ECON 202 Drexel University Assignment 2

Professor: Mara Pa Olivero

NAME: _______________________________________________ Note: There are 10 extra credit points on this assignment. SHORT ANSWER SECTION (100 points) Question 1: (15 points)
Obtain the value of nominal GDP and real GDP in 2007 and 2008 for this economy (7.5 points)

Good

2007

2007 Q07 100 200 100

2008 P08 $1 $1 $1

2008 Q08 500 500 500

P07 Food $10 Leisure and $20 entertainment Education $40

Explain why looking just at the evolution of nominal GDP would make an analyst erroneously conclude that this economy has gone through a severe crisis/recession in 2008. (7.5 points) ANSWER: Nominal GDP 2007 = $9000 Nominal GDP 2008 = $1500 Real GDP 2007 (in constant 07 dollars) = $9000 Real GDP 2008 (in constant 07 dollars) = $35000

Because prices have fallen by a larger proportion than the increase in quantities produced. So, even with a significant increase in the quantities of goods and services available for consumption, nominal GDP has fallen between these two years.

Question 2: (15 points)

What are the three economic costs of high unemployment? (5 pts each) ANSWER: Loss of output or actual GDP falling below potential GDP, loss in tax revenue for the government, increased cost of unemployment insurance.

Question 3: (10 points)

What are the two types of inflation that an economy can experience? Make sure to explain how they differ from each other. (5 points) ANSWER: Demand-pull inflation: AD price level Cost-push inflation: AS price level

Question 4: (10 points)

What are the two main costs of high inflation rates? (5 points each) ANSWER: The uncertainty created by inflation may inhibit long-term contracts. It systematically discriminates against people on fixed incomes, and it may favor borrowers at the expense of lenders.

Question 5: (15 points)

Why do countries gain from international trade? Make sure to talk about the benefits of both exports and imports. ANSWER: FROM IMPORTS: They can import resources they lack at home. They can import goods for which they are a relatively inefficient producer. FROM EXPORTS: Earn money from exports. Producing larger quantities for export markets sometimes allows countries to become more efficient.

Question 6: (10 points)

On the problem of macroeconomic stabilization: a) Mention at least four policies needed to fight unemployment (5 points). b) Mention at least four policies needed to fight inflation (5 points). ANSWER: a) Increase in G, tax cut (corporate or income), expansionary monetary policy. b) The opposite of the previous four.

Question 7: (15 points)

Are higher inflation rates a necessary consequence/cost of faster economic growth? Why? Or why not? Please explain. ANSWER: No, because economic growth raises both AD and AS in an economy. The increase in AD puts an upward pressure on prices, but the increase in AS compensates that pressure (at least partially).

Question 8: (10 points)

Mention the three main determinants of potential GDP. ANSWER: The growth rate of the labor force The growth rate of the nations capital stock The rate of technical progress

EXTRA CREDIT QUESTION: (10 points)

Use the income approach to calculate GDP in the economy of Spain where consumption = 5 billion euros, total wages for the entire economy are 4 billion, investment = 2 billion euros, Spanish firms make 5 billion worth of profits, the federal government spends 1 billion and the state and local governments spend 2 billion, imports are 1 billion and exports are 10 billion, interest income is 7 billion and the owners of capital get 3 billion. Show your work and write down the equation needed to calculate GDP according to the income approach.

ANSWER:
total wages = 4 billion profits = 5 billion

interest income = 7 billion rents = 3 billion GDP = wages + interest + rents + profits + purchases from other firms = 19 billion