Economics 222

Sections C, D and E

Winter 1998

Exercise A

1. To eliminate the influence of price changes in growth accounting, GDP is measured in real terms (relative to a base year). To do this, link to the CANSIM database from the QED web pages and select series D10000, which is quarterly nominal GDP, and series P700000, which is monthly price indices for all items, in Canada. In the retrieval form, convert both series to "annual" using the "average" method and select the years 1990 to 1992.

(a) What are the growth rates of nominal GDP from 1990 to 1992?

(b) What are the inflation rates from 1990 to 1992?

(c) Find the growth rates of real GDP from 1990 to 1992.

(d) Suppose all you knew were the price indexes for 1990 and 1992 (you do not know the price index for 1991). Calculate the (constant) annual rate of inflation from 1990 to 1992.

2. In 1995, an economy's real GDP was 4962.4, the capital stock was 12,503.4 and employment was 122.8 (in millions of workers). In 1996, the numbers were: real GDP 5083.6, capital stock 13,880 and employment 124. Suppose the production function in both years is given by,

Y =A K^(0.25) N^(0.75)

where K is capital, N is labour and A is TFP. (Note: (^) denotes exponent)

(a) Calculate TFP for 1995 and 1996.

(b) How much did TFP grow from 1995 to 1996.

(c) Suppose tax incentives had raised the capital stock in 1996 making it 10% higher (than the figure given above). If employment did not change, what would have been the percent increase in real output between 1995 and 1996?

3. For 1992, Econoland had the following nominal quantities (in billion of dollars) and price index (1987=100) for each category of expenditure.

Nominal Value Price Index
Consumption 438.5 122.1
Fixed Investment 121.0 115.0
Government Purchases 173.4 131.2
Exports 187.7 108.1
Imports 194.5 98.0
Change in Inventories -6.2 115.0

(a) Calculate the real quantity for each category (to one decimal point).

(b) Calculate nominal and real GDP.

(c) Find the implicit price deflator (1987=100).

4. A reporter claims a high economic activity in Canada will increase domestic demand for imports, ceteris paribus, causing a fall in net exports. To verify this, collect data on real total consumption (C) (D20488), real aggregate investment (I) (D20471) and real merchandise imports (M) (D20481). In the retrieval form, convert both series to "annual" using the "average" method and select the years 1992 to 1995.

(a) What are the growth rates of C, I and M from 1992 to 1995?

(b) If domestic economic activity is measured by the sum of C and I, what can you say about the growth in economic activity and merchandise imports?

(c) Can you think of other factors that could affect net exports?

5. Canada has large foreign debt, both private and public. Explain how this affects:

(a) the difference between GDP and GNP

(b) the difference between NX and CA.

6. Suppose the nominal interest rate is 3.5%, today's price level is 125 and you expect the price level to be 130 one year from now.

(a) What is the expected inflation rate?

(b) What is the expected real interest rate?

(c) Based on your answer in (b), would you increase or decrease your savings, and why?

7. Suppose that the aggregate production function in Canada can be thought of as:

Y = A K^(0.25) N^(0.75).

Use the values for K, N, and A for 1991 from Table 3.1 in the textbook.

(a) What was MPK in 1991? What units is it measured in?

(b) What was MPN in 1991? What units is it measured in?

Assignment 1 Solutions:

1. For part (c), real GDP = (nominal value/price index)x100, then find growth rates.

(d) let constant inflation rate = pi,

then, (1+pi)(1+pi) = (index_1992)/(index_1990)

2.(a) TFP = 12.72 (for 1995) = 12.60 (for 1996)

(b) growth rate of TFP = (12.6-12.72)x100/12.72 = -0.94%

(c) 10% increase. Capital stock = 15268 Subst. in output equation : Y = 5204.54 (for 1992) percent increase in Y = 4.88% 3. (a) real GDP = (nominal value/price index)x100

Nominal value Price Index Real Value
Consumption 438.5 122.1 359.13
Fixed Investment 121.0 115.0 105.22
Government Purchase 173.4 131.2 132.16
Exports 187.7108.1173.64
Imports194.598.0198.47
Changes in Inventories-6.2115.0-5.39
Totals719.9566.26

(c) implicit price deflator = (nominal value/real value)x100 = 127.1

4.(c) Other factors: exchange rate, interest rates (similar channel, but can be mentioned), etc. A couple of factors is fine.

5. students should should know relationships:

(a) GNP = GDP + NFP

(b) CA = NX + NFP

then explain why a large foreign debt leads to negative NFP. Hence, GNP < GDP and CA < NX.

6.(a)Expected inflation = [[expected P(t+1) - P(t)]/P(t)]x100

= [(130-125)/125]x100

= 4.0%

(b) expected real interest rate = nominal rate - expected inflation = 3.0 - 4.0 = -1.0%

(c) NO. For example, returns from $1.00 savings is worth less than today. Consumption today will thus increase and savings reduce.

7. In 1991 (see Table 3.1 in textbook), K=493 ($billion), N=12.3 (millions of workers), A=14.94

(a) MPK: differentiate function w.r.t K at this point. No unit (pure number)

(b) MPN: differentiate function w.r.t N at this point. Unit in billions of 1986 dollars per a million workers.