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Tutorial 1

(1) The document provides an example economy producing cars, computers, and oranges in 2009 and 2010. It calculates nominal and real GDP for each year using different price indexes and discusses why the real GDP growth rates differ. (2) It defines the GDP deflator as the ratio of nominal to real GDP and calculates inflation rates for 2009-2010 using the different price indexes. (3) It derives the government expenditure multiplier using calculus and the Keynesian cross model. (4) Given a consumption function and values for investment, government purchases, and taxes, it graphs the planned expenditure function and determines the equilibrium level of income.

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33 views

Tutorial 1

(1) The document provides an example economy producing cars, computers, and oranges in 2009 and 2010. It calculates nominal and real GDP for each year using different price indexes and discusses why the real GDP growth rates differ. (2) It defines the GDP deflator as the ratio of nominal to real GDP and calculates inflation rates for 2009-2010 using the different price indexes. (3) It derives the government expenditure multiplier using calculus and the Keynesian cross model. (4) Given a consumption function and values for investment, government purchases, and taxes, it graphs the planned expenditure function and determines the equilibrium level of income.

Uploaded by

Aditya
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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HS20021/HS20001 Economics: Tutorial 1

Anubhab Pattanayak

Date: September 2, 2022

1. An economy produces three goods: cars, computers, and oranges.


Quantities and prices per unit for years 2009 and 2010 are as follows:

2009 2010
Quantity Prices Quantity Prices
Cars 10 $2,000 12 $3,000
Computers 4 $1,000 6 $500
Oranges 1,000 $1 1,000 $1

(a) What is nominal GDP in 2009 and in 2010? By what percentage


does nominal GDP change from 2009 to 2010?
(b) Using the prices for 2009 as the set of common prices, what is
real GDP in 2009 and in 2010? By what percentage does real
GDP change from 2009 to 2010?
(c) Using the prices for 2010 as the set of common prices, what is
real GDP in 2009 and in 2010? By what percentage does real
GDP change from 2009 to 2010?
(d) Why are the two output growth rates constructed in (b) and (c)
different? Which one is correct? Explain your answer.

1
Answer to Q. 1:

(a) 2009 nomial GDP: 10($2,000)+4($1,000)+1000($1) = $25,000


2010 nomial GDP: 12($3,000)+6($500)+1000($1) = $40,000
Nominal GDP has increased by:

(40, 000 − 25, 000) 15, 000


× 100 = × 100 = 0.6 × 100 = 60%
25, 000 25, 000

(b) 2009 real GDP (in 2009 base year prices) : $25,000
2010 real GDP (in 2009 base year prices) : 12($2,000) + 6($1,000)
+ 1000($1) = $31,000
Real (2010) GDP has increased by:

(31, 000 − 25, 000) 6, 000


× 100 = × 100 = 0.24 × 100 = 24%
25, 000 25, 000

(c) 2009 real GDP (in 2010 base year prices) : 10($3,000) + 4($500)
+ 1,000($1) = $33,000
2010 real GDP (in 2010 base year prices) GDP: $40,000.
Real (2010) GDP has increased by 21.2%.
(d) The answers measure real GDP growth in different units. Neither
answer is incorrect, just as measurement in inches is not more or
less correct than measurement in centimeters.

2
2. The ratio of nominal GDP to real GDP is known as GDP deflator.
Hence, GDP deflator in year t, termed as Pt , is given by:
Nominal GDPt
Pt =
Real GDPt

Thus, nominal GDP is equal to the GDP deflator times real GDP.
The GDP deflator gives the average price of output (the final goods
produced ) in the economy. The rate of change in the GDP deflator
Pt − Pt−1
given by i = is called the rate of inflation.
Pt−1
Now consider the economy described in Problem (1).

(a) Use the prices for 2009 as the set of common prices to compute
real GDP in 2009 and in 2010. Compute the GDP deflator for
2009 and for 2010, and compute the rate of inflation from 2009
to 2010.
(b) Use the prices for 2010 as the set of common prices to compute
real GDP in 2009 and in 2010. Compute the GDP deflator for
2009 and for 2010 and compute the rate of inflation from 2009 to
2010.
(c) Why are the two rates of inflation different? Which one is correct?
Explain your answer.

3
Answer to Q. 2:

(a) 2009 base year:


Deflator(2009) = 1;
Deflator(2010) = $40,000/$31,000 = 1.29
Inflation = 29%
(b) 2010 base year: Deflator(2009) = $25,000/$33,000 = 0.76;
Deflator(2010) = 1
Inflation = (1 = 0.76)/0.76 = .32 = 32%
(c) Similar reasoning as in Answer (1d).

4
3. Use derivative to derive the government expenditure multiplier.
Answer to Q. 3:
The government-purchases multiplier is easily derived using calculus.
Let’s begin with the equation for the Aggregate demand (planned ex-
penditure) AD = C(Y − T ) + I + G. In equilibrium AD = Y , i.e.,
planned expenditure = actual expenditure, where Y is aggregate in-
come (or GDP which captures the actual expenditure in the economy).
Hence, we have
Y = C(Y − T ) + I + G
where, T - taxes and I - investment are held constant (assuming short-
run). The government expenditure multiplier studies the effect of an
additional Re. 1 spending by the government on aggregate income in
the short-run. Differentiate the above equation to obtain

dY = C ′ dY + dG

where, C ′ is the slope of the consumption function or the MPC. Re-


arrange to find
dY 1 1
= =
dG (1 − C ′ ) 1 − MPC

5
4. In the Keynesian cross, assume that the consumption function is given
by
C = 200 + 0.6(Y − T )

Planned investment is 75 and the government purchases and taxes are


both 50.

(a) Graph the planned expenditure function. In this graph, what is


represented in the X −axis? What is represented on the Y −axis?
(b) What is the equilibrium level of income?

6
Answer to Q. 4:

(a) Total planned expenditure is

P E = C(Y − T ) + I + G

Given C = 200 + 0.6(Y − T ), G = T = 50 and I = 75. We


plug-in these values in the above equation to obtain the Planned
Expenditure Function:

P E = 200 + 0.6(Y − 50) + 75 + 50

or
P E = 0.6Y + 295
The Planned Expenditure Function obtained above relates Planned
Expenditure (PE) with Aggregate Income (Y). Hence, on the
X −axis, we will have aggregate income (Y). On the the Y −axis,
we will have planned expenditure(PE). We graph it as below:

PE

Y
7
(b) To find the equilibrium level of income, combine the planned-
expenditure equation derived in part (a) with the equilibrium
condition Y = P E:
Y = PE
Or Y = 0.6Y + 295

Solving this we get the equilibrium agrregate income,

Y ⋆ = 737.5

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