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EC1101EINTRODUCTIONTOECONOMICANALYSIS

AcademicYear2011/2012,SemesterI

Tutorial6
MacroTutorial1

NATIONALINCOMEACCOUNTING

1.
Determinewhethereachofthefollowingisconsumption,investmentor
neither.

a.
Alandscapingcompanybuysanewfourwheeldrivevehicletocarry
bushesandflowers.

Investmentitisbusinessspendingforthepurchaseofphysical
capital.

b.
Adoctorbuysanewfourwheeldrivevehicletouseonvacation.

Consumptionpurchaseofagoodbyaconsumer/household.

c.
Thecampusbookstoreincreasesitsinventoryoftextbooks.

Investment

d.
Youbuytoothpasteatthesupermarket.

Consumption

e.
ThestategovernmentofAlaskabuysfourwheeldrivevehiclesforits
gamewardens.

Neitheritcountsasgovernmentpurchases.

2.
ThefollowingdataareextractedfromtheEconomicSurveyofSingapore2002
publishedbytheMinistryofTradeandIndustry.

Item
S$millionat1995prices
Privateconsumptionexpenditure
66,812
Governmentconsumptionexpenditure
20,033
Grossfixedcapitalformation
44,929
Increaseinstocks
8,487
Netexportsofgoodsandservices
40,145
Statisticaldiscrepancy
2,579
Netfactorincomefromabroad
947
Totalpopulation
4,171,300

a.

b.

3.

CalculateSingaporesrealGDPin2002.Whichofthethreeapproaches
didyouuse?
RealGDP(spendingapproach)
=C+I+G+(XM)+statisticaldiscrepancy
=$(66,812+20,033+44,9298,487+40,1452,579)million
=$160,853million

Note:
I=grossfixedcapitalformation+increaseinstocks
Ifandwhenthestatisticaldiscrepancyisprovidedinthedata,we
incorporateittoarriveatGDP.(Statisticaldiscrepancyan
adjustmentgiventhepossiblesourcesofinaccuracyand
incompletenessofdatacollected)

ComputerealGDPpercapita.
RealGDPpercapita=GDP/population
=$160,853million4,171,300
=$38,561.84

Supposeacommunityspends$1milliononsalariesandequipmentforits
policedepartment.Becauseitbelievesthatcitizensarenowmorelawabiding,
thecommunitydecidestocutbackonthenumberofpoliceofficersit
employs.Asaresult,thecommunitynowspendsonly$800,000onthepolice.
Thecrimerateremainsthesame.

a.
WhathappenstomeasuredGDP?
MeasuredGDPgoesdownby$200,000becauselessisspenton
policeservices.

b.
DoesGDPaccuratelyreflectwelfareinthiscase?Explainthe
underlyingissuethatthisexampleposes.
GDP,whilstusefultomeasuringwelfare,isnotaperfectproxyfor
welfare.Obviously,welfaredoesnotgodownwhenthereisless
crime.Theunderlyingissueisthatthecrimelevelremainsthe
sameevenifGDPfalls.Thus,wecouldsaythatthecommunitys
welfareisunchanged.

NOMINALVERSUSREAL;PRICEMOVEMENTS

4.
Supposethereareonlythreegoodsinaneconomy:

Year
Good
Price
Quantity
2009
Tomatoes
$3/kg
1,000kg

Squash
$1/kg
600kg

Telephones
$100
20

2010
Tomatoes
$4.50/kg
900kg

Squash
$2/kg
700kg

Telephones
$125
30

a.
CalculatenominalGDPfor2009and2010.
NominalGDPin2009
=(31,000)+(1600)+(10020)
=3,000+600+2,000
=$5,600

NominalGDPin2010
=(4.5900)+(2700)+(12530)
=4,050+1,400+3,750
=$9,200

b.
CalculatethepercentagechangeinGDPfrom2009to2010using2009
pricesand2010prices.

Using2009prices:

RealGDPin2009=NominalGDPin1999=$5,600

RealGDPin2010
=(9003)+(7001)+(30100)
=2,700+700+3,000
=$6,400
PercentagechangeinGDPfrom2009to2010using2009prices
=(6,4005,600)5,600100
=14.29%

Using2010prices:

RealGDPin2009
=(1,0004.5)+(6002)+(20125)
=4,500+1,200+2,500
=$8,200

RealGDPin2010=NominalGDPin2010=$9,200

PercentagechangeinGDPfrom2009to2010using2010prices
=(9,2008,200)8,200100
=12.2%

Moralofthestory:Choiceofthebaseyeardeterminestheanswergrowthrateof
GDPfromoneyeartothenext(sameyearsinbothscenarios)isdifferentwhen
differentbaseyearsareusedforcomparison.

c.
WhatistheGDPdeflatorfor2010ifitisequalto1.0in2009?

GDPdeflator
=nominalGDPrealGDP
=9,2006,400
=1.44

5.
Ajobpaid$3,000in1960.TheCPIin1960was29.6comparedto179.9in2010.
In2010,whatsalarywouldbecomparableto1960s$3,000inrealterms?
Salaryneededin2010=3,00029.6179.9=$18,233.11

6.
AtypicalhouseholdinOrangelandconsumesonlyorangejuiceandshorts.
Lastyear,whichwasthebaseyear,thehouseholdspent$400onjuiceand
$120onshorts.Inthebaseyear,juicewas$2abottleandshortswere$10a
pair.Thisyear,juiceis$3abottle,shortsare$12apairandatypical
householdhasbought180bottlesofjuiceand14pairsofshorts.

a.
WhatisthebasketusedintheCPI?

TheCPIbasketisthequantitiesboughtinthebaseyear.Inthebase
year,atypicalhouseholdspent$400onjuiceat$2abottle,sothe
quantityofjuiceboughtwas$400$2=200bottles.Thehousehold
spent$120onshortsat$10apair,sothequantityofshortsbought
was$120$10=12.Thus,theCPIbasketis200bottlesofjuiceand12
pairsofshorts.

b.
CalculatetheCPIinthecurrentyear.

ThecostoftheCPIbasketlastyearwas$400+$120=$520.Thecost
oftheCPIbasketinthecurrentyearis($3200)+($1212)=$744.
SotheCPIis($744$520100)=143.1

c.
Calculatetheinflationrateinthecurrentyear.

TheinflationrateisthepercentagechangeintheCPI.Becausethe
lastyearwasalsothebaseyear,theCPIlastyearwas100.Sothe
4

inflationrateforthecurrentyearis[(143.1100)100]100,which
is43.1percent.

d.

7.

8.

9.

Istheinflationratethatyouvecalculatedlikelytobebiased?Whyor
whynot?
Asthereisnotlikelytobeasubstitutionbias*orqualityadjustment
bias,theinflationratecalculatedcanbetakentobeunbiased.
*
1.Wearetoldinthequestionthatconsumersonlyconsume
orangejuiceandshortstherearenoothersubstitutegoodsin
theeconomy.
2.Shortsarenotsubstitutesfororangejuice.

Note:Thisverysimpleeconomy(only2goodsintheentireeconomy
andgoodsthatdonotreallyhavethepotentialofvastimprovements
inquality)hasbeenusedtohighlightthesourcesofsubstitutionbias
andqualityadjustmentbias.

Assumethatafteryougraduate,youmovetoasimpleeconomyinwhich
onlythreegoodsareproducedandconsumed:fish,fruitandmeat.Suppose
thatonJanuary1,fishsoldfor$2.50perkilo,meatwas$3.00perkiloandfruit
was$1.50perkilo.Attheendoftheyear,youdiscoverthatthecatchwaslow
andthatfishpriceshadincreasedto$5.00perkilobutfruitpricesstayedat
$1.50perkiloandmeatpriceshadactuallyfallento$2.00.Canyousaywhat
happenedtotheoverallCPI,intermsofwhetheritincreased,decreased,or
stayedthesame?Doyouhaveenoughinformationtocalculatetheinflation
rate?
YoucannotsaywhathappenedtotheCPIbecauseyoudonotknowthe
quantitiesinthebasket.Youalsodonothaveenoughinformationto
determinetheinflationratebecauseyouneedtheCPIatthebeginningand
theendoftheyeartocomputetheinflationrate.

SupposesomeonetoldyouthattheconsumerpriceindexforGDPina
countrywas135.Whydoesthisfactnotconveymuchinformationtoyou?
Wedonotknowwhatthebaseyearis.Sowhilewehaveameasureof
relativeprices,wedonotknowwhatthismeasureisrelativeto.

IfYear1isthebaseyear,thepriceindexforYear2is105andthepriceindex
forYear3is103.Explainwhathashappenedtothecostoflivingbetween
Years1and2andYears2and3.
Year1=100
5

Year2=105
Year3=103
InflationfromYear1toYear2=(105100)100100=5%
InflationfromYear2toYear3=(103105)105100=1.9%
ThecostoflivingincreasedbetweenYears1and2(inflation)butdecreased
betweenYears2and3(deflation).

10.

Supposeyouhavesavingsdepositedinanaccountataninterestrateof4
percentandyourfathertellsyouheearned8percent10yearsago.Usethe
conceptoftherealinterestratetoanswerthefollowingquestions.

a.
Whichofyougotabetterreturn?

Thisanswercannotbedeterminedwithoutknowingtherateof
inflation10yearsago,aswellasthecurrentrateofinflation.

b.
Supposetherateofinflationwas5percent10yearsagoanditisnow3
percent.Doesthisinformationchangeyouranswer?

Yes.
Realinterestrate10yearsago
=NominalinterestrateInflationrate
=85=3%
Realinterestratetoday
=NominalinterestrateInflationrate
=43=1%
Yourfathergotabetterreturnbecausethereturnonsavingsdeposits
washigher10yearsago.