# Solutions manual Macroeconomics 8th Edition Gregory Mankiw

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1 Solutions manual Macroeconomics 8th Edition Gregory Mankiw C H A P T E R 2 The Data of Macroeconomics Questions for Review 1. GDP measures the total income earned from the production of the new final goods and services in the economy, and it measures the total expenditures on the new final goods and services produced in the economy. GDP can measure two things at once because the total expenditures on the new final goods and services by the buyers must be equal to the income earned by the sellers of the new final goods and services. As the circular flow diagram in the text illustrates, these are alternative, equivalent ways of measuring the flow of dollars in the economy. 2. The consumer price index measures the overall level of prices in the economy. It tells us the price of a fixed basket of goods relative to the price of the same basket in the base year. The GDP deflator is the ratio of nominal GDP to real GDP in a given year. The GDP deflator measures the prices of all goods and services produced, whereas the CPI only measures prices of goods and services bought by consumers. The GDP deflator includes only domestically produced goods, whereas the CPI includes domestic and foreign goods bought by consumers. Finally, the CPI is a Laspeyres index that assigns fixed weights to the prices of different goods, whereas the GDP deflator is a Paasche index that assigns changing weights to the prices of different goods. In practice, the two price indices tend to move together and do not often diverge. 3. The Bureau of Labor Statistics classifies each person into one of the following three categories: employed, unemployed, or not in the labor force. The unemployment rate, which is the percentage of the labor force that is unemployed, is computed as follows: Unemployment Rate Number of Unemployed Labor Force 100. Note that the labor force is the number of people employed plus the number of people unemployed. 4. Every month, the Bureau of Labor Statistics (BLS) undertakes two surveys to measure employment. First, the BLS surveys about 60,000 households and thereby obtains an estimate of the share of people who say they are working. The BLS multiplies this share by an estimate of the population to estimate the number of people working. Second, the BLS surveys about 160,000 business establishments and asks how many people they employ. Each survey is imperfect; so the two measures of employment are not identical. Problems and Applications 1. A large number of economic statistics are released regularly. These include the following: Gross Domestic Product the market value of all final goods and services produced in a year. The Unemployment Rate the percentage of the civilian labor force who do not have a job. Corporate Profits the income of corporations after payments to workers and creditors. It gives an indication of the general financial health of the corporate sector. 5

3 7 Answers to Textbook Questions and Problems C h a p t e r 2 The Data of Macroeconomics 7 Among other things, we observe the following trends in the economy over the period : (a) Personal consumption expenditures have been around two-thirds of GDP, although the share increased markedly between 1980 and (b) The share of GDP going to gross private domestic investment fell slightly from 1950 to It fell sharply from 2005 to 2012 due to the recession. (c) The share going to government consumption purchases rose sharply from 1950 to (d) Net exports, which were positive in 1950, have been negative since that time. (e) The share going to national defense purchases has fallen slightly. (f) The share going to state and local purchases rose from 1950 to (g) Imports have grown rapidly relative to GDP. 6. a. i. Nominal GDP is the total value of goods and services measured at current prices. Therefore, Nominal GDP 2000 (P cars Q cars ) + (P bread Q bread ) (\$50, ) + (\$10 500,000) \$5,000,000 + \$5,000,000 \$10,000, Nominal GDP 2010 (P cars Q cars ) + (P bread Q bread ) ii. iii. (\$60, ) + (\$20 400,000) \$7,200,000 + \$8,000,000 \$15,200,000. Real GDP is the total value of goods and services measured at constant prices. Therefore, to calculate real GDP in 2010 (with base year 2000), multiply the quantities purchased in the year 2010 by the 2000 prices: Real GDP 2010 (P cars Q cars ) + (P bread Q bread ) (\$50, ) + (\$10 400,000) \$6,000,000+ \$4,000,000 \$10,000,000. Real GDP for 2000 is calculated by multiplying the quantities in 2000 by the prices in Since the base year is 2000, real GDP 2000 equals nominal GDP 2000, which is \$10,000,000. Hence, real GDP stayed the same between 2000 and The implicit price deflator for GDP compares the current prices of all goods and services produced to the prices of the same goods and services in a base year. It is calculated as follows: Implicit Price Deflator 2010 Nominal GDP Real GDP 2010 Using the values for Nominal GDP 2010 and real GDP 2010 calculated above: \$15,200,000 Implicit Price Deflator 2010 \$10,000, This calculation reveals that prices of the goods produced in the year 2010 increased by 52 percent compared to the prices that the goods in the economy sold for in (Because 2000 is the base year, the value for the implicit price deflator for the year 2000 is 1.0 because nominal and real GDP are the same for the base year.)

4 8 Answers to Textbook Questions and Problems C h a p t e r 2 The Data of Macroeconomics 8 iv. The consumer price index (CPI) measures the level of prices in the economy. The CPI is called a fixed-weight index because it uses a fixed basket of goods

6 10 Answers to Textbook Questions and Problems C h a p t e r 2 The Data of Macroeconomics 1 0 b. Nominal spending is the total value of output produced in each year. In year 1 and year 2, Abby buys 10 apples for \$1 each, so her nominal spending remains constant at \$10. For example, Nominal Spending 2 (P red Q red ) + (P green Q green ) (\$2 0) + (\$1 10) \$10. c. Real spending is the total value of output produced in each year valued at the prices prevailing in year 1. In year 1, the base year, her real spending equals her nominal spending of \$10. In year 2, she consumes 10 green apples that are each valued at their year 1 price of \$2, so her real spending is \$20. That is, Real Spending 2 (P red Q red ) + (P green Q green ) (\$1 0) + (\$2 10) \$20. Hence, Abby s real spending rises from \$10 to \$20. d. The implicit price deflator is calculated by dividing Abby s nominal spending in year 2 by her real spending that year: Nominal Spending Implicit Price Deflator 2 2 Real Spending 2 \$10 \$ Thus, the implicit price deflator suggests that prices have fallen by half. The reason for this is that the deflator estimates how much Abby values her apples using prices prevailing in year 1. From this perspective green apples appear very valuable. In year 2, when Abby consumes 10 green apples, it appears that her consumption has increased because the deflator values green apples more highly than red apples. The only way she could still be spending \$10 on a higher consumption bundle is if the price of the good she was consuming fell. e. If Abby thinks of red apples and green apples as perfect substitutes, then the cost of living in this economy has not changed in either year it costs \$10 to consume 10 apples. According to the CPI, however, the cost of living has doubled. This is because the CPI only takes into account the fact that the red apple price has doubled; the CPI ignores the fall in the price of green apples because they were not in the consumption bundle in year 1. In contrast to the CPI, the implicit price deflator estimates the cost of living has been cut in half. Thus, the CPI, a Laspeyres index, overstates the increase in the cost of living and the deflator, a Paasche index, understates it. 8. a. Real GDP falls because Disney does not produce any services while it is closed. This corresponds to a decrease in economic well-being because the income of workers and shareholders of Disney falls (the income side of the national accounts), and people s consumption of Disney falls (the expenditure side of the national accounts). b. Real GDP rises because the original capital and labor in farm production now produce more wheat. This corresponds to an increase in the economic well-being of society, since people can now consume more wheat. (If people do not want to consume more wheat, then farmers and farmland can be shifted to producing other goods that society values.)

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