Department of Economics Spring 2017

University of California, Berkeley Professor Olney

Economics 100B Problem Set #1 Solutions Page 1 of 6

Suggested Solutions for Problem Set #1

1. (3 points; 1/4 point each) ) Based on what you learned in your principles course, and in your own
words, define each of the following terms. (It’s important that this is your own words, not copied or
paraphrased from a source. If you can’t define these terms in your own words, reconsider whether this
is the course for you.)

 gross domestic product: total annual economic output of a nation

 unemployment rate: percent of the labor force unemployed (out of work & looking for work)
 labor: an input to the production process; people’s work effort
 inflation rate: percentage change over time in some average measure of prices
 economic growth: more than one definition floats out there. [1] increases over time in the standard
of living (real GDP per capita); [2] increases in real GDP (even if real GDP per capita declines)
 aggregate demand: total demand for domestically-produced final goods and services by
households, businesses, government agencies, and the rest of the world
 money: anything that is accepted in exchange for goods and services, used as a unit of account,
and which has a store of value. In the U.S. currently, coins, currency, checking balances,
denominated in dollars, are money.
 capital: an input to the production process, machines and buildings
 fiscal policy: changes in G, TA, or TR by the fiscal authorities (in the US, the Congress with the
approval of the President). In some definitions, also add: undertaken with the goal of affecting the
macroeconomy.
 monetary policy: changes in interest rates and the money supply, by the central bank
 government deficit: annual difference between government spending (G + TR) and government
revenues (TA)
 government debt: accumulation over time of the annual deficits minus the annual surpluses. Total
outstanding value of IOU’s issued by the government

2. (2 points total; 1/2 point for each part)

Use Fred Economic Data at https://fred.stlouisfed.org/to answer the questions.

a. On one graph, graph “constant GDP per capita” for the United States, China, Mexico, and three
other countries of your choice. Time period: 1960 on. Vertical axis: linear scale
Department of Economics Spring 2017
University of California, Berkeley Professor Olney
Economics 100B Problem Set #1 Solutions Page 2 of 6
Department of Economics Spring 2017
University of California, Berkeley Professor Olney
Economics 100B Problem Set #1 Solutions Page 3 of 6

b. Discuss your graph by addressing at least these questions. Which country has the highest
standard of living (real GDP per capita)? Have living standards increased over time in all of the
countries you chose? Has the rank order of the countries you chose changed over time?

Your answer will vary because it’s unlikely you chose the same 6 countries.

Except for a brief period in the early 1990s, the US has the highest standard of living, 1960-2015.
Venezuela was second in the 1960s but its economy has stagnated since then, while standard of living
in the US and Japan have increased. The standard of living in the US and Japan are, on average, far
greater than is found in the other four countries: China, Mexico, Venezuela, and India. India remains,
on average, the poorest of these 6 countries.

c. Now change the vertical axis to log scale and reprint the graph. Again, if you don’t have a color
printer, write in labels so it is clear which country corresponds to which line.

d. Discuss this second graph by addressing at least these questions: Which country has the fastest
growth rate of living standards over this period? Are any countries stagnant? Declining? Which?

The rate of growth is the slope of the ln(constant GDP per capita) compared with time. China has the
fastest rate of growth (steepest line) over this 55 year period. The economy of Venezuela has been, at
best, stagnant and occasionally in decline. Compared with India & China, the US and Japanese and
Mexican economies have shown relatively slow growth on average since the 1990s.

3. Crank through the calculus!

a. Use the rules of natural logs and calculus to show that the rate of growth over time of a product of
two variables, ab, is the sum of the rates of growth of the variables a and b..
Department of Economics Spring 2017
University of California, Berkeley Professor Olney
Economics 100B Problem Set #1 Solutions Page 4 of 6

b. Use the rules of natural logs and calculus to show that the rate of growth over time of a quotient of
two variables, a/b, is the difference between the rates of growth of the variables a and b.

c. Use the rules of natural logs and calculus to show that the rate of growth over time of a variable b
raised to a constant power, ba, is the constant a times the rate of growth of the variable b.
Department of Economics Spring 2017
University of California, Berkeley Professor Olney
Economics 100B Problem Set #1 Solutions Page 5 of 6

4. Cobb-Douglas production function.

Assume the production function is Cobb-Douglas.

Assuming the production function is Cobb-Douglas means to assume that we have a

multiplicative function, with each factor of production raised to a power. The sum of the
powers must equal 1, which is what gives a Cobb-Douglas production function the property
of constant returns to scale.

For part a, use the formula . For part b, use the formula

a. What is the value of output per worker when K = 1,000,000; L = 500; E = 100; and α =
0.25?

a. Y/L = = (2,000)0.251000.75 = 211.5

b. What is the value of output per worker when the capital intensity is 4, labor efficiency is
1,000, and α = 1/3?

b. Y/L = = 2(1,000) = 2,000

c. Excel graph (first version of PS solutions had an error in calculations here; this is corrected graph
as of 2/3/2017)
Department of Economics Spring 2017
University of California, Berkeley Professor Olney
Economics 100B Problem Set #1 Solutions Page 6 of 6

5.

For each activity listed below, indicate where the activity would be recorded on the
expenditure side of U.S. GDP accounting. Your choices are C, I, G, GX (exports), IM
(Imports), and NR (not recorded). Give a brief explanation for each answer; one sentence
should suffice.

a. A family from Sweden, visiting Berkeley, buys jewelry from a vendor on Telegraph
Avenue.
EX. Export of a good (jewelry) that was produced domestically (in Berkeley) and purchased
by someone who is not a resident of the United States (a Swede). Where the purchase takes
place is irrelevant.

b. A California-resident Cal student purchases a new textbook that was published in

Singapore.
C and IM. Purchase of a good (a book) by a U.S. resident, thus C. But the item was
produced abroad, so also IM. It is recorded in both places. The addition to US GDP is any
difference between C & IM, which would be the value added domestically. If the book was
purchased in Singapore, the $ value nets out to zero, but because the sources of information
for C and IM are different, the transaction gets recorded in both places.

c. Bancroft Clothing buys Cal sweatshirts that were manufactured in Vietnam. The
sweatshirts do not sell.
I and IM. When Bancroft Clothing buys the sweatshirt, it’s an intermediate good. Normally
we don’t record intermediate goods but in this case we do because the good didn’t sell in
the current period. It was instead added to the inventory of Bancroft Clothing, which is
recorded in I (investment). The sweatshirt was manufactured in Vietnam, so it is also
recorded in IM. So far, there is no value added in the US.

f. The local school district pays its teachers their monthly salaries.
G. People don’t pay to go to public K-12 school, so there is no “purchase” of public
education. Instead we record the value of the government-paid inputs to the production of
education. Salaries paid teachers in public schools are recorded in G.