Macroeconomocs Unit 6

Unit 6 Problem Set #6 1. a. GDP is the dollar value of all final goods & services produced within a country’s borders in one year. Intermediate goods, non-production transactions, illegal or black-market activities, household production, and inventory are not counted for GDP. GDP can be calculated using the expenditure approach where you add up all spending on final goods and services produced in a year or using the income approach where you add up all income earned in a year. The four components are Consumption (ex. movie tickets), Investment (ex. company builds new factory), Government (ex. military buys new equipment), and Net Exports (ex. fruit grown in Mexico sold in Florida). b. Nominal GDP is measured in current prices. It is not adjusted for inflation from year to year. Real GDP is expressed in constant, unchanging dollars. It is adjusted for inflation, and it’s better. For example, a movie could have a nominal GDP of $3’000’000 in the year 2000 and it would have the same GDP the year 2010, but its real GDP would go from $3’000’000 in 2000 to $4’000’000 in 2010. c. I would also need to know the county’s total GDP and its total population to reflect the standard of living. d. 2. a. Frictional Unemployment is when people are temporarily unemployed or in between jobs. Individuals are qualified workers with transferable skills but aren’t working. For example, recent graduates looking for jobs. Structural Unemployment is caused by the obsoleting of some skills. Workers do not have transferrable skills and theses jobs will never come back, so workers must learn new skills to get a job. For examples, VCR repairmen. Cyclical Unemployment results from economic downturns (recessions). As demand for goods and services falls, demand for labor falls and workers are fired. For example, cashiers after self-checkout started spreading. b. The Unemployment Rate is calculated using this equation: ¿ Unemployed ×100 . The Natural Rate of UnemploymentRate= ¿∈ LaborForce Unemployment is when there’s no unemployment due to cyclical/recession reasons. 0% unemployment is impossible and undesirable. 3. a. Consumer Price Index measures changes in the price level of a market basket of consumer goods and services purchased by households. Priceof Market Basket ∈CurrentYear CPI= × 100 . A CPI of 90 means that Priceof Market Basket∈BaseYear inflation decreased by 10% from the base year to Year 1. A CPI of 100 means that inflation did not change from the base year to Year 2. A CPI of 125 means that inflation increased by 25% from the base year to Year 3. A CPI of 150 means that inflation increased by 50% from the base year to Year 4. The percent change in prices from Year 3 to Year 4 is not 25% because CPI is relative to the base year and cannot be compared to other years. The CPI between Year 3 and Year 4 is (150-125)/125 x 100 = 20%. b. and NominalIR=RealIR+ExpectedInflation RealIR=NominalIR−ExpectedInflation . Your real income would fall if, for example, your nominal interest rate was 5% and the rate of inflation was 10%. Your real income would stay the same if, for example, your nominal interest was 5% and the rate of inflation was 5%. Your real income would increase if, for example, your nominal interest was 10% and the rate of inflation was 5%. c. If actual inflation is greater than the anticipated inflation, then borrowers of money on a fixed interest rate would benefit because they are paying back their debt with less real dollars, and lenders who loan money on a fixed rate interest would suffer because they are getting less real dollars. d. The first problem is Substitution Bias where as prices increase for the fixed market basket, consumers buy less of these products and more substitutes that may not be in the market basket. So, CPI is higher than what consumers are paying. For example, gas prices going up, causing people to switch to a cheaper alternative like ethanol. The second problem is New Products. Since, the CPI market basket may not include the newest consumer products, CPI measures prices but not the increase in choices. For example, when eBooks came out, they weren’t calculated at all, since CPI is a fixed that changes slowly over time. The last problem is Product Quality. The CPI ignores improvements in product quality. So, CPI may suggest that prices stay the same, though the economic well-being has improved significantly. For example, iPhones don’t go up in price but they get better every year. 4. a. Trade Surplus is positive net exports where the exports are bigger than the imports. Trade deficit is negative net exports where the imports are bigger than the exports. Current account is made up of net exports, investment income, and the money that flows from the private sector to the public sector. Financial account measures the purchase and sale of assets abroad. An example of current account is the money earned by an American who rents out his house in Guatemala. The money he receives is not a future liability, but rather just money. An example of financial account is the sale of United States bonds to China. Those bonds are a future liability as they can be sold again. b. Appreciation and depreciation occur when a currency experiences an increase of decrease of value. A good or commodity that grows in worth is appreciating, and a good that loses its worth is depreciating. An example for appreciation is a house. An example for depreciation is a car. If you demand one currency, you need to supply your own currency. If Americans wants to buy German products, then they supply dollars to pay for euros. The euro appreciates because demand for that currency increased, and the dollar depreciated because the supply increased. c. The first FOREX shifter is Consumer Tastes which are specialty goods like Italian Olive Oil or Tourism like Disney. The second one is Relative Income where, for example, Italy has stronger GDP growth, so they buy more imports. The third one is Relative Inflation where, for example, if price levels increase more in Peru, they’ll buy more imports. The last FOREX shifter is Interest Rates where, for example, if the U.S. has higher interest rates than Japan, then more US dollars will be demanded. d. For households, the weaker US dollar means the earlier benefits of currency strength are likely to dissipate. On the flipside, local businesses could gain, especially if they’re exporters, and that could boost the economy as a whole. The weaker US dollar has also contributed to costlier imports. While European consumers may be loading up on American imports, overseas goods have become costlier for people in the U.S. to buy. People taking overseas vacations have a much more reduced spending power. Even those taking local road trips are restricted by higher gas prices.