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Midterm_I_AK

# Midterm_I_AK - Econ 102 Macroeconomic Theory Midterm 1...

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Econ 102 Macroeconomic Theory Midterm 1 Answers 1. The CPI and the GDP deflator differ from each other in the following ways: (3 points) CPI measures prices of all goods and services bought by consumers only whereas the GDP deflator includes all goods and services in the economy. CPI includes prices of imported goods but the GDP deflator only takes into account goods that are produced domestically. The CPI is computed using a fixed basket of goods i.e fixed weights are assigned to different goods. The GDP deflator on the other hand allows the basket of goods to change over time, and hence, the weights change. CPI tends to overstate inflation as it uses a fixed basket of goods. There are three problems that arise: (3 points) Consumers may substitute towards cheaper goods. The introduction of new goods increases the real value of the dollar, which is not reflected in the CPI. Quality improvements are not captured by the CPI. 2. Year 1 Year 2 Goods Quantity Price Quantity Price Wine 10 1 11 1 Cheese 10 1 8 2 Nominal GDP in Year 1 = 10 * 1 + 10 * 1 = 20 Nominal GDP in Year 2 = 11 * 1 + 8 * 2 = 27 Real GDP in Year 1 = 20 Real GDP in Year 2 = 11 * 1 + 8 * 1 = 19 GDP deflator = Nominal GDP/ Real GDP in Year 1 = 20 / 20 = 1 in Year 2 = 27 / 19 (1 point for each of the above numbers) 3. GDP is a measure of output that is produced domestically. Exports are goods and services that are produced domestically but are sold to other countries.

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