# Week 4 Tutorial Question Solutions (Ch2 & 3)

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1 Chapter 2: Q1: Macroeconomics P.52 Numerical Problems #3 part (a) Q2: Macroeconomics P.52 Numerical Problems #5 Chapter 3: Q3: Macroeconomics P.101 Numerical Problems #5 Q4: Macroeconomics P102 Analytical Problems #5 Q1: ABC Computer Company has a \$20, 000,000 factory in Kanata. During the current year, ABC builds \$2,000,000 worth of computer components. ABC s costs are labour \$1,000,000; interest on debt, \$100,000; and taxes, \$200,000. ABC sells all its output to XYZ Supercomputer. Using ABC s components, XYZ builds four supercomputers at a cost of \$800,000 each (\$500,000 worth of components, \$200,000 in labour costs, and \$100,000 in taxes per computer). XYZ has a \$30,000,000 factory. XYZ sells three of the supercomputers for \$1,000,000 each; at year s end, it has not sold the fourth. The unsold computer is carried on XYZ s books as an \$800,000 increase in inventory. a. Calculate the contributions to GDP of these transactions, showing that all three approaches give the same answer. 1) Product Approach: The GDP contributions of these companies are \$3.8 million. The value added by ABC is 2 million while the value added by XYX is 1.8 million. You can also think that ABC did not produce any final good as they are all sold to XYZ as intermediate goods. So the value of the final product is 3 million worth of supercomputers sold in the market plus 0.8 million unsold supercomputer in inventory. In total we get \$3.8 million worth of GDP. 2) Expenditure Approach: GDP = C + I + G + NX where C = \$3 million spent by households on supercomputer, I = \$0.8 million as firm s inventory investment, G and NX = \$0 in this case. So we have GDP = \$3.8 million. 3) Income Approach: GDP = labour income + corporate profits + interest and investment income + unincorporated business income + indirect taxes subsidies + depreciation The income approach yields the same GDP total contribution. The amounts are: Week 4 Page 1

2 ABC XYZ Total Labour \$1.0 million \$0.8 million \$1.8 million Profit \$0.7 million \$0.6 million \$1.3 million Taxes \$0.2 million \$0.4 million \$0.6 million Interest \$0.1 million \$0.0 million \$0.1 million Total of all incomes = \$3.8 million Q2: You are given the following information about an economy: Gross private domestic investment 40 Government purchases of goods and services 30 Gross national product (GNP) 200 Current account balance -20 Taxes 60 Government transfer payments 25 Interest payment from the government (all to domestic households) 15 Factor income from the rest of the world 7 Factor payment to the rest of the world 9 Find the following, assuming that government investment is zero: a. Consumption b. Net exports c. GDP d. Net factor payments e. Private saving f. Government saving g. National saving Given data: I = 40, G = 30, GNP = 200, CA = 20 = NX + NFP, T = 60, TR = 25, INT = 15, NFP = 7 9 = 2. Week 4 Page 2

3 a. Consumption = 150 Week 4 Tutorial Question Solutions (Ch2 & 3) Since GDP = GNP NFP, thus GDP = Y = 200 ( 2) = 202 Since NX + NFP = CA, thus NX = CA NFP = 20 ( 2) = 18. Since Y = C + I + G + NX, thus C = Y (I + G + NX) = 202 ( ( 18)) = 150. b. Net exports = 18 Since CA = 20 = NX + NFP and NFP = 7 9 = 2. Thus NX = CA NFP = -20 (-2) = -18 c. GDP = 202 Since GDP = GNP NFP, thus GDP = Y = 200 ( 2) = 202 d. Net factor payments from abroad = 2 NFP = 7 9 = 2. e. Private saving = 30 Spvt = (Y + NFP T + TR + INT) C = (202 + ( 2) ) 150 = 30. f. Government saving = 10 Sgovt = (T TR INT) G = ( ) 30 = 10 g. National saving = 20 S = Spvt + Sgovt = 30 + ( 10) =20. Q3: Consider an economy in which the marginal product of labour MPN is MPN = 309 2N, where N is the amount of labour used. The amount of labour supplied, NS, is given by NS = w + 2T, where w is the real wage and T is a lumpsum tax levied on individuals. a. Use the concepts of income effect and substitution effect to explain why an increase in lump-sum taxes will increase the amount of labour supplied. Week 4 Page 3

4 If the lump-sum tax is increased, there is an income effect on labour supply, not a substitution effect (since the real wage is not changed). An increase in the lump sum tax reduces a worker's wealth, so labour supply increases. b. Suppose that T = 35. What are the equilibrium values of employment and the real wage? If T = 35, then NS = w + (2 x 35) = w. Labour demand is given by w = MPN = 309 2N, or 2N = 309 w, so N = w/2. Setting labour supply equal to labour demand gives: w/2 = w, so 62.5 = 12.5w, thus w = 62.5/12.5 = 5. With w = 5, N = 92 + (12 x 5) = 152. c. With T remaining equal to 35, the government passes minimum-wage legislation that requires firms to pay a real wage greater than or equal to 7. What are the resulting values of the employment and the real wage? Since the equilibrium real wage (w = \$5) is below the minimum wage, the minimum wage is binding. With w = 7, N = /2 = Note: NS = 92 + (12 x 7) = 176, so NS > N and there is unemployment. Q4: Suppose that under a new law all businesses must pay a tax equal to 6% of their sales revenue. Assume that this tax is not passed on to consumers. Instead, consumers pay the same prices after the tax is imposed as they did before. What is the effect of this tax on labour demand? If the labour supply is unchanged, what will be the effect of the tax on employment and the real wage? The tax reduces the marginal product of labour by 6%, since that portion of output goes to the government rather than to the firm. Thus labour demand is reduced. With labour supply unchanged, the downward shift in labour demand reduces the real wage and employment, as shown in the following figure. Week 4 Page 4

5 w NS W 1 W 2 ND 2 ND 1 N 2 N 1 N Week 4 Page 5

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