Question

The table below shows production and prices for a stylized economy. Assume the base year is 2005. Price per unit of X(S) Production of Y Price per unit Year Production of X of Y (S) 2005 200 units 500 2010 2015 300 units 400 units Calculate nominal and real GDP for 2005, 2010 and 2015 assuming the base year is 2005 Calculate the GDP deflator for 2005, 2010, and 2015. What is the inflation rate between 2005 and 2010? Between 2010 and 2015? Assume that the market basket for the typical consumer is given by the quantities in 2005 Calculate the CPI for 2005, 2010, and 2015. What is the inflation rate between 2005 and 2010? Between 2010 and 2015? On an annual basis, how fast has the real economy grown between 2005 and 2015? Using this rate, how long will it take the economy to double in size? Defend your answer.

Answer 1

Nominal GDP for 2005 = 200 $\times$ $10 + 500 $\times$ $ 5

Nominal GDP for 2005 = $ 4500

Nominal GDP for 2010 = 300 $\times$ 15 + 400 $\times$ 4

Nominal GDP for 2010 = $ 6100

Nominal GDP for 2015 = 400 $\times$ 20 + 200 $\times$ 2

Nominal GDP for 2015 = $ 8400

Real GDP is calculated at constant prices i.e. using the prices of the base year 2005.

Real GDP for 2005 = 200 $\times$ $10 + 500 $\times$ $ 5

Real GDP for 2005 = $ 4500

Real GDP for 2010= 300 $\times$ $10 + 400 $\times$ $ 5

Real GDP for 2010 = $ 5000

Real GDP for 2015 = 400 $\times$ $10 + 200 $\times$ $ 5

Real GDP for 2015 = $ 5000

Nominal GDP GDP deflator = Real GDP X 100

$4500 GDP deflator 2005 = 34500 X 100

GDP deflator for 2005 = 100

$6100 GDP deflator 2010 = 55000* 100

GDP deflator for 2010 = 122

$8400 GDP deflator 2015 = 5000 X 100

GDP deflator for 2015 = 168

GDP deflator 2010 - GDP deflator 2005 Inflation rate 2005 - 2010 = - x 100 GDP deflator 2005

122 - 100 Inflation rate 2005 - 2010 = 100X100

Inflation rate b/w 2005 - 2010 = 22%

168 - 122 Inflation rate 2010 - 2015 = * 100 122

Inflation rate b/w 2010 - 2015 = 37.70%

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Cost of the basket of goods in 2005 = 200 $\times$ $10 + 500 $\times$ $ 5 = $ 4500

Cost of the basket of goods in 2010 = 300 $\times$ $15 + 400 $\times$ $ 4 = $ 6100

Cost of the basket of goods in 2015 = 400 $\times$ 20 + 200 $\times$ 2 = $ 8400

$4500 Consumer price index 2005 = $4500 X 100

Consumer price index 2005 = 100

$6100 Consumer price index 2010 = $4500 X 100

Consumer price index 2010 = 135.56

$8400 Consumer price index 2015 = $4500 X 100

Consumer price index 2015 = 186.67

Inflation rate 2005 - 2010 = 135.56 - 100 135.56 - X 100

Inflation rate 2005 - 2010 = 26.23%

Inflation rate 2010 - 2015 = 186.67 - 135.56 - X 100 135.56

Inflation rate 2010 - 2015 = 37.70%

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Real growth of economy between 2005 and 2015 is calculated as follows:-

Real growth 2005 - 2015 = Real GDP 2015 - Real GDP 2005 Real GDP 2005 - X 100

Real growth 2005 - 2015 = 5000 - 4500 4500 - X 100

Real growth rate between 2005 and 2015 = 11.11%

The time it takes for the economy to double in size can be found using the rule of 72.

Time to double = 72 $\div$ growth rate = 72 $\div$ 11.11%

Time to double = 6.48 years

The time required for the economy to double in size in 6.48 years. In this example we have considered the economy to be producing only two goods i.e. X & Y but in reality the economy will producing more than two goods, infact thousands of different products and services. Hence it is likely that the economy will double in size in 6.48 years.