Q: An economy produces three goods: cars, computers, and oranges. In 2020, 10 cars at $$2000$$ each, 4 computers at $$1000$$ each, and 1000 oranges at $$1$$ each are produced. In 2021, 12 cars at $$3000$$ each, 6 computers at $$500$$ each, and 1000 oranges at $$1$$ each are produced. What is the percentage change in nominal GDP from 2020 to 2021?

Nominal GDP in 2020: $$10 \times 2000 + 4 \times 1000 + 1000 \times 1 = 20000 + 4000 + 1000 = 25000$$ Nominal GDP in 2021: $$12 \times 3000 + 6 \times 500 + 1000 \times 1 = 36000 + 3000 + 1000 = 40000$$ Percentage change: $$\frac{40000 - 25000}{25000} \times 100 = 60\%$$

Q: If the price of cars increases from $$2000 in 2020 to$$ $$3000 in 2021$$, but the quantity produced also increases from $$10 to$$ $$12$$, what is the real GDP in 2021 using 2020 prices?

Real GDP in 2021 (using 2020 prices): $$12 \times 2000 = 24000$$

Q: The Consumer Price Index (CPI) is used to measure inflation. If the cost of the basket in the base year is $$1000$$ and in the current year is $$1200$$, what is the inflation rate?

Inflation rate: $$\frac{1200 - 1000}{1000} \times 100 = 20\%$$

Question 1

Suppose the economy is described by the following equations:

$$C = 160 + 0.6Y_D$$
$$I = 150$$
$$G = 150$$
$$T = 100$$

What is the equilibrium level of output ($$Y$$)?

Accepted Answer

$$Y = 1000$$

Question 2

Given the consumption function $$C = c_0$ + c_1$ Y_D$$ and the tax function $$T = t_0$ + t_1$ Y$$, where $$Y_D = Y - T$$, if $$c_1 = 0.8$ and t_1$ = 0.25$$, what is the value of the government spending multiplier?

Accepted Answer

$$\frac{1}{1 - c_1$ (1 - t_1$)} = \frac{1}{1 - 0.8(1 - 0.25)} = \frac{1}{1 - 0.8 	imes 0.75} = \frac{1}{1 - 0.6} = \frac{1}{0.4} = 2.5$$

Question 3

An economy produces three goods: cars, computers, and oranges. In 2020, 10 cars at $$2000$$ each, 4 computers at $$1000$$ each, and 1000 oranges at $$1$$ each are produced. In 2021, 12 cars at $$3000$$ each, 6 computers at $$500$$ each, and 1000 oranges at $$1$$ each are produced. What is the percentage change in nominal GDP from 2020 to 2021?

Accepted Answer

Nominal GDP in 2020: $$10 	imes 2000 + 4 	imes 1000 + 1000 	imes 1 = 20000 + 4000 + 1000 = 25000$$
Nominal GDP in 2021: $$12 	imes 3000 + 6 	imes 500 + 1000 	imes 1 = 36000 + 3000 + 1000 = 40000$$
Percentage change: $$\frac{40000 - 25000}{25000} 	imes 100 = 60\%$$

Question 4

Suppose the government increases spending ($$G) by$$ $$10$$ units in an economy with a marginal propensity to consume ($$c_1) of$$ $$0.75. $$Taxes are fixed. By how much does equilibrium output ($$Y) $$increase?

Accepted Answer

Multiplier: $$\frac{1}{1 - c_1$} = \frac{1}{1 - 0.75} = 4$$
Increase in $$Y$$: $$10 	imes 4 = 40$$

Question 5

If the marginal propensity to consume ($$c_1) is$$ $$0.8$$ and the marginal propensity to invest ($$b_1) is$$ $$0.1$$, what is the value of the multiplier in the model $$C = c_0$ + c_1$ Y_D$$, $$I = b_0$ + b_1$ Y$$, $$Y_D = Y - T$$?

Accepted Answer

Multiplier: $$\frac{1}{1 - (c_1$ + b_1$)} = \frac{1}{1 - (0.8 + 0.1)} = \frac{1}{0.1} = 10$$

Question 6

A seafood restaurant buys $$100$$ worth of fish from a fisherman. A family spends $$100 on a $$fish dinner at the restaurant. What is the contribution to GDP from these transactions?

Accepted Answer

$$100$$, only the final sale to the family counts for GDP

Question 7

Suppose the government starts with a balanced budget ($$G = T). If $$both $$G$$ and $$T$$ increase by $$10$$ units, what is the effect on equilibrium output ($$Y) if $$the marginal propensity to consume ($$c_1) is$$ $$0.6$$?

Accepted Answer

Balanced budget multiplier: $$\frac{\Delta Y}{\Delta G} = 1
So$$ $$Y$$ increases by $$10$$

Question 8

If the price of cars increases from $$2000 in 2020 to$$ $$3000 in 2021$$, but the quantity produced also increases from $$10 to$$ $$12$$, what is the real GDP in 2021 using 2020 prices?

Accepted Answer

Real GDP in 2021 (using 2020 prices): $$12 	imes 2000 = 24000$$

Question 9

The Consumer Price Index (CPI) is used to measure inflation. If the cost of the basket in the base year is $$1000$$ and in the current year is $$1200$$, what is the inflation rate?

Accepted Answer

Inflation rate: $$\frac{1200 - 1000}{1000} 	imes 100 = 20\%$$

Question 10

Suppose the government increases taxes ($$T) by$$ $$20$$ units in an economy with a marginal propensity to consume ($$c_1) of$$ $$0.75. By $$how much does equilibrium output ($$Y) $$decrease?

Accepted Answer

Tax multiplier: $$-\frac{c_1$}{1 - c_1$} = -\frac{0.75}{1 - 0.75} = -3$$
Decrease in $$Y$$: $$20 	imes 3 = 60$$

Question 11

If the marginal propensity to consume ($$c_1) is$$ $$0.7$$ and the marginal propensity to invest ($$b_1) is$$ $$0.2$$, what condition must $$(c_1$ + b_1$)$$ satisfy for the multiplier to be positive?

Accepted Answer

$$(c_1$ + b_1$) \u003c 1$$

Question 12

Suppose the parameter $$b_1 ($$business confidence) increases. How will equilibrium output ($$Y) be $$affected in the model $$C = c_0$ + c_1$ Y_D$$, $$I = b_0$ + b_1$ Y$$, $$Y_D = Y - T$$?

Accepted Answer

Equilibrium output will increase, because the multiplier $$\frac{1}{1 - (c_1$ + b_1$)}$$ increases as $$b_1$$ increases

Question 13

If the government implements an automatic stabilizer through taxes such that $$T = t_0$ + t_1$ Y$$, what is the effect on the government spending multiplier compared to a fixed tax system?

Accepted Answer

The multiplier is smaller with automatic stabilizers, because $$t_1$$ \u003e 0$$ reduces the effect of changes in G$ on Y$

Question 14

Suppose the government starts with a balanced budget and there is a drop in autonomous consumption ($$c_0). $$What happens to equilibrium output ($$Y) $$and taxes ($$T$$)?

Accepted Answer

$$Y$$ decreases and $$T$$ decreases, because lower output reduces tax revenue

Question 15

Why might some economists argue that reducing public debt is desirable but not urgent?

Accepted Answer

Because high debt may not immediately harm economic growth if interest rates are low and the economy is stable

Question 16

Using the value-added approach, if a jewelry manufacturer pays its workers $$250,000 to $$make silver necklaces, which it sells directly to consumers for $$1,000,000$$, what is the value added and GDP?

Accepted Answer

Value added is $$1,000,000 ($$sales) minus $$250,000 ($$wages) = $$750,000$$; GDP is $$1,000,000$$

Question 17

If the GDP deflator in 2020 is $$110$$ and in 2021 is $$121$$, what is the rate of inflation from 2020 to 2021?

Accepted Answer

Inflation rate: $$\frac{121 - 110}{110} 	imes 100 = 10\%$$

Question 18

Suppose Delta Air Lines buys a new jet from Boeing for $$200$$ million. How does this transaction affect US GDP?

Accepted Answer

It increases US GDP by $$200$$ million, as it is a final good produced domestically

Macroeconomics Study Guide: GDP, Fiscal Policy, and Multipliers

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