QUIZ 1

15 Feb, 2014

Duration: 20 Minutes

Section1 . Short Answers

Q.1. In macroeconomics, why do we talk about business cycles for the economy as a whole, rather than

just talking about the ups and downs of particular industries?

Answer. We talk about business cycles for the economy as a whole because recessions and expansions

are not confined to few industries they reflect upturns and downturns for the economy as a whole. In downturn/recession, almost every sector of the economy reduced output and unemployment increases

whereas every sector increases output and unemployment reduces in expansion/upturn.

Q.2. Name three methods of calculating GDP? Why the three methods of calculating GDP produce the

same estimate of GDP?

Answer. Please refer to Slide No. 11 of lecture 2

Q.3. Why does collective bargaining have the same general effect on unemployment as a minimum wage?

Answer. Please refer to Slide No. 18 and 19 of lecture 3

Section 2. Numerical Problem

Q.4. Assume there are only two goods in the economy, French fries and onion rings. In 2011, 1,000,000

servings of French fries were sold at $0.40 each and 800,000 servings of onion rings at $0.60 each. From

2011 to 2012, the price of French fries rose by 25% and servings sold fell by 10%; the price of onion

rings fell by 15% and the servings sold rose by 5%.

a. Calculate nominal GDP in 2011 and 2012. Calculate real GDP in 2012 using 2011 prices.

b. why would an assessment of growth using nominal GDP be misguided?

Answer.

Quantity Unit Price Total value

French Fries 1,000,000 0.40 400,000

Onion rings 800,000 0.60 480,000

Nominal GDP-2011 880,000

25% increase in price of French fries = 25% * 0.40 = 0.10,

Thus New price = 0.40 = 0.10 = 0.50

10% fall in the quantity of French fries = 10% * 1,000,000 = 100,000,

Thus new quantity = 1,000,000 - 100,000 = 900,000

15% fall in price of onion rings = 15% * 0.60 = 0.09,

Thus new price = 0.60 0.09 = 0.51

5% increase in the quantity of onion rings = 5% * 800,000 = 40,000,

Thus new quantity = 800,000 + 40,000 = 840,000

Name:

Quantity Unit Price Total value

French Fries 900,000 0.50 450,000

Onion rings 840,000 0.51 428,400

Nominal GDP-2012 878,400

Calculating Real GDP using prices of 2011

Quantity Unit Price Total value

French Fries 900,000 0.40 360,000

Onion rings 840,000 0.60 504,000

Real GDP-2012 864,000

b. Comparison of nominal GDP in 2011 to nominal GDP in 2012 shows a decline of [(880,000 -

878,400)/880,000] / 100 = 0.18%. But a comparison using real GDP shows a decline of [(880,000 864,000)/880,000] / 100 = 1.8%.

In this case, the calculation based on nominal GDP underestimates the true magnitude of the change.