Econ 2101

Javier Birchenall
Due date: Monday, July 7, 2014
Problem set 1: Labor markets and GDP measurement
The following problem set will serve two purposes. First, it will acquaint you with some basic supply and
demand analysis for the labor market, and second, it will make you familiar with the basic measure of
economic activity, the real Gross Domestic Product, GDP. Plan to spend 6 hours (maybe more) on these
questions. Please return the problem set on time (next Monday during class), remember you have the chance
to miss one and only one, use it wisely. If you have any problems regarding the questions please contact me
immediately. Good luck!
I. A labor market model (30%)
Consider a labor market characterized by the a typical supply and demand system of equations. Consider
the supply equation rst. Households decide to oer their services, their hours of work, according to:

= +

,
in which

represents the labor supply, the wage rate, and

the number of hours people would supply to
the labor market even if the wages were zero. The response of the labor supply to wages is positive, 0,
because higher wages are an incentive for work. The parameter measures how responsive people are to
wages. If is high, a small increase in wages makes people provide considerable more hours of work. If is
small, in order to entice people to work more hours, a large change in wages is needed.
Consider the demand for labor. Firms use workers for production according to:

=

,
with

as the demand for labor. The demand for labor depends negatively on the wage. The parameter

represents the amount of labor a rm will like to hire if the wages were zero.
Equilibrium in the labor market occurs at an employment level

and a wage

so that the labor market

clears. That is, supply

is equal to demand

.
(a) Show that in the labor market equilibrium

is given by:

1 +
. (*)
[HINT: All you need to do is make

and nd the solution given as the wage that makes the

equality hold.]
(b) Show that in the labor market equilibrium

is given by:

1 +
+

1 +
. (**)
[HINT: Substitute

in the labor supply equation or in the labor demand equation. Both should give
you the same answer.]
(c) If

increases, what happens to the equilibrium wage and employment levels? Will wages and em-
ployment be positively correlated or negatively correlated ? Remember,

and

are positively
correlated if

is high when

is high (and

is low when

is low), and negatively correlated if

is low when

is high (and

is high when

is low).
II. Computing GDP growth (30%)
This problem uses US GDP data to familiarize you with the computation of growth rates. There is nothing
special about the period under consideration and more recent data will yield similar insights. Consider the
following data on real GDP per capita in the United States
Table 2. U.S. real GDP per capita.
Year U.S. real GDP per capita (2000 dollars)
1950 $11,745
1960 $13,951
1970 $18,561
1980 $22,784
1990 $28,598
1995 $30,525
1996 $31,396
1997 $32,520
1998 $33,544
1999 $34,367
2000 $35,265
2001 $35,165
2002 $35,368
2003 $35,895
2004 $36,939
2005 $37,773
(a) Calculate the percentage growth rates in real GDP per capita in each of the years 1996 through 2005
from the previous year.
(b) Now, instead of calculating the annual percentage growth rates in the years 1996 through 2005 directly,
use as an approximation 100 (ln

ln
1
) where

is real per capita GDP in year . How close

does this approximation come to actual growth rates you calculated in part (a)?Table 2. U.S. real
GDP per capita.
(c) Repeat parts (a) and (b), but now calculate the percentage rates in growth in real per capita GDP
from 1950 to 1960, from 1960 to 1970, from 1970 to 1980, 1980 to 1990, and 1990 to 2000. In this case,
how large an error do you make by approximating the growth rate by the change in the natural log?
Why is there a dierence here relative to parts (a) and (b)?
(d) During which decade from 1950 to 2000 was growth in real per capita GDP the highest? when was it
the lowest?
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III. Apples and oranges or GDP measurement (30%)
As the well-known expression states, we cannot compare apples to oranges. This, however, has not
limited measurement of economic activity but it has created the need of a more meaningful comparison.
The measurement question we will consider in this part of the problem set is the measurement of real and
nominal GDP in an economy that produces apples and oranges. The exercise is based on the textbook.
The quantities and prices of apples and oranges in two dierent years are reported in the table below.
Fill in the missing entries.
Table 2. Data for Real GDP example
2011 2012 Percentage change, 2011-2012
Quantity of apples 50 80
Quantity of oranges 100 120
Price of apples (in dollars) 1.00 1.25
Price of oranges (in dollars) 0.80 1.60
Nominal GDP
Real GDP in 2011 prices
Real GDP in 2012 prices
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IV. A caveat for GDP (5%)
Suppose a woman marries her butler. After they are married, her husband continues to wait on her as
before, and she continues to support him as before (but as a husband rather than as an employee). How
does the marriage aect GDP? How should it aect GDP?
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