GDP is the measure of an economy adopted by the United States in 1991. It is the total market values of goods and services produced by workers and capital within a nation’s borders during a given period (usually 1 year).

  1. Boeing is a US company dealing in aeroplanes building and sales. if the company sells an aeroplane to the United Airline, still a United States company, the GDP would be affected since is the total market values of goods and services produced by workers and capital within a nation’s borders during a given period (usually 1 year). The productivity in this case is within the US border. This transaction would enter into investment as a national income accounting categories.
  2. When Boeing sells aeroplanes to the US Air Force, this transaction is government expenditure and increases the GDP of the country.
  3. A United States Citizen, Donald Trump, Purchase of an aeroplane from Boeing is considered to be consumed as a national income accounting category. Consumption increases the Gross Domestic Product of the US.
  4. US Steel Inc. sale of steel to Boeing is considered an investment kind of transaction.  Investment usually increases a country’s GDP.
  5. When Airbus Europe sells an airplane to American Airlines, this transaction is categorized as imports and decreases the US GDP.
  6. If Boeing builds airplanes to sell next year, the airplanes increases the GDP and the transaction would be within investment kind of transaction.

Answer to Question 2

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In an economy that entirely produces and consumer bathing suits, which are durable goods; Suntan Lotion, nondurable goods; as well as flights Cancun, a service, the GDP of the economy can be calculated as follows.

  1. Nominal GDP = $(30 * 100 + 6 * 200  + 200* 30) = $10,200
  2. Real GDP = $(30 * 100 + 6 * 200  + 200* 30) – $(30 * 100 + 6 * 200  + 200* 30) = $2,100
  3. GDP deflector =  {$(40 * 150 + 7 * 300 + 600 * 0) – $(30 * 100 + 6 * 200  + 200* 30) }/(450-350)= ($8,100- $10,200)/100 = $2,100/100 = $21
  4. CPI = $(30 + 6 + 200) = $236/350 = 0.6742857142857143 = 67.4%

GDP deflector provides a different answer from CPI since GDP deflector gives the value of price change while the CPI provides the Change in percentage. CPI is an index of the cost of all goods and services to a typical consumer.

  1. If increased immigration in the US increases labor force, real wages will freeze while rental prices will increase. Workers would not be happy about the immigration but owners of factories will since they will benefit from the cheaper labor.

 Answer to Question 3

Given the production function: Y = 9K1/3 L2/3, in which level of capital in this economy is 100 while the level of labor in the same economy is 100,

  1. The equilibrium real wage as wells as the real rental rate on capital can be calculated as Y = (9 * 100 1/3) * (100 2/3) = 41.77*21*53 = 982.8481. Equilibrium wage is given as 1001/3 = 4.64 while equilibrium rent is given as 1002/3 = 21.53
  2. The total payments to labor and that to owners of capital can be calculated as 100 1/3) * (100 * 2/3) = 982.8481.
  3. Total payment for labor is 9 * 4.64 = 41.77 while total payment for rent is 21.53 * 1 = 21.53.
  4. The fraction of total production that goes to the payment of labor is given by 41.7/63.3 = 65.99% while 21.53/63.3 = 34.01%.

Answer to Question 4

Given that Y = 4K + 5L ,K=1000 and L= 800, G = 3000 T = 3000, I = 2000 – 6000r C = 600 + 0.6(Y-T)

  1. Equilibrium level of interest rate will be given as


200-6000r = 600 + 0.6 (Y-T)

200-600r =600 +0.6 (4000 + 4000-3000)

=600 + 0.6 * 5000 – 200

-600r = 3400

r = -5.67, thus I = 200 – 3400 = -3200

For the case of investment, it is given as I = 2000 since it is not affected by interest rates or taxes. Equilibrium Consumption is given as C = 600 + 0.6(4000 + 4000 – 3000) = 3600.

Y = 3600 + 2000 + 3000

= 8600

  1. I the level of T is lowered by 10 percent, Y would be equal to Y = C + 2000 + 3000. But the value of C is given by

C= 600 + 0.6(4000 + 4000 – 2700) = 3780. Therefore, the value of Y would increase to 8780. The economic output would increase by 180.

Now the new equilibrium values for investment and consumption would be:

C = 3780, as calculated, Now, C= I = 3780 = 200 – 600r; then -600r = 3580

R = -5.97

Thus, equilibrium I = 200 – 3580 = -3380. Investment will be crowded out by 180 due to the tax cut.

  1. The intuition for the reason why the interest rate has a negative sign as far as investment is concerned is that the two have a negative relationship. When the rate of interest is high, investment becomes expensive and thus it falls. When the rate of interest is low, the rate of investment increases. The two therefore have a negative relationship. Consumption is affected by interest rate in the case whereby the rate of interest increased to lower the level of investment. Low investment lowers productivity and the level of income among consumers. This lowers the aggregate demand and consequently the rate of consumption. The vice versa would be true when the level of interest is lowered. Given this situation, tax cut would crowd out consumption by more amount than investment since investors feel the effect first and reduce production lowering the level of production and consumption.
  2. The above guess can be tested as follows:

C = 600 + .6(Y-T) – 3000r,

= 3600 -3000r

=3600- 3000(-5.97)

= 21,510


Now the, the equilibrium value of investment before the tax was 3400, and 3380 after the tax cut.

From C = 21,510, then C = I,

21,510 = 200 – 600r,

r= -21310/600


Thus, r has increased implying that investment would be decreased.

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