1. office hours: 8:00AM – 8:50AM tuesdays LUMS C85
ECON 102 Tutorial: Week 14
Ayesha Ali
office hours: 8:00AM – 8:50AM tuesdays LUMS C85

2. Today’s Outline Planet Money Podcast – Invention of the Economy
So, why was GDP invented?
Is GDP still relevant today or is it outdated?
Feedback: Did you like the podcast? Was it useful in understanding the lecture/worksheet/textbook material?
Week 14 worksheet:
Discussion: Q1, Q2, Q3,
Problems: Q8, Q9, Q10, Q11, Q12, Q13
Reminder: please make sure you review and understand the questions that we are not covering in class as well – you never know which ones could come up in an exam.
Also, for this section of the course, I’d highly recommend reading along in the textbook as well.

3. Question 1
In the years to 2050 the Japanese population is expected to decline, while the fraction of the population that is retired is expected to increase sharply.
What are the implications of these population changes for total output and average living standards in Japan, assuming that average labour productivity continues to grow?
Slowing population growth and an increased share of retired people both imply slower growth in the number of people employed.
If average labour productivity (output per employed worker) continues to grow at earlier rates, total output will still grow more slowly than before, because of slower growth in the number of workers. So, If average labour productivity stagnates, then total output will grow very slowly or even decline.
What if average labour productivity stagnates?
Living standards depend not on total output but on output divided by the total population.
Slowing population growth reduces total output, but also reduces the number of people who share that output.
So slower population growth in itself should not affect living standards. However, a reduced share of the population that is working, all else equal, will reduce output per person, lowering living standards.
Slower productivity growth will only worsen this problem.
What are the implications of these population changes for total output and average living standards in Japan, assuming that average labour productivity continues to grow?

4. Question 2
Is it possible for average living standards to rise during a period in which average labour productivity is falling? Discuss, using a numerical example for illustration.
It is possible, if the decline in average labour productivity (output per worker) is offset by an increased share of the population that is employed.
For a simple example, suppose an economy has two people, one of whom is working.
The one worker produces 10 units of output, so average labour productivity is 10.
Output per person (10/2) is 5.
Now suppose that average labour productivity drops to 8 but both people are working.
Then total output is 16 and output per person is 8, so average living standards (output per person) rise even though average labour productivity (output per employed worker) has fallen.

5. Question 3
The following data give total output, total population and numbers employed for Germany and Turkey in 2009.
Germany
Turkey
Output (billions of $s)
1,631
590
Population (millions) 83 77
Numbers employed (millions) 40 23
Find output per person and average labour productivity in each country.
Output per person = output / population
Labour productivity = output / number of people employed
How do living standards compare?
Germany:
output per person: $1,631 billion / 83 million people = $19,651 per person
average labour prod.: $1,631 billion / 40 million employed = $40,775 per person employed
Turkey:
output per person: $590 billion / 77 million people = $7,662 per person
average labour prod.: $590 billion / 23 million employed = $25,652 per person employed
Both the living standard (output per person) and average labour productivity (output per worker) are higher in Germany than in Japan.
But the difference between living standards in the two countries is more marked than the difference in labour productivity.

6. Question 4
Data released in February 2011 suggests that China has overtaken Japan as the world’s second largest economy as measured by the absolute size of its GDP.
Does this necessarily imply that the real living standards of Chinese citizens are now higher than those of their Japanese counterparts?
The average living standard in a country is measured by output per person.
So that means it depends not only on the size of GDP (total output), but also on the size of the population.
So, because China’s population is much larger than Japan’s, the average living standard of a Chinese citizen is still lower than that of a Japanese citizen.

7. Question 5 Expenditure (% of GDP) Revenue Ireland 48.9 34.5 Norway
Eurostat, the European agency that collects a wide variety of statistics about the European economy, reports the following figures for government expenditures and revenue in Ireland and Norway for 2009.
Expenditure
(% of GDP)
Revenue
Ireland
48.9
34.5
Norway
45.8
37.8
Find the government deficit/surplus (as a % of GDP) for each country in 2009.
Ireland’s budget position is revenue – expenditure = 34.5 – 48.9 = as a% of GDP.
Norway’s budget position is 37.8 – 45.8 = -8 as a % of GDP.
Both countries ran a budget deficit in 2009, though Norway’s was smaller than Ireland’s.

8. Question 6
Classify the following into either stabilisation or structural economic policies:
a. The central bank reacts to a rise in inflation by increasing interest rates.
stabilisation policy
(policy aimed at moderating short-term economic fluctuations)
b. The finance minister responds to a rise in unemployment by cutting the rate of
income tax.
 c. In an attempt to increase productivity the government announces new tax
incentives to promote research and development.
structural policy (policy aimed at changing the structure of the economy)
d. The EU negotiates a new free trade deal with China
structural policy
e. The government deficit increases as the economy moves into recession.

9. Question 7
Suppose a small European country produces thee goods – wine, cigars and cameras. In a given year the country produces 1 million litres of wine at €2 per litre, 10 million cigars at €0.50 per cigar and 500,000 cameras at €100 per camera.
What is the country’s aggregate output in that year?
Aggregate output is the total value of production.
So in this case, we would add up the value of all of the country’s output:
Aggregate output: million litres of wine x €2
+ 10 million cigars x €0.50
+ 0.5 million cameras x €100
Aggregate output = €57 million.

10. What exactly is GDP? GDP is defined as:
the market value of the final goods and services produced in a country during a given period.
Let’s break down the definition to understand what it actually means.
the market value:
GDP is an aggregate of the market values of the goods and services produced in the economy. Goods and services that are not sold in markets, (such as unpaid housework) are not counted in the GDP. An important exception is goods and services provided by the government, which are included in GDP, at the government’s cost of providing them.
…of final goods and services:
Final goods and services are counted in GDP. Intermediate goods and services, which are used up in the production of final goods & services are not counted. In practice, the value of final goods and services is determined by the value-added method. The value added by any firm equals the firm’s revenue from selling its product minus the cost of inputs purchased from other firms. Summing the value added by all firms in the production process yields the value of the final good or service.
…produced in a country during a given period:
Only goods and services produced within a nation’s borders are included in GDP. Only goods and services produced during the current year are counted as part of the current-year GDP.
Two things we do not count in GDP are: Transfer Payments, and Intermediate Goods.

11. Question 8
How would each of the following transactions affect the GDP of the United Kingdom?
a. The UK government pays €1 million in salaries for government workers.
Government purchase of a service; GDP increases by €1 million.
b. The UK government pays €1 million to social security recipients.
Transfer payment; GDP does not change.
c. The UK government pays a UK firm €1 million for newly produced computers.
Government purchase of a good; GDP increases by €1 million.
d. The UK government pays €1 million in interest to holders of UK government bonds.
Government interest payment; GDP does not change.
e. The UK gov. pays €1 million to Saudi Arabia for crude oil to add to UK official oil reserves.
Government purchase of goods of €1 million is exactly offset by net exports of -€1 million (the oil is imported); GDP does not change. This makes sense, since no additional production occurred within the UK.

12. Question 9
Intelligence Incorporated produces 100 computer chips and sells them for €200 each to Bell Computers. Using the chips and other labour and materials, Bell produces 100 personal computers. Bell sells the computers, bundled with software that Bell licenses from Microsoft at €50 per computer, to PC Charlie’s for €800 each. PC Charlie’s sells the computers to the public for €1,000 each.
Calculate the total contribution to GDP using the value added method.
Do you get the same answer by summing up the market values of final goods and services?
Value added by each firm is as follows:
Intelligence Inc.: 100 chips x €200 = €20,000
Microsoft: software packages x €50 = €5,000
Bell: computers x €800
minus purchased inputs (€20,000 in chips and €5,000 in software)
= €80,000 - €25,000 = €55,000
PC Charlie’s: computers x €1000
minus purchased inputs (€80,000 in computers at wholesale)
= €100,000 - €80,000 = €20,000
Sum of value added: €20,000 + €5,000 + €55,000 + €20,000 = €100,000
This is the same result we get by summing up the market values of final goods and services (the 100 computers sold by PC Charlie’s at €1,000 each equals €100,000).
Pgs. 440 – 445 do a good job of explaining the background information and examples needed for Question 9

13. How do we calculate GDP? GDP = C + I + G + NX
Economists divide the users of the final goods and services that make up the GDP into four categories: households, firms, governments, and the foreign sector.
Corresponding to the four groups of final users are four components of expenditure: households consume, firms invest, governments make government purchases, and the foreign sector buys the nation’s exports.
This method is called the expenditure method of measuring GDP:
GDP = Consumption + Investments + Gov’t purchases + Net Exports
GDP = C + I + G + NX
Pgs in your textbook explain this method in more detail.

14. Question 10
In the expenditure method of measuring GDP how would each of the following expenditures be categorised for the UK under the headings of Consumption , Investments, Government purchases and Net Exports?
a. Purchase of new TVs by households
comes under consumption
b. Unsold cars produced by a domestic firm
comes under investment (as part of inventories)
c. A New York bank purchase of a consultancy report commissioned from a London financial adviser.
comes under exports
d. A pay increase for the armed forces
comes under government purchases
e. A windows manufacturer buys a new fleet of cars for its sales personnel.
comes under investment

15. Question 11
At the start of the year John buys a clapped-out vintage sports car for €1,000. He pays a garage €1,500 to repair and paint the bodywork and buys €2,000 worth of spare parts which he fits himself. He also has to pay €300 to insure the car against fire and theft. At the end of the year John sells the refurbished car for €8,000.
What is the contribution to this year’s GDP?
The contribution is €7,000.
If we sum the market values of final goods and services, we will have the price of the refurbished car at €8,000 minus the cost of the vintage car at €1,000 (which was produced in a previous year).

16. Question 12 Here are some data for an economy.
So, using the terms from the table:
GDP = (consumption expenditure + household purchases of durable goods)
+ (business fixed investment + end-of-year inventory stocks
– beginning-of-year inventory stocks + construction of new homes and apartments)
+ government purchases of goods and services
+ exports – imports.
So GDP = (€600 + €150) + (€100 + €125 – €100 + €100) + €200 + €75 – €50 = €1200.
Why aren’t we including “sales of existing homes and apartments”?
They are not relevant for GDP because they were constructed in an earlier year.
Why aren’t we including “government payments to retirees”?
They represent transfers rather than the purchase of a good or service.
Consumption expenditures
€600
Exports
  75
Government purchases of goods and services
 200
Construction of new homes and apartments
 100
Sales of existing homes and apartments
Imports
  50
Beginning-of-year inventory stocks
end-of-year inventory stocks
 125
Business fixed investment
Government payments to retirees
Household purchases of durable goods
 150
Here are some data for an economy.
Find its GDP. Explain your calculation.
We know how to find GDP:
GDP = Consumption + Investments + Gov’t purchases + Exports – Imports
Or,
GDP = C + I + G + NX

17. How do we compare GDP over time?
We can use GDP to compare economic activity across different countries, or we can use GDP per capita to compare living standards across different countries, or we can use GDP over total number of workers employed to compare average labour productivity across different countries.
But, if we want to use GDP to compare one year to another year, then we have to consider the fact that money is worth different amounts in different years (due to prices changing over time, or we could say due to inflation).
So, we have nominal GDP, which is just the GDP which measures economic activity valued at the current-year prices -- that’s what we’ve been calculating in our problems so far.
In order to adjust for inflation, or changes in prices, we have real GDP. To find real GDP, we need to value the quantity produced in a given year by the prices in a particular year, which we call the base year. This is what we are going to do in Problem 13. So
Real GDP = quantity produced in the current year X prices in the base year.
Also note that: in general, in the base year, real GDP and nominal GDP are the same.
Comparisons of economic activity across different times should always be done using real GDP, and not using nominal GDP.

18. Question 13
The nation of Small-Land produces soccer balls, cases of beer, and painkillers. Here are data on prices and quantities of the three goods in 2000 and 2005:
Assume that 2000 is the base year. Find nominal GDP and real GDP for both years.
For the year 2000:
Nominal GDP = (100 x €5) + (300 x €20) + (100 x €20)= €8500
Real GDP(using prices from 2000) = (100 x €5) + (300 x €20) + (100 x €20) = €8500.
Notice that nominal GDP and real GDP are the same for the base year.
For the year 2005:
Nominal GDP = (125 x €7) + (250 x €20) + (110 x €25) = €8625
Real GDP(using prices from 2000) = (125 x €5) + (250 x €20) + (110 x €20) = €7825
So real GDP has actually declined between 2000 and 2005.
Balls
Beer
Painkillers
 Year
Quantity
Price (€)
2000
100 5
300 20
2005
125 7
250
110 25

19. Next Class Week 15 Worksheet – Inflation and unemployment
Chapters 18 & 19
Discussion Questions – living standards & productivity
Note: We’ll re-visit inflation and unemployment again, when we talk about the Phillips Curve in Weeks 21 and 22.
Podcast for next week:
An in-depth look at the CPI: Planet Money #222
Please note: When you click the listen button or the add to playlist button, a second window is opened with the media player. Sometimes there is a brief advertisement before the podcast starts.