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Mankiw, Chapter 2
Study Questions
1.
Suppose Real GDP and Nominal GDP both rise in 1998, but Real GDP rises at a faster rate than
Nominal GDP. What does this imply about inflation in 1998?
2.
Explain why Real GDP is a better measure of overall production in an economy than Nominal GDP.
3.
Explain how it would be possible for Real GDP to rise at the same time that Real GNP falls.
4.
(10 points) When the average level of prices in a country falls, economists say that the country is
experiencing deflation.
a. (5 points) If a country is experiencing deflation, what does this imply about the country's GDP
Deflator? Answer in one or two sentences.
b. (5 points) Suppose a country is experiencing deflation and that Nominal GDP is rising. Explain in
1 or 2 sentences what these facts imply about Real GDP. (Is Real GDP rising, falling, or
indeterminate -- and why?)
5.
(10 points) In late January of 1994 the Commerce Department reported that Real GDP grew at a
seasonally adjusted annual rate of 5.9% in the fourth quarter of 1993.
a. (5 points) Is this growth best considered as "strong," "weak," or "average?" Explain in one or two
sentences.
b. (5 points) Suppose a newspaper columnist writes that "... most of the growth during this quarter
was due to the strong demand generated by the Christmas holidays." Would you agree? Explain
in one or two sentences why or why not.
6.
a.
b.
7.
(5 points) In late January of 1994 the Commerce Department reported that Real GDP grew at a
seasonally adjusted annual rate of 5.9% in the fourth quarter of 1993. Suppose that today (October
12, 1995) you look up historical data on Real GDP growth. Explain in one or two sentences why
the entry for 1994 Real GDP growth will probably NOT be 5.9%.
(5 points) In late March of 1998, the US Department of Commerce will release a report on GDP
in the United States. For which quarter of which year will this report describe the level of GDP?
(10 points) Consider the following data:
Year
Nominal GDP
(Billion $)
Real GDP
(Billion 1987$)
1973
1975
1,349.6
1,585.9
3,268.6
3,221.7
Explain why Nominal GDP is so much less than Real GDP during both of these quarters.
SAMPLE ANSWERS
1.
If Real GDP rises at a faster rate than Nominal GDP, then the ratio (Nominal GDP / Real GDP)
decreases, which means that the GDP Deflator decreases. When the GDP Deflator decreases, the
overall average level of prices in the economy falls, which in turn means that the inflation rate is
negative. Negative inflation is sometimes referred to as deflation.
Chapter 2 Study Questions
Page 2
2.
Real GDP is a better measure of overall production in the economy than Nominal GDP because
Nominal GDP can change with changes in prices even if overall production does not change. Real GDP
is constructed using base year prices, so unlike Nominal GDP, Real GDP cannot change with price
changes -- because it assumes prices never change!. Real GDP changes only when the overall level of
production changes. Changes in the overall level of production change Nominal GDP as well, but they
are not the only things that change Nominal GDP: price changes also cause Nominal GDP to change.
3.
Real GDP is the value at base year prices of production within the borders of a country (call it Country
A), whereas Real GNP is the value at base year prices of production using labor and property owned by
the residents of a country. Suppose the level of production within the borders of Country A rises, but
that all of this increase is due to an increase in production with labor and property owned by foreign
residents. Thus the rise in production causes the Real GDP of Country A to rise, while there is no
effect on the Real GNP of Country A. At the same time, suppose there is a decrease in the level of
production in other countries attributable to the labor and property owned by residents of Country A.
This means that the Real GNP of Country A falls.
4.
a.
b.
The GDP Deflator is decreasing over time.
GDP Deflator = Nominal GDP/Real GDP. If the deflator is falling, then the ratio of nominal to
real GDP is falling. If Nominal GDP is rising, the only way the ratio can fall is if Real GDP is
rising by more (in percentage terms) than Nominal GDP is rising.
5.
a.
b.
This is “strong growth.” Average is 2.5 - 3.0 percent.
No. Reported GDP numbers are seasonally adjusted, so the normal Christmas increase is taken
into account. To be true, the statement would have to say “stronger than normal” holiday sales.
6.
a.
The January 1994 report of 1993:4 GDP was the initial estimate. Most likely, it was subsequently
revised several times.
This will be the “final estimate” of 4th quarter 1997 GDP.
b.
7.
Prices were much lower in 1973 and 1975 than in the base year of 1987.