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.) [Note: In prosperous years with positive inflation, both nom inal and real GDP grow over tim e. The exam problem s m ay com bine negative inflation with real GDP growth or positive inflation with real GDP decline. Review the practice problem here and the exam ples in the textbook. ! ! Know how to construct the im plicit price deflator using the chain-linked m ethod. The exam problem s derive the im plicit price deflator and real GDP in each year.]

** Exercise 1.1: Real GDP and the Im plicit Price Deflator A country m akes bread and wine in 20X7 and 20X8, at the quantities and prices shown in the table below. The im plicit price deflator in 20X7 is 100. 20X7 Bread Quantity Price 26,000 4 W ine 5,000 10 Bread 32,000 5 20X8 W ine 4,000 20

Use the average prices in 20X7 and 20X8 as base prices (the chain-link m ethod). A. B. C. D. E. F. G. H. I. W hat is nom inal GDP in 20X7 and 20X8? W hat are the base prices of bread and wine for com paring 20X7 and 20X8? W hat is GDP in 20X7 and 20X8 at the base prices? W hat is the ratio of real GDP in 20X8 to real GDP in 20X7? W hat is real GDP in 20X7 and 20X8? W hat is the im plicit price deflator in 20X8? How would the answers change if the im plicit price deflator were 125 in 20X7 instead of 100? Explain the error in the following statem ent: “The price of bread rose 25% from 20X7 to 20X8, yet consum ers bought m ore bread. The dem and curve for bread m ust have changed from 20X7 to 20X8.” Explain the error in the following statem ent: “Real G DP depends on the quantities of goods, not their prices. To determ ine if real GDP increased or decreased, we need the quantities of each good in the two years, not the prices of the goods in the two years.”

000 × 1.25 / 1.50 + 4. so real GDP = nom inal GDP = $154. real GDP = $154.50 W ine: ½ × ($10.Part A: Nom inal GDP is quantity tim es price.00 + $5. Real GDP for 20X8 could be in 20X1 dollars.000 × $15 = $192.000 Part D: The ratio of real GDP in 20X8 to real GDP in 20X7 is $204.063 Part E: In 20X7.000 / $163.000 / 26. so it is hard to com pare nom inal GDP am ong years Real GDP depends on two item s: the base units and the m ethod of m easuring inflation. The base year affects the im plicit price deflator.000 × $16 = $204.000 20X8: 32. the real price of bread declined 14.68%. and then derive the change in the real price of the good. using the nom inal prices in each year.68 Part G: The differences are only in the units of m easurem ent.625 = 146. Part F: The im plicit price deflator is 100 × nom inal GDP / real GDP = 100 × $240.000 = 1. ! ! 20X7: 26.00) = $15.000 × $20 = $240.000. These units differ for each year. a final exam problem m ay give the im plicit price deflator for one year and derive the deflator for the other year. or 20X9 dollars.852.625 Jacob: W hat are the units of nom inal GDP and real GDP? Rachel: Nom inal GDP has units of current dollars. Final exam problem s use the chain-link m ethod in the textbook to m easure inflation. Derive the im plicit price deflator from all the goods in the econom y. In 20X8. and the quantity of bread bought rose 32. the im plicit price deflator is one.000 × $4 + 5. . 20X5 dollars.000 / $192. Part I: The change in the real GDP is the weighted average change in the quantities of goods produced.000 20X8: 32.000 × $5 + 4.000 Part B: The base prices for the chain link m ethod are the average prices in each adjacent pair of years: ! ! Bread: ½ × ($4.8%. The prices of goods give the weights.00) = $4.063 = $163. Take heed: An exam problem m ay ask for the change in the real price of a good after adjusting for inflation. so the real price of bread rose by a factor of 1.4668 = 0.50 + 5.000 × $10 = $154.000 × $4.000 – 1 = 23%. It does not depend on the way we m easure inflation or the im plicit price deflator. Real GDP has no natural units.00 Part C: Base price GDP = quantity × price using these base prices: ! ! 20X7: 26.000 × $4. Nom inal GDP does not change and the price level is 25% higher. so real GDP is 20% lower each year and the im plicit price deflator for 20X8 is 25% higher.00 + $20. That is. Part H: The nom inal price of bread rose 25% and the price level rose 46.

.900 + 150Z 20X8: 300 × 5 + 200 × ½ × (Z + 6) = 2. W hat are the average prices of bread and wine in 20X7-20X8? B. 20X7 Bread Quantity Price 200 4 W ine 300 6 Bread 300 6 20X8 W ine 200 Z Using the chain-link m ethod. Assum ing real GDP does not change. Part A: The average price of bread is ½ × (4 + 6) = 5 and the average price of wine is ½ × (6 + Z).** Exercise 1. Part B: Use the average prices to com pute real GDP: ! ! 20X7: 200 × 5 + 300 × ½ × (Z + 6) = 1.100 + 100Z Part C: Equating the two years gives 1.2: Real GDP A country produces the following quantities of bread and wine. so the solution is easy. W hat are real GDP in 20X7 and 20X8? C. The solution m ethod is the sam e. real GDP does not change from 20X7 to 20X8.900 + 150Z = 2. The figures in this exercise are sym m etric.100 + 100Z A 50Z = 200 A Z = 4. solve for Z. 20X8: 300 loaves of bread and 200 flasks of wine at prices of $6 per loaf and Z per flask. ! ! 20X7: 200 loaves of bread and 300 flasks of wine at prices of $4 per loaf and $6 per flask. A. Final exam problem s use other figures and m ight say that real GDP increases P% from 20X7 to 20X8.

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