14.02 Principles of Macroeconomics
Problem Set 1: Spring 1998

This problem set is due on Friday, February 13, 1998, in your recitation. Please make sure to put your TA name and section time on your work.

a) Recently, inflation in the US has been below its historical average, while in Europe and Japan it's been above their respective historical averages.
b) The Japanese trade surplus has grown larger every year since 1980
c) The European Union is a smaller economy than the US economy.

2. In 1994, output in the European Union increased and, yet the unemployment rate rose. Since more ouput ordinarily requires more workers, how can this be?

3. Would the following transactions be counted as part of GDP? (Explain)
a) A seafood restaurant buys \$1000 worth of fish
b) You pay \$250 to have your computer repaired
c) You make \$8.00 in an MIT experiment and \$20 shovelling snow for your neighbor
d) A supermarket pays \$2000 for computer maintenance to its computer provider

4. Imagine an economy with only two production activities: farming and bakeries. Calculate GDP in three different ways.
a) Farmers sell \$200.000 worth of wheat to the bakeries. Farmers pay their workers \$100.000 (only labor is used in production, seeds are free).
b) Consumers buy \$500.000 worth of bread. Bakers pay their workers \$200.000

5. How does the GDP deflator differ from the CPI?

6. Do you think a CPI for professors would lead to higher or lower inflation than a CPI for students? (Hint: what factors should you consider?)

7. Consider a small economy produces three goods: car, pentium, and orange. Production and prices in 1996 and 1997 are as follows:

Goods 1996 Quantity 1996 Price 1997 Quantity 1997 Price
Car(units) 300 \$10,000 350 \$12,000
Pentium (units) 500 \$3,000 600 \$1,500
Orange (lbs.) 800 \$2 600 \$3

Fill in the following table based on the information above. Please show your work as well.

Year 1996 1997
Nominal GDP

Real GDP (1996 price)

Real GDP (1997 price)

GDP Deflator (1996 price)

GDP Deflator (1997 price)

How does GDP growth rate change when the base year changes? How about inflation? Does this make sense?

8. What characteristics of a medical checkup would you consider to construct a hedonic price index? How would hedonic pricing affect your estimate of the change in price in medical checkups in the last decade?