Calculating price indexes and real GDP
Answer A
Shopping basket of 2014
Items Price Quantity consumed per month Shopping basket of 2014
2014 2015 2014 2015 2014 Prices
Hotdogs 1.50 1.60 3 2 4.5
Cans of cola 0.75 0.70 16 18 12
Chocolate bars 1.00 1.00 7 7 7
Magazines 3.50 4.50 3 2 10.5
Movies 3.00 2.75 2 3 6
Total 40
The total value of Student A’s 2014 shopping basket in 2014 prices is $40.
In computation of 2014’s shopping basket, the weight of the items are the respective quantities of goods consumed in the particular year.
Answer B
Shopping basket of 2014 (2015 prices)
Items Price Quantity consumed per month Shopping basket of 2014
2014 2015 2014 2015 2015 Prices
Hotdogs 1.50 1.60 3 2 4.8
Cans of cola 0.75 0.70 16 18 11.2
Chocolate bars 1.00 1.00 7 7 7
Magazines 3.50 4.50 3 2 13.5
Movies 3.00 2.75 2 3 5.5
Total 42
Student A’s shopping basket at 2015 prices is obtained as $42
Student A’s price index
Items Price Quantity consumed per month Price index of 2015 (base year 2014)
2014 2015 2014 2015 Q1P1 Q1P0
Hotdogs 1.50 1.60 3 2 3.2 3
Cans of cola 0.75 0.70 16 18 12.6 13.5
Chocolate bars 1.00 1.00 7 7 7 7
Magazines 3.50 4.50 3 2 9 7
Movies 3.00 2.75 2 3 8.25 9
Total 40.05 39.5
CPI 101.39
The 2014 value of this index is 100.
Answer D
Difference between GDP deflator and Consumer Price Index
In calculation of GDP deflator include all goods and services produced within the economy. The calculation of CPI on the other hand include only the goods and services bought by the consumers in an economy (Goodwin et al., 2015). GDP deflator thus does not include price of imported goods while CPI does not include price of exported goods.
Answer III
Finding Real Gross Domestic Product
Year Nominal GDP (current $ billion) GDP Deflator Real GDP (2014 $ billion)
2012 $837.506 91.691 $913.40
2013 982.4 98.923 993.096
2014 1152.9 100 1152.9
2015 1373.8 110.187 1246.790
2016 1589.6 120.598 1318.1
Answer B
The official unemployment rate, which was 8.57 percent in 2014, has fallen to 8.16 percent in 2015. The number of unemployed persons in the labor force increased from 150000 in 2014 to 160000 in 2015.
Answer C
If underemployed and discouraged workers are included, then size of the labor in 2014 would be (1750000 + 400000) = 2150000 and size of labor force in 2015 would be (1960000+500000) = 2460000.
Answer b
Unemployment rates and labor force size
Equilibrium in the money market occurs at the intersection of money demand and money supply curve (Uribe & Schmitt-Grohe, 2017). Given the money demand and money supply schedule, quantity demanded and quantity supplied of money supply equal corresponding to the interest rate of 3 percent. The equilibrium quantity of money is $10 billion and equilibrium interest rate is 3 percent.
Answer c
If the prevailing interest rate in the market is 4 percent, then quantity demanded of money equals 2.5 billion dollar while quantity supplied of money is 10 billion dollar. As quantity supplied of money exceeded that of quantity demanded, there will be an excess supply of money in the market (Heijdra, 2017). If the interest rate is 1 percent, then quantity demanded of money equals 40 while quantity supplied of money remain fixed at 10 billion dollars. As quantity demanded of money exceeded quantity supplied there exists an excess demand for money in the market.
Answer f
An increase in real output in the economy increases demand for money as people demand more money to make necessary transaction in order to purchase new GDP. As money demand increases, money demand curve shifts to the right causing interest rate to increase (Goodwin et al., 2015). A decrease in price level increases supply of real money balances shifting the money supply curve to the right. The increased money supply reduces equilibrium interest rate.
A decrease in interest rate is associated with an increase in bonds price following an increase in demand for bond. Reverse is the case for an increase in interest rate (Uribe & Schmitt-Grohe, 2017). That is bond price falls with increase in interest rate.
Particulars Value
Amount 10,000
Interest rate 4%
Bond price $9,615.38
Particulars Value
Amount 10,000
Interest rate 2%
Bond price $9,803.92
As interest rate falls to 2 percent, bond price increases from $9615.38 to $9803.93
Answer b
Particulars Value
Amount 10,000
Interest rate 6%
Bond price $9,433.96
When interest rate increases to 6 percent, bond price falls to $9433.96.
Answer VII
Answer a
Excess Reserve
Particulars Value
Reserve ratio 5%
Issued in deposits 10,000,000
Actual reserve 600,000
Excess reserve 9,400,000
Answer b
Money multiplier
Particulars Value
Reserve ratio 5%
Money multiplier 20
Answer c
Amount of money creation in the baking system
Particulars Value
Reserve ratio 5%
Money multiplier 20
Reserves 600,000
Total amount of money creation in the banking system 12,000,000
Answer VIII
Answer A
The contractionary monetary policy taken by Bank of Canada increases interest rate of Canada. As interest rate in Canada increases, this attracts more and more investors to invest in Canadian dollar. This in turn increases demand for Canadian dollar. In the foreign exchange market of Canadian dollar, the demand for Canadian dollar increases shifting the demand curve for Canadian dollar to the right (Heijdra, 2017). As a result, the value of Canadian dollar in terms of US dollar increase causing appreciation of CAD. This is shown in the figure below.
Answer B
If Americans find Canada a more attractive place for financial investment, then demand for Canadian dollar increases. As US investors demand more Canadian dollar demand curve for Canadian dollar shifts to the right. This increases price of Canadian dollar relative to US dollar indicating an appreciation of Canadian dollar. In the foreign exchange market, equilibrium quantity traded for Canadian dollar increases.
Answer C
The problem of Canadian dollar induces more snowbirds to travel to United State each winter. This requires Canadian snowbird to increase their demand for US dollar. The higher demand for US dollar implies a lower demand of Canadian dollar. Under this situation demand curve for Canadian dollar shifts to the left. This in turn increases price of US dollar relative to Canadian dollar meaning an appreciation of US dollar. Appreciation of US dollar means a relatively lower price of Canadian dollar or depreciation of CAD.
Answer D
Credit crisis in a nation hurts confidence of investors. As the credit crisis hurts US market more than it does Canadian market, investors are more willing to make direct and portfolio investment in Canada. This results in a higher demand for Canadian dollar raising the value of CAD relative to USD.
Answer E
The expansionary monetary policy in the form of a lower interest rate weakens strength of domestic currency. This is because the lower interest rate reduces attractiveness of investors to invest in Canadian dollar (Johnson, 2017). The lower demand for Canadian dollar results in a lower relative price of Canadian dollar in terms of US dollar.
Answer F
If Canada is viewed as a less attractive place to make financial investments by Americans, then they will demand Canadian dollar less. Reduced demand for Canadian dollar shifts the demand curve inward causing price of Canadian dollar relative to US dollar to fall. This is shown in the figure below.
Answer IX
Answer a
The exchange rate between Canada and US is given as
The US dollar price of an item priced $520 in Canadian dollar is therefore obtained as
Answer b
The exchange rate between US dollar and Canadian dollar is given as
Therefore, Canadian dollar price of an item priced at $24000 in US currency can be computed as
Answer c
Given that,
US dollar price of the item priced at $3 in Canadian dollar is therefore obtained as
Answer d
The Canadian dollar price of an item priced at $82 in US dollar can be computed as
Answer X
Answer 1
a) When consumers are more confident about prospects for the Canadian economy, then they increase their consumption spending. As consumers’ spending is one of the important components of aggregate demand, increase in consumption spending increases aggregate demand (Uribe & Schmitt-Grohe, 2017). This shifts the aggregate demand curve rightward increasing both equilibrium price level of real output. This is shown in figure 4.
b) Interest rate is the cost of borrowing fund. A rise in interest rate increases the borrowing cost lower investment. The decline in investment lowers aggregate demand. In response to a fall in aggregate demand, the aggregate demand curve shifts to the left. With contraction in aggregate demand, equilibrium moves downward. Consequently, there is a decline in both equilibrium price and equilibrium real output.
c) If government increases tax rates on household earning, then people will have less disposable income to spend for consumption. With a hike in tax rate, consumption spending decrease causing aggregate demand to fall (Johnson, 2017). This shifts the aggregate demand curve inward. This will cause is a decline in both real output and real price level.
d) Governments’ purchase of goods and services is an important component of aggregate demand. If newly elected government increases its purchase of goods and services, then this increases aggregate demand. Accordingly, aggregate demand curve shifts to the right causing equilibrium price and equilibrium real output to increase.
References
Goodwin, N., Harris, J. M., Nelson, J. A., Roach, B., & Torras, M. (2015). Macroeconomics in context. Routledge.
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.
Johnson, H. G. (2017). Macroeconomics and monetary theory. Routledge.
Uribe, M., & Schmitt-Grohe, S. (2017). Open economy macroeconomics. Princeton University Press.
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