Fill This Form To Receive Instant Help
Fill This Form To Receive Instant Help
Homework answers / question archive / Question 1 Economists use economic models to replicate real life situations for economic policy
Question 1
Economists use economic models to replicate real life situations for economic policy. Production possibilities frontier is one of the few economic models used to explain the behavior of economies. You are supposed to use a production possibilities frontier to show society's trade-off between two "goods" - a clean environment and the quantity of industrial output. What factor do you think determines the slope of the frontier? Illustrate what happens to the frontier if engineers develop a new way of producing electricity that emit lesser pollutants.
Question 2
a) Elucidate how an economy's income must always equal its expenditure.
b) Assume a hypothetical economy that produces only one good - Peanut Butter. In year 1, the quantity produced is 4 packs and the price is Rs.400 per pack. In year 2, the quantity produced is 5 packs and the price is Rs.500 per pack. In year 3, the quantity produced is 6 packs and the price is Rs.600 per pack. Year 1 is the base year.
a. What is nominal GDP for each of these three years?
b. What is real GDP for each of these years?
c. What is the GDP deflator for each of these years?
d. What is the percentage growth rate of real GDP from year 2 to year 3?
e. What is the inflation rate as measured by the GDP deflator from year 2 to year 3?
f. In this one-good economy, how might you have answered parts (d) and (e) without first answering parts (b) and (c)?
Answer 2
a) An economy's income must equal its expenditure, because every transaction has a buyer and a seller. That is each rupee of someone's spending becomes each rupee of someone's income. Thus, expenditure by buyers must equal income to seller.
b)
(a) Nominal GDP is calculated at current price
Nominal GDP in year 1 = Quantity * Price for 1 year = 4 * Rs 400 = Rs 1600
Nominal GDP in year 2 = Quantity * Price for 1 year =5 * Rs 500 = Rs 2500
Nominal GDP in year 3 = Quantity * Price for 1 year = 6 * Rs 600 = Rs 3600
(b) Real GDP is calculated at base year price that is year 1
Real GDP in year 1 = Quantity * Price for 1 year = 4 * Rs 400 = Rs 1600
Real GDP in year 2 = Quantity * Price for 1 year = 5 * Rs 400 = Rs 2000
Real GDP in year 3 = Quantity * Price for 1 year = 6 * Rs 400 = Rs 2400
(c) GDP deflator = (Nominal GDP / Real GDP ) * 100
GDP deflator for year 1 = 1600 / 1600 * 100 = 100
GDP deflator for year 2 = 2500 / 2000 * 100 = 125
GDP deflator for year 3 = 3600 / 2400 * 100 = 150
(d) percentage growth rate of real GDP from year 2 to year 3 = (Change in real GDP over the period / Real GDP in year 2) *100
That is 2400 - 2000 /2000 * 100 = 20 %
(e) inflation rate as measured by the GDP deflator from year 2 to year 3 = (Change in GDP deflator over the period / GDP deflator in year 2 ) * 100
That is 150 - 125 / 125 * 100 = 20%
(f) For one good economy percentage growth rate of real GDP is same as rate of growth in production
Moreover, inflation rate measured by GDP deflator is same as the usual inflation rate over the period
Therefore we could have answered (d) and (e) without answering (b) and ( c)
