Question

1 Suppose the value of the CPI is 1.26 in year one, 1.285 in year two and 1.298 in year three. Assume also that the price of computers increases by 4% between year one and year two, and by another 4% between year two and year three. Between year two and one, and year three and two, the price level is increasing, the inflation rate is _______, and the relative price of computers is _________. (Increase or decrease for the inflation rate and relative price?)

2 If the natural rate of unemployment equals 5% and the actual rate of unemployment equals 2%, then cyclical unemployment equals: ( )

3 Over the period of a year, Alex's nominal GDP decreases by 20% and real GDP decreases by 20%. This implies that, during this time:

The CPI has fallen by less than 20%.

The CPI has remained constant.

The CPI has fallen by more than 20%.

The CPI has risen by less than 20%

4.

Household saving	$300
Business saving	$300
Government purchases	$600
Government transfers and interest payments	$300
Government tax collections	$900
GDP	$5000

Public saving is _____ and national saving is ______.

Answer 1

1 Compute inflation rate increase / decrease

Inflation measures an increase in the prices of goods and services while deflation indicates a decrease.

Rate of inflation _{between Year 2 and Year 1} = [(CPI_{Year 2} - CPI_{Year 1}) / CPI_{Year 1}] * 100

                                                       = [(1.285 - 1.26) / 1.26] * 100 = (0.025 / 1.26) * 100

                                                       = 1.98%

Rate of inflation _{between Year 3 and Year 2} = [(CPI_{Year 3} - CPI_{Year 2}) / CPI_{Year 2}] * 100

                                                         = [(1.298 - 1.285) / 1.285] * 100 = (0.013 / 1.285) * 100

                                                         = 1.01%

Computer Prices have increased by 4% from year 1 to year 2 and then by another 4% year 2 to year 3

Inflation rate on the other hand has decreased from between year two and year one to year three and year two.

Between year two and one, and year three and two, the price level is increasing, the inflation rate is decreasing, and the relative price of computers is increasing.

2. Compute Cyclical Unemployment rate

Cyclical unemployment caused by the economic activity movement. When economy expands, cyclical unemployment decreases. When economy contracts say during recession, cyclical unemployment increases.

Cyclical Unemployment rate = Actual rate of Unemployment - Natural rate of Unemployment -

                                          = 2% - 5% = -3%

Cyclical unemployment equals: -3%

3. CPI is measured as

CPI_prev = [Nominal GDP_prev / Real GDP_prev] * 100

CPI_new = [Nominal GDP_prev * 0.8 / Real GDP_prev* 0.8] * 100 = CPI_prev * (0.8 / 0.8) = CPI_prev

if both Nominal and GDP fall by 20 %, the CPI will remain the same'

The CPI has remained constant is the CORRECT choice.

4. Public, Private and National Savings are computed as

Public Saving = Government Tax collection - Government Purchases - Government Transfers and Interest payments

                       = $900 + $600 - $300 = $0

Private Saving = Household Saving + Business Saving

                     = $300 + $300 = $600

National Saving = Public Saving + Private Saving

                       = $0 + $600 = $600

Public Saving is $0 and National Saving is $600