205 EC - Homework 04 Solutions
1. Nominal GDP is the total money value of all final goods and services produced within the boundaries of a country in a given period of time. Nominal GDP is computed by multiplying the output of each final good by its price and then adding up all of these dollar values. Real GDP adjusts nominal GDP to account for changes in prices, thus allowing one to compare GDP from different years in order to examine the changes in production. While potential GDP is the level of GDP the country would achieve if capital and labor were utilized at normal levels. 2. The natural rate of unemployment is the rate of unemployment that would be associated with the economy when it is operating at its potential GDP. 3. Nominal GDP in 2002 = (price of coconuts in 2002)*(output of coconuts in 2002)+(price of coffee in 2002)*(output of coffee in 2002) = 1,400*$75+35,000*$1.55 = $159,250. Nominal GDP in 2003 = (price of coconuts in 2003)*(output of coconuts in 2003)+(price of coffee in 2003)*(output of coffee in 2003) = 1,450*$76+40,000*$1.45 = $168,200. The percentage change in nominal GDP from 2002 to 2003 is (nominal GDP in 2003 - nominal GDP in 2002)/(nominal GDP in 2002)*100 = 5.62%. 4.Real GDP in 2002 = (price of coconuts in 2002)*(output of coconuts in 2002)+(price of coffee in 2002)*(output of coffee in 2002) = 1,400*$75+35,000*$1.55 = $159,250. Using 2002 as the base year real GDP in 2003 = (price of coconuts in 2002)*(output of coconuts in 2003)+(price of coffee in 2002)*(output of coffee in 2003) = 1,450*$75+40,000*$1.55 = $170,750. The percentage change in real GDP from 2002 to 2003 is (real GDP in 2003 - real GDP in 2002)/(real GDP in 2002)*100 = 7.22%. 5. GDP deflator = (nominal GDP / real GDP) * 100 = ($168,200 / $170,750) * 100 = 98.5% 6. The major costs to the economy of inflation are an increase in the of variability relative prices, since not all prices will rise by the same percentage each year. Second, resources may be devoted to mitigating the erosion of purchasing power due to inflation. Third, there is an increase in uncertainty about future real prices since indexing is not always perfect. This will complicate future planning. 7. Year Inflation 1999 ----2000 3.36 2001 2.84 2002 1.58 2003 2.28
8. If the labor supply curve shifts to the right, the real wage falls to restore equilibrium in the labor market. Overall the real wage is lower and employment is higher. With higher employment, the economy produces more output according o its short run aggregate production function. So potential GDP rises. 9. Investment is the purchase of new residential housing, plants, machinery, equipment, inventory, etc. Investment is downward sloping because an increase in the real interest rate means fewer investment projects will be profitable enough to pay the higher interest costs on loans. If businesses expect the economy to expand in the future, they may increase investments in plants, machinery, and ...