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ECON112 Macroeconomics Problem Set 1 *Solution* By Yao Amber Li Fall 2010 (Instructor: Li, Yao; TA: Fok Pik Lin, Astor) ------------------------------------------------------------------------------------------------------------------------------------

40 marks total

Part I: True/False/Uncertain Please justify your answer with a short argument. (10 marks, 2 marks each)

One mark is for correct judgment. One mark is for correct argument. 1. GDP is the value of all goods and services produced in the economy during a given period. False.

GDP = Value of * FINAL* goods & services produced in the economy during a given period.

2. When disposable income equals zero, consumption equals zero. False. When disposable income equals zero, consumption is still positive due to autonomous consumption/consumer confidence/c0.

3. The multiplier is greater than 1 if T = 0 and G = 0. True.

If the marginal propensity to consume is less than 1, it means that people consume less than 100% of their disposable income. It also implies that the multiplier is greater 1 (you can also write down the formula of the multiplier and indicate c1 is less than 1). The fact that T = 0 and G = 0 is irrelevant.

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4. Paradox of saving occurs when the attempts by people to save more lead to a decline in output and an increase in saving in the short run. False. … leads to a decline in output and unchanged saving. (you should understand the mechanism behind).

5. When MPC (marginal propensity to consume) increases and investment decreases, goods market equilibrium output increases. Uncertain.

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Part II: NATIONAL ACCOUNTS (Chapter 2) (14 marks)
For Part II, consider an artificial economy and assume the following: (1) HKUST is an autonomous economy. (2) The only good/service produced at HKUST is undergrad (freshmen) education.

1. Fill in the following table: (2 marks)
year # of HKUST freshmen Price (tuition: HK$) 1990 2000 2001 2002 300 900 1,000 1,100 2,000 20,000 21,000 23,000 600,000 18,000,000 21,000,000 25,300,000 Nominal GDP Real GDP (in 1990 $) 600,000 1,800,000 2,000,000 2,200,000 Real GDP (in 2000 $) 6,000,000 18,000,000 20,000,000 22,000,000

2. Find the growth rate of real GDP (using 2000$ as common price) for 2001 and 2002. (Express as percentage change and round to the nearest tenth). (2 marks)

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Growth rate of real GDP for 2001 (at 2000 price): (20,000,000-18,000,000)/18,000,000 = 11.1% Growth rate of real GDP for 2002 (at 2000 price): (22,000,000-20,000,000)/20,000,000 = 10.0%

3. Find the growth rate of real GDP (using 1990$ as common price) for 2001 and 2002. (Express as percentage change and round to the nearest tenth). (2 marks) Growth rate of real GDP for 2001 (at 1990 price): (2,000,000-1,800,000)/1,800,000 = 11.1% Growth rate of real GDP for 2002 (at 1990 price): (2,200,000-2,000,000)/2,000,000 = 10.0%

4. Given GDP deflator in 2000 is 100, compute inflation rate using GDP deflator (using 2000$) for 2001 and 2002. (3 marks) GDP deflator = (nominal GDP in year t) / (real GDP in year t) = Pt

In year 2000: GDP deflator = 100 In year 2001: GDP deflator = 105, inflation rate = 5% In year 2002: GDP deflator = 115, inflation rate = 9.5%

5. Calculate the real GDP for 2001 in chained (2000) dollars by constructing a chain-type index, if the index for 2000 is 1. Compare them with your answers in Question 1 on real GDP for 2001 (in 2000$, i.e., not chained). Are your answers in Question 1 and 5 different or same? Why? (5 marks) Step 1 (2 marks): Nominal GDP in 2000: 18,000,000 2001 real GDP (in 2000$): 20,000,000 Rate of change in production in 2000 prices: (20,000,000 - 18,000,000)/18,000,000 = 11.1%

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2000 real GDP (in 2001$): 900*21,000=18,900,000 Nominal GDP in 2001: 21,000,000 Rate of change in production in 2001 prices: (21,000,000-18,900,000)/18,900,000=11.1% Step 2 (1mark): The average rate of change = 11.1% Step 3 (1 mark): Index of 2000 = 1, Index of 2001 = 1 +0.111=1.111 Step 4 (1...
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