Problem Set 1

Antnio de Pinho, nr 14123

Francisco Lbano, nr 13984
Mariana Figueiredo, nr 14104
Pedro Sousa, nr 13992
Exercise 1

Portugal
Year GDP per capita Real GDP Unemployment Debt (Total,
(base 2010, USD) Growth YoY Rate % of GDP)
2015 21 960,47 1,45% 12,44% 149,65
2014 21 537,46 0,91% 13,90% 151,69
2013 21 229,35 -1,13% 16,18% 141,38
2012 21 354,50 -4,03% 15,53% 137,10
2011 22 160,79 -1,83% 12,68% 107,85
2010 22 540,00 1,90% 10,77% 104,07

United Kingdom
Year GDP per capita Real GDP Unemployment Debt (Total,
(USD, base 2010) Growth YoY Rate % of GDP)
2015 41 187,68 2,22% 5,30% 112,62
2014 40 620,02 3,07% 6,11% 113,30
2013 39 707,96 1,91% 7,53% 102,82
2012 39 225,08 1,31% 7,89% 107,01
2011 38 986,87 1,51% 8,04% 103,29
2010 38 708,68 1,92% 7,79% 89,11

Real GDP Growth YoY

4,000%
3,000%
2,000%
1,000%
0,000%
10 11 12 13 14 15
-1,000%
-2,000%
-3,000%
-4,000%
-5,000%

Real GDP YoY Growth PT Real GDP YoY Growth UK

Real GDP YoY Growth EU average

1
In the United Kingdom, in 2015, GDP per capita measured at constant US dollars was 188% of its
Portuguese counterpart, while debt to GDP was 37 pp lower in the UK compared to Portugal. In both cases,
debt to GDP increased from 2009 to 2015, although it increased 50% more in Portugal.

Real GDP YoY growth was higher in the UK during the whole data range. 2012 corresponds to a trough in
GDP growth in both countries, as well as in the EU average. This suggests macroeconomic conditions in
the EU area were then particularly adverse. 2012 also corresponds to the maximum spread between
Portuguese and UK GDP growth, indicating that Portugals productive capacity was the one more severely
affected by those negative conditions.

In 2009, unemployment in the UK was only 2 percentual points below that of Portugal. This difference has
increased over time, due to a surge in Portuguese unemployment in 2012, and stands today at 7 pp.

Sources:
World Bank national accounts data (2017), GDP constant at 2010 USD, (Accessed on 26 February 2017)
OECD (2017), Unemployment rate (indicator), doi: 10,1787/997c8750-en (Accessed on 26 February 2017)
OECD (2017), General government debt (indicator), doi: 10,1787/a0528cc2-en (Accessed on 26 February
2017)

2
Exercise 2

a)
i) Production-based GDP contribution

= +

contribution = (20 000 1 200) + (6 000 0,06) 0 =

GVA stands for the gross value added by the firm. In this case, sales minus the cost of intermediate
goods.

Ti stands for indirect taxes. In this case, the VAT of the products sold in Portugal (30% of total
production).

Zf stands for subsidies received by the company, which in this case are none.

Spending-based GDP contribution

= + + + ( )

contribution = 6 360 + 0 + (200) + (14 000 1 000) =

C stands for private consumption spending in Portugal. In this case, 30% of the companys total
production ( 6 000) plus VAT at 6%.

G stands for government consumption spending, which in this case is null.

IG stands for gross investment. In this case, it is negative due to a fall in inventories. Such fall
corresponds to the raw materials that the company is bought domestically. We disregard VAT over
this purchase because the buyer (the firm under analysis) is able to deduct it.

(X-IM) stands for the trade balance. In this case, the company exports 70% of its total production,
and imports 1 000 in raw materials.

3
 Income-based GDP contribution

= +
= + +
= + + + + +

contribution = 12 375 + 0 + 0 + 6 425 + 0 + 360 0 =

W stands for wages including direct taxes. In this case, 10 000 plus social security contribution.

R stands for rent paid. In this case, none.

J stands for interest paid. In this case, none.

stands for profits, either distributed or not. The company operated with a profit of 6 425,
corresponding to sales raw materials costs - (wages + SS contribution of the firm).

CFC stands for the consumption of fixed capital, or depreciation, which we disregard.

Ti Zf is the factor cost adjustment, necessary to derive GDP at market prices from base prices. In
this case, Ti is 360 (VAT of the output sold in Portugal) and Zf is 0.

Conclusion: by using the three methods to calculate Gross Domestic Product at market prices, we
conclude that the contribution of this company to the Portuguese GDPmp is of 19 160.

ii) Contribution to GNP at market prices

= + = +

contribution = 18 800

contribution = 18 800 + (5 000 6425) =

NRFI stands for net receipts of factor income from the ROW (receipts from ROW - payments to
ROW). In this case, the company receives a rent payment from France ( 5 000) and pays dividends
to French residents in the value of the profits ( 6 425).

We assume that only profits - remuneration for the use of capital - are distributed as dividends.
Consequently, the rent - remuneration for the use of land, and not capital - isnt included in the
profits of the company, and isnt distributed to the shareholders.

Conclusion: this companys contribution to the Gross National Income at base prices is of 17 375.

4
 iii) Contribution to the budget balance

= + + ( + + + + )

contribution = 0 + 360 + (1 100 + 2 375) (0 + 0 + 0 + 0 + 0) =

Td stands for direct taxes paid by firms and households, which in this case are none.

Ti stands for indirect taxes paid by firms and households. In this case, the VAT of the goods sold
domestically.

SS stands for social security contributions. It corresponds to 11% of wages (paid by the employee)
plus 23,75% paid by the firm.

G corresponds to government consumption spending. Trfgov stands for transfers from the
government to households - welfare and unemployment benefits -, IPD stands for interest in public
debt, Zf stands for subsidies and Igov for government investment. In this case, all of these variables
are zero.

Conclusion: the contribution of the company to the budget balance is of 3 835.

b) Contribution to French GNPbp

= + = +

contribution = W + GOS = 5 000

contribution = contribution + 6 425 5 000 =

The company contributes to the GDPbp of France in the value of the rent ( 5 000). Following the
income-based approach, one can see that this value will correspond to a rent paid by a French-based
firm, included in the gross operating surplus.

In this case, French entities will pay the rent to the Portuguese firm ( 5 000). From the viewpoint of
France, this constitutes a payment to the ROW.

French agents will receive dividends in the value of companys profits ( 6 425), which constitutes a
receipt from the ROW.

Conclusion: the contribution of this company to the French Gross National Product at base prices is of
6 425.

5
c) If the company were to retain its profits, there would no longer be an outflow (payment to ROW) in the
computation of the Portuguese GNP related to the dividends paid to shareholders of French residence.

Similarly, the inflow (receipts from ROW) related to dividends in the computation of the contribution
to the French GNP would disapear.

Note that by profits we again consider the remuneration for the use of capital.

Consequently, the contribution of the firm to Portuguese GNP at base prices would be:

= +

=5 000

contribution = 18 800 + 5 000 =

This corresponds to an increase of 6 425 compared to the situation where profits are distributed.

The contribution of the firm to French GNP at base prices would be:

= 5 000

contribution = 5 000 5 000 =

This corresponds to a decrease of 6 425 compared to the situation where profits are distributed.

Conclusions: the contribution to Portuguese GNPbp increases by the amount of the profits ( 6 425),
while the contribution to French GNPbp decreases by the same value.

All other accounts remain constant, because they do not depend on the NRFI, in which the distribution
of dividends to France is included.

Note that we assume the consequences of the investment made by the company arent immediate. Thus
we only account for the retention of the profits by the firm, and disregard future implications of the
investment.

6
Exercise 3

1
a) [Growth in prices from 1 to ] = 1
, where is the implicit deflator of year t with
respect to some base year b.

To prove this statement, let denote the GDP of year a measured at the price level of year b. It
is axiomatic that = 1
1
(1 + nominal change) = 1 (1 + price change). Then,

1
1 1
(1 + nominal change)1 1
100 1 100 1
1 (1 + real change)1
1
= = =
1 1
1 1
1
100
1 1

1
1 1 + nominal change
1 ( 1 + real change 1)
1 + nominal change

= 1 = 1 = 1 + price change 1 =
1 1 + real change
1

= price change

Thus, using the previous formula,

2014 2013
2014 2014 100 101,1
Growth in prices from 2013 to 2014 = 2013 = 0,0109 = 1,09%
2014 101,1

2015 2014
2014 2014 100,6 100
Growth in prices from 2014 to 2015 = 2014 = = 0,0060 = 0,60%
2014 100

2016 2015
2014 2014 102,1 100,6
Growth in prices from 2015 to 2016 = 2015 = 0,0149 = 1,49%
2014 100,6

7
b) Let denote the GDP of year a at the price level of year b. Again,

= 1
1
(1 + nominal change) = 1 (1 + price change)

That is, to obtain the GDP of year t at current prices, one multiplies the GDP of year t at constant
t-1 prices by one plus the price change between years t-1 and t. Using this method,
2014 2014
2014 = 2013 (1 0,0109) = 320.000 (0,9891) = 316.512 m

2015 2015
2015 = 2014 (1 + 0,0060) = 350.000 (1,0060) = 352.100 m

2016 2016
2016 = 2015 (1 + 0,0149) = 360.000 (1,0149) = 365.364 m

c)
i. Mathematical reasoning

Let n = nominal growth rate, r = real growth rate and p = growth in the price level. Then,

1+ 1+
1 + = (1 + )(1 + ) 1 + = = 1
1+ 1+

Since, according to forecasts, the nominal growth rate is expected to exceed the real growth rate,

> 1 1+ 1+
> 1 + > 1 + >1 1 > 0 > 0 1 + > 1
1+ 1+

Thus, one can conclude that growth in prices is expected to be positive - prices will increase,
meaning there is inflation (at least as measured by the deflator - as this change in prices is measured
with respect to the overall output of the economy, not just consumer goods).

Note that one assumes the real growth rate to be greater than -1. This is a reasonable assumption,
even when taken outside the context of the question at hand, since a real growth rate of -1 would
imply a complete shutdown of the production sector of the economy. Furthermore, in case that were
to happen, the concept of a price level for domestic production would loose its meaning.

ii. Economic intuition

In a more intuitive approach, one can look at the fact that real growth only takes into consideration
changes in the quantity produced from year to year, while nominal growth measures changes in
quantity as well as in the price of the items produced.

If the economy experiences positive real growth, it is certain that there has been growth in the
quantity of output produced. Positive nominal growth, however, can be the result of an increase in
either the quantity of output or in the price level of the economy (or both).

Consequently, if nominal growth is greater than real growth, the price level must have also risen -
that is, there is inflation (the growth rate in prices is positive).

8
9