Answers to Some Practice Problems for Exam 1

 

1. In 1982, the average hourly earnings of private nonagricultural production workers were $7.68 per hour.  By 2000, the average hourly earnings had risen to $13.75.  In 2000, the CPI was 172.2, compared to 96.5 in 1982.  What were the real earnings of private non-agricultural production workers in 2000 measured in 1982 dollars?

 

$7.71

 

2. The nominal salary paid to the US President along with data for the CPI are given for various years below:

 

Year	Presidential Salary	CPI (2000 = 100)
1920	75,000	11.6
1940	75,000	8.1
1960	100,000	17.2
1980	200,000	47.9
2000	400,000	100

     

a.       Which year was the real presidential salary the highest?

 

1940 (gdps – 646552, 925926, 581395, 417537, 400000)

 

3. Indicate how each of the following activities will affect this year’s GDP:
1. The $25 sale of a used economics textbook to the UVA bookstore.
2. Family lawn services provided by Smith’s 16-year-old child.
3. Lawn services purchased by Smith from the neighbor’s 16-year-old child who has a lawn-mowing business.
4. $60,000 of income earned by an American college professor teaching in England.

 

a, b, d – no affect on gdp,  c – increases gdp by amount of expenditure

 

Name three things that are omitted from GDP that might cause a downward bias in GDP. 

 

Downward – non-market production, leisure, underground economy (and quality changes)

 

4. The accompanying chart presents 2000 data from the national income accounts of the United States:

 

Component	Billions of Dollars
Personal Consumption	6757
Employee Compensation	5638.2
Rents	140
Gov’t Consumption and investment	1743.7
Imports	1468
Depreciation	1257.1
Corporate profits	946.2
Interest income	567.2
Exports	1097.3
Gross private investment	1832.7
Indirect business taxes	699.6
Self-employment income	710.4
Net income of foreigners	-4.4

 

Choose either expenditure or income approach to calculate GDP – tell which factors go to your approach, and calculate.

 

Expenditure: personal consumption, gov. consumption, imports, exports, gross private investment – total = 9962.7

 

Income: emp. Compensation, rents, depreciation, corporate profits, interest income, business taxes, self-employment income, net income to foreigners – total = 9954.3

 

5. What is full employment?  When full employment is present, will the rate of unemployment be zero?  Explain.

 

Full employment is when there is no cyclical unemployment in the economy.  Does NOT mean rate of unemployment is zero.

 

 

6. Using the following data, calculate (a) the labor force participation rate, (b) the rate of unemployment, and (c) the employment/population ratio:

 

Population                               10,000

Labor force                            6,000

Not currently working                        4,500

Employed full-time                 4,000

Employed part-time                1,500

Unemployed                           500

 

a.       60 %

b.      8.3 %

c.       55%

 

Classify each of the following as either employed, unemployed, or not in labor force.

a.       Sally stays at home to raise her 3 young children.  Sally used to be a teacher, and plans to return to teaching after her children have graduated from high school.

b.      Andrea was recently fired from her job at McDonalds.  Her brother, who owns a Burger King, has told her that he expects to be able to hire her in a few months when business picks up again.

c.       Karen is a college student who grades papers for a mathematics professor for about 5 hours per week at minimum wage.  She has started searching for post-graduation jobs.

 

A – not in labor force, b – unemployed, c - employed

 

7. Name the four types of unemployment and give an example of each one.

 

Frictional (time for matching), Structural (changes in industry), seasonal (season demand changes), cyclical (recessionary business conditions)

 

8. Assume that both union and management representatives agree to wage increases because of their expectation that prices will rise 10 percent during the next year.  Explain why the unemployment rate will probably increase if the actual rate of inflation next year is only 3 percent.

 

This means that workers have higher real wages and firms have higher real costs.  As a result, firms must cut back on output and resources, including labor, so unemployment increases.

 

 

9. Indicate how each of the following would influence US aggregate supply in the short-run:
1. An increase in real wage rates
2. A severe freeze that destroys half the orange trees in Florida
3. An increase in the expected rate of inflation in the future

 

All reduce SRAS.

 

10. Explain how and why each of the following factors would influence current aggregate demand in the United States:

 

1. Rapid growth of real income in Canada and Western Europe.
2. A reduction in the real interest rate.
3. A higher price level

 

A, b – increase AD.  C – does not change.

 

11. How will an increase in the inflation rate affect (a) the money rate of interest and (b) the real rate of interest?

 

1. increase money rate of interest (Fisher)
2. does not affect real interest rate

 

12. Suppose the only two countries in the world are England and Portugal, and the only two goods that these countries produce are books and coffee.  England can produce 5 books per day and 10 pounds of coffee beans per day.  Portugal can produce 2 books per day and 8 pounds of coffee per day.  Who has the absolute and comparative advantages in each of these goods?  If the countries decide to trade, who produces what and what will the range of prices be of the goods (i.e. coffee must sell for less than ___ books per pound and more that ___ books per pound for the countries to both trade)?

 

Absolute – England for both

Comparative – England for books, Portugal for coffee

Prices: coffee (between ¼ and ½ books), books (between 2 and 4 pounds coffee)

 

13. If the present value of a good is $40, and the interest rate is 5%, what is the future value of the good a year from now?  In five years?

 

One year = (1.05)*40 = 42

Five years = (1.05)^5 * 40 = 51.05

 

14. If actual inflation is greater than expected inflation, do we expect that firms are hurt or laborers are hurt?

 

Laborers are hurt because their contracted nominal wage was only increased for expected inflation, not actual.

 

15. Why is the supply curve for loanable funds upward-sloping?

 

The price of loanable funds is the interest rate.  At high interest rates, people know that they will be paid more in the future for their savings, so they will save more.

 

16. If the average price of the appropriate market bundle of goods was $4,000 (in billions) in 1996 and $6,000 (in billions) in 1999, what is the GDP Deflator for both 1996 and 1999 using 1996 as the base year?

 

The GDP Deflator for 1996 is 100 because it is the base year and the GDP Deflator for 1999 is ($6000/$4000)*100 = 150.

 

17. The nominal salary paid to the President of the United States along with data for the Consumer Price Index (CPI) is given for various years below.

 

 

Year	Presidential Salary	CPI (2000 = 100)	Real Salary (purchasing power of 2000 $)
1920	$75,000	11.6	646552
1940	$75,000	8.1	925,926
1960	$100,000	17.2	581,395
1980	$200,000	47.9	417,537
2000	$400,000	100	400,000

 

 

 

 

 

 

 

 

a.       Calculate the president’s salary measured in the purchasing power of the dollar in 2000.  See added column in above table.

b.      Which year was the real presidential salary the highest? In 1940

c.       The president’s nominal salary was constant between 1920 and 1940.  What happened to real salary?  Can you explain why? His real salary increased.  This happened because the price level actually decreased (there was deflation).