SOLUTIONS Muliple Choice Quesions Soluions are provided direcly when you do he online ess. Numerical Quesions 1. Nominal and Real GDP Suppose han an economy consiss of only 2 ypes of producs: compuers and auomobiles. Sales and price daa for hese wo producs for wo differen years are as follows: Table 1 (1) (2) (3) (4) (5) Year No. of Compuers Sold Price per Compuer No. of Auomobiles Sold Price per Auomobile 1975 200,000 $10,000 1,000,000 $6,000 1995 1,500,000 $2,000 1,500,000 $10,000 Nominal GDP in any year is calculaed by muliplying he quaniy of each final produc sold by is price and summing over all final goods and services. Algebraically, his can be wrien as i P i Q i where P i and Q i represen he price and he quaniy sold of he i h final good or service. Assuming ha all compuers and auomobiles are final goods, calculae nominal GDP in 1975 and in 1995. Soluion: Nominal GDP in 1975 = $ 8 billion; Nominal GDP in 1995 = $ 18 billion. 1. Using 1975 as he base year, real GDP in 1975 is equal o nominal GDP in 1975. Calculae real GDP in 1995 using 1975 as he base year. Soluion: $ 24 billion. 2. Calculae he percenage change in real GDP beween 1975 and 1995 using 1975 as he base year. Soluion: 200% 3. Calculae real GDP in 1975 using 1995 as he base year. Soluion: Real GDP in 1975 using 1995 as a base = $ 10.4 billion. 1
4. Calculae he percenage change in real GDP beween 1975 and 1995 using 1995 as he base year. Soluion: 73.1% 5. Explain why your answers o 3 and 5 are differen. Soluion: In 1975 compuers were expensive relaive o auomobiles. Consequenly, when 1975 is used as a base year, he dramaic increase in he quaniy of compuers produced beween 1975 and 1995 is muliplied by a big price ($10,000) resuling in a large increase in real GDP. In 1995 however, compuers were cheap relaive o auomobiles. Consequenly, when 1995 is used as he base year, he large change in he quaniy of compuers produced in he period is muliplied by a relaively low price ($2,000) resuling in a much smaller increase in GDP. 2
2. The GDP Deflaor and he Consumer Price Index 1. Le 1975 be he base year for he CPI (i.e. CPI 1975 = 100). If he fixed marke baske is he oal amouns of compuers and auomobiles purchased in 1975, use he daa in Table 1 o calculae he CPI in 1995, using 1975 as he base year. Soluion: 130. 2. Calculae he GDP deflaor in 1995 using 1995 as he base year (i.e. 1975 = 100). Soluion: 75. 3. Calculae he percenage changes in CPI and he GDP deflaor beween 1975 and 1995. Soluion: %CPI (1975 = 100) = 30%; % Deflaor (1975 = 100) = -25%. 4. Explain why you answers in 3 are so differen from each oher and relae your explanaion o he difference beween he Laspeyres and Paasche indices. Soluion: In 1975 compuers comprised a small porion of he consumer marke baske. Therefore, in a Laspeyres index like he CPI, he dramaic reducion in he price of compuers will be ouweighed by he increase in he price of auomobiles. For a Paasche index like he GDP deflaor, however, he weigh given o compuers is much greaer because hey comprise a much large porion of he GDP in 1995 han in 1975. Consequenly, in his index, he reducion in compuer prices will ouweigh he increase in auomobile prices. Compuer Quesions - Soluions are available in he aached EXCEL files. For his par of he assignmen you will need o download daa from he S. Louis Federal Reserve Bank a: hp://research.slouisfed.org/fred2/ 1. Download daa for he Consumer Price Index (All Urban Consumers, All Iems, Seasonally Adjused) and daa for he GNP Deflaor. Noice ha he CPI daa is recorded monhly while he GDP deflaor is recorded quarerly. You need o creae wo series of inflaion based on hese wo indices and compare hem graphically. You will need o perform he following seps: a. Generae a quarerly series of he CPI. You can do his by selecing he observaion for las monh of each quarer (i.e. March, June, Sepember, December). b. Generae he year-o-year growh rae using he log ransformaion: Inf { ln( Index ) ln( Index )} = 100 4 3
c. Compare he wo series for inflaion in a common graph ha displays he wo series. Make sure ha you label he graph, he axis and unis of measuremen and he lines ha are displayed. d. Commen on he resuls, making special emphasis on he behavior of each index around business cycle roughs and peaks (go o he NBER websie: www.nber.org, o obain he relevan daes). Noes: You should urn in only 1 page wih he graph and a mos 1 paragraph wih he commens. The commens can be included in he same page where you have he graph, eiher by hand or in Word. 4
2. Download daa on he Real GDP (Annual frequency) and he Unemploymen Rae (Civilian Unemploymen Rae from he Household Survey, Seasonally Adjused). Noe ha he unemploymen rae daa is monhly. a. You will need o creae a yearly series based on he average unemploymen rae over he year. You can do his using he AVERAGE funcion in excel and hen selecing he December observaions of each year. b. Once boh series are a an annual frequency, calculae he growh rae of real GDP using he log ransformaion and generae he change in he unemploymen rae from one year o he nex. c. Finally, do a scaer-plo where he growh rae of real GDP is on he verical axis and he change in he unemploymen rae on he horizonal axis. Use he Add Trendline opion from he Char menu and selec o display a linear rend. Be sure o selec as Opions ha he equaion and he R 2 be displayed as well. d. Inerpre he relaion you jus compued in ligh of Okun s law. Noes: You should urn 1 page wih he graph and a mos 1 paragraph wih your commens. The commens can be included in he same page where you have he graph, eiher by hand or in Word. 5