LSE Economics Department

EC210 Macroeconomic Principles 2015/2016

Michaelmas Term

Rachel Ngai
32L.1.15, x7017
l.ngai@lse.ac.uk

Problem Set 1: Measurement

1. Gross domestic product: In year 1 and year 2, two products are produced in a given
economy, bicycles and computers. Suppose that there are no intermediate goods. In
year 1,500 bicycles are produced and sold at $500 each, and in year 2, 420 bicycles
are sold at $600 each. In year 1, 300 computers are sold for $800 each, and in year
2, 355 computers are sold for $850 each.
(a) Calculate nominal GDP in each year.
(b) Calculate real GDP in each year, and the percentage increase in real GDP
from year 1 to year 2 using alternatively the first and second year as the base
year. What is real GDP growth using the chain-weighted method? Prove that
real chain-weighted GDP in year 2 using year 1 as the base year is equal to
491, 470.
(c) Calculate the implicit GDP price deflator and the percentage inflation rate
using year 1 as the base year. Calculate the CPI and the CPI rate of inflation
using the same base year. Can you explain why the CPI inflation is different
from the one computed from the deflator? Is it a systematic feature that you
would expect to find in the data? Explain any differences in your results.

2. Production, expenditure and income approaches to GDP : Consider three firms: firm
A, a mining enterprise; firm B, a steelmaker; firm C, a car maker. Calculate the
GDP of this economy by the product, the expenditure and the income approach,
based on the following assumptions.
All values are in Euros. Firm A has extracted 10 million Euros worth of ore. It
paid its workers 7 million in wages and paid out 3 million as dividends. Firm B
produced steel sheet worth 25 million, having bought and used all the ore produced
by firm A. It paid out 5 million in wages, 3 million as dividends to shareholders,
and retained earnings of 2 million. Firm C has manufactured 75 million worth of
vehicles and sold them all to domestic households, having purchased steel sheets for
20 million from firm B. In addition, Firm C imported engines from abroad for 20
million, and purchased 10 million worth of robots also from abroad. Its wage bill
amounted to 15 million and it paid out all remaining earnings as dividends.

3. (Additional) Purchasing power parity: Considerable research effort, based on detailed price surveys in numerous countries under the auspices of the International
Comparison Program (ICP), has resulted in the publication of the Penn World Table
(PWT) which provides measures of real GDP per capita at constant international
prices for over one hundred countries since 1950. These data are commonly referred
to as purchasing power parity or PPP measures of real income and are used for
international comparison of living standards instead of market exchange rates.
(a) Explain why the use of market exchange rates can be misleading for international income comparison.
(b) The World Bank and the IMF sometimes use the term international dollar.
How do you understand it?