Macroeconomics

1. MM Company had developed a project that created 700 new jobs in Mexico. In 2019, the project's sales were $90 million and its intermediate input purchases were $50 million.

(a)Assume that the intermediate input purchases were made entirely outside Mexico. How much did the project contribute to the GDP of Mexican economy in 2019 under this assumption?

(b)Now, consider an alternative scenario. Assume that MM Company made the intermediate input purchases inside Mexico from another Mexico-based company named INT Inc. In turn, INT, Inc. bought $30 million worth of inputs for its $50 million sale to MM Company from outside the country and produced all the value added itself in Mexico. Also, assume that INT, Inc. had excess capacity to meet the demand of MM Company without turning away any other customer. How much did the MM Company project contribute to the GDP of Mexican economy in 2019 under these alternative assumptions?

Counting the cost of living

The Fed and the White House wrestle with price indices

United StatesMay 11th 2013edition

May 11th 2013 WASHINGTON, DC

IN RECENT years inflation has been one of the few economic indices that has not caused much trouble to Americans. Contrary to repeated warnings, it has neither rocketed higher nor turned into deflation. But policymakers now face a different sort of inflation problem: determining which of many competing indices is giving the best picture of prices in America.The most popular measure, the consumer price index (CPI), is a representative basket of goods and services drawn from a survey of the spending habits of 12,200 households. The index assumes that consumers buy the same quantity of each commodity from one period to the next until the basket is updated, every two years. The change in the cost of that basket is the inflation rate. But this almost certainly overstates the cost of living, because consumers continually adjust their spending patterns to buy more of what is cheap and less of what is dear.

America's statisticians have known about this substitution bias since at least 1961, when a commission urged the development of a better index. In 1996 the Bureau of Economic Analysis (BEA) adopted "chain-weighted" indicesones that are continuously updated to reflect changing spending patternsto calculate real GDP. And in 2002 the Bureau of Labour Statistics (BLS) began calculating a chain-weighted version of the CPI.

Inflation has run about a quarter of a percentage point lower using the chained CPI, and about a third of a point lower using another measure, the BEA's price index of personal consumption expenditure (PCE). This matters to almost no one except the Federal Reserve, which bases its forecasts and decisions on PCE inflation. Even for the Fed the distinction seldom matters, so long as the two inflation measures behave similarly. Lately, though, they have not: stripping out the volatile food and energy categories, underlying PCE inflation dived to 1.1% in March, while core CPI inflation has stabilised around 1.9% (see chart).If inflation really were falling so fast, alarms would be ringing at the Fed, since deflation may not be far behind. But that seems unlikely. Apart from being chain-weighted, the PCE includes some things the CPI omits, such as the share of medical expenses borne by employers and governments and supposedly "free" services such as no-fee bank accounts. Slower-rising medical and financial-service costs explain most of the recent drop in PCE inflation. Neither effect seems to reflect broader economic trends and, once they fade, PCE inflation should rebound.

Confusion over the right inflation index has spread from monetary to fiscal policy. In April Barack Obama's budget proposed using the chained CPI to index Social Security and federal military and civil-service retirement benefits, tax brackets and tax breaks. But Mr Obama is less interested in economic fidelity than in making a political point: by curbing Social Security benefits, a Democratic sacred cow, he hoped to entice Republicans into agreeing to raise taxes as part of a deficit deal. And almost half the $230 billion raised by the proposal over the next decade would come through increased revenue by pushing taxpayers into higher tax brackets and reducing the value of their tax breaks more quickly.

Yet Mr Obama would stick with the original CPI for a host of other programmes, such as Medicaid and college grantsand for estimating the poverty level. So, under his proposal, the federal government would endorse two different inflation rates, just to lock in a higher rate of funding for favoured programmes.

Mr Obama has long said Americans should pay more tax to finance a more generous safety net. Whatever the merits of that goal, cherry-picking inflation rates is a dubious way to achieve it.

2. This question is based on the article, "Counting the cost of living," published by The Economist on May 11, 2013. The article compares the PCE and CPI measures of the price of level and discusses the reasons for their differential trends in early 2010s.

(a)According to the article, what is the main difference between PCE and CPI measures and why was PCE growing slower than CPI in early 2010s?

(b)According to the article, "in 2002 the Bureau of Labour Statistics (BLS) began calculating a chain-weighted version of the CPI." What was the problem the non-chained version of CPI that prompted this change?

(c)According to the article, in April 2013, President Obama proposed using the chained CPI instead of the traditional CPI for indexing Social Security and federal military and civil-service retirement benefits, tax brackets and tax breaks. How could such a proposal help reduce the government's budget deficit?

3. When calculating the consumer price index for Argentina in the late 2000s, the country's government tended to lower the consumption-basket weights of products that experienced large price increases. The government claimed that this was done based on economic theory and empirical consideration, but it did not offer any documentation of the empirical research results that guided the weight adjustments. Critics of the government claimed that the weight adjustments were politically motivated and were aimed to make inflation look much lower than its true rate.

What sort of economic theory and empirical consideration may have justified the weight adjustments? Could the critics be right that the government was mis-using economic theory? How could the weight reductions reduce the measured inflation rates?