods, the AD-curve shifts towards right from the position AD0 to the position AD1 )(red line). Now, the equilibrium the price and the demand will increase as shown in the gure. Now the new equilibrium price and the demand are given by P1 and Y1 , respectively, and which are greater than their respective initial values, P0 and Y0 . Since the price has increases, the expected prices P e will also increase. This will rotate the SRAS -curve towards the LRAS -curve, to maintain full employment. This is denoted by the curve, SRAS (green line). Hence, at this point, equilibrium price value P > P1 > P0 and equilibrium demand value Y0 < Y < Y1 . This change in the SRAS would continue till curve matches with the LRAS , which the stability condition for full employment. Hence, the increase in investments would result in the increase the price values to Pf in and the demand value would be the same as Y0 .

V.

QUESTION 5

A) GDP is dened as, Y = C + I + G + N X, where the symbols stand for the usual notation, and N X = X IM , is the net exports. Further, the Disposable Income, 1 2 DI = Y T = Y Y = Y. 3 3

3 Hence, 2 Y = 0.9DI + I + G + N X = 0.9 Y + 100 + 540 40 = 0.6Y + 600, 3 0.4Y = 600 Y = 1500. Therefore, the Budget Decit, 1 BD = G T = 540 1500 = 40. 3 B) Now, given that the government wants to reduce G by BD, the new goverment spending, G = 500. Hence the 1 new GDP, Y = 1460. And the new tax income, T = 3 1460 = 486.7. Hence, the new budget decit would be BD = 500 486.7 = 13.3. Therefore, the GDP as well as the budget decit would decrease by reducing the government expenditure.

VI.

QUESTION 6

1. 2. 3. 4. 5. 6. 7. 8.

Choice Choice Choice Choice Choice Choice Choice Choice

C B C D A B C A