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Eco 302
Test 1
Name_______________________________
9 March 2011
Please write answers in ink. You may use a pencil to draw your graphs. Good luck.
1. Suppose the following table records the total output and prices for an entire economy.
Suppose further that the base year in the following table is 2008.
Year Price of Corn Dogs Quantity of Corn Dogs Price of Fresca Cans of Fresca
2008
$ 1.50
100
$2.00
100
2009
2.00
110
2.50
90
2010
3.00
120
3.00
100
a. Calculate nominal GDP for 2008, 2009, and 2010.
b. Calculate real GDP for 2008, 2009, and 2010.
c. Calculate the GDP deflator for 2008, 2009, and 2010.
d. Use the GDP deflator to determine the inflation rates for 2009 and 2010.
e. Was the increase in nominal GDP from 2008 to 2009 due to an increase in real output or
simply an increase in prices? Explain.
f. Would nominal GDP have increase from 2009 to 2010 if prices had not risen? Explain.
2008
2009
2010
$1.50
$2.00
$3.00
2008
2009
2010
$ 350.00
2008
2009
2010
$ 350.00
2008
2009
2010
100.00
100
110
120
$2.00
$2.50
$3.00
100
90
100
$ 445.00
$ 660.00
$ 345.00
$ 380.00
128.99
2009
29.0%
173.68
2010
34.7%
Because real GDP declined in 2009, the increase in nominal GDP was strictly due to prices.
Real GDP increased in 2010. Nominal GDP would have increased if prices had not changed.
2. The following table shows the prices and quantities of the typical market basket of goods
consumed in Dogville. The base year is 2008.
Year
Price of
Coke Zero
Quantity of
Coke Zero
2008
2009
2010
$2.00
3.00
4.00
100
90
90
Price of
Cheese
Puffs
$1.00
1.20
1.30
Quantity of
Cheese
Puffs
40
50
60
Price of
Ice Cream
Quantity of
Ice Cream
$1.00
2.00
3.00
60
80
70
a. Compute the cost of the market basket for each year.
b. Calculate the CPIs for 2008, 2009, and 2010.
c. Calculate the inflation rates for 2009 and 2010
200
300
400
40
48
52
2005
2006
2007
100
156
210.6667
2006
2007
56.0%
35.0%
60
120
180
300
468
632
3. During the Great Inflation of the 1970s, (a) the growth rates of M1 and M2 were higher
than previously, and (b) the growth rate of M2 was much higher than the growth rate of
M1. Explain how the high inflation of the decade relates to each of these facts.
By the quantity theory of money, rapid growth of the money supply (relative to the growth
rate of aggregate output) causes the inflation rate to be high. When inflation is high,
holding cash and non-interest bearing deposits is costly, so people shift as much money as
possible into interest -bearing accounts, so the narrow monetary aggregate M1 does not grow
as fast as the broader aggregate M2. By the Fisher effect, nominal interest rates rise with
expected inflation, so interest-bearing accounts provide some compensation for inflation.