Macroeconomic Analysis: Exercise 1

1. Explain the difference between nominal GDP and real GDP.

2. What is a price index? What does the GDP deflator measure?
3. What is the relationship between labor employment and real GDP? What is the relationship
between the rate of growth in real GDP and the rate of unemployment:
[Answer: Production occurs when economic recourses-human, capital and natural-are employed.
Hence, the greater the employment of labor the higher the level of real GDP. Because greater
output is associate with higher levels of employment, there should be fewer unemployed workers
at higher output levels. It thereby follows that increases in the rate of economic growth would be
associated with decreases in the rate of unemployment. Arthus Okun (Okuns law) found that an
annual 2.5% increase in the rate of real growth above trend growth results in a 1% decrease in the
rate of unemployment.
4. Explain the terms: (a) business cycle, (b) stabilization policy, and (c) Monetary and fiscal policy.
(a) Business cycles are recurrent, but not periodic, fluctuations in economic activity that occur
around the secular trend of GDP over a period of several years. The expansionary phase of
the of the business cycle normally peaks at a point above the trend growth, whereas the
through for the contractionary phase is normally below the trend growth. The trend path of
the GDP is the path GDP would take if factors of production were fully employed. Full
employment of factors of production is an economic, not a physical, concept.
Physically, labor is fully employed if everyone is working 16 hours per day all year. In
economic terms, there is full employment of labor when everyone who wants a job cab find a
one within a reasonable amount of time. Because the definition is not precise, we typically
define full employment of labor by some convention, for example, that labor is fully
employed when the unemployment rate is 5.5%.
Output is not always at its trend level, that is, the level corresponding to (economic) full
employment of factors of production. Rather, output fluctuates around the trend level. During
an expansion (or recovery) the employment of factors of production increases, and that is a
source of increased production. Output can rise above trend because people work overtime
and machinery is used for several shifts.

Conversely, during a recession unemployment increases and less output is produced than
could in fact be produced with existing resources and technology.
The output gap measures the gap between actual output and the amount of output the
economy could produce at full employment given the existing resources. Full-employment
output is also called potential output.
(b) A stabilization policy is an action taken by the government to impact aggregate demand to
moderate the expansion and contraction phases of the business cycle. During an expansion,
the objective is to moderate the growth of spending: the objective during the recession
(economic contraction) is to reduce the rate of decrease in spending.
(c) Monetary policy aims to stabilize economic activity by controlling the money supply or
interest rates while fiscal policy utilizes a change in tax rates and or the level of government
spending for the same objective.
5. Explain the components of the equation

C Taka 20 0.90Yd

C C cYd

. Explain the components of the equation

. Which components of this equation represent exogenous consumption

and endogenous consumption?

Answer:

C
Represents other variables which affect consumption but whose value is unchanged.
Behavioral coefficient c measures the change in consumption that results from a change in

(c C / Yd )
disposable income

. As c is positive, consumption and disposable income move

in the same direction.

Consumption is Taka 20 regardless of the disposable income (DI). 0.90 Y d indicates that
consumption change by Taka 0.90 each time there is a 1 Take change in DI.
Taka 20 in the consumption equation represents exogenous consumption, consumption which is
determined by variables other than current DI but whose influence is external to the model.
0.90Yd represents endogenous consumption, since models of output determine current DI.
6. Income and expenditures approach to calculate the GDP.
Income Approach to calculate GDP:
Compensation of employees

Taka 422.7
2

Rents
Interest
Profit

122.2
403.6
Proprietors income
Corporate

478.3
586.6

NATIONAL INCOME(NI)
Indirect business Taxes

5813.5
679.0

Net national product (NNP)

Capital consumption allowance

6492.5
754.2

GNP
Plus: Payments of factor income
to rest of the world
Less: Receipts of factor income from the
rest of the world

7246.7
215.3
-208.3

GROSS DOMESTIC PRODUCT

1.
2.
3.
4.

7253.8

Expenditures Approach to calculate GDP

Personal consumption expenditure
Taka 4924.9
Gross private domestic investment
1065.3
Government expenditures
1358.3
Net exports
-94.7
GROSS DOMESTIC PRODUCT
7253.8

Personal Disposable Income Calculation

National income

Taka5813.5

Less:
Corporate profit

586.6

Contributions to social security plus the interest

1066.3

Govt. and business transfers to individuals

1022.6

Net interest paid to individuals

717.1

Dividend paid by corporations to individuals

214.8

Plus:

Personal Income

6115.1

Less:
3

Personal tax and nontax payments to government

794.3

Personal Disposable Income

5320.8

7. Measuring GDP:
Suppose, in a two-sector model, that individuals receive the following payments from the business sector:
Wage: Taka 520, Interest Taka 30, rent Taka 10, and profits Taka 80. Consumption spending is Taka 550
and investment is Taka 90. (a) Find the market value of the output and household saving. (b) What is the
relationship of savings and investment?
Answer:
(a) The market value of output is Taka 640 [Income approach] = Wages of Taka 520 + Interest of
Taka 30 + Rent of Taka 10 +Profits of Taka 80. OR by adding consumption and investment (Taka
550 +Taka 90). [Under expenditures approach]. Saving is Taka 90, found by deducting the Taka
550 that individuals consume from their income Taka 640.
(b) Both saving and investment equal Taka 90. This relationship always holds true in a two-sector
model, since leakages must always equal injections.
8. What is leakage from the circular flow? Why is investment spending viewed as an injection into
the circular flow?
a. A leakage occurs when income received is not spent by its recipients; for example, when
households are the sole recipients of income from production, their decision to save is a
leakage from the flow of income and spending.
b. Investment represents an injection of spending into circular flow. Those who desire to
invest obtain funds from those who save.
9. Assume that in a closed economy individuals receive income of Taka 760 and pay taxes of Taka
100 to the government; consumer spending is Taka 560; gross investment is Taka; depreciation is
Taka 40; government spending is Taka 130. (a) Find GDP and household saving. (b) What are the
leakages and injections for this closed economy? What is the relationship of these leakages and
injections?
10. From the following data, find (a) National income, (b) personal income, (c) personal disposable
income, and (d) Personal saving.
a. Compensation of employees
b. Business interest payments
c. Rental income of persons
d. Corporate profits
e. Proprietors income
f. Corporate dividends

$1866.3
264.9
34.1
164.8
120.3
66.4
4

g. Social security contributions

253.0
h. Personal taxes
402.1
i. Interest paid by consumers
64.4
j. Interest paid by government
105.1
k. Government and business transfers
374.5
l. Personal consumption expenditures
1991.9
11. Table 1.1 presents the price and units of aggregate output for 200x and 200y. (a) Present in Table
1.2, nominal GDP for 200x and 200y. (b) Also calculate in Table 1.2 real output for 200y by
measuring 200y output in 200x. What is the purpose of such a calculation? (c) What is the GDP
deflator in 200y?
Good
A
B
C
D
E

25
50
40
30
60

200x
Taka 1.5
7.5
6.0
5.0
2.0

30
60
50
35
70

200y
Taka 1.6
8.0
7.0
5.50
2.50

12. Suppose that households purchase the categories of goods and services listed in Column 1 of
Table 2.1; the relative importance of each category is given by the weight assigned in column 2.
The price index for each category during year 1 and year 2 is found in columns 3 and 4,
respectively. (a) From the data, calculate the CPI for year 1 and year 2. (b) What is the rate of
inflation between year 1 and year2 as measured by the change in the CPI?
Category
Food and beverage
Housing
Apparel
Transportation
Medical care
Entertainment
Other
Total

Price index for each category

Year1
270
300
180
280
300
230
250

Weight
0.175
0.460
0.046
0.193
0.049
0.036
0.041
1.00

Year 2
270
330
180
308
330
241
250