Assignment No 2

ASSIGNMENT NO 2
NAME: NOOR US SUBHA
PROGRAM: BBA(HONS)
STD ID: 20191-26628
SUBMITTED TO : SIR AJAZ RASHEED
REVIEW QUESTIONS
QUESTION NO 6: DEFINE PRIVATE SAVING.HOW IS PRIVATE SAVING USED IN
THE ECONOMY? WHAT IS THE RELATIONHIP BETWEEN PRIVATE SAVING
AND NATIONAL SAVING?
Private saving is private disposable income minus consumption. Saving of the private sector is known as
private saving.
S(pvt)= (Y+INT+NFP-T+TR) -C
Private disposable income is total output minus taxes paid plus transfers and interest received from the
government.
Private saving is used to finance investment spending, the government budget deficit, and the current
account.
National saving is private saving plus government saving.It is the saving of economy as a whole.
S= S(PVT) + S(GOVT)
=(Y+INT-T+TR+C+NFP)+(T-TR-INT-G)
=Y+NFP-C-G
QUESTION NO 9 : DESCRIBE HOW THE CPI AND CPI INFLATION IS

CALCULATED.WHAT ARE SOME REASONS THAT CPI INFLATION MAY
OVERSTATE THE TRUE INCREASE IN COST OF LIVING?
The consumer price index is a price index that measures the prices of consumer goods .CPI is the price
index that is a ratio between value of fixed set of goods and services at current year by the value of
fixed set of goods and services at base year .CPI inflation is the growth rate of the CPI. CPI inflation
overstates true inflation because it is difficult to measure changes in quality. Another reason is that the
price index doesn’t account for substitution away from goods that become relatively more expensive
towards goods that become relatively cheaper.
NUMERICAL PROBLEMS
3. ABC Computer Company has a $20,000,000 factory

in Silicon Valley. During the current year ABC builds
$2,000,000 worth of computer components. ABC’s costs
are labor, $1,000,000; interest on debt, $100,000; and
taxes, $200,000.
ABC sells all its output to XYZ Supercomputer.
Using ABC’s components, XYZ builds four supercomputers at a cost of $800,000
each ($500,000 worth of components, $200,000 in labor costs, and $100,000 in
taxes
per computer). XYZ has a $30,000,000 factory.
XYZ sells three of the supercomputers for
$1,000,000 each . At year’s end, it had not sold the
fourth. The unsold computer is carried on XYZ’s books
as an $800,000 increase in inventory.
a. Calculate the contributions to GDP of these transactions, showing that all three
approaches give the
same answer.
a) ABC produces output valued at $2 million and has total expenses of $1.3 million ($1 million for
labor, $0.1 million interest, $0.2 million taxes). So its profits are $0.7 million. XYZ produces
output valued at $3.8 million ($3 million for the three computers that were sold, plus $0.8
million for the unsold computer in inventory) and has expenses of $3.2 million ($2 million for
components, $0.8 million for labor, and $0.4 million for taxes). So its profits are $0.6 million.
According to the product approach, the GDP contributions of these companies are $3.8
million, the value of the final product of XYZ. ABC’s production is of an intermediate good, used
completely by XYZ, and so is not counted in GDP. According to the expenditure approach, the
GDP contribution is also $3.8 million, with $3 million (of sold computers) adding to the capital
stock (as investment spending), and $0.8According to the expenditure approach, the GDP
contribution is also $3.8 million, with $3 million (of sold computers) adding to the capital stock
(as investment spending), and $0.8 million (the unsold computer) as inventory investment.
b) The income approach yields the same GDP total contribution.
The amounts are:
TOTAL
Labor $1.0 million + $0.8 million= $1.8 million
Profit $0.7 million+ $0.6 million = $1.3 million
Taxes: $0.2 million + $0.4 million= $0.6 million
Interest: $0.1 million + $0.0 million= $0.1 million
Total of all incomes = $3.8 million
b. Repeat part (a), but now assume that, in addition

to its other costs, ABC paid $500,000 for imported
computer chips.
(b) If ABC pays an additional $.5 million for computer chips from abroad. The correct answer is easiest
to see using the expenditure approach. As in part a, there is $3.8 million spent on final goods, but now
there are also net exports of −$0.5 million. So the total expenditure on domestically produced goods is
only $3.3 million. The product approach gets the same answer because the $0.5 million is a contribution
to GDP of the country in which the chips were made, and so must be deducted from the GDP of the
United States. The value added in the United States is only $3.3 million. The income approach gives the
same answer as in part a, except that the cost of importing the chips reduces ABC’s profits by $0.5
million, so the sum of the incomes is only $3.3 million.
5. You are given the following information about an

economy:
Gross private domestic investment = 40
Government purchases of goods and services = 30
Gross national product (GNP) = 200
Current account balance = -20
Taxes = 60
Government transfer payments to the domestic private
sector = 25
Interest payments from the government to the domestic
private sector = 15 (Assume all interest payments by
the government go to domestic households.)
Factor income received from rest of world = 7
Factor payments made to rest of world = 9
Find the following, assuming that government investment is zero:
a. Consumption
Consumption = 150
b. Net exports
NX =CA – NFP
= −20 − (−2)
= −18
c. GDP
GDP = GNP − NFP, GDP = 200 − (−2)
= 202
d. Net factor payments from abroad

NFP =7 − 9 = −2
e. Private saving
S(pvt) = (Y + NFP − T + TR + INT) – C
=[ 202 + (−2) − 60 + 25 + 15] −150
= 30
f. Government saving
S(govt) = (T − TR − INT) − G
= (60 − 25 − 15) – 30
= −10
g. National saving
S = Spvt + Sgovt
= 30 + (−10)
= 20.
6. Consider an economy that produces only three types

of fruit: apples, oranges, and bananas.
APPLES 3000 × $3 = $ 9,000

BANANAS 6000 × $2 = $12,000
Oranges 8000 × $5 = $40,000
Total $61,000
At base year prices

APPLES 3000 x $2= 6000
BANANAS 6000x $3=18000
ORANGES 8000x $4=32000
Total $56000
Current-Year Quantities at Current-Year Prices

APPLES 4,000 ×$3= 12000
BANANAS 14,000 × $2 = $ 28,000
ORANGES 32,000 × $5 = $160,000
Total $200,000
At Base-Year Prices
APPLES 4,000× $2 = $ 8,000
BANANAS 14,000 × $3 = $ 42,000
ORANGES 32,000 × $4 = $128
a. Find nominal GDP in the current year and in the

base year. What is the percentage increase since
the base year?
(a) Nominal GDP is $56 thousand in the base year and $200 thousand in the current year. Nominal
GDP between the base year and the current year:
[($200,000/$56,000) − 1] × 100%
= 257%.
b. Find real GDP in the current year and in the base

year. By what percentage does real GDP increase
from the base year to the current year?
(b) Real GDP is calculated by finding the value of production in each year at base-year prices. Thus, real
GDP is $56,000 in the base year and $178,000 in the current year. In percentage terms, real GDP
increases from the base year to the current year by
[($178,000/$56,000) − 1] × 100%
= 218%
c. Find the GDP deflator for the current year and the
base year. By what percentage does the price level
change from the base year to the current year?
(c) The GDP deflator is the ratio of nominal GDP to real GDP. In the base year, nominal GDP equals real
GDP, so the GDP deflator is 1. The GDP deflator in current year is $200,000/$178,000 = 1.124. Thus the
GDP deflator changes by
[(1.124/1) − 1] × 100%
= 12.4%
d. Would you say that the percentage increase in

nominal GDP in this economy since the base year
is due more to increases in prices or increases in
the physical volume of output?
(d) Nominal GDP rose 257%
Prices rose 12.4%
Real GDP rose 218%
Most of the increase in nominal GDP is because of the increase in real output, not prices
8. Hy Marks buys a one-year government bond on

January 1, 2012, for $500. He receives principal plus
interest totaling $545 on January 1, 2013. Suppose that
the CPI is 200 on January 1, 2012, and 214 on January
1, 2013. This increase in prices is more than Hy had
anticipated; his guess was that the CPI would be 210 at
the beginning of 2013. Find the nominal interest rate,
the inflation rate, the real interest rate, Hy’s expected
inflation rate, and Hy’s expected real interest rate
The nominal interest rate is
[(545/500) − 1] × 100%
= 9%
The inflation rate is
= [(214/200) − 1] × 100%
= 7%
Real interest rate is nominal rate minus inflation rate
=9% − 7%
=2%
Expected inflation was
= [(210/200) − 1] ×100%
= 5%
Expected real interest rate is nominal rate minus expected inflation rate
9% - 4%
=5%
ANALYTICAL PROBLEM
QUESTION NO 3: Economists have tried to measure the GDPs of virtually all the
world’s nations. This problem asks you
to think about some practical issues that arise in that
effort.
a. Before the fall of communism, the economies of
the Soviet Union and Eastern Europe were centrally planned. One aspect of central
planning
is that most prices are set by the government.
A government-set price may be too low, in that
people want to buy more of the good at the fixed
price than there are supplies available; or the price
may be too high, so that large stocks of the good
sit unsold on store shelves.
What problem does government control of
prices create for economists attempting to measure a
country’s GDP? Suggest a strategy for dealing with
this problem.
(a) One major problem in a planned economy is that the prices do no measure the market value.
When the price of an goods or commodity is too low, then goods are really more expensive than
their listed price suggests. Because the item’s value exceeds its cost, measured GDP is too low.
When the price of an goods or commodity is too high, goods stocked on the shelves may be
valued too highly. This ends up in an overvaluation of firms’ inventories, so that measured GDP
is too high. A strategy for dealing with this problem is to have GDP analysts estimate what the
market price should be by looking at prices of the same goods in market economies and use his
“shadow” price in the GDP calculations.
b. In very poor, agricultural countries, many people

grow their own food, make their own clothes, and
provide services for one another within a family or village group. Official GDP
estimates for these
countries are often extremely low, perhaps just a
few hundred dollars per person. Some economists
have argued that the official GDP figures underestimate these nations’ actual
GDPs. Why might this
be so?
Again, can you suggest a strategy for dealing with this measurement problem?
GDP figures does not include the products produced in homes as they are not sold on matket
economies, making their value difficult to measure. A possible way to do it might be to look at the
standard of living relative to a market economy, and estimate what income it would take in a market
economy to support that standard of living.

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ASSIGNMENT NO 2

NAME: NOOR US SUBHA

STD ID: 20191-26628

SUBMITTED TO : SIR AJAZ RASHEED

QUESTION NO 9 : DESCRIBE HOW THE CPI AND CPI INFLATION IS

3. ABC Computer Company has a $20,000,000 factory

b. Repeat part (a), but now assume that, in addition

5. You are given the following information about an

d. Net factor payments from abroad

=[ 202 + (−2) − 60 + 25 + 15] −150

6. Consider an economy that produces only three types

APPLES 3000 × $3 = $ 9,000

Oranges 8000 × $5 = $40,000

At base year prices

BANANAS 6000x $3=18000

ORANGES 8000x $4=32000

Current-Year Quantities at Current-Year Prices

BANANAS 14,000 × $2 = $ 28,000

ORANGES 32,000 × $5 = $160,000

BANANAS 14,000 × $3 = $ 42,000

ORANGES 32,000 × $4 = $128

a. Find nominal GDP in the current year and in the

b. Find real GDP in the current year and in the base

d. Would you say that the percentage increase in

(d) Nominal GDP rose 257%

Prices rose 12.4%

Real GDP rose 218%

8. Hy Marks buys a one-year government bond on

The inflation rate is

Real interest rate is nominal rate minus inflation rate

Expected inflation was

b. In very poor, agricultural countries, many people

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