Econ402_Solutions_Set1 - Economics 402, Winter 2008 Problem...

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Economics 402, Winter 2008 Problem Set 1 Suggested Solutions 1 National Accounting in Hobbiton 1. What are the net exports in Hobbiton, what are the net factor payments from abroad? Recall that net exports = exports - imports. Exports here are simply the $30 in potatoes sold to Bree. Imports are the $20 in brew purchased from Bree. Thus, net exports are $10. There are no factor payments in either direction, so net factor payments are $0. 2. National accounting is a piece of magic, and like all things magic it is related to the number three: three ways to the goal. Using these three ways, explain to Sam in detail what Hobbiton’s GDP was in the first year of the Shire reckoning. Keep in mind that the mayor has never heard about this magic, so you will have to be very pedantic! Make sure he does not confuse the three ways. The three methods to calculate GDP are the expenditure approach, the income approach, and the value added approach. Consider each of these in turn. Expenditure approach GDP is the sum of expenditures by households and government, investment by firms, and the value of net exports. That is, Y = C + I + G + NX . Consumption: Patrons to the Green Dragon bought $70 in mashed potatoes and $40 of brew. Households in the Shire bought $50 in potatoes at the farmer’s market. Thus, C = $70 + $40 + $50 = $160. Investment: Farmer Baggins saves $20 in potatoes for the winter. This is inventory invest- ment, so I = $20 Government spending: The government “produced” two policemen worth $20 each: $40 Net exports: In part 1) we calculated that net exports are $10. Thus, Y = C + I + G + NX = $160 + $20 + $40 + $10 = $230. Income approach GDP is the sum of wage income, after-tax profits, interest income, and indirect taxes. Wage income: Rosy gets $20 while the policemen get $40 total. After-tax profits: Farmer Baggins has $150 in sales (including the value of inventory invest- ment) and no costs. The Green Dragon makes $20 in profit from potatoes and $20 in profit from brew. In addition, the Green Dragon pays $20 in labor. So profits from the farmer and the Green Dragon is $150 + $20 + $20 - $20 = $170. Interest income:
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Econ402_Solutions_Set1 - Economics 402, Winter 2008 Problem...

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