Difference between Nominal GDP and Real GDP

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Macroeconomic Analysis: Exercise 1

1. Explain the difference between nominal GDP and real GDP. 2. What is a price index? What does the GDP deflator measure? 3. What is the relationship between labor employment and real GDP? What is the relationship between the rate of growth in real GDP and the rate of unemployment:

[Answer: Production occurs when economic recourses-human, capital and natural-are employed. Hence, the greater the employment of labor the higher the level of real GDP. Because greater output is associate with higher levels of employment, there should be fewer unemployed workers at higher output levels. It thereby follows that increases in the rate of economic growth would be associated with decreases in the rate of unemployment. Arthus Okun (Okun’s law) found that an annual 2.5% increase in the rate of real growth above trend growth results in a 1% decrease in the rate of unemployment. 4. Explain the terms: (a) business cycle, (b) stabilization policy, and (c) Monetary and fiscal policy.

(a) Business cycles are recurrent, but not periodic, fluctuations in economic activity that occur around the secular trend of GDP over a period of several years. The expansionary phase of the of the business cycle normally peaks at a point above the trend growth, whereas the through for the contractionary phase is normally below the trend growth. The trend path of the GDP is the path GDP would take if factors of production were fully employed. Full employment of factors of production is an economic, not a physical, concept.

Physically, labor is fully employed if everyone is working 16 hours per day all year. In economic terms, there is full employment of labor when everyone who wants a job cab find a one within a reasonable amount of time. Because the definition is not precise, we typically define full employment of labor by some convention, for example, that labor is fully employed when the unemployment rate is 5.5%.

Output is not always at its trend level, that is, the level corresponding to (economic) full employment of factors of production. Rather, output fluctuates around the trend level. During an expansion (or recovery) the employment of factors of production increases, and that is a source of increased production. Output can rise above trend because people work overtime and machinery is used for several shifts.

Conversely, during a recession unemployment increases and less output is produced than could in fact be produced with existing resources and technology.

The output gap measures the gap between actual output and the amount of output the economy could produce at full employment given the existing resources. Full-employment output is also called potential output.

(b) A stabilization policy is an action taken by the government to impact aggregate demand to moderate the expansion and contraction phases of the business cycle. During an expansion, the objective is to moderate the growth of spending: the objective during the recession (economic contraction) is to reduce the rate of decrease in spending. (c) Monetary policy aims to stabilize economic activity by controlling the money supply or interest rates while fiscal policy utilizes a change in tax rates and or the level of government spending for the same objective. 5. Explain the components of the equation. Explain the components of the equation. Which components of this equation represent exogenous consumption and endogenous consumption? Answer:

Represents other variables which affect consumption but whose value is unchanged. Behavioral coefficient c measures the change in consumption that results from a change in disposable income . As c is positive, consumption and disposable income move in the same direction.

Consumption is Taka 20 regardless of the disposable income (DI). 0.90 Yd indicates that consumption change by Taka 0.90 each time there is a 1 Take change in DI.

Taka 20 in the consumption...
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