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Universidad Carlos III de Madrid – Department of Economics

Principles of Economics - Problem Set 8 SOLVED AND CORRECTED

Conceptual Questions

Write down a short and concise answer. When you are asked to solve the question in class,
explain the concept clearly and give examples or pieces of evidence.

1. What is Gross Domestic Product? Give at least three examples of goods that
are bought or sold but that are not included in the GDP.
The GDP is the total amount of production in a country given a year. Three
examples of goods that are not included in the GDP are mortgages, prostitution,
used car, and money laundering. Products that don’t pay value added tax, i.e.
making a sandwich for myself.

2. What is the difference between Real GDP and Nominal GDP? What is the
GDP deflator?
The real GDP uses a base year price and the nominal GDP uses current prices. The
GDP deflator is the changes in ratio between nominal GDP to real using a base
year.

3. Why is the total income equal to total expenditure for an economy as a whole?
Total income is equal to total expenditure in an economy as a whole because for
every buyer there is a seller so for every dollar one spends somebody else receives
it as income. Through mathematical explanation we have the GDP defined by total
income and by total expenditure making them both equal to.

4. In which component(s) of the Spanish GDP is recorded a car produced in

Germany and bought by a consumer in Santander? And a machine produced
in Almería and sold to a Japanese firm?
A car produced in Germany and bought by a consumer in Santander is recorded in
the Imports component and a machine produced in Almerìa and sold to a Japanese
firm will be recorded in the Exports component.

5. In which component(s) of the GDP is recorded the production and sale of a

new house? And the transaction of a used house? And the rent paid by
renters?
The production and sale of a new house will be recorded the Investments
component. The transaction of a used house will not be recorded, and the rent paid
by renters will be recorded as consumption.

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 6. The government purchases component of GDP does not include spending on
transfer payments such as Social Security. Thinking about the definition of
GDP, explain why transfer payments are excluded.
The transfers made by the government are excluded from the GDP because they are
not purchasing any good or service but instead are redistributing the income.

Problems

1. In an economy, only three goods are produced: ham, bread and sandwiches.

GOODS QUANTITY PRICE

Ham 100 (kg) 20
Bread 200 (kg) 4
Sandwiches 300 (units) 3

Ham and bread do not require any intermediate good and 10 kg. of ham 50 kg. of
bread are used to produce sandwiches; the rest of the goods are all final products.
a) Calculate the added value in each of the three sectors
b) Calculate the value of the final products
GOODS QUANTITY PRICE Final VALUE ADDED VALUE
HAM 100 (kg) 20 (100- 100x20=2000
10)x20)=1800
BREAD 200 (kg) 4 (200-50) 200x4=800
x4=600
SANDWICHES 300 (units) 3 300x3=900 300x3-10x20-
50x4=500
c) Compare the answers in question a and b and comment.
Goods without intermediate goods can`t be added value because they are final goods.

2. Consider an economy in which investment is 15%, government expenditure is

18%, transfers 10 % of the GDP and the consumption is 70% of the GDP. What is
the value of the net exports (NX) in terms of GDP percentage?
Y= 70+15+18+(NX) =100
NX=100-70-15-18
NX =-3
Transfers do not enter the equation

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 Other questions

1. Below is some data from the land of milk and honey.

Year Price of Milk Quantity of Price of Quantity of
Milk Honey Honey
2010 $2 100 $6 50
2011 $2 200 $6 100
2012 $4 200 $12 100

a. Compute nominal GDP, real GDP, and the GDP deflator for each year, using
2010 as the base year.

Year Price Quantity Price of Quantity Nominal Real Deflator

of of Milk Honey of Honey
Milk
2010 $2 100 $6 50 500 500 100
2011 $2 200 $6 100 1000 1000 100
2012 $4 200 $12 100 2000 1000 200

b. Compute the percentage change in nominal GDP, real GDP, and the GDP
deflator in 2011 and 2012 from the preceding year. For each year, identify the
variable that does not change. Explain in words why your answer makes sense.
Year Nominal Real Deflator Nom % Real % Defl%
2010 500 500 100 - - -
2011 1000 1000 100 100% 100% 0%
2012 2000 1000 200 100% 0% 100%

c. Did economic well-being rise more in 2011 or 2012? Explain.

2011 because real GDP went up by 100% whereas in 2012 had a 0% of variation.

3. Consider an economy with GDP=1000 in 2002, with private consumption C=500,

and net exports of 0. If we know that in 2003 private consumption increased by 5%
and that investment, public expenses and exports did not change:
a) The GDP increased by 5%
b) The GDP increased by 2.5%
c) The change in GDP cannot be computed.
d) The GDP did not increase

4. What components of GDP (if any) would each of the following transactions affect?
Explain.
a) A family buys a new refrigerator. CONSUMPTION
b) Aunt Pilar buys a new house. INVESTMENT
c) Seat sells an Ibiza from its inventory. None, its production was already in the past

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 d) You buy a pizza. CONSUMPTION
e) Madrid repaves the A-4. GOVERNMENT EXPENSES
f) Your parents buy a bottle of French wine. IMPORT and CONSUMPTION
g) Coca-Cola expands its factory in Madrid. INVESTMENT

5. Between 1970 and 1990 the Spanish nominal GDP has always increased, this
means that:
a) Every year between 1970 and 1990 more goods were produced;
b) Every year between 1970 and 1990 the prices increased;
c) The increase in prices between 1970 and 1990 is higher than the increase in GDP
d) Either prices or the quantity of goods has increased every year