0115002HW1

ECONOMICS 0115
HOMEWORK #1: ANSWERS

1. Given the this data, May 1985: NILF = 100m, E = 110m, U = 10m, answer the following:

a. If 5m teenagers (16 years or over) enter the labor force in June 1985 (LF = 5m) and 4m find employment, calculate the uer for May and June.

June: uer = U/(U + E) = 11m/(11m + 114m) = 0.088 = 8.8%

b. Calculate the LF (=labor force) and NILF for May and June.

June: LF = 114m + 11m = 125m; NILF = 100m - 5m = 95m

Table 1

Nominal Real GDP
Year GDP GDP Deflator

1981 $3055 $3250 94

1982 $3170 $3170 100

1983 $3410 $3280 104

1984 $3500 $3240.7 108

2. Complete Table 1. Show your work.

$3170 = (x/100)100, x = $3170

$3280 = ($3410/x)100, x = ($3410/$3280)100 = 104

($3500/108)100 = x = $3240.7

3. When the rate of inflation is expected to be zero, Larry wants to lend money if the interest rate is at least 5% while Moe wants to borrow money if the interest rate is 5% or less. Thus they make a loan agreement at 5% when inflation is expected to be zero.

9%, since the 4% expected inflation rate must be added to the 5% interest rate (keeps purchasing power of principal plus interest constant)

3%, since the 2% expected deflation rate must be subtracted from the 5% interest rate (same reason)

Larry is willing to lend money at 9% or more

Moe is willing to borrow money at 11% or less

They can agree on any interest rate between 9% and 11% (including 9 and 11%)

4. Workers in IBM have worked out a wage agreement under the expectation that the rate of inflation will be zero over the period of the contract. In order, to protect the workers against unanticipated inflation, however, the contract is indexed. This means that at the end of each year the nominal wage rate will increase by the same percentage as the Consumer Price Index (CPI). At the beginning of the contract period the CPI is 214 and the nominal wage rate is $10 an hour. At the end of the first year the CPI is 225 and at the end of the second year the CPI is 234. What will the new nominal wage rate be at the end of the first year? At the end of the second year?

Nominal Real
Year CPI Wage Wage

0 214 $10/Hr $4.67

1 225 x1 $4.67

2 234 x2 $4.67

Real Wage = ($10/214)100 = $4.67

(x1/225)100 = $4.67

$4.67(225/100) = x1

x1 = $4.67(2.25) = $10.51

$4.67(234/100) = x2

x2 = $4.67(2.34) = $10.93

5. Assume nominal GNP doubles between year 1 and year 2.

Nominal GNP in Year 1 = X1, CPI1 = 100

Nominal GNP in Year 2 = 2X1, CPI2 = 200

Real GNP1 = (X1/100)100 and

Real GNP2 = (2X1/200)100

So Real GNP1 = Real GNP2 (No change in Real GNP)

b. If the average level of prices has less than doubled between year 1 and year 2 what has happened to real GNP?

CPI1 = 100 and CPI2 = 150

Real GNP2 = (2X1/150)100 or X1(4/3)

So Real GNP2 > Real GNP1 (Real GNP has risen)

6. Calculate the following:

a. If the price index in year 1 is 100 and the inflation rate is 8% for each of the next 3 years, what is the price index for each of these 3 years? Interpret your results. Price
Year Index (Change in P)/P

1 100.0 --

2 108.0 8%

3 116.6 8%

4 126.0 8%

b. If the price index in year 1 is 100 and the inflation rate is 7%, 8% and 9% in each of the next 3 years, what is the price index for each of these 3 years? Interpret your results.

Price
Year Index (Change in P)/P

1 100.0 --

2 107.0 7%

3 115.6 8%

4 126.0 9%

c. If the price index is 200 in year 1 and the inflation rate is 10%, 8%, and 6% for each of the next 3 years, what is the price index for each of these 3 years? Interpret your results.

Price
Year Index (Change in P)/P

1 200.0 --

2 220.0 10%

3 237.6 8%

4 251.9 6%

P' = P(1+Pdot) = 200(1.1) = 220

P' = 220(1.08) = 200(1.1)(1.08) = 237.6

P' = 237.6(1.06) = 220(1.08)(1.06)

= 200(1.1)(1.08)(1.06)

= 251.9

d. If the price index for year 1 is 200 and the deflation rate is 8% a year for each of the next 3 years, what is the price index for each of these 3 years? Interpret your results. Price
Year Index (Change in P)/P

1 200.0 --

2 184.0 -8%

3 169.3 -8%

4 155.7 -8%

P' = 200(1-0.08) = 200(.92) = 184.0

P' = 184(1-0.08) = 200(.92)² = 169.3

P' = 169.3(1-0.08) = 184(.92)² = 200(.92)³= 155.7

e. If the price index for year 1 is 125 and the deflation rate is 8%, 7%, and 6% for the next 3 years, what is the price index for each of these 3 years? Interpret your results.

Price
Year Index (Change in P)/P

1 125.0 --

2 115.0 -8%

3 107.0 -7%

4 100.5 -6%

P' = 115(1-0.07) = 125(1-0.08)(1-0.07) = 107.0

P' = 107(1-0.06) = 115(1-0.06)(1-0.07)

= 125(1-0.06)(1-0.07)(1-0.08)

= 100.5