Question

Consider the Country of Econoland, which specializes in producing computers and bicycles. In 1998 Econoland produced 30 bicycles which were priced at $10 a bike and 2 computers which were priced at $100 a computer. In 1999 Econoland produced 30 bicycles at $11 a bike and 5 computers at $90 a computer. e. If the nominal inters rate was 8% from 1998 to 1999 what was the real interest rate if inflation was computed using the GDP Deflator with base year of 1998? f. suppose the government of Econoland measure inflation using a bundle of 2 bikes and 1 computer. What would they have measured the inflation rate being from 1998 to 1999?

If nominal interest rate was 8% from 1998 to 1999 what was the real interest rate if inflation was computed using the GDP Deflator with base year of 1998?

Suppose the government of econoland measured inflation using a bundle of 2 bikes and 1 computer. What would they have measured the inflation rate being from 1998 to 1999?

Answer 1

(e)

The base year is 1998.

The value of GDP deflator in the base year is always 100.

So, the GDP deflator in 1998 is 100.

Calculate the nominal GDP in 1999 -

Nominal GDP = [30 * $11] + [5 * $90] = $330 + $450 = $780

The nominal GDP in 1999 is $780.

Calculate the real GDP in 1999 -

Real GDP = [30 * $10] + [5 * $100] = $300 + $500 = $800

The real GDP in 1999 is $800.

Calculate the GDP deflator in 1999 -

GDP deflator = [Nominal GDP/Real GDP] * 100

GDP deflator = [$780/$800] * 100 = 97.5

The GDP deflator in 1999 is 97.5

Calculate the inflation rate -

Inflation rate = [(GDP deflator in 1999 - GDP deflator in 1998)/GDP deflator in 1998] * 100

Inflation rate = [(97.5 - 100)/100] * 100

Inflation rate = -2.5%

The inflation rate is -2.5%.

Calculate the real interest rate -

Real interest rate = Nominal interest rate - Inflation rate

Real interest rate = 8% - (-2.5%) = 8% + 2.5% = 10.5%

The real interest rate is 10.5%.

(f)

The base year is 1998.

The value of price index in base year is always 100.

So, CPI in 1998 is 100.

The market basket contains 2 bikes and 1 computer.

Calculate the value of market basket in 1998 -

Value = [2 * $10] + [1 * $100] = $20 + $100 = $120

Calculate the value of market basket in 1999 -

Value = [2 * $11] + [1 * $90] = $22 + $90 = $112

Calculate the price index in 1999 -

Price index = [Value of market basket in 1999/Value of market basket in 1998] * 100

Price index = [112/120] * 100 = 93.33

The price index in 1999 is 93.33

Calculate the inflation rate -

Inflation rate = [(Price index in 1999 - Price index in 1998)/Price index in 1998] * 100

Inflation rate = [(93.33 - 100)/100] * 100

Inflation rate = -6.67%

The inflation rate is -6.67%.