## PROBLEMS AND APPLICATIONS

1. Look at the newspapers for the past few days. What new economic statistics have been released? How do you interpret these statistics?

2. A farmer grows some wheat and sells it to a miller for \$1.00. The miller turns the wheat into flour and then sells the flour to a baker for \$3.00. The baker uses the flour to make bread and sells the bread to an engineer for \$6.00. The engineer eats the bread. What is the value added by each person? What is GDP?

3. Suppose that a woman marries her butler. After they are married, her husband continues to wait on her as before, and she continues to support him as before (but as a husband rather than as an employee). How does the marriage affect GDP? How should it affect GDP?

4. Place each of the following transactions in one of the four components of expenditure: consumption, investment, government purchases, and net exports.

1. A domestic airline manufacturer sells an airplane to the government.

2. A domestic airline manufacturer sells an airplane to a domestic airline operator.

3. A domestic airline manufacturer sells an airplane to Air France.

4. A domestic airline manufacturer sells an airplane to a Canadian golf professional.

5. A domestic airline manufacturer builds an airplane to be sold next year.

5. Find data on GDP and its components, and compute the percentage of GDP for the following components for 1950, 1970, and 1990.

1. Personal consumption expenditures

2. Gross private domestic investment

3. Government purchases

4. Net exports

5. Federal government purchases

6. Provincial and municipal government purchases

7. Imports

Do you see any stable relationships in the data? Do you see any trends? (Hint: A good place to look for data is the Historical Statistical Supplement of the Canadian Economic Observer—an annual summary publication of Statistics Canada. Alternatively, you can access Statistics Canada over the internet. Follow the suggestions described in the preface to this book.)

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6. Consider an economy that produces and consumes bread and automobiles. In the table below are data for two different years.

 Year 2000 Year 2010 Price of an automobile \$50,000 \$60,000 Price of a loaf of bread \$10 \$20 Number of automobiles produced 100 120 Number of loaves of bread produced 500,000 400,000
1. Using the year 2000 as the base year, compute the following statistics for each year: nominal GDP, real GDP, the implicit price deflator for GDP, and a fixed-weight price index such as the CPI.

2. How much have prices risen between year 2000 and year 2010? Compare the answers given by the Laspeyres and Paasche price indices. Explain the difference.

3. Suppose you are a member of Parliament writing a bill to update the indexing provisions for the Canada Pension Plan. Would you use the GDP deflator or the CPI? Why?

7. Abby consumes only apples. In year 1, red apples cost \$1 each, green apples cost \$2 each, and Abby buys 10 red apples. In year 2, red apples cost \$2, green apples cost \$1, and Abby buys 10 green apples.

1. Compute a consumer price index for apples for each year. Assume that year 1 is the base year in which the consumer basket is fixed. How does your index change from year 1 to year 2?

2. Compute Abby’s nominal spending on apples in each year. How does it change from year 1 to year 2?

3. Using year 1 as the base year, compute Abby’s real spending on apples in each year. How does it change from year 1 to year 2?

4. Defining the implicit price deflator as nominal spending divided by real spending, compute the deflator for each year. How does the deflator change from year 1 to year 2?

5. Suppose that Abby is equally happy eating red or green apples. How much has the true cost of living increased for Abby? Compare this answer to your answers to parts (a) and (d). What does this example tell you about Laspeyres and Paasche price indices?

8. Consider how each of the following events is likely to affect real GDP. Do you think the change in real GDP reflects a similar change in economic well-being?

1. A hurricane in Ontario forces Canada’s Wonderland to shut down for a month.

2. The discovery of a new, easy-to-grow strain of wheat increases farm harvests.

3. Increased hostility between unions and management sparks a rash of strikes.

4. Firms throughout the economy experience falling demand, causing them to lay off workers.

5. The government passes new environmental laws that prohibit firms from using production methods that emit large quantities of pollution.

6. More high-school students drop out of school to take jobs mowing lawns.

7. Fathers around the country reduce their workweeks to spend more time with their children.

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9. In a speech that Senator Robert Kennedy gave when he was running for president of the United States in 1968, he said the following about GDP:

[It] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.

Was Robert Kennedy right? If so, why do we care about GDP?