Econ 116
Fall 2016
Problem Set 1 Solutions
I.
1. The expenditure approach and the income approach to measuring GDP yield the same
result. When money is spent for a good or service, this is also income which is received by the
firm. This, in turn, goes towards paying wages or other expenses such as interest or taxes, and
what remains is corporate profit.
2. Nonmarket activities like the home services provided by the stay-home-spouses also
produce economic values and constitute a significant part of our economic activities.
3. Illegal production of drugs should be counted in GDP because it is a final good produced
by the factors of production, but it is difficult to measure using official statistics.
4. Double counting occurs when certain transactions like intermediate consumption are
counted multiple times due to, for example, simply adding up all sales of goods and services
in the economy rather than adding up just the final sales or adding up all values of output
rather than just the value added for each product produced. To illustrate this point more
clearly, Ford’s contribution to GDP is the value added from all the products that it produces.
GDP counts only final sales, so it should also either only count the cars sold for final
consumption, or, if computing GDP by value added, subtract Ford’s cost of inputs. e.g. even if
Ford produced and sold one thousand cars for $1 each its contribution to GDP wouldn’t be
$1000 if it bought the car nearly assembled from somebody else and only added once cent to
the value.
5. The unemployment rate is the fraction of people who are in the labor force but do not
have a job. However, if you do not have a job, to be counted in the labor force you must be
actively looking for a job. So, if the number of employed people increases and the number of
people looking for a job substantially increases, then it is possible for the unemployment rate
to increase.
6. Payments from Social Security are pure transfers and do not represent any current
production of goods or services and so are not counted in GDP.
7. Purchase of stock does not itself represent any current production. Nonetheless, any fees
paid to a broker for the purchase represent a current service and are counted in GDP.
II.
2015 IV
$16,490.7
GDP (billion)
2016 I
$16,525.0
2016 II
$16,570.2
From 2015 IV to 2016 I:
% Change =
Annual rate = ((1 +
16525.0 − 16490.7
× 100 ≈ 0.208%
16490.7
16525.0 − 16490.7 4
) − 1) × 100 ≈ 0.835%
16490.7
From 2016 I to 2016 II:
% Change =
Annual rate = ((1 +
16570.2 − 16525.0
× 100 ≈ 0.274%
16525.0
16570.2 − 16525.0 4
) − 1) × 100 ≈ 1.099%
16525.0
III.
Year Jan
Feb
Mar
Apr
May
Jun
2014
2015 234.954 235.415 235.859 236.197 236.876 237.423
2016 238.107 237.707 237.920 238.890 239.410 239.927
Jul
Aug
Sep
Oct
Nov
Dec
237.259 237.163 237.510 237.651 237.261 236.464
237.734 237.703 237.489 237.949 238.302 238.041
239.828
Inflation during the last 12 months:
239.828 − 237.734
× 100 ≈ 0.881%
237.734
Inflation during the 12 months before:
237.734 − 237.259
× 100 ≈ 0.200%
237.259
Deflation occurs when CPI decreases over some period. During the last 12 months, deflation
occurred (with annualized deflation rates in parentheses) in August 2015 (0.157%), September
2015 (1.086%), December 2015 (1.322%), February 2016 (2.035%), and July 2016 (0.496%).
Annualized deflation rate for August 2015, for instance, can be computed as:
237.734 − 237.703 12
((1 +
) − 1) × 100 ≈ 0.157%
237.734
IV.
To find the price level in a given year using 2015 quantity weights, multiply the price of each
good in that year times the quantity purchased in 2015, and sum across goods:
2015 Price Level = (5 × 100) + (4 × 80) + (10 × 200) + (13 × 50) + (20 × 20) = 3870
2016 Price Level = (7 × 100) + (4 × 80) + (15 × 200) + (15 × 50) + (22 × 20) = 5210
% change = (
5210 − 3870
) × 100 ≈ 34.63%
3870
To find the price level in a given year using 2016 quantity weights, multiply the price of each
good in that year times the quantity purchased in 2016, and sum across goods:
2015 Price Level = (5 × 75) + (4 × 100) + (10 × 200) + (13 × 50) + (20 × 25) = 3925
2016 Price Level = (7 × 75) + (4 × 100) + (15 × 200) + (15 × 50) + (22 × 25) = 5225
% change = (
5225 − 3925
) × 100 ≈ 33.12%
3925
Since the price change of each good is weighted differently, the inflation rates will be different
depending on the base year used. Using the first year quantities will miss how quantities change
based on price substitution effects (i.e. consuming more when the price decreases and less when
the price increases) and will tend to overstate inflation as a result.
To find nominal GDP for a given year, multiply the price of each good times the quantity
produced, and sum across goods:
2015 GDP = (5 × 100) + (4 × 80) + (10 × 200) + (13 × 50) + (20 × 20) = 3870
2016 GDP = (7 × 75) + (4 × 100) + (15 × 200) + (15 × 50) + (22 × 25) = 5225