EC 214 - MACROECONOMICS II

SPRING 2018-2019
CLASS 1

# Question 1
The demand for apples in an economy is represented with the equation QD = 10Y − 40P
where QD stands for the quantity of apples demanded, Y is the aggregate income of con-
sumers and P is the market price of apples. The supply of apples is characterized by
QS = 20P − 10X where QS is the number of apples supplied and X is the price of fertilizer
used in the production of apple. Using this information answer the following questions:
a) Characterize the equilibrium price (P ∗ ) and quantity (Q∗ ) of apples in terms of Y and
X.
b) Find the equilibrium price and quantity of apples when Y = 60 and X = 12.
c) The government officials think that the equilibrium price you have found in part b is not
sufficiently high for farmers to live in comfort. As a result, the government sets a minimum
price of apples at Pmin = 14. How does this policy affect the equilibrium price and quantity
in the apple market?
d) Now suppose that aggregate income falls due to an economic crisis and becomes Y = 40.
How do the equilibrium price and quantity change compared to the equilibrium you have
found in part b? Why? Justify your answer both algebraically and geometrically.

# Solution of Question 1
a) At the equilibrium price P ∗ the demand for apples and the supply of apples are equal to
each other: QD = QS = Q∗ . Hence, at P ∗ we can equate the demand and supply equations:

QD = QS
10Y − 40P ∗ = 20P ∗ − 10X
10Y + 10X = 60P ∗
10Y + 10X
P∗ =
60
We now have the expression for the equilibrium price as P ∗ = 10Y 60
+10X
. In order to find
∗
the expression of equilibrium quantity Q , we should use the equilibrium price expression in
either the demand equation or the supply equation (here I will plug the expression of P ∗ in
the supply equation and proceed)

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 Q∗ = 20P ∗ − 10X
 
∗ 10Y + 10X
Q = 20 − 10X
60
 
10Y + 10X
Q∗ = − 10X
3
10Y + 10X − 30X
Q∗ =
3
∗ 10Y − 20X
Q =
3
b) In order to calculate the equilibrium price and quantity when Y = 60 and X = 12, we
are going to use these numbers in the equilibrium price and quantity expressions that we
have found in the previous part:
10 × 60 + 10 × 12 720
P ∗ at Y = 60 & X = 12 → = = 12
60 60
10 × 60 − 20 × 12 360
Q∗ at Y = 60 & X = 12 → = = 120
3 3
c) The minimum price enforced by the government is greater than the equilibrium market
price as Pmin = 14 > 12 = P ∗ . Because of this, due to this price floor policy there is going
to be an excess supply of apples:

2
 P rice 16

QS
14

E
∗
P 12

10
QD

0
0 20 40 60 80 100 120 140 160 180 200
QD at Pmin Q∗ QS at Pmin Quantity

Excess supply=160-40=120

QD at Pmin → 10 × 60 − 40 × 14 = 600 − 560 = 40

QS at Pmin → 20 × 14 − 10 × 12 = 280 − 120 = 160

Excess Supply at Pmin → 160 − 40 = 120

d) Due to the fall in aggregate income both the equilibrium price and the equilibrium
quantity decrease. This occurs as the demand curve shifts to the left due to the reduction
in aggregate income.
10 × 40 + 10 × 12 26
P ∗ at Y = 40 & X = 12 → =
60 3

3
 10 × 40 − 20 × 12 160
Q∗ at Y = 40 & X = 12 → =
3 3
P rice 16

QS
14

E1
P1∗ 12

10
E2 QD1
P2∗
8

4 QD2

0
0 20 40 60 80 100 120 140 160 180 200
Q∗2 Q∗1 Quantity

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# Question 2
The following table shows the details of production that took place in Macroland in 2018.
Note that people can use CPUs (central processing units) and HDDs (hard-drives) in order
to upgrade their existing computers. For the production each newly built computers for the
use of consumers 1 CPU and 1 HDD is required. For the sake of simplicity, assume that
Aluminium and Silicon does not require any inputs of production (that is, aluminium and
silicon producers just mine these by themselves). Using the information provided in this
table, answer the following questions:

Type Total Quantity Market Price Inputs Used in the Can Be Directly
of Good Produced of Each Unit Production of One Unit Used By Consumers
Aluminium 200 5 No inputs used No
Silicon 100 3 No inputs used No
CPUs 20 50 2 Aluminium & 5 Silicon Yes
HDDs 40 30 4 Aluminium Yes
Computer 15 100 1 CPU & 1 HDD Yes

a) Which goods are intermediate goods? Which goods can be classified as final goods? Are
there anything in between?
b) What is the value added created by the producer of each type of good?
c) Calculate the gross domestic product (GDP) of Macroland in 2018 using the production
approach.
d) Suppose that at the end of 2018 the computer producer is only able to sell 10 computers.
The CPU producer is able to sell 15 CPUs while the HDD producer is able to only sell
30 HDDs. Calculate the 2018 GDP of Macroland using the expenditure approach. Is your
answer different than the one you found in ”part c”? Why or why not?

# Solution of Question 2
a) Silicon and aluminium are definitely intermediate goods, as they are only used as inputs
in the production of CPUs and HDDs. Computers are final goods as they can be directly
consumed by consumers and also not used in the production of another good. However,
CPUs and HDDs are both intermediate and final goods: they are final goods as they can be
used by consumers when they want to upgrade their PCs by themselves, and they are also
intermediate goods as they are used in the production of computers.

b)

Type Total Quantity Market Price Inputs Used in the Value

of Good Produced of Each Unit Production of One Unit Added
Aluminium 200 5 No inputs used 200 ∗ 5 − 0 = 1000
Silicon 100 3 No inputs used 100 ∗ 3 − 0 = 300
CPUs 20 50 2 Aluminium & 5 Silicon 20 ∗ 50 − 20 ∗ (2 ∗ 5 + 5 ∗ 3) = 500
HDDs 40 30 4 Aluminium 40 ∗ 30 − 40 ∗ (4 ∗ 5) = 400
Computer 15 100 1 CPU & 1 HDD 15 ∗ 100 − 15 ∗ (50 + 30) = 300

c) We can calculate the GDP of Macroland in 2018 by just aggregating all value added

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created. Therefore,

GDP = 1000 + 300 + 500 + 400 + 300

= 2500

d) We first have to distinguish CPUs and HDDs sold to consumers from those sold to com-
puter producers - as those purchased by consumer producers will be counted as intermediate
goods and since GDP is the expenditure on final goods and services produced within the
boundaries of a country. Since the production of one computer requires 1 CPU and 1 HDD,
then the number of CPUs and HDDs directly purchased by consumers will be equal to:

CPUs directly purchased by consumers = 15 − 15 ∗ 1 = 0

HDDs directly purchased by consumers = 30 − 15 ∗ 1 = 15

Therefore, the total expenditure on final goods and services by consumers will be equal to:
Expenditure on final Expenditure on CPUs Expenditure on HDDs Expenditure on computers
= + +
goods by consumers by consumers by consumers by consumers
| {z } | {z } | {z }
0∗50=0 15∗30=450 10∗100=1000
= 450 + 0 + 1000
= 1450

So consumers’ total expenditure on final goods and the GDP calculated using the pro-
duction approach turn out to be different. Is there anything that we neglected during our
calculations? Actually, yes! Goods that are produced by firms but not purchased by con-
sumers are assumed to be purchased by the owners of the firms and added to firms’ inventory
stocks at the end of the year - so that there exists no final good on which money is not spent.
Thus, we have to calculate firms’ inventory investments and add this to consumers’ total
expenditure on final goods to get the correct answer.
As 15 computers are produced and only 10 of them are sold, then 5 computers are
added to the computer producer’s inventory stock. Therefore, computer producer’s inventory
investment will be equal to:
Inventory investment
= (15 − 10) ∗ 100 = 5 ∗ 100 = 500
of the computer producer
The CPU producer is able to sell only 15 of the 20 units she produced. Her inventory
investment will be equal to
Inventory investment
= (20 − 15) ∗ 50 = 5 ∗ 50 = 250
of the CPU producer
The HDD producer is able to sell only 30 of the 40 units he produced. Her inventory

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investment will be equal to
Inventory investment
= (40 − 30) ∗ 30 = 10 ∗ 30 = 300
of the HDD producer
Then, total inventory investment by producers will be equal to:

Total inventory
= 500 + 250 + 300 = 1050
investment
And total expenditure will be equal to:

Expenditure on final Total inventory

Total expenditure = +
goods by consumers investment
= 1450 + 1050
= 2500

So by taking into consideration the inventory investment by firms, we are able to verify
that GDP = Total value of final goods = Total expenditure = 2500