Question

suppose the natural gdp is constant. for every 1 percent increase in the rate of inflation above its expected levals, firms are willing to increase real gdp by 4 percent. initially, the output ratio is 100 and the inflation rate equals 4 percent. based on this information.

a. calculate the inflation rates when output ratio is 95 and 105 respectively.

b. Growth rate of nominal GDP in the economy.

Answer 1

A Calculation of inflation

1. When output ratio is 95 , which means it is declined by 5%

When Inflation rises 1%, Real GDP rises by 4%, then if output reduces by 5%, what will be the inflation

= 5% * 1% / 4%

= 1.25%, thus inflation rate will be reduced by 1.25%.

Actual inflation rate is 4%, when output is 95, inflation will be 4 - 1.25 = 2.75%

2. When output ratio is 105, which means it is increased by 5%

When Inflation rises 1%, Real GDP rises by 4%, then if output increases by 5%, what will be the inflation

= 5% * 1% / 4%

= 1.25% , thus inflation rate will be increased by 1.25%

Actual inflation rate is 4%, when output is 105, inflation will be 4 + 1.25 = 5.25%

B Growth rate of nominal GDP in the economy

1. When output ratio is 95 , Nominal growth rate will be

Nominal growth rate = Real growth rate + Inflation rate

= - 5% + ( -1.25% )

= -6.25%

2. When output ratio is 105 , Nominal growth rate will be

Nominal growth rate = Real growth rate + Inflation rate

= 5% + 1.25%

= 6.25%