Download QUESTIONS FOR DISCUSSION

QUESTIONS FOR DISCUSSION
1.
Microsoft sells operating systems, applications software, and technical services. How
would you compute changes in the volume of output from one year to the next? How
would price changes affect your computations?
Microsoft should measure the volume of its output by it market value,
not it’s physical quantity. The problem that Microsoft has with
measuring changes in the volume of output from one year to the next is
the same problem we have in measuring aggregate output. As a result,
the company should calculate a figure like real GDP.
Product price changes will, however, distort this number. Increases in
prices will make nominal GMP increase, even if physical output does not
increase. Microsoft needs to adjust GMP for changes in the market price
of its products by calculating real GMP. If it does not do so, and prices
rise or fall, the company will have a false reading of its physical volume.
2.
According to the Headline on p. 228, when did the U.S. economy go into a recession?
According to the Headline, the U.S. economy entered a recession during the
July-to-September quarter, when GDP fell by 0.4 percent on an annual basis.
However, as the generally-accepted definition of a recession is two consecutive
quarters of GDP contracting, it was too early to say that the economy was in a
recession.
3.
Could we ever achieve an unemployment rate below "full" employment? What problems
might we encounter if it did?
Yes, but as labor becomes relatively more scarce, workers are able to command
wage increases that could result in product prices increasing, i.e., the labor
shortage results in inflation.
4.
Have you ever had difficulty finding a job? Why didn't you get one right away? What
kind of unemployment did you experience?
Answers will vary, but should reflect structural, cyclical, and frictional reasons.
5.
Why might inflation accelerate as the unemployment rate declines?
As the unemployment rate declines, qualified workers become harder to find. As
a result, employers often must pay premiums to workers to attract them into the
labor force or away from current employers. The result is inflationary
6.
During the period shown in Table 10.4, what happened to
(a) the nominal price of gold, and
(b) the real price of gold during the period shown?
a) According to the information provided in the table, the nominal price of gold
declined by 29 percent.
b) Since price of gold fell by 29 percent it is 71 percent of its original value. At
the same time, because the average price of goods, i.e., the inflation rate, rose by
32 percent, they are 132 percent of their original values. The real price of gold
is $71/1.32 = $53.78. Thus, the price of gold is approximately 54 percent of its
original value or a real decline of 46 percent.
7.
According to Table 10.2, who was most adversely affected by price changes in
2002? Consumers who a) eat a bacon and egg breakfast, or b) just have coffee?
People who eat bacon and egg breakfast found that the price of bacon and eggs
both increased substantially (7.1% and 9.3%, respectively), while people who
just have coffee for breakfast found the price of coffee decreased (by 4.1%).
Ceteris paribus, those who eat a bacon and egg breakfast are adversely affected
by the price changes while those who have just coffee actually experience an
improvement in their standard of living.
8.
Which of the following people would we expect to be hurt by an increase in the
rate of inflation from 3 percent to 6 percent?
a.
A homeowner with a $50,000 fixed-rate mortgage on his home.
Whatever this person’s nominal mortgage (interest) rate was, the real
interest rate will decline by 3 percentage points. Ceteris paribus,
borrowers benefit from inflation.
b.
A retired person who receives a monthly pension of $500 from her former
employer.
This person’s purchasing power of the $500 fixed income will decline,
thus, this person is hurt by inflation.
c.
An automobile worker with a cost-of-living provision in his employment
contract.
Assuming that the cost-of-living provision is based on this rate of
inflation and results in a 6 percent increase in salary, this person’s
purchasing power will not change. This person will not be hurt or
benefited by inflation.
d.
A wealthy individual who owns corporate bonds that pays her an interest
rate of 8% per year.
Interest rates generally move in the same direction as inflation because
nominal interest rates include an inflation component. The values of
bonds move in the opposite direction of the movement in interest rates.
As a result, the value of the bonds declines as inflation increases and this
person is harmed by inflation. In addition, this individual receives a
fixed income from this bond. This purchasing power of this fixed income
is diminished by inflation.
9.
Would it be advantageous to borrow money if you expected prices to rise? Why, or why
not? Provide numerical example.
The simple answer is that it is generally advantageous to borrow under
these circumstances if you can lock in a fixed rate and buy whatever it is
you are buying before prices rise. You gain first by buying at the preinflation price, and second you are repaying the loan with deflated
dollars.
A more complex answer depends upon whether financial markets
anticipate inflation correctly. If they do, then the inflation premium is
already included in the interest rate and there is no advantage in
borrowing money. If the financial markets are incorrect but you guess
correctly, i.e., you expect higher inflation than do the financial market,
then yes, because as prices (and incomes) rise, the real cost of the
borrowed money will decline. For example, assume that you borrow
$100 at 5 percent interest rate. In one year, you must repay $105. If
prices rise by 10 percent during that year, the real value of the $105 you
repay will only be approximately $95. You will have borrowed $100
worth of purchasing power for $95 worth of purchasing power.
10.
Why did the Great Depression last so long? What happened to all the jobs?
The length and depth of the Great Depression were due to the complete
lack of confidence created by events such as the stock market crash and
the closing of banks. In such a situation, consumers were unwilling to
spend what little they had and businesses did not have the confidence to
invest. In addition, monetary and fiscal policies at the time were not
designed correctly to provide a stimulus to the economy. Monetary
policy called for an increase in the reserve requirement (contractionary)
and fiscal policy was only slightly expansionary. The absence of any
significant government spending to take up the slack until the buildup for
World War II let the Great Depression continue so long. As a result,
many people were laid off resulting in one some of the highest
unemployment in U.S. history.