Download Quiz 1: Winter 2004

Quiz 1: Winter 2006
Macroeconomics (Circle Section Registered Below)
Name _________________________
Section: Tues 1:30 Tues 3:00
Tues 6:00
Put answers in the space provided!!!! Calculators are allowed. Very limited partial credit will
be given if we can follow your though process. As a result, show your work by writing down
relevant formulas. If we can EASILY follow your work, we will give some partial credit if you
get a wrong answer. If we cannot EASILY follow your work, no partial credit will be given!
Quiz is out of 20 points.
Question 1 (parts a and b)
Below are the nominal sales for a fictitious company during the previous six years (in billions):
2000
2003
$1.532
$1.554
2001
2004
$1.517
$1.594
2002
2005
$1.433
$1.649
The CPI is reported monthly by the Bureau of Labor Statistics (BLS). Below are the June CPI
figures for all U.S. urban consumers between the years of 2000 and 2005. You are to deflate all
nominal variables in the economy by the appropriate June CPI figures for each year. The base
year for the current CPI is 1982-1984 (the actual base year is not important for this analysis – but
if it makes you feel better you can think of it as being July of 1983).
2000
2003
a.
1.722
1.837
2001
2004
1.778
1.893
2002
2005
1.797
1.941
In 2005 dollars, what are the real sales for this company in 2000? --- 4 points
Real Sales 2000 (in $2005) = (Nominal Sales 2000/ [CPI 2000]) * [CPI 2005]
As in the supplemental notes, using this formula converts the 2000 sales into base year
prices than scales them back up by 2005 prices.
In this example = [1.532/1.722] * [1.941] =
b.
$1.727
In 2005 dollars, what was the real change in sales for this company between 2000 and
2002? (Use the exact formula) --- 4 points.
To compute the real growth in sales between 2000 and 2002 (in 2005 prices), we need to
compute real sales in 2000 in 2005 prices and real sales in 2002 in 2005 prices. We
computed real sales in 2000 in 2005 prices above. We now need to compute real sales in
2002 in 2005 prices. To do this, we use the following formula.
Real Sales 2002 (in $2005) = (Nominal Sales 2002/ [CPI 2002]) * [CPI 2005]
= ($1.433/1.797) * [1.941]
= $1.548
The real growth in sales between 2000 and 2002 will be (all in 2005 dollars):
=
=
[Real sales 2002 – real sales 2000] / real sales 2000
[1.548 – 1.727] / 1.727
=
-10.36%
I did not specify that the answer should be a growth rate. So, another valid answer is:
=
=
[Real sales 2002 – real sales 2000]
[1.548 – 1.727]
=
-0.179
Note: You needed to have the negative signs to get this correct (one of the points of the
question is to determine that sales fell in real terms!) You will loose 1 point for not having
the negative sign.
Question 2 --- 4 points
In class, we learned how to compute expected real interest rates in the economy. Suppose that
you were given the following information:
1) Real GDP growth between 2005 and 2006 is
expected to be 4%, 2) The inflation rate between 2005 and 2006 is expected to be 3%, 3)
Investment is suppose to grow at 6% between 2005 and 2006, and 4) nominal interest rates on a
one year risk free loan (i.e., a one year Treasury) between 2005 and 2006 is 5%. Given this
information, what is the expected real interest rate on a one year risk free loan between 2005 and
2006? (Note: All information is not necessary – Use the approximation formula (the one given
in class when discussing inflation). Show your work (including formulas used). Put your answer
in the box.
This one was really easy. re = i – πe (this came directly from the notes)
where re is the expected real interest rate, i is the nominal interest rate, and π e is the
expected inflation rate. If I borrow a dollar today at rate i, some of that payment is going
to compensate the lender for the fact that they are letting me borrow money (r) and some of
that payment is going to compensate the lender for the fact that the amount they lent to me
is worth less when I pay it back than when I borrowed it (π).
None of the other information is relevant (expected gdp growth does not enter into the real
interest rate calculation nor does growth in investment). As the course progresses, we will
see that these other variables are related – but not by definition!
So, expected real interest rates equal: 5% -3% = 2% (this is technically an approximation)
The actual formula for real interest rates is:
(1 + r) = (1 + i)/(1+π)
or r = (1 + i)/(1+π) - 1
This would imply the actual real interest rate would be 1.94% (or approximately
2%).
See notes on real vs nominal for details.
If you knew the simple definition of real interest rates, this was a very easy question!
Question 3 -- 5 points total – 1 point each for correctly assessing whether each answer is true
Which of the following statements are true? (Circle the true answers)
I think all of these were fairly straight forward. Go to the lecture notes to see details of all
the answers.
a.
Real GDP always equals nominal GDP in the base year of a price index.
True – this is a definition: Real Variable (in t) = Nominal Variable (in t) /PI (in t)
If year t is the base year, PI (in t) is 1. So, by definition, Real Variable (in t) = Nominal
Variable (in t).
b.
By definition, investment equals private savings plus public savings plus net exports.
False: I = S(hh) + S(gvt) – NX. It should be “less net exports” not “plus net exports”.
c.
In the short run, increases in aggregate demand will cause rising real incomes and
rising prices.
True – A shift out to the right in AD will increase output and increase prices.
d.
True:
e.
False:
By definition, national savings in the economy equals total income less government
spending less consumption.
S = Y – C – G = I + NX (this is straight from are algebra definitions).
During every recession of the past 35 years, consumption growth has been close to
zero or negative.
As we discussed during last week, during the 2001 recession, consumption
growth was very strong. This is something we are going to revisit as the
class progresses.
Question 4 --- 3 points
In the article “Fighting America’s Inflation Flab” (from October of 2000), the Economist noted
that the Federal Reserve in 2000 was favoring another price index over the CPI to measure the
increase in prices of consumer goods. What was the name of the deflator that the Fed preferred?
(The whole article was about comparing the CPI to this deflator – Note: GDP deflator is NOT the
correct answer!). [Your answer should only be 4 words, one of which should be deflator (or 3
letters and the word deflator if you want to give the abbreviation). If you give more than 4 words,
points will be deducted].
Personal Consumption Expenditure Deflator (PCE deflator). I gave full credit if you said
“consumption deflator” or something that included the word consumption and deflator in
your answer. Also, some of you wrote CPE deflator – that is close enough. I am not testing
your memory of things – i just want to make sure people are keeping up with the reading.
Having a sense of the answer lets me know that you did the reading (and internalized some
of the material in the article).