{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Problem_Set_1-Econ_202

# Problem_Set_1-Econ_202 - Solution key for the assigned...

This preview shows pages 1–3. Sign up to view the full content.

Solution key for the assigned questions from the textbook Chapter 2 Questions 4, 6, 7 & 8 (a) Government purchases (G) (b)Investment (I) (c) Export (EX) (d) Consumption (C) (e) Inventory investment (I) Question 6: Year 2000 Year 2010 Price of a automobile \$50,000 \$60,000 Price of a loaf of bread \$10 \$20 Quantity of automobiles 100 120 Quantity of loaves 500,000 400,000 Base year 2000 (a) Nominal GDP (2000) = (P 2000 bread * Q 2000 bread ) + (P 2000 automobile * Q 2000 automobile ) = (\$10 *500,000) + (\$50,000*100) = \$10,000,000 Nominal GDP (2010) = (P 2010 bread * Q 2010 bread ) + (P 2010 automobile * Q 2010 automobile ) = (\$20 *400,000) + (\$60,000*120) = \$15,200,000 Real GDP is the total value of goods and services measured at constant prices. As, base year is 2000, Real GDP at 2000 is same as nominal GDP of 2000 which is \$10,000,000. Real GDP (2010) = (P 2000 Bread * Q 2010 Bread ) + (P 2000 automobile * Q 2010 automobile ) = (\$10 *400,000) + (\$50,000*120) = \$10,000,000 Real GDP did not change from year 2000 to year 2010. The GDP price deflator = (Nominal GDP/Real GDP)*100 The GDP price deflator compares current prices of all goods and services produced to the prices of the same goods and services in a base year. For year 2000, the price deflator is 100 For year 2010, the price deflator is 152 The prices of goods produced in year 2010 increased by 52 percent compared to the prices that the goods in the economy sold for in 2000.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
CPI measures the level of prices in the economy. The cost of basket in 2000 = (P 2000 bread * Q 2000 bread ) + (P 2000 automobile * Q 2000 automobile ) = (\$10 *500,000) + (\$50,000*100) = \$10,000,000 The cost of basket in 2010 = (P 2010 bread * Q 2000 bread ) + (P 2010 automobile * Q 2000 automobile ) = (\$20 *500,000) + (\$60,000*100) = \$16,000,000 CPI in 2000 = (\$10,000,000/\$10,000,000)*100 =100 CPI in 2010 = (\$16,000,000/\$10,000,000)*100 =160 b. CPI is a Laspeyres price index because it is computed with a fixed basket of goods. The calculation from the previous question indicates that price rose by 60 percent in 2010 from what they were in 2000. GDP deflator, on the other hand, is a Paasche index because it is computed with a changing basket of goods. The price rose by 52 percent in year 2010 from what they were in 2000. The discrepancy between the CPI and GDP deflator illustrates that the change in the price level depends on how the goods prices’ are weighted. The GDP deflator weights the price of goods by the quantities purchased in the year 2010. The CPI weights the price of goods by the quantities purchased in the year 2000. In this example, the price of cars rose by 20 percent, whereas the price of bread rose by 100 percent, making bread relatively more expensive. CPI weights the price of goods by the quantities purchased in year 2000. The GDP weights the price of goods purchased by the quantities purchased in the year 2010. The quantity of bread consumed was higher in 2000 than in 2010, so the CPI (fixed weight) places a higher weight on bread. Since the price of bread increased relatively more than the price of cars, CPI shows a larger increase in the price level. (c) We discussed in the class both indexes have their own problems. So there is no clear cut answer.CPI does not take into account the substitution effect of the price change. As a good becomes more expensive, people buy less of it and more of other goods. In this example, consumers bought less bread and more cars. An index with fixed weights, such as CPI,
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 13

Problem_Set_1-Econ_202 - Solution key for the assigned...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online