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Introduction to Economic Growth and Instability Topics Covered: Nominal vs. Real income - Economic Growth - Business Cycle – Unemployment - Inflation True or False: 1) In an economy characterized by persistent inflation, nominal GDP will usually be greater than real GDP. 2) If nominal GDP in one year is kd 5,000 billion and the price index is 135, the real GDP that year is kd 3,704 billion. 3) If the price level rises from 125 to 150 from one year to the next, then the rate of inflation that year is 15 percent. 4) The nominal interest rate is the sum of the real interest rate and the premium paid to the lender to offset the expected rate of inflation. 5) If real GDP is 50 and nominal GDP is 100, the GDP price index is 200. 6) Economic growth is defined as the increase in nominal GDP which occurs over a period of time. 7) If the total population is 175 million, the labor force is 100 million, and 89 million workers are employed, then the unemployment rate is 11 percent. 8) Official unemployment statistics overstate unemployment because discouraged workers who are not actively seeking work are counted as unemployed. 9) Okun's law suggests that every 1 percentage point increase in unemployment above the natural rate of unemployment gives rise to a 2 percent GDP gap. 10) People who work part time, but desire to work full time, are considered to be officially unemployed. 11) The business cycle is so named because upswings and downswings in business activity are equal in terms of duration and intensity. 2 Multiple choice: 1) The GDP deflator or price index equals : A) B) C) D) gross private domestic investment less the consumption of fixed capital gross national product less net foreign factor income earned in Kuwait . nominal GDP divided by real GDP . real GDP divided by nominal GDP. 2) If the price index is 130, this means that : prices are 130 percent higher than in the base year . prices are .13 times higher than in the base year . prices are 30 percent higher than in the base year . nominal GDP must be inflated to determine the real GDP. A) B) C) D) Year Price Index 1 100 2 95 3 105 4 125 5 125 3)Refer to the above table. Inflation occurs between years : A) B) C) D) 1 and 2 . 2 and 4 . 4 and 5 . 5 and 6. 4) Refer to the above table. From year 1 to 2 : A) B) C) D) there is inflation . prices are stable . there is deflation . there is hyperinflation. 5) Refer to the above table. From year 3 to year 4, the price level is: A) B) C) D) Year 1 2 3 increasing. decreasing. both increasing and decreasing. constant. Nominal GDP 5200 5500 5740 Real GDP 4800 Price Index 112 5000 6) Refer to the above table. What is the GDP price index in Year 1 ? A) B) C) D) 105.2 108.3 109.6 111.5 6 120 3 7) Refer to the above table. What was real GDP in Year 2 ? A) B) C) D) kd 4,820 kd 4,875 kd 4,911 kd 5,320 8) Nominal GDP differs from real GDP because : A) B) C) D) nominal GDP is based on constant prices . real GDP is based on current prices . real GDP is adjusted for changes in the price level . nominal GDP is adjusted for changes in the price level. Norminal GDP Nominal and Real GDP Real GDP 1996 Time 9) Which of the following statements is correct on the basis of the diagram above ? A) B) C) D) Real GDP must be deflated in each year after 1996 to determine nominal GDP . Nominal GDP must be inflated in each year since 1996 to determine real GDP . Nominal GDP must be deflated in each year before 1996 to determine real GDP . Nominal GDP must be inflated in each year before 1996 to determine real GDP. 10) If real GDP declines in a given year, nominal GDP : A) B) C) D) must decline . must increase . may either rise or fall . is likely to remain constant. 11) In year 1, nominal GDP for a nation was kd 3,053 billion and the price index was 94. In year 2, nominal GDP was kd 3,166 billion and the price index was 100. To make year 1 GDP comparable with the year 2 (base year) GDP, the year 1 GDP must be : A) B) C) D) inflated to kd 3,368 billion . inflated to kd 3,248 billion . deflated by 11 percent . inflated by 8 percent. 4 12) Which measure of inflation would include consumer goods and capital goods? A) B) C) D) the GDP price index the consumer price index the Retail Trade Survey the Survey of Manufactures 13) One year nominal GDP was kd 286 billion and the price index was 88. Real GDP that year was : A) B) C) D) kd 252 billion . kd 325 billion . kd 308 billion . kd 262 billion . 14) If real GDP in a year was kd 3,668 billion and the price index was 112, then nominal GDP in that year was approximately : A) B) C) D) kd 3,846 billion . kd 3,925 billion . kd 4,108 billion . kd 4,379 billion . 15) The rate of economic growth is best defined as the: A) B) C) D) percentage increase in real GDP over time. increase in investment as a percentage of GDP over time. percentage increase in consumption expenditures over time. percentage increase in the quality of capital, human, and natural resources which occurs over time. 16) The best measure of economic growth adjusted for the population of a nation is the increase in: A) B) C) D) aggregate demand over time. real GDP per worker over time. real GDP per capita over time. real GDP per dollar of capital stock over time. 17) Real GDP was kd 9,950 billion in Year 1 and kd 10,270 billion in Year 2. What was the approximate rate of economic growth from Year 1 to Year 2? A) B) C) D) 1.6 percent 2.4 percent 3.2 percent 4.3 percent 18) Real GDP was kd 9,950 billion in Year 1 and kd 10,270 billion in Year 2. The population rose from 270 million in Year 1 to 275 million in Year 2. What was the approximate increase in real GDP per capita rate from Year 1 to Year 2? A) C) 1.3 percent 3.3 percent B) D) 2.1 percent 4.2 percent 5 19) Nominal GDP was kd 9,500 billion in Year 1 and kd 10,000 billion in Year 2. The GDP price index was 170 in Year 1 and 175 in Year 2. Between Years 1 and 2, the rate of growth in real GDP was approximately: A) B) C) D) 1.6 percent. 2.3 percent. 4.4 percent. 5.3 percent. 20) Data on the growth of real GDP and real GDP per capita understate economic growth because they : A) B) C) D) fail to account for increases in the workweek . fail to account for improvements in product quality . do not take into account improvements in education . take into account changes in resource allocation. 21) The diagram is best described as an idealized : A) B) C) D) business cycle . cyclical variation . recession cycle . prosperity cycle. A E B D C Time 22) Refer to the above diagram. The phases of the business cycle from points A to D are, respectively : A) B) C) D) peak, recession, recovery, trough . trough, recovery, expansion, peak . expansion, recession, trough, peak . peak, recession, trough, recovery. 23) Which phase of the business cycle would be most closely associated with an economic contraction ? A) B) C) D) peak recession trough recovery 24) In the recovery phase of a business cycle : A) B) C) D) the inflation rate decreases, but productive capacity increases. the inflation rate and productive capacity decrease . employment increases, but output decreases . employment and output increase. 6 25) A recession is defined as: A) B) C) D) a fall in the natural rate of unemployment. a rise in the natural rate of unemployment. a fall in real GDP that lasts six months or longer. the minimum point in the business cycle before the recovery phase. 26) The level of total spending is the immediate determinant of the : A) B) C) D) ratio of private to public goods production . level of real output and employment . size of the labor force . Structure of the labor force . 27) Which is the correct way to calculate the unemployment rate ? A) B) C) D) [(unemployed)/(population)] x 100 [(unemployed)/(labor force)] x 100 [(labor force)/(population)] x 100 [(labor force)/(unemployed)] x 100 28) Assuming the total population is 200 million, the labor force is 100 million, and 92 million workers are employed, the unemployment rate is : A) B) C) D) 4 percent . 6 percent . 8 percent . 10 percent. 29) A nation has a population of 260 million people. Of these, 60 million are retired, in the military, in institutions, or under 16 years old. There are 188 million who are employed and 12 million who are unemployed. What is the unemployment rate ? A) B) C) D) 4 percent 6 percent 9 percent 27 percent 30) In an economy, 35 million workers are employed out of a labor force of 50 million and a total population of 70 million. The unemployment rate is : A) B) C) D) 15 percent . 25 percent . 30 percent . 50 percent. 31) The unemployment rate in an economy is 12 percent. The civilian labor force is 50 million. The number of employed workers in the economy is : A) B) C) D) 38 million . 40 million . 42 million . 44 million. 7 32) In calculating the unemployment rate, "discouraged" workers who are not actively seeking employment are : A) B) C) D) excluded . included . treated the same as part-time workers . used to determine the size of the labor force. 33) In calculating the unemployment rate, part-time workers are : A) B) C) D) counted as unemployed because they are not working full-time . counted as employed because they are receiving payment for work . used to determine the size of the labor force, but not the unemployment rate . treated the same as "discouraged" workers who are not actively seeking employment. 34) Official unemployment rate statistics may : A) B) C) D) overstate the amount of unemployment by including part-time workers in the calculations . understate the amount of unemployment by excluding part-time workers in the calculations . overstate the amount of unemployment because of the presence of "discouraged" workers who are not actively seeking employment . understate the amount of unemployment because of the presence of "discouraged" workers who are not actively seeking employment. 35) A headline reads: "Steel industry suffers slump as import competition increases; unemployment rises." This type of unemployment can best be characterized in economic terms as : A) B) C) D) frictional . structural . cyclical . natural. 36) The best example of a "frictionally unemployed" worker is one who : A) B) C) D) reduces productivity by causing frictions in a business . is laid off during a recessionary period in the economy . is in the process of voluntarily switching jobs . is discouraged and not actively seeking work. 37) A headline states: "Real GDP falls again as the economy slumps." This condition is most likely to produce what type of unemployment ? A) B) C) D) structural cyclical frictional natural 8 38) The natural rate of unemployment: A) B) C) D) means that the economy will always operate at its natural rate. means that the economy will always realize its potential output. is equal to the total of frictional and structural unemployment. is a fixed unemployment rate that does not change over time. 39) The GDP gap measures the amount by which: A) B) C) D) nominal GDP exceeds real GDP. actual GDP exceeds potential GDP. potential GDP exceeds actual GDP. actual GDP exceeds national income. 40) The amount by which potential GDP exceeds actual GDP is one measure of the: A) B) C) D) natural rate of unemployment. aggregate cost of unemployment. difference between real and nominal GDP. difference between real and nominal income. 41) Okun's law indicates that for: A) B) C) D) every 1 percent that the actual unemployment rate exceeds the natural unemployment rate, there is generated a 2 percent GDP gap. every 1 percent that the actual unemployment rate exceeds the natural unemployment rate, there is generated a 5 percent GDP gap. a 5 percent GDP gap, there is generated a 1 percent increase in the natural unemployment rate. a 2 percent GDP gap, there is generated a 2 percent increase in the actual unemployment rate. 42) If the natural rate of unemployment is 4.5 percent and the actual unemployment rate is 6.5 percent, then Okun's law indicates that the GDP gap is: A) B) C) D) 2 percent. 3 percent. 4 percent. 6 percent. 43) In an economy nominal GDP is kd 4,000 billion. The actual unemployment rate is 8 percent and the natural rate of unemployment is 6 percent. According to Okun's law there will be: A) B) C) D) kd 80 billion lost in potential output. kd 100 billion lost in potential output. kd 160 billion lost in potential output. kd 300 billion lost in potential output. 9 44) Inflation is a rise in: A) B) C) D) the general level of prices over time. the standard of living over time. industrial production. real GDP. 45) The consumer price index was 115 one year and 120 the next year. The rate of inflation from one year to the next was approximately: A) B) C) D) 2.2 percent. 2.9 percent. 3.4 percent. 4.3 percent. 46) The consumer price index was 247 in year 1 and 272 in year 2. The rate of inflation in year 2 was: A) B) C) D) 12 percent. 10 percent. 8 percent. 6 percent. 47) Over a ten-year period, the consumer price index doubled. On the basis of this information we can say that the average annual rate of inflation over this period was approximately: A) B) C) D) 10 percent. 9 percent. 7 percent. 5 percent. 48) If the annual inflation rate is 5 percent a year, about how many years will it take for the price level to double? A) B) C) D) 10 years 12 years 14 years 16 years 49) Inflation that occurs when total spending is greater than the economy's ability to produce output at the existing price level is: A) B) C) D) anticipated inflation. demand-pull inflation. cost-push inflation. unanticipated inflation. 50) Inflation caused by a rise in per unit production costs is referred to as: A) B) C) D) cost-push inflation. demand-pull inflation. unanticipated inflation. hyperinflation. 10 51) You are given the following information about the economy: (1) nominal interest = 8 percent; (2) real rate of interest = 6 percent. The inflation premium is: A) B) C) D) 2 percent. 6 percent. 8 percent. 14 percent. 52) Demand-pull inflation: A) B) C) D) occurs when prices of resources rise, pushing up costs and the price level. occurs when total spending exceeds the economy's ability to provide output at the existing price level. occurs only when the economy has reached its absolute production capacity. is also called cost-push inflation. 53) "Too much money chasing too few goods" best describes: A) B) C) D) the GDP gap. demand-pull inflation. the inflation premium. cost-push inflation. 54) Inflation initiated by increases in wages or other resource prices is labeled: A) B) C) D) demand-pull inflation. demand-push inflation. cost-push inflation. cost-pull inflation. 55) Cost-push inflation: A) B) C) D) is caused by excessive total spending. shifts the nation's production possibilities curve leftward. moves the economy inward from its production possibilities curve. is a mixed blessing because it has positive effects on real output and employment. 56) During a period of hyperinflation: A) B) C) D) creditors gain because their loans are repaid with dollars of higher value. people tend to hold goods rather than money. income is redistributed away from borrowers. the real value of the national currency rises. 57) Inflation affects: A) B) C) D) both the level and the distribution of income. neither the level nor the distribution of income. the distribution, but not the level, of income. the level, but not the distribution, of income. 11 Essay Questions: What is meant by the term business cycle? List the four phases of the business cycle. What are two criticisms of the unemployment rate? How do these criticisms relate to the overstating or understating of the unemployment rate? Explain the differences among the frictional, structural, and cyclical forms of unemployment. Define the “full-employment” or “natural” rate of unemployment and give its approximate percentage rate as economists currently define it. What is “demand-pull” inflation? Describe cost-push inflation and its major source. Some economists believe that creeping (moderate) inflation cannot be accepted because a gradual increase in prices leads to an ever-rising rate of inflation. Other economists argue that in order to achieve rapid economic growth, some moderate price increases are necessary and that rigid price stability would cause considerable unemployment. Contrast and evaluate these two points of view. Problems: (1) The next four questions refer to the following price and output data over a five-year period for an economy that produces only one good. Assume that year 2 is the base year. Year 1 2 3 4 5 Units of output 16 20 30 36 40 Price per unit kd 2 3 4 5 6 (a) If year 2 is the base year, give the price index for year 3. (b) Give the nominal GDP for year 4. (c) What is the real GDP for year 4? (d) Tell which years you would deflate nominal GDP and which years you would inflate nominal GDP in finding real GDP. 12 (2) The following data show nominal GDP and the appropriate price index for several years. Compute real GDP for each year and indicate whether you have “inflated” or “deflated” nominal GDP in finding real GDP. All GDP are in billions. Year 1 2 3 4 5 6 Nominal GDP kd117 124 143 149 178 220 Price level index 120 104 85 96 112 143 Real GDP ___ ___ ___ ___ ___ ___ Inflated (I) Deflated (D) ___ ___ ___ ___ ___ ___ (3) Suppose an economy's real GDP is kd 50,000 in year 1 and kd 55,000 in year 2. What is the growth rate of its GDP? Assume that population was 100 in year 1 and 105 in year 2. What is the growth rate in GDP per capita? (4) Use the following data to calculate: (a) the size of the labor force and (b) the official unemployment rate. Total population 1,500; population under age 16 and institutionalized, 360; not in labor force, 450; unemployed, 69; workers with part-time jobs who are looking for full-time jobs, 30.