Problem Set 2 Answers.doc – Introduction to Macroeconomics…

  • December 4, 2020

Introduction to Macroeconomics                                                                                   New York University

Marc Lieberman                                                                                                            Fall, 2013

Answers to Problem Set #2

1.

  1. Included as C, +$2,000
  2. Included as I, +$2,500 (when a business buys physical capital—a tool that labor uses that is expected to last a long time, e.g., longer than a year), it is part of “business purchase of plant and equipment.”  This is one of the components of investment spending.
  3. Included as G, +$5,000 (In this case, the government is the final user of a currently produced good)
  4. Included as NX, +$3,500  (This is an export of a good to a foreign resident, even though the purchase takes place in the U.S.  It will add $3,500 to exports, and therefore add $3,500 to net exports, which are exports minus import.)
  5. Not included (just an exchange of assets between people; nothing is produced)
  6. Included as G, +$135,000  (The Mayor is producing “the services of running the city,” and the NY city government is the final user of those services—that is, they aren’t being purchased as an input in order to sell something to someone else.)
  7. Only the commission is included, as C,  +$100 (the $9,000 in stock is just an exchange of assets between the buyer and the seller; they are pieces of paper, rather than goods or services produced.)
  8. Included as I, +$40,000 (these unsold goods add to GMs stock of inventories, and the change in inventories is one of the components of investment spending)
  9. Not included (this is a transfer payment; no goods or services have been produced)
  10. Not included in our calculation of GDP (The paper is an intermediate good; it’s contribution to GDP will be recorded as part of the price of the automobiles that GM sells to final users.)
  11. Not included (No goods or services are produced; this is just an exchange of assets—in this case, money—between the household and the bank)
  12. Not included (just an exchange of assets between the household and the charity)
  13. Included in two components: C, +$18,000; NX, -$6,000, so the contribution to GDP is +$12,000.  (To see why, note that consumption spending is all final goods and services that U.S. households buy, in this case $18,000.  But this “mistakenly” includes the value of final and intermediate goods that were produced abroad, and don’t belong in U.S. GDP. We take care of this “mistake” by subtracting anything imported into the U.S.—whether it’s a final or intermediate good.  Thus, since imports are $6,000, NX = exports – imports =  – $6,000 in this case.
  14. The books will be included as C, +$7,000.  They will also be included as investment, -$7,000. (A decrease in inventories.)  Net effect on GDP: zero.
  15. The total contribution to GDP during the current year is $600.  Of this, $500 (the total value of the app) is included as “I” (in the investment subcategory “creation of intellectual property”).  In addition, $100 (the 5 purchases of the App at $20 each) count as “C” (consumption).   (Further note: Yes, this seems like double counting, and in a way, it is.  But the Bureau of Economic Analysis regards this activity as producing two things: (1) The $500 app, which is long-lasting intellectual property, adding to the total capital stock of the economy; and (2) the $100 in consumption value provided to people this year.

2.

C = $2,000 + $100 + $18,000 +$7,000 + $100 = $27,200.

I = $2,500 + $40,000 – $7,000 + $500 = $36,000

G = $5,000 + $135,000 = $140,000

NX = $3,500 – $6,000 = -$2,500

GDP = $27,100 + $35,500 + $140,000 – $2,500 = $200,700

3.

a. Expenditure approach: GDP increases by $4,500 (included as “C”).  G, I and NX are unaffected.  Explanation: The only thing “produced” in the year 2012 is the $4,500 worth of services provided by the car dealership, both “getting the car in shape” and serving as “middleman” between buyer and seller.  These services are provided to the household that bought the car, and are therefore part of C.  The value of the used car itself (before the dealer “improved it”) was already counted in GDP in 2003, the year it was originally produced.  [Note: the most common error here is to add in the $20 in labor paid to the employee.  But when using the “expenditure” approach, the value of the labor is already embodied in the $4,500 value of the services provided by the dealer, which we’ve already counted. To add the labor again separately would be to count its value twice.]

b. Factor‑Payments Approach: For this approach, we add up all the wages, rent, interest and profit across all households that received these factor payments, and find that GDP increases by $4,500.  Explanation: There is $20 in wages (paid to the employees of the dealership) plus $4,480 in profits ($5,000 received for the car, minus $500 paid for the car, minus $20 paid as wages, leaves $4,480 in profit for the owner).  There are no other factor payments. Adding up: $20 + $4,480 = $4,500 in total factor payments. 

[Note: In case you are wondering: If the problem had told us that the owner had made other factor payments, e.g. rent or interest, then profits would be lower by the amount of these payments, but these other factor payments – when added to the (lower) profits – would still give the same total factor payments of $4,500. Also: If the problem had told us that the car dealer used intermediate goods like Windex or glue, then the dealer’s factor payments would have been lower than $4,500, but factor payments by other firms supplying the intermediate goods would have been included, giving us the same total  $4,500 in factor payments.]

c. Value added approach: In this approach, we add up all the value added by every firm in the economy.  In this problem, there was only one firm: the car dealership. It purchased a car for $500 and sold it for $5,000.  Therefore (since there was no mention of any intermediate goods that it bought before selling the car), it’s value added was $4,500. (Same as when you sell your book to the bookstore and the bookstore sells it for a higher price to someone else – the value added by the bookstore is the amount extra that it charges to make the book conveniently available.  In this case, the value added by the used car dealer – aside from making the car conveniently available — also included some minor repair and cleanup.)

4.

a. Based on the dialogue in the film, Unger’s denominator  appears to have been the $14 trillion total value of U.S. equities (he says, “…in terms of investments on Wall Street, American equities…”). This gives him a fraction of $860 billion / $14,000 billion = .061 or 6.1%. 

b. If Unger was using the total value of U.S. equities in his denominator, then he was calculating the value of all U.S. assets owned by Saudi Arabia (stocks, real estate, bonds, bank accounts and everything else) as a percentage of the value of just one type ofU.S. assets (stocks only). This does not tell use the fraction of the “U.S. Economy” that the Saudis own. 

[To see why Unger’s statement is illogical, here’s an addition fact not provided in the problem, used here just for illustration:  In 2004, U.S. residents owned $45.9 in U.S. assets (stocks, bonds, real estate, etc.).  So if we use Unger’s logic, and divide American ownership of assets by U.S. GDP, Americans that year would have owned 327% of the U.S. economy, since $45.9 trillion / $14 trillion = 3.27 or 327%.  Clearly, it’s impossible for Americans to own more than 100% of the U.S. economy.) 

c.  Using U.S. GDP in the denominator, we would get $860 billion / $11,700 billion = .074 or 7.4%, which is even larger than Unger’s estimate.  But this estimate is illogical. The numerator—Saudi ownership of U.S. wealth—is a “stock” variable: it refers to a quantity of assets owned at a given point in time, rather than a process that takes place over a period of time. The denominator, GDP, is a “flow” variable: a process that takes place over a period of time (in this case, one year).  It measures production, not ownership.  It makes no sense to measure the percentage of the U.S. economy that Saudia Arabia owns by taking their ownership of U.S. assets (stock variable) as a percentage of total U.S. production or GDP (flow variable).   So the 7.4% figure reported by some websites was not the fraction of the U.S. economy owned by the Saudis.

[Again, to see the logical error here: Let’s use the same logic to determine the supposed share of American ownership of the U.S. economy.  We’ll use the data cited in b. above (that $45.9 billion of total U.S. assets was owned by Americans). In that case,  we’d have to conclude that Americans owned 392% of the U.S. economy, because $45.9 trillion / $11.7 trillion = 3.92 or 392%. But it is not possible for anyone, including Americans, to own more than 100% of the economy.]

d. The correct way to determine the percentage of the “economy” owned by the Saudis (using the $860 billion figure) is to look at the fraction of all U.S. assets that are owned by the Saudis: $860 billion / $54,000 billion = .0159 or about 1.6%. In words, the Saudis owned between one and two percent of the “U.S. economy” (i.e., of the total assets of the U.S. economy).

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