ECON 212 Problems, Spring 2008

Refer to the information provided in Table 6.4 below to answer the questions that follow. 1. Answer Parts (a) through (g) using the information in Table 6.4 describing the Macrovian economy. Quantities are given in millions of Macrovian dollars (M$). (a) Calculate gross private investment. (b) Calculate Macrovian GDP. (c) Calculate gross national product (GNP). (d) Calculate net national product (NNP). (e) Calculate national income. (f) Calculate personal income. (g) Calculate disposable personal income. (a) Gross private investment = Business investment in plant and equipment + Residential construction + Inventory investment = 586.1 + 453.7 + -30.9 = 1008.9. (b) GDP = C + I + G + (EX - IM) = 3514.8 + (586.1 + 453.7 - 30.9) + 1589.7 + (380.4 - 285.0) = 6208.8 (millions of Macrovian dollars). (c) GNP = GDP - Net factor payments to the rest of the world = 6,208.8 - (-)17.3 = 6,226.1. (d) NNP = GNP - Depreciation = 6,226.1 - 643.5 = 5,582.6. (e) National income = GNP - (Depreciation + Indirect business taxes minus subsidies) = 6,226.1 - (643.5 + 489.6) = 5,093.0. (f) Personal income = National income + Government transfer payments and interest - (Payroll taxes + Corporate taxes + Corporate profit - Dividends) = 5,093.0 + 337.1 - (441.7 + 215.9 + 45.7) = 4,726.8. (g) Disposable personal income = Personal income - Personal taxes = 4,726.8 - 600.0 = 4,126.8. 2. Compare and contrast the terms nominal GDP and real GDP. Nominal GDP measures gross domestic product in current dollars. Real GDP measures gross domestic product by adjusting Nominal GDP for price changes. Difficulty: E Type: C Table 6. 1 3. Using the above table calculate the nominal GDP for 1987. Bread = 6 x $1 = $6 Paper Clips = 10 x $.50 = $5 Wine = 2 x $5 = $10 Nominal GDP is thus the sum of the above figures - $21. Difficulty: E Type: A 4. Using Table 6.1 calculate real GDP for 1988 using 1987 as the base year. Real GDP in 1988 is calculated using 1987's prices. Therefore the value of production of bread, paper clips and wine is $5.00, $6.00 and $15.00 respectively totaling to $26.00. Difficulty: M Type: A 5. Using Table 6.1 calculate the percentage increase in Real GDP from 1987 to 1988 using 1987 as the base year. The increase in real GDP from 1987 to 1988 is equal to ($26-$21)/$21 * 100% = 23.8% Difficulty: E Type: A 6. If nominal GDP is $8 trillion and real GDP is $5 trillion, calculate the value of the GDP deflator. Real GDP = Nominal GDP ----------------- GDP Deflator / 100 Therefore the GDP Deflator = Nominal GDP / Real GDP x 100 = $8 trillion / $5 trillion x 100 = 160. Difficulty: E Type: A Table 7-1 7. Using Table 7.1 above, calculate the unemployment rate. The total amount of people who are unemployed and looking for work are 400 + 200 + 100 = 700. The labor force equals this number plus the employed - 700 + 8000. The unemployment rate is equal to 700/8700 x 100% = 8.04% Difficulty: E Type: A 8. Assume that the CPI for year 3 is 120 and the CPI for year 4 is 130. Compute the inflation rate for year 4. The inflation rate = (130 - 120)/120 * 100% = 8.33% Difficulty: E Type: A 9. Suppose you want to earn a 7% rate of return on a one-year loan you are about to make and the expected inflation rate for the duration of the loan is 5%. How much interest should be charged? Secondly, suppose that your forecasts are 2% below the actual level. What would happen to your real rate of return? What if you overestimated inflation by 2%. You would need to assess an interest rate of 12% to earn 7%. The 5% is simply an inflation premium. However, if you underestimate inflation by 2% your real rate of return will only be 5% not 7%. Likewise, if you overestimate the inflation rate you will be in the happy circumstance of earning a 9% rate of return (12% - 3%). 10. Identify the following individuals as either "better off", "worse off" or "no different" from unanticipated inflation. Creditors who make variable interest rate mortgages that are tied to the Consumer Price Index Creditors who make fixed interest rate loans Homeowners who pay fixed interest rate mortgages Landlords who receive rent in multi-year contracts Creditors who make variable interest rate mortgages that are tied to the Consumer Price Index no different Creditors who make fixed interest rate loans worse off Homeowners who pay fixed interest rate mortgages better off Landlords who receive rent in multi-year contracts worse off Difficulty: E Type: C 11. Suppose that you take out a loan at the bank for $1000 and are required to pay it back with interest of $100 at the end of the year. Suppose that there was no inflation at all when you took out the loan. By the end of the year the price level has increased 7%. Calculate both the nominal interest rate and the real interest rate on this simple loan arrangement. The nominal interest rate is equal to $100/$1000 x 100% = 10%. The real interest rate is 10% - the 7% inflation which is 3% 12. Lenders and borrowers expect the inflation rate to equal the actual inflation rate. The consumer price index is 110 in year 1 and 126.5 in year 2. If the interest rate charged by Richie Rich in year 2 is 40%, what is Rich's real interest rate? Rich's real interest rate is 25%. The inflation rate in year 2 is (change in CPI/initial CPI) × 100, or 15%. The real interest rate (25%) is the difference between the market interest rate (40%) and the expected inflation rate (15%). 13. If year 1 is the base year and the price index for year 2 is 105 and the price index for year 3 is 103, what is the inflation rate in years 2 and 3? Explain what has happened between years 1 and 2, years 2 and 3, and years 1 and 3 to the cost of living. The inflation rate in year 2 is 5%. The inflation rate in year 3 is -1.9%. The cost of living increased between years 1 and 2 and years 1 and 3, but decreased between years 2 and 3.