11 Sep ECON 230 Introduction to Macro Economics

1. Calculate the GDP of this simple economy:

Consumer purchases = $230

Investment = $80

Government purchases = $35

Exports = $60

Imports = $90

2. Government purchases do not include all government activity. In the U.S. most of government spending is on transfer payments Social Security, Medicare and Medicaid comprise close to $3 Trillion of a $4 Trillion federal budget, they are the first third and fourth largest programs, military is number 2). These three programs did not exist in 1933 and two of them did not exist until 1965 so they had to grow quite a bit to get this big so quickly). Let’s see how much, complete the following table:

Year

Total Transfers

Total Federal Budget

Transfer as Percent of Spending

1950

$13.6 billion

$42.5 billion

2007

$1,551.0 billion

$2,800.0 billion

Growth Rate (%)

3. The Island of Sark is a small island in the English Channel, it has been continuously populated since 1565 (and populated off and on from before the birth of Christ). In 1565 Queen Elizabeth I granted Helier de Carteret Sark in perpetuity on condition that he kept the island free of pirates and occupied by at least forty men who were English subjects and swore allegiance to the Crown. This he duly did, leasing 40 parcels of land (known as “Tenements”) at a low rent to forty families, on condition that a house was built and maintained on each parcel and that “the Tenant” provided one man, armed with a musket, for the defense of the island. The 40 tenements survive to this day but the population has never been more than 1,000 and currently stands around 490. It has an interesting history during World War II. Until 2008 the Sark economy was based on the feudal system but is now more democratic and very dependent on tourism. It is currently in the middle of an effort to double its population. Its GDP is approximately £3,200 million (broken down as follows Consumption = £2,240; Investment = £480; Government = £320; Exports = £300 and Imports = £140.

Let’s explore some possible outcomes from this population increase campaign for calculation purposes we will ignore the million part of the GDP.

a. If successful and the population doubles the GDP will increase from £3,200. Let’s assume round 250 houses will have to be built which will cost £2,500. What will GDP be if they all come in one year?

b. What will GDP be the following year?

c. The new population increases production and increases demand for goods and services so trade with surrounding islands (Jersey and Guernsey) increases. So imports of food and horses increase (cars are outlawed on Sark) by £340 and exports increase by £210. What is the new GDP?

d. A few years later a freak storm blows through and damages 10 new houses that were built in less sheltered places and are repaired costing £10,500. What is the new GDP?

4. During The Great Leap Forward, millions of Chinese starved to death because farmers who were moved to the communal farms did not produce enough food. These were the same farmers on mostly the same land so why did food production decrease?

5. There are two ways restaurants can handle tips; each server keeps what s/he earns or pool the tips to be divided equally at the end of the night. And there are two ways servers can treat customers; attentive or neglectful. Attentive behavior has a higher cost in extra trip to the tables and engaging with the customers more.

a. If tips are pooled what incentives are there for the servers to be nice? What behavior would you expect from servers?

b. Which approach would the customers probably prefer?

BONUS QUESTION (5 Points)

Institutions are vital to growth. Offer and explanation as to why good institutions (strong property right, cultural trust, markets, low corruption government) are not more universal.