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PS#4

The document outlines the guidelines for a problem set in the Principles of Economics course, including submission rules and group work requirements. It presents several economic problems related to consumer price index calculations, GDP changes, and equilibrium income in an economy. The problems require analysis of different consumer behaviors and economic scenarios to understand the impact on CPI and GDP.

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nakasato.24
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3 views

PS#4

The document outlines the guidelines for a problem set in the Principles of Economics course, including submission rules and group work requirements. It presents several economic problems related to consumer price index calculations, GDP changes, and equilibrium income in an economy. The problems require analysis of different consumer behaviors and economic scenarios to understand the impact on CPI and GDP.

Uploaded by

nakasato.24
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Principles of Economics

UN1105-1 (Gulati) Fall 2024


PS #4: November 6, 2024
DUE: November 13, 2024

General Problem Set Guidelines


1. No late problem sets will be accepted. Problem sets are to be submitted via Gradescope no later than 8:30AM on
November 13.
2. The TAs will read and grade the problems sets. Write legibly—or risk the consequences. Show work and not just
solutions where numerical answers are indicated.
3. You are required to work in the preassigned groups. Copying another group’s work is cheating. You are not
allowed to use other external sources (AI, people, etc.). Submit one solution set per group with all names on each
sheet and make sure you upload as per Gradescope instructions. Enter the names of all group members in the
appropriate way on Gradescope.
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1. The consumer price index, or CPI, measures the cost of living for a typical urban household by multiplying the price for
each category of expenditure (housing, food, and so on) times a measure of the importance of that expenditure in the
average consumer’s market basket and summing over all categories. However, using data from the consumer price index,
we can see that changes in the cost of living for different types of consumers can vary a great deal. Let’s compare the cost
of living for a hypothetical retired person and a hypothetical college student. Let’s assume that the market basket of a retired
person is allocated in the following way: 10% on housing, 15% on food, 5% on transportation, 60% on medical care, 0% on
education, and 10% on recreation. The college student’s market basket is allocated as follows: 5% on housing, 15% on food,
20% on transportation, 0% on medical care, 40% on education, and 20% on recreation. The accompanying table shows the
May 2016 CPI for each of the relevant categories.
CPI May 2016
Housing 242.8
Food 248.0
Transportation 194.6
Medical care 460.5
Education 246.9
Recreation 117.2
Calculate the overall CPI for the retired person and for the college student. The CPI for all items in May 2016 was 239.4.
How do your calculations for a CPI for the retired person and the college student compare to the overall CPI?
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2. Why would you expect real GDP per capita in California and Pennsylvania to exhibit convergence but not in California
and Baja California, a state of Mexico that borders the United States? What changes would allow California and Baja California
to converge?
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3. The Bureau of Economic Analysis reported that, in real terms, overall consumer spending increased by $345.8 billion in
2015.
a. If the marginal propensity to consume is 0.50, by how much will real GDP change in response?
b. If there are no other changes to autonomous spending other than the increase in consumer spending in part a, and
unplanned inventory investment, I-Unplanned, decreased by $100 billion, what is the change in real GDP?
c. GDP at the end of 2014 was $15,982.3 billion. If GDP were to increase by the amount calculated in part b, what would be
the percent increase in GDP?

4. Assume an economy in which:


• Consumers always spend $250 billion plus half of after tax income.
• Investors always want to spend $700 billion.
• Government always levies a tax of $200 billion and spends all the resulting revenue, i.e. G = 200 = T.
• Exports = 0.1Y and Imports = 100.
a. What is the consumption function for this economy?
b. What will be the equilibrium level of income? Why is this an equilibrium?
c. Assume that when this equilibrium level of national income is reached (i.e., your answer to part b), the economy is still
experiencing inflationary pressures. To combat this inflation, the government wants to increase taxes in order to cut the
equilibrium level of national income to $2,000 billion. (Government spending will remain unchanged at $200 billion.) How
large must this tax increase be?
d. Suppose that consumers respond to this new policy by paying all of the tax increase out of accumulated savings (i.e.
consumption is not altered by the tax increase). Now when the tax is introduced, what is the new equilibrium level of national
income?

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