Answers to Analytical Questions

Solutions Manual for Macroeconomics Understanding the Global Economy, 3e David Miles, Andrew Scott, Francis Breedon (All Chapters) 1 / 4

©2012 John Wiley & Sons Ltd.www.wiley.com/college/miles Answers to Analytical Questions Chapter 1 What is Macroeconomics?

• In 2010 Bangladeshi GDP per capita (2005 US$ PPP from World Bank development indicators

rather than the 1990 base data shown in the figure) was 1488. If GDP per capita grows at a rate g for N years then GDP per capita will reach the level Y(N) = 1488(1+g) N . To catch up with the US level of GDP per capita in 2010 (42297) in 10 years we would have 42297/1488=(1+g) 10 .Therefore we can solve for the required growth rate g = (42297/1488) 1/N -1. This gives the following table

10 Years 20 Years 30 years Catch up US 2010 39.8 18.2 11.8 Catch up UK 2010 36.1 16.7 10.8

GDP growth is approximately equal to GDP per capita growth plus population growth. Therefore the faster a countries population growth, the greater the GDP growth is required to achieve a given GDP per capita target.

• In the first scenario there is considerable idiosyncratic risk. For instance, firm A can have output

of either 1 or 5 and so can firm E. However, note that A and E have negatively correlated output – when one is doing well the other is doing badly. Both firms do not do well at the same time.However, while there is substantial idiosyncratic risk there is no aggregate risk. Summing across all firms shows that output is always 15 in both cases. The economy would show no aggregate fluctuations despite the fact that every year firms will be experiencing substantial fluctuations.

In the second scenario there is no idiosyncractic uncertainty but only aggregate uncertainty.Every firm experiences exactly the same fluctuations (e.g. either 3 or 4) and all do well or badly at the same time. As a result the economy fluctuates between good and bad times which are shared across everybody.

In the first case of no aggregate risk it would be straightforward for firms to offer insurance to one another or lend and borrow through a financial system. In the second case with aggregate risk such schemes would not work.

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©2012 John Wiley & Sons Ltd.www.wiley.com/college/miles Answers to Analytical Questions Chapter 2

The Language of Microeconomics: The National Income Accounts

• The inflation rate is the percentage change in overseas prices. The question gives us prices for all

goods in 2004 and 2005 and also output for 2004. We can use the output data for 2004 to weight the various goods to arrive at an average price. Total output in 2004 is 8000 + 3600 +

2400 + 2000 = 16000. This gives us the following weights for each good :

Good Weight

A 8000/16000 = 0.5

B 3600/16000 = 0.225

C 2400/16000 = 0.15

D 2000/16000 = 0.125

Therefore average prices in 2004 are 0.5 x 8 + 0.225 x 9 + 0.15 x 4 + 0.125 x 2 = 6.875. Using the same weights for 2005 gives a price index of 0.5 x 9 + 0.225 x 6 + 0.15 x 8 + 0.125 x 3 = 7.425. To calculate inflation we need the percentage change in prices which is (7.425-6.875)/6.875 = 9.4%.

Would it help if we knew levels of output in 2005? We have constructed an index of prices for 2005 based on 2004 output weights. This could be misleading due to the “substitution” problem discussed in the text. B has fallen in price by a third whilst D has increased in price by a half.Consumers may respond to these price changes by buying more B and less D leading to a change in output weights and a lower estimate of inflation (as B with its price fall would get a higher weight). This is the rationale behind the shift to chain weighting.If we did have output data for 2005 as well as 2004 then we could calculate real and constant price GDP and obtain a measure of the GDP deflator.

2. Using Year 3,4 and 5 prices we have the following calculations :

Year GDP Year 3 Prices Implied Growth GDP Year 4 Prices Implied GDP Growth GDP Year 5 Prices Implied GDP Growth GDP Chain Weights Implied GDP Growth

3 20 26 32 20

4 24 20% 31 19% 38 18.8% 23.92 19.6%

5 34 41.7% 44 41.9% 54 42.1% 33.97 42%

Chain weighting makes only a minor difference to calculated GDP growth rates in this example.Chain weighting produces a “smoother” range of GDP growth numbers. Using Year 5 prices (very high for Garlic) gives rapid growth in Year 5 but less for Year 4. Using Year 3 prices does the opposite.

3. Manufacturers value added is: total sales of 500 less inputs of 200 = 300

Retailers value added is: total sales of 500 less inputs of 450 = 50

Farmers and mining companies value added is: total sales of 350 less no inputs = 350 Total value added is therefore 700.

• Income from overseas assets is worth 0.84% of GDP (7% of 12%). Income paid back overseas is

worth 0.88% of GDP. Thus GNI is slightly smaller than GDP by 0.04% (GNI + GDP + 0.84 – 0.88).

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©2012 John Wiley & Sons Ltd.www.wiley.com/college/miles

• GDP is C+I+G+X-M = A$418+A$158+A$125+A$151-A$156 = A$696

After the changes the figures are: A$459.8 + A$162.7 +A$128.8+X-M = A$730.8

Thus X-M = - A$20.5 so the gap between exports and imports falls (it was -A$5). The increase in Australian output (GDP) is not enough to meet the increase in demand for goods (from consumption, investment and the government) and so the country imports more from overseas.

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