MACROECONOMICS – ECON 111Tutorial 1

TUTORIAL INFORMATION

Eilya TorshizianPhD student and research assistant

Email addresse.torshizian@auckland.ac.nz

OfficeRoom 260-6121, Level 6, Owen G.

Bld.Tutorial forum

Economics bulletin at Facebookhttp://Eilya.Torshizian.com

ME

Academic ExperienceECON 721, 711, 701, 322, 212, 111 and MATHS 105, 108

Education The University of Auckland, PhD student, under supervision of Professor Arthur Grimes.The University of Tehran, MA and BA in Theoretical EconomicsIUST, Information Technology engineering.

Work ExperienceMember of the board of directors at Rateb Construction and Development Co.Chief executive officer at Exir Kish mineral water manufacturer.

QUESTION 1

1. Why is it desirable for a country to have a large GDP? Give an example of something that would raise GDP and yet be undesirable?

FINAL GOOD

GDP represents the amount of money one would need to purchase one year’s worth of the economy’s production of all final goods and services.

It is desirable for a country to have a large GDP because people could enjoy more goods and services.

GDP is not the only important measure of well-being.

For example, laws that restrict pollution cause GDP to be lower.

If laws against pollution were eliminated, GDP would be higher but the pollution might make us worse off. for example, an earthquake would raise

GDP, as expenditures on clean-up, repair, and rebuilding increase.

2. WHAT COMPONENTS OF GDP, IF ANY, WOULD EACH OF THE FOLLOWING TRANSACTIONS AFFECT? EXPLAIN.

- A family buys a new refrigerator- Aunt Jane buys a new house- Fisher and Paykel sells a washing machine from

its stock- You buy a pizza- Transit New Zealand repaves Highway 1- Your parents buy a bottle of Australian wine

from a store in Dunedin- Nestle Australia builds a new chocolate factory

in Christchurch

Y = C + I + G + NX

A family buys a new refrigerator

Consumption (C):the spending by households on goods and services, with the exception of purchases of new housing.

Investment (I):the spending by firms on capital equipment, inventories, and structures, including new housing.

Government purchases (G):

the spending on goods and services by local, state, and federal governments

Y = C + I + G + NX

Aunt Jane buys a new house

Consumption (C):the spending by households on goods and services, with the exception of purchases of new housing.

Investment (I):the spending by firms on capital equipment, inventories, and structures, including new housing.

Government purchases (G):

the spending on goods and services by local, state, and federal governments

Y = C + I + G + NX

Fisher and Paykel sells a washing machine from its stock

Consumption (C):the spending by households on goods and services, with the exception of purchases of new housing.

Investment (I):the spending by firms on capital equipment, inventories, and structures, including new housing.

Consumption increases because a washing machine is a good purchased by a household, but investment decreases because the washing machine in Fisher and Paykel’s inventory had been counted as an investment good until it was sold.

Y = C + I + G + NX

You buy a pizza

Consumption (C):the spending by households on goods and services, with the exception of purchases of new housing.

Investment (I):the spending by firms on capital equipment, inventories, and structures, including new housing.

Government purchases (G):

the spending on goods and services by local, state, and federal governments

Y = C + I + G + NX

Transit New Zealand repaves Highway 1

Consumption (C):the spending by households on goods and services, with the exception of purchases of new housing.

Investment (I):the spending by firms on capital equipment, inventories, and structures, including new housing.

Government purchases (G):

the spending on goods and services by local, state, and federal governments

Y = C + I + G + NX

Your parents buy a bottle of Australian wine from a store in Dunedin

Consumption (C):the spending by households on goods and services, with the exception of purchases of new housing.

Investment (I):the spending by firms on capital equipment, inventories, and structures, including new housing.

Government purchases (G):

the spending on goods and services by local, state, and federal governments

Y = C + I + G + NX

Nestle Australia builds a new chocolate factory in Christchurch

Consumption (C):the spending by households on goods and services, with the exception of purchases of new housing.

Investment (I):the spending by firms on capital equipment, inventories, and structures, including new housing.

Government purchases (G):

the spending on goods and services by local, state, and federal governments

QUESTION 3 The government purchases component

of GDP does not include spending on transfer payments such as the superannuation benefit. Think about the definition of GDP; explain why transfer payments are excluded.

With transfer payments, nothing is produced, so there is no contribution to GDP.

GDP represents the amount of money one would need to purchase one year’s worth of the economy’s production of all final goods and services.

QUESTION 4

Goods and services that are not sold in markets, such as food produced and consumed at home, are generally not included in GDP. Can you think of how this might cause the numbers in the second column of table 7.3 to be misleading in a comparison of the economic well-being of New Zealand and India? Explain.

NOT INCLUDED IN GDP?!Average Measure

Infrastructure Inequality

NOT INCLUDED IN GDP

Some things that contribute to well-being are not included in GDP. (Have a look at question 1)

the value of leisure

the value of a clean environment

the value of almost all activities that takes place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

In countries like India, people produce and consume a fair amount of food at home that is not included in

GDP. So GDP per person in India and New Zealand will differ by more than their comparative economic well-

being

QUESTION 5 Suppose the following table records the total output and the prices for an entire

economy in a country. Assume the base year in the following table is 2006.

Year Price of Pizzas

Qty of Pizzas

Price of Mac

Combo

Qty of Mac Combos

2006 $10 240 $8 400

2007 $12 400 $10 600

2008 $14 360 $15 550(a) Calculate the Nominal Gross Domestic Product (GDP) for the years 2006, 2007 and 2008, explain clearly why economists do not use Nominal GDP to measure economic growth.

(b) Calculate the Real GDP for the years 2006, 2007 and 2008.

(c) Compute the GDP Deflator for the years 2006, 2007 and 2008, and explain clearly what the GDP Deflator tells you about the price level in the economy.(d) Explain fully whether or not Real GDP figures of a developed country and an underdeveloped country can be used to measure the relative prosperity of people living in those two countries in a meaningful manner.

(a) Calculate the Nominal Gross Domestic Product (GDP) for the years 2006, 2007 and 2008, explain clearly why economists do not use Nominal GDP to measure economic growth.Nominal GDP for the years:2006 = 10*240 + 8*400 = $5,600 2007 = 12*400 + 10*600 = $10,800 2008 = 14*360 + 15*550 = $13,290 Nominal GDP is not used by economists to measure economic growth, because of the distortion created by the price effect.

(b) Calculate the Real GDP for the years 2006, 2007 and 2008.Real GDP for the years:2006 = 10*240 + 8*400 = $5,600 2007 = 10*400 + 8*600 = $8,800 2008 = 10*360 + 8*550 = $8,000

(c) Compute the GDP Deflator for the years 2006, 2007 and 2008, and explain clearly what the GDP Deflator tells you about the price level in the economy.GDP deflator for the years: 2006 = 10002007 = 1227.22008 = 1661.2The GDP deflator in this instance explains the increase in the price level.

(d)Explain fully whether or not Real GDP figures of a developed country and an underdeveloped country can be used to measure the relative prosperity of people living in those two countries in a meaningful manner.

The real GDP figures cannot be used meaningfully to compare the relative prosperity levels of a developed and an underdeveloped country as the real GDP figure in an underdeveloped country is understated due to the inability of this statistic to capture the value of the large amount of non-market economic activities, including the black economy. This is because most activities are cash transactions and no invoices are raised, whereas in a developed country only a very small proportion of such unrecorded economic activities take place.

(e) The Per Capita Real GDP in New Zealand is approximately NZ$37000. Explain fully whether this figure is a clear indication or not of the standard of living of people living in New Zealand.

(f) A recent World Bank report stated that New Zealand was well above Australia as a pleasant place to live in although the per capita Real GDP of Australia is well above that of New Zealand. Explain clearly the basis of this ranking.

Year Price of Pizzas

Qty of Pizzas

Price of Mac

Combo

Qty of Mac Combos

2006 $10 240 $8 400

2007 $12 400 $10 600

2008 $14 360 $15 550

(e) The Per Capita Real GDP in New Zealand is approximately NZ$37000. Explain fully whether this figure is a clear indication or not of the standard of living of people living in New Zealand.

The per capita GDP figure given in the question is only an average and fails to give any indication of the distribution of income in New Zealand. Averages can be misleading as the national cake is not divided equally amongst the population.  (f) A recent World Bank report stated that New Zealand was well above Australia as

a pleasant place to live in although the per capita Real GDP of Australia is well above that of New Zealand. Explain clearly the basis of this ranking.

The reason for ranking New Zealand above Australia as a pleasant place to live is based on aspects of the quality of life such as the level of crime, the amount of pollution, and the amount of leisure time that can be enjoyed by inhabitants of New Zealand in comparison with Australia. These aspects cannot be quantified in terms of dollars, but affect the quality of life in the two countries.

EXTRA QUESTION 1

One day Barry the Barber collects $500 for haircuts. Over this day, his equipment depreciates in value by $50. Of the remaining $450, Barry sends $30 to the government as GST, pays $100 to his new employee who is an exchange student from the UK and has a work permit, takes home $220 in wages and retains $100 in his business to add new equipment in the future. From the $220 that Barry takes home, he pays $70 in income taxes. Based on this information, compute Barry’s contribution to the following measures of income:

a) Gross Domestic Product b) Gross National Income c) National Disposable Income

GDP +NCT GNP +NFI

A

GNDI

NDP +NCT NNP +NFI

A

NNDI

- D

ep

recia

tion -

Dep

recia

tion -

Dep

recia

tion -

Dep

recia

tion-

Dep

recia

tion

NCT: Net Current Transfer (Immigrants, aids)NFIA: Net Factor Income from AbroadGNDI: Gross National Disposable Income

= GDP - $100 = 400 = GNI.

a) GDP equals the dollar amount Barry collects, which is

b) Gross National Product (GNP) tracks down total income of all citizens of a country =

c) NNP = GNP – depreciation =$400 - $50 = $350.

NNP + NCT= $350 + $0.

$350 + $50 = $400.Gross National Disposable income = NDI + depreciation =

National Disposable income (NDI) =

$500.

FOR PRACTICE Consider an economy that produces only one good.

In year 1, the quantity produced is Q1 and the price is P1. In year 2, the quantity produced is Q2 and the price is P2. In year 3, the quantity produced is Q3 and the price is P3. Year 1 is the base year. Answer the following questions in terms of these variables, and be sure to simplify your answer if possible.

What is nominal GDP for each of these three years? What is real GDP for each of these three years? What is the GDP deflator for each of these three

years? What is the percentage growth rate of real GDP from

year 2 to year 3? What is the inflation rate as measured by the GDP

deflator from year 2 to year 3?

YEAR I: PI QINominal GDP values the production of goods and services at current prices.

P1Q1 P2Q2 P3Q3

Real GDP uses constant base-year prices to value the economy’s production of goods and services.

The GDP deflator – calculated from the ratio of nominal to real GDP – measures the level of prices in the economy.

Real GDP growth rate year 2 to 3

Inflation rate Year 2 to 3

P1Q3 P1Q2

1000P2/P11000 1000P3/P1

x 100 = x 100

x 100 = x 100

P1Q1