ECONOMICS Essay Example

  1. Inflation makes Nominal GDP is defined as the value of final goods and services evaluated at current year prices and in calculating it, you assume the current values of final goods and services. Therefore, Nominal GDP unlike real GDP does not make any adjustments for inflation and thus it makes it seem as if there is growth in production when in actual sense there is no. thus, when there is increase in nominal GDP from one year to the other, this increase is partly due to increase in prices (inflation) and partly due to changes in quantities thus making nominal GDP a poor measure of the increase in total production from one year to the next since it does not differentiate the part of the increase that is due to inflation from that which is from increase in production.

In measuring real GDP, chain volume measure refers to a series of economic data from successful years adjusted for inflation though computing the production volume for each year in the prices of preceding year and then chain linking the data hence obtaining a time series of production figures where inflation effects have been removed.

Measured GDP does not reflect the total production in the economy because the effects of inflation are not fully eliminated in the measured GDP. Furthermore, measured GDP excludes some of the production especially that which happens in the informal sector. Other production not included in measured GDP include production happening in people’s gardens for own consumption, gifts and donation to charity, meals that are prepared at home, caring for own children for free, work done by house wives among similar production. Their exclusion thus means that Measured GDP does not reflect the total production in the economy.

  1. Factors determining labor productivity include Skills or level of education of the workforce, the amount of capital invested per worker, technology, availability of natural resources and the workforce’s health.
    Actions that government can take to improve productivity include increasing investment in infrastructure to enhance movement, lower corporation taxes and improve work incentives , improve education and training while increasing related opportunities, improving access to quality health care, facilitating inward migration of skilled labor, tax breaks for use of new technologies, boosting business access to capital and research and innovation and deregulation of markets to encourage competition thus enhancing efficiency.

  2. The 65 year old man is not in the labor force since he has already reached retirement age.

ii) The university student is employed since although he has not found a job suiting his skills, he is gainfully employed as a wait-person for 30 hours a week.

iii) The manufacturing worker is unemployed since he is out of work and is no longer looking for a job hence he is not working.

  1. Labor force participation rate = Labor force/ Working age non-institutionalized population

= (180,000+ 20,000)/(180,000+ 20,000+50,000)

= ($200,000/250,000)100

  1. Dead capital is related to the informal economy in that the informal economy is not controlled by the government and hence the government does not know what goes on in the informal economy. Thus, participants in the informal economy are the ones that possess dead capital since they do not register it making it hard for it to be valued or to be used for normal economic production. Dead capital in this case refers to capital in the form of unregistered real property and hence it is lost value since the property owner is unable to transfer if for capital access. On the other hand, the informal economy is that part of the economy that is not taxed or regulated by the government and whose activities are not included in the GNP and GDP of the country.

ii) This is not an advantageous situation to be in for the poor in Peru. This is because they hold a lot of dead capital meaning that they cannot use them to lift themselves out of the poverty they are in. The fact that their properties are not registered means they don’t pay land taxes and municipal rates which might be seen as an advantage. However, the disadvantage is that they cannot use them to acquire capital since for instance they can’t pledge them as collateral in the banks to obtain loans with which to develop themselves, neither can they sell them for capital or even move out of the shanties and live more improved lives. As such, they are likely to be poor living in the shanties forever in the name of avoiding paying taxes and rates as long as they continue to hold dead capital which is a great disadvantage to them.

iii) This would impact on the measurement of Peru’s GDP in that the consumption and the investments that take place in the informal economy which is about 70% of the working population would not be captured in the country’s GDP. This would have a great impact on the company’s GDP implying that the country is likely to remain poor for a long time (Romer, 2016). The components that would be most affected are Consumption by the private households in the informal economy as well as the investments happening in the informal economy due to the fact that properties in the economy are considered dead capital and hence valueless. This would have a negative effect on transfer payments since the not all production will be captured in GDP computation meaning that more would need to be spent in terms of transfer payments than if these assets were held in a formal economy.

iv) Informal economy would hinder economic growth in Peru. This is because the activities in the economy are not documented and hence no taxes can be paid from these activities. In addition, businesses in the informal sectors would be unable to attract capital through loans since they are not registered while properties in such a sector which is a huge part of Peru economy are considered dead capital and hence valueless meaning that the informal economy cannot use them to acquire capital thus hindering growth for the informal economy and hence for Peru as a whole.

  1. CPI For 2012

Market basket at base period (2005) prices = 1($1,700) + 10($25) + 50 ($1.00) = $2,000

Market basket at current period (2012) prices = 1($1,200)+ 10 ($30)+ 50 (2) = $1,600

CPI for 2012 = ($1,600/$2,000) *100 = 80

  1. In constructing CPI, the first step involves finding records of past prices. The prices of the items purchased previously are then added together. Then, a record of current prices is found. Then the current prices are added together. The current prices are then divided by the old prices. The result is then multiplied by 100 before subtracting 100 from the new result to find the change in CPI.

This method of CPI construction however has some weaknesses including the fact that CPI considers only consumer goods hence failing to provide an index that measures all consumption or production in the economy and also fails to factor in substitution. Using the method, new products are not factored in until they become staple purchases by consumers hence giving incomplete picture.

  1. Durable goods are most affected by business cycle since their production can be postponed until when recession is over. Thus, expansion in business cycle will see more durable goods being produced while contraction will lead to few durable goods being produced. However, non-durable goods being mostly consumer goods are consumed at all-time regardless of the business cycle.

  2. There are four business cycle phases;

During the peak, business activities reach a temporary maximum and unemployment lowers while inflation increases. During recession, unemployment rises while inflation lowers. During the trough at the bottom of the recession period, unemployment rises to the highest with inflation is low. During expansion or recovery phase, unemployment begins to fall with inflation beginning to rise.

  1. The data you would look at to evaluate whether the economy has entered an economic contraction include data on Nonfarm employment, industrial production, real retail sales and real personal income excluding transfer receipts. At the onset of contraction, the nonfarm employment, industrial production, real retail sales as well as real personal income begin to contract. This is because firms start laying off their staff hence unemployment start rising. The number of production orders also decline hence lowering production, the real personal incomes will also come down as firms strive to reduce costs by cutting incomes. The reduced real personal incomes mean that people cut on consumption thus bringing down real retail sales. Thus, the onset of economic contraction is characterized by gradual decline of the above data.

  1. RBA uses open market operations to control both short term and long term interest rates by varying the amount of liquidity that is circulating in the economy by ensuring there is just sufficient supply to meet funds demand at RBA’s targeted interest rate. Thus, when there is a high demand threatening to push up the interest rates, the bank uses open market operations hence increasing funds supply hence maintaining the desired rate. On the other hand, the RBA reduces the supply of funds when there is a fall in demand for cash. Increasing supply of cash involves buying of second-hand government bonds from the banks paying them in cash thus increasing cash supply. On the other hand, reducing cash supply is through RBA selling bonds to the banks which they pay from their exchange settlement accounts as well as using repurchase agreements lately. Thus, the actions of RBA in the open market increase or decrease interest rates depending on the desired action.

  2. A fall in the cash rate will lead to a reduction in interest rates which will reduce the cost of borrowing meaning that households that are borrowers will higher future incomes net of interest repayments. The income effect is likely to lead to higher current and future consumption. For the households that are net savers, lower interest rates are likely to reduce their incomes hence reducing their current and future consumption dampening the increase in consumption that results from the reduced interest rates.

  3. A) Real GDP will be higher

b) Potential GDP will not change

c) The price level will decline

d) The employment rate will increase

  1. Real exchange rate =(nominal exchange rate* average price of a good in country A)/Average price of a good in country B

Nominal exchange rate = £0.6= $1

Australia price level = 125

British price level = 100

Real exchange rate =(0.6*100)/125

Real exchange rate = 0.48

The exchange rate of the dollar to the pound is thus £0.48= $1

  1. a) The grater than expected increase in inflation in Australia has been caused by an increase in aggregate demand as well as lowering Australian dollar which has resulted in increases in price level. Inflation has also resulted from increasing interest rates and a rise in carbon taxes which has pushed up production costs leading to rising inflation. The article does not provide much evidence of why inflation has increased but it does indicate that prices of almost everything with exception of fuel has increased. It also indicates that the carbon taxes by labor government are partly to blame for the inflation. Lowering Australian dollar causes goods to be more expensive especially those that are imported from other countries. In addition, it causes the interest rates to rise thus resulting in an increase in inflation since what a single dollar can buy today will be less tomorrow if the value of the dollar is lower.

b) The underlying inflation rate influences the RBA’s position on charging interest rates. This is because the RBA would be forced to increase interest rates so as to make money more expensive and hence reduce the money supply in the economy which in turn would reduce the aggregate demand and hence bring down inflation.

  1. The existence of unemployment benefits or other transfer programs reduce the severity of an economic contraction by stimulating consumption. Unemployment benefits and other transfers affect recipients’ incomes directly with the higher incomes boosting their demand for normal goods and services. In addition, the higher incomes also affect their other activities for instance by increasing their demand for leisure and subsistence goods produced by the household thus boosting their production activities. This way, the unemployment benefits and other transfers serve to reduce the severity of an economic contraction by enabling the unemployed and the groups that receive transfers to consume more which has a direct effect on the entire economy.

  2. The most appropriate fiscal policy to achieve potential GDP is that which leads to reduced aggregate demand so as to move the economy from point B to equilibrium at potential GDP. As such, the fiscal policy should involve the government cutting on its spending and/or increasing taxes. This will reduce consumer spending which in turn lower aggregate prices will hence bring the economy to the equilibrium. If the policy is successful in moving the economy from point B to equilibrium at potential GDP, unemployment will increase owing to reduced government spending as well as the reduced aggregate demand and consumption and hence production. However, this is likely to improve the government budget by reducing budget deficit as a result of the reduced spending.

  3. a) Expansionary fiscal policy

b) Expansionary fiscal policy

c) Expansionary fiscal policy

d) Expansionary fiscal policy

  1. Decreasing government purchases by $200 billion or raising taxes by $200 billion will not necessarily restore the economy to potential GDP. This is because there are GDP is not only composed of government spending and taxes. There are other components that need to be looked at to ensure that the GDP can be restored to the potential GD.

  2. Fiscal spending could have led to the avoidance of a recession by stimulating consumption since government spending will increase household incomes through employment meaning they can spend more due to the higher income.


Government spending &Price level


Y1 Y2 Real GDP

b) The floating exchange rate and monetary easing would have led to avoidance of a recession by reducing the cost of money hence ensuring more money is flowing in the economy which would stimulate demand thus avoiding a recession.


Interest rate &Price level


Y1 Y2 Real GDP

c) Fiscal policy is an action of the government increasing its spending by undertaking various capital projects which employ people hence releasing cash into the economy. It may also involve introduction of cash transfers by the government. On the other hand, monetary policy is the intervention by the central bank (RBA) through altering the amount of money circulating in the economy to achieve desired effect.


Romer, D2016, Advanced macroeconomics theory, London, Rutledge.