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Economics 304
Homework #1 – A ride into reality!
Due Wednesday, 1/27, at the beginning of class - no late papers accepted!
Instructions: Please show all work or points will be taken off. Good luck!
1. (50 points total) In this first homework assignment, we are getting our ‘hands dirty’ to
get familiar with some of the major macroeconomic variables that we will be using and
working with throughout the semester. Our first chapter with ‘something to sink our teeth
into’ is chapter 3 and it is all about the factors of production, the labor market, and of
course, the production function. Major variables in this part of the macroeconomy (i.e.,
the supply side of the economy) include, but certainly are not limited to, employment
(denoted N), real wages (denoted w = W/P where W = nominal wage and P is the price
index - typically the CPI) and real GDP (denoted Y). When we move to chapter 4 we
encounter many more major macroeconomic variables including consumption (C),
investment (I), and the real interest rate (denoted r), among others. We are going to use
FRED as our source of data (many professional economists use this site, nice clean
data!)1
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FRED stands for Federal Reserve Economic Data.- click Here for the FRED website
Use the following link to answer part a) below
Click Here for data on the MW
a) (5 points) What would the minimum wage have to be in 2014 to equal the purchasing
power of the minimum wage in 1960? Please take the price index to two decimal places.
First, figure out PI in 1960 and in 2014:
1960: $1.00/ PI = 5.30 ..... PI = 18.87
2014: $7.25 / PI = 4.82 .....PI = 150.41
$1.00 / .1887 = MW14 / 1.5041.....MW14 = $7.97
The fall in oil prices have been making the headlines for some time now. We are going
to use the following two links to answer parts b) and c). Please take all calculations to
two decimal places.
Click Here for oil prices (click on 'view data' on left to obtain the values)
Click Here for the CPI (again, use the view data tab to obtain the values)
b) (5 points) Calculate the percent change in real oil prices over the most recent 10 year
period (from 2005-12-01 - 2015-12-01).
2005-12-01
59.41
2015-12-01
37.21
2005-12-01
198.100
2015-12-01
237.847
real oil price in 2005 = 59.41/1.981 = 29.99
real oil price in 2015 = 37.21/2.37847 = 15.64
% change = ((29.99 - 15.64) / 29.99) = - 47.85%
c) (5 points) What would the (nominal) price of oil need to be in Dec. 2015 so that the
real price of oil in Dec. 2015 would equal the real price of oil in Dec. of 2005?
X / 2.37847 = 59.41/1.981 .....X = $71.33
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Use the article on the cost of living in PA to answer parts d) and e)
d) (5 points) Assuming that Centre county is the base county, what is the price index in
Clearfield county? In Allegheny county?
•
Centre, $25,300
•
Clearfield, $19,200
•
Allegheny, $28,700
For Clearfield: (19,200/25,300) x 100 = 75.89
For Allegheny: (28,700/25,300) x 100 = 113.44
e) (5 points) Assume that you received a job offer in Allegheny county for $80,000. What
offer would you need to receive in 1) Centre county and 2) Clearfield county to achieve
the same purchasing power as $80,000 in Allegheny county.
For Centre: $80,000 / 1.1344 = X / 1.00.........X = $70,521.86
For Clearfield: $80,000 / 1.1344 = X / .7589.........X = $53, 519.04
Use the following links to answer the following questions:
For Nominal Wages (W)
Price index CPI (P) 2
Click Here
Click Here
f) (5 points) Calculate the real wage in December of 1995 and then in December of 2000
and calculate the % change in the real wage during this time.
1995-12-01
11.81
2000-12-01
14.29
1995-12-01
153.900
2000-12-01
174.600
w95 = 11.81/1.539 = 7.67
w00 = 14.29 /1.746 = 8.18
%Δw = ((8.18 - 7.67)/7.67) = 6.65%
g) (5 points) Calculate the real wage in December of 2010 and then in December of 2015
and calculate the % change in the real wage during this time.
2010-12-01
19.23
2015-12-01
21.22
2010-12-01
220.472
2015-12-01
237.847
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Hint, when deflating using a price index, move the decimal two places to the left. For example, in 12/09
W = $18.84 and the price index was 217.347. The real wage is thus 18.84 divided by 2.17347 = 8.67
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w10 = 19.23/2.20472 = 8.722
w15 = 21.22 /2.37847 = 8.922
%Δw = ((8.922 - 8.722)/8.722) = 2.29%
h) (15 points) My guess is that most of the class is somewhere around 20 years old. In the
space below (please make space by hitting enter), draw a diagram with the real wage
denoted (w) on the vertical axis and employment on the horizontal axis. Use link below
for employment data.
Employment (N)
Click Here (click on view data on left)
Plot two points on this diagram - point A that represents the real wage and employment in
December of 1995 and then plot point B as the real wage and employment for December
of 2015. Your graph should have two points and no lines. What is the percent change in
the real wage during this period and how many more people are employed during this
most recent 20 year period? Please make sure you completely label graph.
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2. (40 POINTS total)
Excerpt from the WSJ, 1/21/2016
By
Paul Hannon and
Todd Buell
Updated Jan. 21, 2016 11:13 a.m. ET
27 COMMENTS
FRANKFURT—European Central Bank President Mario Draghi Thursday signaled that
the governing council may provide more stimulus at its next meeting in March, noting
that the outlook for inflation had weakened “significantly.”
It seems like the macroeconomic 'buzzword' Quantitative Easing (QE) has returned - the
Fed in the US conducted three rounds of QE with the third jokingly referred to as "QE
infinity." As we know, the Fed is done with QE, at least for now. The ECB earlier in
2015 announced similar plans (as above). Note that the ECB has an inflation target of
2%, just like the Fed.
Use the following link to answer part a)
Click Here for CPI data from the Eurozone!
a) (5 points) Calculate the rate of inflation for the Eurozone for the most recent two years:
from 11/13 - 11/14 and from 11/14 to 11/15
We now move on to the US. You will need to use the following links to answer this
question.
Nominal one year rates (i)
Click Here
Price index CPI (P)
Click Here
Expected Inflation
Click Here
In this part of question 2, we are going to compare the most recent one year real interest
rates in the US - both ex-ante and ex-post.
A couple notes are in order.
i) Expected inflation data is one year hence - so for example, expected inflation for the
period from July 2010 to July 2011 is given in July 2010 and if you view the data, the
expected inflation during this time is 2.7% = πe.
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ii) To calculate the actual rate of inflation, for example, during the July 2010 to July 2011
period you need to take the percent change in P = %Δ P. Using the CPI data, we have the
price index equaling 217.7 in 7/2010 (beginning of August given the end of month data)
and 225.6 in 7/2011 (end of July, 2011). Note, this is a 12 month period. The actual rate
of inflation during this time is 3.63% = π
iii) When using the one year nominal interest rate to calculate the all important real
rate(s) of interest we need to be careful. For example, using the same one year time
period (July 2010 - July 2011) we simply use the one year rate given as of July 2010.
Think of buying the bond in July 2010, putting it in a safety deposit box (or under your
mattress, a coffee can, etc.) and then cashing it in when it matures in July 2011 (you get
your principal times whatever the nominal interest rate is). In viewing the data, the one
year rate in July 2010 is 0.29%. So clearly (and by design of the Fed), both the ex-ante
and ex-post real rates are negative during this period and differ because expected
inflation was not equal to actual inflation.
b) (5 points) Using the most recent data (from 12/14 - 12/15) calculate the ex-post real
interest rate.
r = .21 - .66 r = -0.45%
2014-12-01
2015-12-01
236.284
237.847
c) (5 points) Given the most recent data, what is the ex-ante one year real rate of interest?
r = .65 - 2.6 r = -1.95%
d) (5 points) Assuming that the Fed feels that there is still significant slack in the
economy, that is, they wish that consumption was higher, which real interest rate does the
Fed want the consumer to consider, the ex-post or the ex-ante? Explain.
Exante! The real returns to savings are more negative - spend spend!
We discussed the evils of deflation.
e) (10 points) From a macroeconomic perspective, why is deflation so bad? Please refer
to consumer behavior and the corresponding behavior of firms in a deflationary
environment. Please explain completely.
Explain
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f) (10 points)Now discuss the fact that persistent deflation is the central bank's worst
nightmare Why is this environment such a nightmare for the central bank and monetary
policy and why is persistent deflation such a nightmare? Explain using the Fisher
equation for the real rate of interest and refer to both the ex-post and ex-ante real rate of
interest.
Use equation and explain why the persistent is so important!
3. (50 points total – 10 points each part) Real vs nominal GDP. When we get to chapter
three we consider a production function where the output of all our factors of production
is of course real GDP. Recall that Nominal GDP is the total value of goods and services
produced at current prices where real GDP is the total value of goods and services
expressed in constant prices (we deflate nominal GDP by a price index called the GDP
deflator). The links for the data used in this problem are below.
Nominal GDP
GDP Deflator (P)
GDP
GDPCTPI
a) Let us go back to the 1981 – 1982 recession – Click here for the NBER site. Note that
officially, this recession began in third quarter of 1981 and ended in the fourth quarter of
1982. Calculate the percent change in nominal GDP during this recession (for all
calculations use the data from 1981-07-01 to 1982-10-01 (GDP data is quarterly).
(3407.8 - 3261.2) / 3261.2 = 4.5%
b) Now calculate the percent change in the GDP price deflator during this recession.
(52.566 - 49.096)/49.096 = 7.1%
c) Now calculate the percent change in real GDP. Hint, calculate real GDP in 1981-07-01
and in 1982-10-01 and take the percent change.
(6482.9 - 6642.5)/6642.5
= - 2.4%
d) What is this period often referred to and why (starts with S!)?
Stagflation - explain!
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e) Finally, draw a graph with the general price level on the vertical axis (the GDP
deflator) and real GDP on the horizontal axis. Label the initial point (the beginning of
recession) as point A and the end point (the end of recession) as point B. Be sure to label
graph completely using the specific numbers you calculated above.
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