University of California Merced

ECON 101 – Intermediate Macroeconomic Theory

Instructor: Jesus Sandoval-Hernandez

Homework 1ak
1. For each of the following transactions, indicate whether it represents an increase in the U.S.
gross domestic product (GDP), and, if so, state whether it represents U.S. consumption,
investment, government purchases of goods or services, or net exports. If the transaction does
not change U.S. GDP explain why not.
(a) Ms. Scott buys a used Honda Accord from her friend Danielle for $7,500.
Answer: Not included in U.S. GDP. Used goods are not included.
(b) You spent $12,500 on college tuition this year.
Answer: Included in U.S. GDP. Transaction is part of consumption (services).
(c) Pizza Hut buys 100 pounds of cheese from Wisconsin to make pizzas.
Answer: Cheese is an intermediate good not the final good.
(d) Mr. Luong is a Chinese citizen who works as a Chemistry teaching assistant at UC Merced
and earns $16,000 a year in salary.
Answer: Included in U.S. GDP. Transaction is included because it occurs in the U.S. Could be
counted as government expenditures or consumption
(e) A candy store buys $500 worth of chocolates made in Belgium.
Answer: Not included in U.S. GDP. Chocolates were made in Belgium. Foreign goods are not
included.
(f) Boeing produces 5 airplanes but are unable to sell them.

Answer: Included in U.S. GDP. Goods that are produced but are unsold are counted as inventories.
Part of Investment

2. An economy produces three goods: cars, computers, and oranges. Quantities and prices for
years 2017 and 2018 are as follows:
2017 2018

Quantity Price Quantity Price

Cars 10 $2000 12 $3000

Computers 4 $1000 6 $500

Oranges 1000 $1 1000 $1

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a. What is the nominal GDP in 2017 and in 2018? By what percentage does nominal GDP
change from 2017 to 2018?
Answer: Nominal GDP 2017 = Prices in 2017* Quantities in 2017
= 2000*10 + 1000 * 4 + 1 * 1000 = $25,000
Nominal GDP 2018 = Prices in 2018 * Quantities in 2018
= 3000*12 + 500 * 6 + 1 * 1000 = $40,000
 growth rate of nominal GDP = g(nominal)=(40,000 – 25,000) / 25, 000 = 0,6=60%
b. Using the prices for 2017 as the set of common prices, what is the real GDP in 2017 and in
2018? By what percentage does real GDP change from 2017 to 2018?
Answer:
Real GDP 2017 = Nominal GDP 2017 = 25.000
Real GDP 2018 = Prices in 2017 * Quantities in 2018
= 2000 * 12 + 1000 * 6 + 1 * 1000= $31,000

 growth rate of real GDP using 2017 prices = g (real2018)

= (31,000 – 25,000) / 25,000 = 24%

c. Using the prices for 2018 as the set of common prices, what is the real GDP in 2017 and 2018?
By what percentage does real GDP change from 2017 to 2018?
Answer:
Real GDP 2017 = Prices in 2018 * Quantities in 2017
= 3000 * 10 + 500 * 4 + 1 * 1000= $33,000
Real GDP 2018 = Nominal GDP 2018 = 40.000
 growth rate of real GDP using 2018 prices = g (real2018)
= (40,000–33,000)/33,000 = 0,21=21%

d. Why are the two output growth rates constructed in (b) and (c) different? Which one is
correct? Explain your answer.
Answer:
Choice of base year matters for the calculated growth rate of real GDP. The reason is that one
set of prices (from one possible base year) may assign different relative weights to the same
quantities than another set of prices (from another possible base year). For instance, if 1960
prices were used and the price of a house and a computer was the same in 1960, GDP today
would increase by the same amount and have the same growth rate whether we produced an
additional computer or built a new house. If instead we used 1970 prices, where the price of
computers was maybe half that of a house, GDP today would increase only half as much if we
produced an additional computer compared to if we built a new house. So if we chose to produce
the computer instead of the house, using different prices would imply different dollar-increases
in GDP. The only way we could get the same growth rate using either set of prices is by
coincidence

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3. Consider the economy described in problem 2.
a. Use the prices for 2017 as the set of common prices to compute real GDP in 2017 and 2018.
Compute the GDP deflator for 2017 and 2018, and compute the rate of inflation from 2017 to
2018.
Answer: Using 2017 as base year:
GDP deflator 2017 = (Nominal GDP 2017) / (real GDP 2017 using 2017 prices) = 1
GDP deflator 2018 = (Nominal GDP 2010) / (real GDP 2018 using 2017 prices) = 40,000 /
31,000 = 1.29

b. Use the prices for 2018 as the set of common prices to compute real GDP in 2017 and 2018.
Compute the GDP deflator for 2017 and 2018, and compute the rate of inflation from 2017 to
2018.
Answer: Using 2018 as base year:
GDP deflator 2017 = (Nominal GDP 2017) / (real GDP 2017 using 2018 prices) = 25,000 /
33,000 = 0,76
GDP deflator 2018 = (Nominal GDP 2018) / (real GDP 2018using 2018prices) = 1
c. Why are the two rates of inflation different? Which one is correct? Explain your answer.
Answer: Choice of base year therefore matters not only for calculated growth rates but also for
calculated inflation rates (using the GDP-deflator as a measure of inflation).

4. An economy has 100 people divided among the following groups: 25 have full-time jobs, 20
have one part-time job, 5 have two part-time jobs, 10 would like to work and are looking for
jobs, 10 would like to work but are so discouraged they have given up looking, 10 are running
their own businesses, 10 are retired, and 10 are small children.
a. Calculate the labor force and the labor-force participation rate.
Answer: The labor force includes full-time workers, part-time workers, those who run their own
businesses, and those who do not have a job but are looking for one. The labor force consists of
70 people. The labor-force participation rate, which is the share of the adult population in the
labor force, is (70/90)  100 = 77.8 percent.
b. Calculate the number of unemployed and the unemployment rate.
Answer: Unemployed workers are those who would like to work and are looking for jobs, so
there are 10. The unemployment rate, which is the share of the labor force that is unemployed, is
(10/70)  100 = 14.3 percent.
c. Calculate total employment in two ways: as measured by the household survey and as
measured by the establishment survey.

Answer: The household survey estimates total employment by asking a sample of households
about their employment status. The household survey would report 60 people employed. The
establishment survey estimates total employment by asking a sample of businesses to report how
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many workers they are employing. In this case, the establishment survey would report 55 people
employed because the 5 people with 2 jobs would be counted twice and the 10 people who run
their own businesses would not be counted.
5. Suppose the production function in medieval Europe is Y=K0.5 L0.5, where K is the amount of
land and L is the amount of labor. The economy begins with 100 units of land and 100 units of
labor. Use a calculator and equations in the chapter to find a numerical answer to each of the
following questions.

a. How much output does the economy produce?

Answer: To find the amount of output produced, substitute the given values for labor and land
into the production function:
Y = 1000.51000.5 = 100.
b. What are the wage and the rental price of land?
Answer: According to the text, the formulas for the marginal product of labor and the marginal
product of land are:

MPL = (1 − α)AKαL−α

MPK = αAKα−1L1−α.
In this problem, α is 0.5 and A is 1. Substitute the given values for labor and land
to find that the marginal product of labor is 0.5 and the marginal product of land is 0.5. We
know that the real wage equals the marginal product of labor and the real rental price of land
equals the marginal product of land.
c. What share of output does labor receive?
Answer: In units of output, labor receives the marginal product of labor times the quantity of
labor, or 50. As a share of total output, this is 50/100 = 0.5, or 50 percent.
d. If a plague kills half the population, what is the new level of output?
Answer: The new level of output is 70.71.
e. What are the new wage and rental price of land?
Answer: The new wage is 0.71. The new rental price of land is 0.35.
f. What share of output does labor receive now?

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Answer: Labor now receives 35.36 units of output. As a share of output, this is 35.36/70.71 =
0.5, or 50 percent. Notice that because the production function is Cobb–Douglas, labor’s share
of output (or income) is the same as before.

6. Consider the following Cobb-Douglas Production Function: Y = 120 K3/4 L1/4

(a) Compute the value of Y for K = 125 and L = 50. Round your answer to two decimal
places.
Answer: Y = 120(125)0.75(50)0.25 = 11929.06
(b) Prove that this production function has constant returns to scale.
Answer: Double K and L (K = 250 and L = 100)
Y = 120(250)0.75(100)0.25 = 23858.12.
Since when inputs doubled, output exactly doubled this production function has constant returns
to scale.
(c) If K = 125 and L = 50, calculate the MPL. What is the equilibrium real wage in the economy?
Round your answer to two decimal places.
Answer: Take the derivative of the production function with respect to L and plug in K = 125
and L= 50.
dY/dL = MPL = 30 K3/4 L-3/4 = 30(125)3/4(50)-3/4 = 59.65
In equilibrium it must be that MPL = real wage. If the MPL is 59.65 then real wage must
also be 59.65.
(d) If K = 125 and L = 50, calculate the MPK. What is the equilibrium real rental price of capital
in the economy? Round your answer to two decimal places.
Answer: Take the derivative of the production function with respect to K and plug in K = 125
and L = 50.
dY/dK = MPK = 90 K-1/4L1/4 = 90(125)-1/4(50)1/4 = 71.57
In equilibrium it must be that MPK = real rental price of capital. If the MPK is 71.57 then
real rental price of capital must also be 71.57.
(e) Calculate the total income earned by labor.
Answer: Total income by labor = 59.65 x 50 = 2982.50
(f) Calculate the total income earned by owners of capital.
Answer: Total income by capital owners = 71.57 x 125 = 8946.25

7. Consider an economy described by the following equations

Y=C+I+G

Y = 8,500

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G = 1,250

T = 950

C = 400 + 0.65(Y – T)

I = 2,125 – 50r

(a) For this economy, compute the following:

a.1. Private Savings

Answer: Private Savings = Y – C – T

C = 400 + 0.65(8500 – 950) = 5307.50

Private Savings = 8500 – 5307.50 – 950 = 2242.50

a.2. Public Savings

Answer: Public Savings = T – G = 950 – 1250 = -300

a.3. National Savings

Answer: National Savings = Y – C – G = 8500 – 5307.50 – 1250 = 1942.50

a.4. Equilibrium interest rate

Answer: S = I

1942.50 = 2125 – 50r

r = 3.65

(b) Is this economy running a budget surplus, budget deficit or a balanced budget? Explain.

Answer: Since G > T, the government is running a budget deficit.

(c) Suppose that Republicans in Congress pass a large tax cut. As a result of the tax cut taxes

falls to T = 750. Assume that all other variables remain constant

Compute the following variables after this decrease in taxes

c.1. Private Savings

Answer: Private Savings

C = 400 + 0.65(Y – T) = 400 + 0.65(8500 – 750) = 5437.50

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Private Savings = 8500 – 5437.50 – 750 = 2312.50

c.2. Public Savings

Answer: Public Savings = T – G = 750 – 1250 = -500

c.3. National Savings

Answer: National Savings = Y – C – G = 8500 – 5437.50 – 1250 = 1812.50

c.4. Equilibrium interest rate

Answer: Equilibrium Interest Rate: Set S = I

1812.50 = 2125 – 50r

r = 6.25

(d) Graphically illustrate the decrease in taxes on the Savings-Investment diagram. Be sure to
clearly label your curves and the axis. In your graph, clearly indicate any shifts of curves and

equilibrium points. Label the initial equilibrium as Point “A” and the new equilibrium as Point

“B”