Question

1. In the fourth quarter of 1982, economic statistics showed the following:

Real GDP Unemployment rate Inflation rate

: $5,189.8 billion : 10.7%

: 4.4%

The conceptual variables corresponding to these data are: Potential output : $5,640.3 billion Natural rate of unemployment : 6.1%

Ideal inflation rate : 1.0%

a) Calculate the output gap.

b) Calculate the unemployment gap.

c) Calculate the inflation gap.

d) Calculate the output loss and inflation loss.

e) Calculate the total loss in the fourth quarter of 1982 if the relative weight on inflation loss equals 2.

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f) Calculate the total loss in the fourth quarter of 1982 if the inflation loss is weighted 6 times of the weight on the output loss.

Answer 1

a) Output gap = [(Actual output - Potential output) / Potential output] * 100

                        = [(5,189.8 - 5,640.6) / 5,640.6] * 100 = -7.99% .

b) Unemployment gap = Unemployment rate - Natural rate of unemployment = 10.7% - 6.1% = 4.6%

c) Inflation gap = Inflation rate - Ideal inflation rate = 4.4% - 1.0% = 3.4%

d) Output loss = (-7.99)² = 63.84

     Inflation loss = 3.4² = 11.56

e) Total loss in the fourth quarter of 1982 = Output loss + (Weight * Inflation loss) = 63.84 + (2 * 11.56) = 86.96

f) Total loss in the fourth quarter of 1982 = Output loss + (Weight * Inflation loss) = 63.84 + (6 * 11.56) = 133.2