ECON 302 Fall 2009 Answers to Assignment #1 1 Homework will be graded for both content and neatness. Sloppy or illegible work will not receive full credit. This homework requires the use of Microsoft Excel. 1) Assume that the economy is composed of three firms: Albert’s furniture (Firm A), Brian’s lumber yard (Firm B), and Carl’s timber harvesting (Firm C). As their names suggest, Firm B purchases timber from Firm C to produce lumber, which is then used by Firm A to produce furniture. Albert directly sells his furniture to consumers. Therefore, only Firm A is producing a final good. Assume that all intermediate goods are used in the production final goods. A) Complete the table. B) Compute GDP using the following equivalent approaches. i) Product Only Firm A produces a final good. The total market value of Firm A’s output is $7000. Therefore, the product approach says that GDP is $7000. Factor of Production Factor Payment Labor Wages Capital Interest Land Rent Entrepreneurship Profit Firm A Firm B Firm CSales $7,000 $3,000 $2,000Raw MaterialsWages $1,500 $250 $1,130Interest Payments $750 $50 $300Rent $1,250 $600 $210Profit $500 $100 $360Factor ExpendituresValue AddedFirm A Firm B Firm CSales $7,000 $3,000 $2,000Raw Materials $3,000 $2,000 $0Wages $1,500 $250 $1,130Interest Payments $750 $50 $300Rent $1,250 $600 $210Profit $500 $100 $360Factor Expenditures $4,000 $1,000 $2,000Value Added $4,000 $1,000 $2,000ECON 302 Fall 2009 Answers to Assignment #1 2 ii) Expenditure Consumers are spending $7000 on final goods/services, so GDP via the expenditure approach is also $7000. In other words, C = $7000, I = $0, G = $0, NX = $0; Y = C + I + G + NX = $7000. iii) Value Added GDP = sum of the value added by firms = $4000 + $1000 + $2000 = $7000. iv) Income GDP = sum of factor income = sum of factor payments made by firms = $4000 + $1000 + $2000 = $7000. C) Although they agree theoretically, briefly discuss why these four approaches to calculating GDP may disagree when applied to a real-world industrialized economy, such as the United States. Does this inconsistency suggest that GDP is a poor measure of economic activity? Why or why not? Real-world data is subject to measurement error and accounting mistakes, so it is not unreasonable that the different methods used in calculating GDP would disagree slightly. Any proposed measure of the level of economic activity in a country would be affected by these problems, so such inconsistency does not imply that GDP is a poorly constructed measure. However, we should be worried if the various GDP approaches are giving us wildly different results.ECON 302 Fall 2009 Answers to Assignment #1 3 2) Working as a research assistant, the US Bureau of Economic Analysis (BEA) has provided you with the following table concerning quarterly US GDP. However, the file has been corrupted, with multiple entries missing. The use of Excel is required for this problem. 2008 2008 2008 2008 I II III IVGross domestic product14,373.90 14,497.80 14,546.70 14,347.30Personal consumption expenditures10,095.10 10,194.70 10,220.10 10,009.80 Goods3,447.20 3,474.90 3,463.00 3,227.50 Durable goods1,145.80 1,126.50 1,088.50 1,019.90 Nondurable goods2,301.40 2,348.40 2,374.50 2,207.60 Services6,647.90 6,719.80 6,757.10 6,782.30Gross private domestic investment2,214.80 2,164.60 2,142.70 2,022.10 Fixed investment2,223.00 2,214.00 2,179.60 2,066.60 Nonresidential1,705.00 1,719.70 1,711.00 1,638.70 Structures586.30 610.6 620.4 620.7 Equipment and software1,118.70 1,109.20 1,090.60 1,018.00 Residential518.1 494.30 468.6 427.8 Change in private inventories-8.2 -49.40 -36.90 -44.5Net exports of goods and services-744.50 -738.7 -757.5 -590.5 Exports1,803.60 1,901.50 1,913.10 1,706.20 Goods1,247.30 1,326.20 1,338.50 1,155.70 Services556.30 575.3 574.6 550.5 Imports2,548.10 2,640.20 2,670.50 2,296.70 Goods2,143.20 2,226.80 2,243.30 1,892.50 Services404.9 413.4 427.20 404.2Government consumption expenditures and gross investment Federal1,038.40 1,069.50 1,108.30 1,114.30 National defense703.6 725.6 763.60 758.9 Nondefense334.8 343.9 344.7 355.40 State and local1,770.00 1,807.60 1,833.10 1,791.602,905.902,808.402,877.102,941.40 A) Complete the table. See above. B) Are imports added to or subtracted from US GDP? Provide a short rationale. Subtracted; imported goods are not produced in the US, and should only be counted in the GDP of the originating country. Adding imports to US GDP would effectively double-count those goods. Using the expenditure approach, imports are included in C (e.g., if a household purchases a bottle of FrenchECON 302 Fall 2009 Answers to Assignment #1 4 wine the expenditure will be recorded as part of consumption expenditure) but then subtracted out in NX. This prevents the inclusion of imported goods in domestic output when computing GDP using the expenditure approach. C) Your faculty advisor notices that US net exports increased substantially in the fourth quarter of 2008. This coincided with the worst of the financial crisis, during which international trade declined sharply. Strictly looking at the data, what is your explanation for this? Both exports and imports declined, but the fall in imports was larger. Therefore, net exports increased. In other words, the decline in imports outweighed the decline in exports. D) In 2008, stock market indices lost 20-25% of their value. Housing prices continued to collapse, and many households viewed real estate as an important form of wealth. Given these economic events, give a brief argument as to why US imports fell by 15%. Devalued stock markets and falling housing prices both imply that consumer wealth is decreasing, so consumer demand for both durable and non-durable goods should decrease. This includes demand for imported goods and services, which explains the decline in US imports.ECON 302 Fall 2009 Answers to Assignment #1 5 3) The following question deals with the GDP accounting equation and an approximation discussed by Mankiw 7e on p. 26. Equations (1) – (4) are provided, so you can take them as known already. “%Δ” stands for percentage change, and is defined in the typical way as %ΔY = (Y’ – Y) / Y = ΔY / Y. YN = C + I + G + NX (1) YR = YN / GDP Deflator = YN / D (2) %Δ(AB) ≈ %ΔA + %ΔB (3)