Homework 3

Macroeconomics 105.08

Instructor: Shana M. McDermott

Due Date: Wednesday, November 28th, 2012

35 points

1. The following data is taken from

Year / Actual GDP / Potential GDP / Price Level (In 2000 billions of $)
2001 / 9875.6 / 9805.5 / 101.507
2002 / 9977.3 / 10121.1 / 103.553

a. Use AD/AS analysis to illustrate what happened with the above data over the 2 years.(5 points)

b. What is the growth rate for potential GDP between the 2 years? How long will it take for potential GDP to double?(4 points)

c. What is the inflation rate between these two years?(2 points)

4. (8 points)

Year / Real GDP / Consumption / Planned Investment / Government Purchases / Net Exports
1 / $5,000 / $4,500 / $350 / $300 / $50
2 / $6,000 / $5,300 / $350 / $300 / $50
3 / $7,000 / $6,100 / $350 / $300 / $50
4 / $8,000 / $6,900 / $350 / $300 / $50

Using the table above, calculate the unplanned change in inventories for each level of GDP, and explain what will happen to GDP. You can use the table below to help guide your analysis, but make sure you provide written explanation.

Year / Real GDP / Aggregate Expenditure / Unplanned Change in Inventories / Real GDP will…. (increase, decrease, or remain the same)
1
2
3
4

5. In “1984”, George Orwell creates a society that exists in a continuous state of war. Individuals see that although “weapons of war are not actually destroyed, their manufacture is still a convenient way of expending labor power without producing anything that can be consumed.” Given this continuous state of war, it is easily assumed that technological progress has ceased to exist. Using AD/AS analysis, demonstrate what is occurring in this society in the short run and long runusing the following assumptions:(5 points)

1. No technological progress

2. Only labor increases, not capital.

3. Government spending increases but consumer consumption does not.

Hint: The economy is “stagnating” or:

Year / Actual GDP / Potential GDP / Price Level
1 / P<P* / P* / 120
2 / P=P* / P* / 120

6.

a. If the money supply is growing at a rate of 5% per year, real GDP (real output) is growing at a rate of 1% per year, and velocity is constant, what will the inflation rate be?(3 points)

b. If the money supply is growing at a rate of 5% per year, real GDP (real output) is growing at a rate of 1% per year, and velocity growing at 2% per year instead of remaining constant, what will the inflation rate be?(3 points)

7. Review for the Final Exam

IRAQ / IRAN
Guns / Butter / Guns / Butter
0 / 8 / 0 / 4
2 / 6 / 1 / 3
4 / 4 / 2 / 2
6 / 2 / 3 / 1
8 / 0 / 4 / 0

a. Who has the comparative advantage in producing Guns? Who has an absolute advantage in producing Guns? Explain(2 points)

b. Can these two countries gain from trading guns and butter if each specializes and trades half of what they make?(2 points)Hint: Each country specializes in the good that they have a comparative advantage in.

c. Explain opportunity costs and give an example. (1 point)