Deck 6: The Goals of Macroeconomic Policy

Question 1

If an earthquake destroys some of the factories in Poorland, what happens to Poorland's potential GDP? What happens to Poorland's potential GDP if it acquires some new advanced technology from Richland and starts using it?

Answer 1

Earthquake reduces the potential GDP
If an earthquake destroys some factories in a country, then the country's potential GDP will be affected. This is because the factories affected by the earth-quake cannot produce any output. Hence, the potential GDP of the country will decrease.
Acquiring new technology will increase the potential GDP
If the country acquires new and advanced technology, then the country's future productivity is bound to increase. Hence, the potential GDP of the country will increase.

Question 2

Two countries start with equal GDPs. The economy of Country A grows at an annual rate of 3 percent, whereas the economy of Country B grows at an annual rate of 4 percent. After 25 years, how much larger is Country B's economy than Country A's economy? Why is the answer not 25 percent?

Answer 2

Country A and B have same size of GDP, whereas country A grows at an annual rate of 3% and country B grows at an annual rate of 4%.
The size of GDP after 25 years can be calculated by using the following formula:
……(1)
Where,
g= Percentage of growth rate
t= Year
Calculate the size of GDP for country A.
Consider that the initial level GDP of the country A is $1; substitute the respective value in Equation (1) to obtain the size of GDP after 25 years.
Hence, country A's GDP size will be
.
Calculate the size of GDP for country B.
Consider that the initial GDP level of country B is $1; substitute the respective value in Equation (1) to obtain the size of GDP after 25 years.
Hence, country B's GDP size will be
.
Percentage difference in size of GDP
Country A's GDP size is 2.09, whereas country B's GDP size is 2.66. Therefore, after 25 years, country B's GDP will be
percent , that is,
.
Although both the economies have started with the same level of GDP, they grow at different rates. Hence, from the next period onward, their GDP size will be different, so the principal size of GDP will change for the successive years. Therefore, the difference in GDP of two countries is not exactly 25%.

Question 3

Why is it not as terrible to become unemployed nowadays as it was during the Great Depression?

Answer 3

Unemployment
Unemployment refers to a situation where people are able and willing to do work but they do not get a job.
Carefree unemployment situation
At the time of great depression during 1930s, people were not able to fulfill their daily basic needs such as food, clothing, and housing because of unemployment problem. Since every country had a shortage in money supply, printing new money was not possible at that time. Moreover, it causes inflation, which would further worsen the economy.
Unlike the great depression period, now the government supports unemployed persons through unemployment insurance and other programs, since the government has the ability to raise funds for these programs. These programs help the unemployed persons to meet their daily basic needs.
Hence, nowadays, unemployment is not as terrible as it was during the great depression.

Question 4

If output rises by 35 percent while hours of work increase by 40 percent, has productivity increased or decreased? By how much?

Question 5

"Unemployment is no longer a social problem because unemployed workers receive unemployment benefits and other benefits that make up for most of their lost wages." Comment.

Question 6

Most economists believe that from 2003 to 2006, actual GDP in the United States grew faster than potential GDP. What, then, should have happened to the unemployment rate over those three years? Then, from 2006 to 2010, actual GDP grew slower than potential GDP, even contracting for several quarters. What should have happened to the unemployment rate over those three years? (Check the data on the inside back cover of this book to see what actually happened.)

Question 7

Why is it so difficult to define full employment? What unemployment rate should the government be shooting for today?

Question 8

Country A and Country B have identical population growth rates of 1 percent per annum, and everyone in each country always works 40 hours per week. Labor productivity grows at a rate of 2 percent in Country A and a rate of 2.5 percent in Country B. What are the growth rates of potential GDP in the two countries?

Question 9

Show why each of the following complaints is based on a misunderstanding about inflation:
a. "Inflation must be stopped because it robs workers of their purchasing power."
b. "Inflation makes it impossible for working people to afford many of the things they were hoping to buy."
c. "Inflation must be stopped today, for if we do not stop it, it will surely accelerate to ruinously high rates and lead to disaster."

Question 10

What is the real interest rate paid on a credit card loan bearing 18 percent nominal interest per year, if the rate of inflation is
a. zero?
b. 4 percent?
c. 8 percent?
d. 15 percent?
e. 20 percent?

Question 11

Suppose you agree to lend money to your friend on the day you both enter college at what you both expect to be a zero real rate of interest. Payment is to be made at graduation, with interest at a fixed nominal rate. If inflation proves to be lower during your college years than what you both had expected, who will gain and who will lose?

Question 12

Below you will find the yearly average values of the Dow Jones Industrial Average, the most popular index of stock market prices, for five different years. The Consumer Price Index for each year (on a base of 1982- 1984 = 100) can be found on the inside back cover of this book. Use these numbers to deflate all five stock market values. Do real stock prices always rise every decade?

Question 13

Below you will find nominal GDP and the GDP deflator (based on 2005 = 100) for the years 1989, 1999, and 2009.
a. Compute real GDP for each year.
b. Compute the percentage change in nominal and real GDP from 1989 to 1999, and from 1999 to 2009.
c. Compute the percentage change in the GDP deflator over these two periods.

Question 14

Fill in the blanks in the following table of GDP statistics:

(No, that's not a misprint. Real GDP was exactly the same in 2007 and 2008.)

Question 15

Use the following data to compute the College Price Index for 2009 using the base 1982 = 100.

Question 16

Average hourly earnings in the U.S. economy during several past years were as follows:

Use the CPI numbers provided on the inside back cover of this book to calculate the real wage (in 1982-1984 dollars) for each of these years. Which decade had the fastest growth of money wages? Which had the fastest growth of real wages?

Question 17

The example in the appendix showed that the Student Price Index (SPI) rose by 42 percent from 1983 to 2009. You can understand the meaning of this better if you do the following:
a. Use Table 5 to compute the fraction of total spending accounted for by each of the three items in 1983. Call these values the "expenditure weights."
b. Compute the weighted average of the percentage increases of the three prices shown in Table 6, using the expenditure weights you just computed. You should get 42 percent as your answer. This shows that inflation, as measured by the SPI, is a weighted average of the percentage price increases of all the items that are included in the index.