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Problems on GDP Calculation

Suppose that initially actual and natural real GDP both equal 11,000 and that the rate of inflation is 3.5 percent. Natural real GDP grows by 3 percent per year over the next five years. Actual real GDP decreases by 2 percent in the first year, but then grows by 4 percent in the second year, 5.5 percent in the third year, 4.2 percent in the fourth year, and 3.5 percent in the fifth year. Inflation in years 1-5 equals 3.1 percent 2.2 percent, 1.6 percent, 1.3 percent, and 1.1 percent, respectively.
Calculate natural real GDP for years 1-5
Calculate actual real GDP for years 1-5
Calculate the output ratio for year 1-5
Calculate the cumulative loss of output for years 1-5
Calculate the sacrifice ratio

Suppose that natural real GDP is constant. For every 1 percent increase in the rate of inflation above its expected level, firms are willing to increase real GDP by 2 percent. The output ratio is initially 100 and the inflation rate equals 2 percent.
Based upon the preceding information, draw the short-run Phillips Curve.
What is the growth rate of nominal GDP in the economy?

An Adverse Supply shock raises the inflation rate associated with every output ratio by 3 percentage points.
Draw the new short-run Phillips Curve
The government chooses to follow a neutral policy in response to this shock. What will be the growth rate of nominal GDP? What will be the new rate of inflation? What will be the output ratio?
If the government chooses to follow an accommodating policy what would be the new inflation rate? The output ratio? The growth rate of nominal GDP?
If the government chooses to follow an extinguishing policy, what would be the new inflation rate? The output ratio? The growth rate of nominal GDP?

Solution Preview

The question that you have here is in a form that most schools do not use today! The actual real GDP is what most people call the real GDP, and the natural real GDP is what most people call the potential GDP.

The growth rate of natural real GDP is called the potential growth rate and is assumed to be constant over the short run. The actual real GDP on the other hand is the actual output, and hence can vary from the natural real GDP, and it does so for most cases.

When you say that initially the actual and natural real GDP both equal 11000, this means that you are starting at full employment (the rate when unemployment rate = natural rate of unemployment, also called non-accelerating inflation rate of unemployment or NAIRU). This basically means it is the sustainable rate of growth.

The natural real GDP growth is given to be 3% per year for the next five years, starting at 11000. So the natural real GDP after each of the next five years is given by the compounded growth value of ...

Solution Summary

The problem set defines the various types of GDP: real GDP, nominal GDP and illustrates how those are calculated with an hypothetical example.

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