Question

1. Suppose the base year is 2005, and the only goods in the economy are apples and bananas. In 2005 both apples and bananas cost $1, and 100 apples and 100 bananas are produced. In 2006, apples cost $20 and bananas cost $5, and 50 apples and 200 bananas are produced.

1. What is nominal GDP in 2005?                     
2. What is real GDP in 2005?                             
3. What is the GDP deflator in 2005?                

In 2006?              

In 2006?              

In 2006?              

4. Suppose the fixed basket of goods is 1 apple and 2 bananas.
5. What is the level of the CPI in 2005?                   In 2006?              
6. What is the CPI inflation rate from 2005 to 2006?               

2. What are the three effects that bias the measurement of CPI?

1.                                          
2.                                          
3.                                          

3. Which of the three effects listed in part c does each of the following illustrate?
   1. US households in 2010 spent a larger fraction of their income on televisions than they did in 1950.                                                                                         
   2. All televisions available in 2010 had higher resolution than any televisions available in 1950.                                                                                              
   3. In 1950, no US household had a plasma screen television, but in 2010 they are widely available.                                                                                          

4. Suppose the average television purchased in 1950 cost $200, and the average television purchased today costs $700.
   1. What is the percentage change in the average television price?

2. Taking into account the effects in part c, is this percentage increase likely an underestimate or overestimate of the true change in the cost of televisions?   

3. Why?                                                                                                        

5. Suppose CPI is as follows in each year:

Year:	2007	2008	2009	2010
CPI:	100	99	125	140

Suppose in the year 2007 you are considering a job offer that pays $50,000 in 2007, plus a 10% (compounding) raise in each of the next three years.

1. What nominal salary will you make in each year?

Year:	2007	2008	2009	2010
Nominal Salary

2. What will your real salary be in each year, using a 2007 base year?

Year:	2007	2008	2009	2010
Salary in 2007$

3. What will your real salary be in each year, using a 2009 base year?

Year:	2007	2008	2009	2010
Salary in 2010$

4. In what year was your real salary highest?
5. Does your answer to 4 depend on the base year selected?                         
6. Suppose instead your contract gave you $50,000 in 2007, plus a cost of living adjustment equal to the percentage change in CPI. Compute the nominal wage in each year.

Year:	2007	2008	2009	2010
Nominal Salary

In what years is this contract better than the original one?        

Answer 1

Nominal GDP 2005

GDP = Price * Quantity

Apples = $1 * 100 = $100

Bananas = $1 * 100 = $100

Total GDP = Apples + Bananas

= $100 + $100 = $200

Real GDP

Assuming 2005 is the base Year

Real GDP 2005 = Nominal GDP 2005 = $200

GDP Deflator 2005

GDP Deflator = ( Nominal GDP / Real GDP ) * 100

GDP Deflator 2005 = ($200 / $200) * 100

= 100 %

Nomnal GDP 2006

Similarly as above

Apples = $20 * 50 = $1000

Bananas = $5 * 200 = $1000

Adding all Above

Nominal GDP 2006 = $2000

Real GDP 2006 using 2005 as base year

= $1 * 50 + $1 * 200

= $50 + $200

= $250

GDP Deflator 2006

= ($2000 / $250) * 100

= 800 %

CPI in 2005

It will be 100% as 2005 is base year

CPI in 2006

(Total Cost of Basket of Goods in 2006 / Total Cost of basket of goods in 2005 ) * 100

Total Cost of Basket of Goods in 2006

Apples = $20 * 1 = $20

Bananas = $5 * 2 = $10

Total Cost of Basket = $20 + $10 = $30

Similarly , for 2005

Total cost of basket of goods = $1 * 1 + $1 * 2 = $3

CPI 2006 = ( $30 / $3 ) * 100

= 1000%

Inflation Rate = [(CPI in 2006 - CPI in 2005) / CPI in 2005]* 100

= [(1000 - 100)/100] * 100

= 900%