Macroeconomics Problem Set 1 – Guided Study Notes

Q1. For each of the following transactions, determine the contribution to the current year’s GDP. Explain the effects on the product, income, and expenditure accounts.

Background

Topic: National Income Accounting and GDP Measurement

This question tests your understanding of how different transactions are recorded in the calculation of Gross Domestic Product (GDP), and how they affect the product, income, and expenditure approaches to GDP.

Key Terms and Concepts:

• GDP (Gross Domestic Product): The total market value of all final goods and services produced within a country in a given period.

• Product Approach: Measures GDP by summing the value added at each stage of production.

• Income Approach: Measures GDP by summing all incomes earned in the production of goods and services.

• Expenditure Approach: Measures GDP by summing all expenditures on final goods and services.

• Final vs. Intermediate Goods: Only final goods are included in GDP to avoid double counting.

Step-by-Step Guidance

1. For each transaction, identify whether it involves a final good or service, or an intermediate good.

2. Determine the value added to GDP by considering only the final sale or the value added at each stage.

3. For each transaction, consider how it would be recorded in the product, income, and expenditure accounts. For example, is it counted as consumption, investment, government spending, or net exports?

4. Think about whether the transaction represents new production in the current year or a transfer of ownership of an existing asset.

5. For transactions involving services (e.g., broker’s fees, childcare, advertising), consider how these services contribute to GDP.

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Q2. Given the following macroeconomic data, find: a) Consumption, b) Net exports, c) GDP, d) Net factor payments from abroad, e) Private saving, f) Government saving, g) National saving.

Background

Topic: National Income Accounting Identities

This question tests your ability to use macroeconomic identities and relationships to solve for unknown variables using given data.

Key Terms and Formulas:

• GDP (Gross Domestic Product): $GDP = C + I + G + NX$

• GNP (Gross National Product): $GNP = GDP + NFP$

• Net Factor Payments from Abroad (NFP): $NFP = ext{Factor income received from abroad} - ext{Factor payments made to abroad}$

• Net Exports (NX): $NX = ext{Current Account Balance}$

• Private Saving: $S_p = Y + NFP + TR + INT - T - C$

• Government Saving: $S_g = T - G - TR - INT$

• National Saving: $S = S_p + S_g$

Step-by-Step Guidance

1. Calculate Net Factor Payments from Abroad (NFP) using the provided data.

2. Use the GNP and NFP to solve for GDP.

3. Use the GDP identity to solve for Consumption (C), given values for I, G, and NX.

4. Use the formula for Private Saving, plugging in the values you have and the Consumption value you found.

5. Set up the equations for Government Saving and National Saving, but stop before plugging in the final numbers.

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Q3. Consider an economy where the marginal product of labor is $MPN = 309 - 2N$, and labor supply is $N^S = 22 + 12w + 2T$. T is a lump-sum tax. a) Use the concepts of income effect and substitution effect to explain why an increase in lump-sum taxes will increase the amount of labor supplied.

Background

Topic: Labor Supply, Income and Substitution Effects

This question tests your understanding of how changes in taxes affect labor supply through the income and substitution effects.

Key Terms and Concepts:

• Income Effect: The change in labor supply resulting from a change in real income, holding the real wage constant.

• Substitution Effect: The change in labor supply resulting from a change in the real wage, holding utility constant.

• Lump-Sum Tax: A tax that is the same amount for everyone, regardless of income or behavior.

Step-by-Step Guidance

1. Recall that a lump-sum tax reduces disposable income but does not affect the real wage.

2. Explain how a decrease in income (from the tax) leads to an income effect, causing individuals to increase labor supply to maintain their standard of living.

3. Note that since the real wage is unchanged, there is no substitution effect from the lump-sum tax.

4. Summarize why the net effect is an increase in labor supply due to the income effect alone.

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Q4. Suppose T = 35. What are the equilibrium values of employment and the real wage?

Background

Topic: Labor Market Equilibrium

This question tests your ability to solve for equilibrium in the labor market by equating labor supply and labor demand functions.

Key Terms and Formulas:

• Marginal Product of Labor (MPN): $MPN = 309 - 2N$

• Labor Supply: $N^S = 22 + 12w + 2T$

• Equilibrium: Set $N^D = N^S$ and solve for $N$ and $w$.

Step-by-Step Guidance

1. Substitute $T = 35$ into the labor supply equation to get $N^S$ as a function of $w$ only.

2. Set the labor demand ($N$ from $MPN$) equal to the labor supply ($N^S$) to form one equation in terms of $N$ and $w$.

3. Express $w$ in terms of $N$ using the $MPN$ equation, since in equilibrium, the real wage equals the marginal product of labor.

4. Substitute this expression for $w$ into the labor supply equation and solve for $N$.

5. Once you have $N$, substitute back to find $w$, but stop before the final calculation.

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Q5. With T = 35, the government passes minimum-wage legislation requiring firms to pay a real wage ≥ 7. What are the resulting values of employment and the real wage?

Background

Topic: Minimum Wage and Labor Market Disequilibrium

This question tests your understanding of how a binding minimum wage affects employment and the real wage in the labor market.

Key Terms and Formulas:

• Minimum Wage: A legally mandated lowest wage that can be paid to workers.

• Labor Demand: $MPN = 309 - 2N$

• Labor Supply: $N^S = 22 + 12w + 2T$

Step-by-Step Guidance

1. Set $w = 7$ in the labor demand equation to solve for the quantity of labor demanded at the minimum wage.

2. Set $w = 7$ in the labor supply equation (with $T = 35$) to solve for the quantity of labor supplied at the minimum wage.

3. Compare the quantities of labor supplied and demanded to determine if there is unemployment (excess supply of labor).

4. Summarize the resulting equilibrium values, but stop before the final calculation.

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Q6. Use the data from table 3.12 in Lecture Notes 2 to calculate how many people become unemployed during a typical month. How many become employed? How many leave the labor force?

Background

Topic: Labor Force Flows and Unemployment

This question tests your ability to use labor market flow data to calculate transitions between employment, unemployment, and out of the labor force.

Key Terms and Concepts:

• Labor Force: The sum of employed and unemployed individuals.

• Labor Market Flows: The movement of individuals between employment, unemployment, and out of the labor force.

Step-by-Step Guidance

1. Review table 3.12 to identify the relevant transition numbers (e.g., employed to unemployed, unemployed to employed, etc.).

2. Sum the appropriate flows to find the total number of people becoming unemployed, employed, and leaving the labor force.

3. Be careful to distinguish between gross flows (total moving in/out) and net changes (overall increase/decrease).

4. Set up the calculations, but stop before the final computation.

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Q7. Can the unemployment rate and the employment ratio rise during the same month? Can the participation rate fall at the same time that the employment ratio rises? Explain.

Background

Topic: Labor Market Indicators

This question tests your understanding of the relationships between the unemployment rate, employment ratio, and participation rate.

Key Terms and Concepts:

• Unemployment Rate: $\text{Unemployment Rate} = \frac{\text{Unemployed}}{\text{Labor Force}}$

• Employment Ratio: $\text{Employment Ratio} = \frac{\text{Employed}}{\text{Population}}$

• Participation Rate: $\text{Participation Rate} = \frac{\text{Labor Force}}{\text{Population}}$

Step-by-Step Guidance

1. Consider scenarios where both the number of employed and unemployed people increase, and how this affects the ratios.

2. Think about how changes in the labor force and population can affect the participation rate and employment ratio simultaneously.

3. Use the definitions to set up possible numerical examples, but stop before drawing final conclusions.

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