# Abby Prob 3 - Assignment 3

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Econ 3123 Oklahoma State University Intermediate Macroeconomics Department of Economics Dr. J.B. Kim Homework 1 (Answers) 7. a. The consumer price index uses the consumption bundle in year 1 to figure out how much weight to put on the price of a given good: (P' xQ' ) + (P' xQ' ) n:d mI CP1' =(P' xQ' ro:d rNi (\$2 x 10) + (\$1 x 0) (\$1 x 10) + (\$2 x 0) = 2. According to the
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Econ 3123 Oklahoma State UniversityIntermediate Macroeconomics Department of Economics Dr. J.B. Kim Homework 1 (Answers) 7. a. The consumer price index uses the consumption bundle in year 1 to figure out how muchweight to put on the price of a given good: ( P' xQ' ) + (P' xQ' ) n:d mI ~ c n   ~ ~   CP1' =(P' xQ' J + ( r ~ Q - ' - - - - - )   ro:d rNi ~ ~   I n ~ n   (\$2 x 10) + (\$1 x 0) (\$1 x 10) + (\$2 x 0) = 2. According to the CPI, prices have doubled. b. Nominal spending is the total value of output produced in each year. In year 1 and year 2, Abby b u y ~   10 apples for \$1 each, so her nominal spending remains con· stant at \$10. For example, Nominal Spending:! = ( P ~ f d   X Q ~ u   ) + ( P ; ~ . n   X Q ~ N ' n )   = (\$2x 0) + (\$1 x 10) = \$10. c. Real spending is the total value of output produced in each year valued at the prices prevailing in year 1. In year 1, the base year, her real spending equalsher nominal spending of \$10. ln year 2, she consumes 10 green apples that are eachvalued at their year 1 price of \$2, so her rea] spending is \$20. That is, Real Spendin152 = ( P ~ e t J   X Q ~ c d   ) + ( P ~ n   X Q: un) = (\$1 x 0) + (\$2x 10) = \$20.Hence, Abby's real spending rises from \$10 to \$20. d The implicitpricedeflator is calculated by dividing Abby'snominal spending in year 2 by her real spending that year: Nominal Spending:l lmplicit Price Deflator:l Real Spending:l \$10 \$20 = 0.5. Thus, the implicit price deflator suggests that prices have fallen by half. The rea 4 son for this ioS that the deflator estimates how much Abby values her apple!:! using prices prevailing in year 1. From this persllective green apples appear very valuable. ln year 2, when Abby consumes 10 green apples, it appears that her con­ sumption has increased because the deflator values green apples more highly than red apples. 1ne only way she could still be spending \$10 on a higher consumptionbundle is if the price of the good she was consuming-feel.  e. lf Abby thinks of red apples and green apples as perfect substitutes, thenthe cost of Jiving in this economy has not changed-in either year it costs \$10 to consume10apples.According to the CPl, howevcr, thc cost of living has doubled. This is because the cpr only takes into accountthe fact that the red apple price has d o u ~   hled; the CPl ignores the fall in the price (If green apples because they were not in the consumptionbundle in year 1. In contrast to thc Crl, the implicit price defla­ tor estimates the cost of Hving has haived. Thus, the CPl, a Laspeyres index, over states the increasc in the cost ofliving and the deflator, a Paasche index, under states it. This chapter of thetcxt discusses the difference between Laspcyres andPaasche indices in more detail. 8. a. Real GDP falls because Disney does not produce finy services whileit is closed. This corresponds to a decrease in economic w e l l · ~ e i n g   because the income of work ers and shareholders of Disney faJ)s (the income side of thenational accounts), and people's consumptionofDisney falls (the expenditure side uf the national accounts). b. Real GDP rises because the srcinaJ capitalandlabor in farm production now pro duce more wheat.Thiscorrcsponds to an increasein the economic well-being of society, since people can now consume more wheat. (If people do not want tocon sume more wheat, then farmers and farmland can be shifted to producing other goods that socicty values.) c. RCH I GDP falls because with fewer workcrs on the job,firms produceless. Thisaccurately reflects a fall in t.. Conomic well-being. d. Real GDP falls because the firms that Jay off workers produce less. This decreases economicweJl-being becausc workers' incomcs fall (theincome sidc), and there are fewer goods for people to buy (the expenditure side). e. Real GDP is likely to fall, as finns shift toward production methods that produce fewer goods but emit less pollution. Economic well-being, however, may rise. The economy now produces less measured output but mure clean air; clean air is nut traJed in markets nnd, thus, does not show up in measured GDP, but is neverthe less a good that people value. f. ReHl GDP rises because the high-school students go from an activity in which they arc not pruducing market goods and scrvices to one in which they are. Economic well-being, however, may decresBe. In ideal national accounts, attending school would show up as investmcnt because it presumably increases the future produc tivity of the worker. Actual national accounts do not measure this typeofinvest mcnt. Note also that future GDP may be lower than it would be if thestudents stayed in school, since the future work force will be less educated. g. Mcasured rea] GDP falls because fathers spend Jess time producing market goods and services. The actual production of goods and services need not have fallen, however. Measured production (what the fathers are paid to do) falls, but unmeasuredproduction of child-rearing serviccs rises.

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