Question.2917 - 3. Suppose you have $7,000 in savings when the price level i n dex is at 100. ( a ) If inflation pushes the price level up by 10 percent, what will be the real value of your savings? ( b ) What is the real value of your savings if the price level declines by 10 percent? 5. According to the News on page 162, ( a ) By what percentage did GDP decline in the fourth quarter of 2008? % ( b ) At that rate, how much output would have been lost in the $14 trillion economy of 2008? $ ( c ) How much income did this represent for each of the 300 million U.S. citizens? $ ( d ) What was the largest percentage GDP decline in a post–World War II U.S. recession? (See Table 8.1.) Page 162 Economy: Sharpest Decline in 26 Years The U.S. economy suffered its biggest slowdown in 26 years in the last three months of 2008, according to the government’s first reading about the fourth quarter released Friday. Gross domestic product, the broadest measure of the nation’s economic activity, fell at an annual rate of 3.8 percent in the fourth quarter, adjusted for inflation. That’s the largest drop in GDP since the first quarter of 1982, when the economy suffered a 6.4 percent decline. . . . Hit by tight credit and soaring job losses, Americans slammed the brakes on spending in the quarter. Consumer spending fell at a 3.5 percent annual rate, which was the se v enth-biggest drop on record. Spending on big-ticket durable goods plunged at a 22 percent pace, the largest d e cline since 1987. Consumer spending accounts for more than two-thirds of overall economic activity. Analysis: Everyone agrees that the macro economy can contract on occasion. The debate is whether such contractions self-correct or require government intervention. A MODEL OF THE MACRO ECONOMY The bumpy growth record of the U.S. economy lends some validity to the notion of a recurring business cycle. Every decade seems to contain at least one boom or bust cycle. But the historical record doesn’t really answer our key questions. Are business cycles inevitable? Can we do an y thing to control them? Keynes and the classical economists weren’t debating whether business cycles occur but whether they are an appropriate target for government intervention. That debate continues. To determine whether and how the government should try to control the business cycle, we first need to understand its origins. What causes the economy to expand or contract? What market forces dampen (self-adjust) or magnify economic swings? Figure 8.4 sets the stage for answering these questions. This di a gram provides a bird’seye view of how the macro economy works. This basic macro model emphasizes that the performance of the economy d e pends on a surprisingly small set of determinants. On the right side of Figure 8.4 the primary measures of macroec o nomic performance are arrayed. These basic macro outcomes include • Output: total value of goods and services produced (real GDP). • Jobs: levels of employment and unemployment. • Prices: average price of goods and services (inflation). • Growth: year-to-year expansion in production capacity. • International balances: international value of the dollar; trade and payment balances with other countries. These macro outcomes define our economic welfare; we measure our economic well-being in terms of the value of output produced, the number of jobs created, price stability, and rate of economic expansion. We also seek to maintain a certain balance in our international trade and financial relations. The economy’s performance is rated by the “scores” on these five macro outcomes. On the left side of Figure 8.4 three very broad forces that shape macro outcomes are depicted. These determinants of macro performance are • Internal market forces: population growth, spending behavior, invention and innovation, and the like. Table 8.1 DATES Duration (months) % decline in real GDP Peak unemployment rate Aug. 1929–Mar. 1933 43 35.4% 24.9% May 1937–June 1938 13 9.4 20.0 Feb. 1945–Oct. 1945 8 23.8 4.3 Nov. 1948–Oct. 1949 11 9.9 7.9 July 1953–May 1954 10 10.0 6.1 Aug. 1957–Apr. 1958 8 14.3 7.5 Apr. 1960–Feb. 1961 10 7.2 7.1 Dec. 1969–Nov. 1970 11 8.1 6.1 Nov. 1973–Mar. 1975 16 14.7 9.0 Jan. 1980–July 1980 6 8.7 7.6 July 1981–Nov. 1982 16 12.3 10.8 July 1990–Feb. 1991 8 2.2 6.5 Mar. 2001–Nov. 2001 8 0.6 5.6 Dec. 2007–June 2009 18 4.1 10.1 6. If the AS curve shifts to the right, what happens (“increases” or “decreases”) to ( a ) The equilibrium rate of output? ( b ) The equilibrium price level?
Answer Below:
3. Suppose you have $7,000 in savings when the price levelindex is at 100. (a) If inflation pushes the price level up by 10 percent, what will be the real value of yoursavings? Answer: Given that inflation has increased the price levels by 10 percent, the price level index becomes 110 (100+10). Now, we know that Real Savings = (Nominal Savings/Price Level)*100 Here, Nominal Savings = $7000 Price Level = 110 Therefore, Real Savings = ($7000/110)*100 = $6363.64 To conclude, with the price level increase of 10 percent, the value of real savings will fall to $6363.64. (b) What is the real value of your savings if the price level declines by 10 percent? Answer: Given that the price levels have declined by 10 percent, the price level index becomes 90 (100-10). Now, we know that Real Savings = (Nominal Savings/Price Level)*100 Here, Nominal Savings = $7000 Price Level = 90 Therefore, Real Savings = ($7000/90)*100 = $7777.78 To conclude, with the price level decline of 10 percent, the value of real savings will increase to $7777.78. 5. According to the News on page 162, (a) By what percentage did GDP decline in the fourth quarter of 2008? % Answer: The GDP fell at an annual rate of 3.8 percent in the fourth quarter of 2008. (b) At that rate, how much output would have been lost in the $14 trillion economy of 2008? $ Answer: At the rate of 3.8 percent, the output loss in a $14 trillion economy of 2008 amounts to $532 billion. (14,000,000,000,000*3.8)/100) (c) How much income did this represent for each of the 300 million U.S. citizens? $ Answer: The per capita loss in income will be equal to the total loss in income divided by the total population. Therefore, the Per capita loss = $532,000,000,000/3,000,000 = $177,334 (d) What was the largest percentage GDP decline in a post–World War II U.S. recession? (See Table 8.1.) Answer: The largest percentage GDP decline in a post-World War II happened during the period between Nov.1973–Mar.1975 with the real GDP declining to 14.7 percent. Page 162 Economy: Sharpest Decline in 26 Years The U.S. economy suffered its biggest slowdown in 26 years in the last three months of 2008,according to the government’s first reading about the fourth quarter released Friday.Gross domestic product, the broadest measure of the nation’s economic activity, fell at anannual rate of 3.8 percent in the fourth quarter, adjusted for inflation.That’s the largest drop in GDP since the first quarter of 1982, when the economy suffereda 6.4 percent decline. . . .Hit by tight credit and soaring job losses, Americans slammed the brakes on spending in thequarter.Consumer spending fell at a 3.5 percent annual rate, which was the seventh-biggest dropon record. Spending on big-ticket durable goods plunged at a 22 percent pace, the largestd e cline since 1987. Consumer spending accounts for more than two-thirds of overalleconomic activity. Analysis: Everyone agrees that the macro economy can contract on occasion. The debate iswhether such contractions self-correct or require government intervention. A MODEL OF THE MACRO ECONOMY The bumpy growth record of the U.S. economy lends some validity to the notion of a recurringbusiness cycle. Every decade seems to contain at least one boom or bust cycle. But thehistorical record doesn’t really answer our key questions. Are business cycles inevitable?Can we do an y thing to control them? Keynes and the classical economists weren’t debatingwhether business cycles occur but whether they are an appropriate target for governmentintervention. That debate continues. To determine whether and how the government should try to control the business cycle,we first need to understand its origins. What causes the economy to expand or contract?What market forces dampen (self-adjust) or magnify economic swings?Figure 8.4 sets the stage for answering these questions. This di a gram provides a bird’seyeview of how the macro economy works. This basic macro model emphasizes that theperformance of the economy d e pends on a surprisingly small set of determinants. On the right side of Figure 8.4 the primary measures of macroeconomic performance arearrayed. These basic macro outcomes include • Output: total value of goods and services produced (real GDP). • Jobs: levels of employment and unemployment. • Prices: average price of goods and services (inflation). • Growth: year-to-year expansion in production capacity. • International balances: international value of the dollar; trade and payment balanceswith othercountries. These macro outcomes define our economic welfare; we measure our economic well-beingin terms of the value of output produced, the number of jobs created, price stability, andrate of economic expansion. We also seek to maintain a certain balance in our internationaltrade and financial relations. Theeconomy’s performance is rated by the “scores” on thesefive macro outcomes.On the left side of Figure 8.4 three very broad forces that shape macro outcomes aredepicted. These determinants of macro performance are • Internal market forces: population growth, spending behavior, invention and innovation,and the like. Table 8.1 DATES Duration (months) % decline in real GDP Peak unemployment rate Aug. 1929–Mar.1933 43 35.4% 24.9% May 1937–June 1938 13 9.4 20.0 Feb. 1945–Oct.1945 8 23.8 4.3 Nov. 1948–Oct.1949 11 9.9 7.9 July 1953–May 1954 10 10.0 6.1 Aug. 1957–Apr.1958 8 14.3 7.5 Apr. 1960–Feb. 1961 10 7.2 7.1 Dec. 1969–Nov.1970 11 8.1 6.1 Nov. 1973–Mar.197516 14.7 9.0 Jan. 1980–July 1980 6 8.7 7.6 July 1981–Nov. 1982 16 12.3 10.8 July 1990–Feb. 1991 8 2.2 6.5 Mar. 2001–Nov.2001 8 0.6 5.6 Dec. 2007–June 2009 18 4.1 10.1 6. If the AS curve shifts to the right, what happens (“increases” or “decreases”) to A shift in the in the AS (Aggregate Supply) curve can be attributed to two reasons – changes in the input prices and technology change. A rightward shift in the AS curve implies either a decrease in input prices or a technological advancement leading to lower production costs. Consequently, the lower production cost will mean an increase in AS and hence the rightward shift. The opposite is true for a leftward shift of the AS curve. (a) The equilibrium rate of output? Answer: As the AS (Aggregate Supply) curve shifts to the right the equilibrium rate of output increases from Q to Q’. (b) The equilibrium price level? Answer: As the AS (Aggregate Supply) curve shifts to the right the equilibrium price level decreases from P to P’.More Articles From Economics
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