1. True or False

1. False. None of them increase. The country produces the same output (clean offices) and in both cases the work is remunerated in dollars. NOTE: If you explicitly assume that the workers who were previously cleaning windows are now producing additional output for the firm, then answering "true" is also acceptable.

2. True. Trading centers like Hong Kong exist, where imports and exports are larger than domestic production.

3. False. Both variables will remain constant, as final output is the same.

1. Inflation

1. With the GDP deflator, nominal GDP in year 2 is \$50. Real GDP in year 2 (i.e. valuing output with year 1 prices) is \$60. This means P2= 5/6, P1= 1, and inflation is (5/6-1)/1 = -1/6 (or -17%). Using a CPI approach, the basket of goods is composed of 2 loaves of bread and 10 cans of beer. The price for this basket goes from 40 dollars in year 1 to 60 dollars in year 2. This implies an inflation rate of 50%.

2. With the GDP deflator, nominal GDP in year 1 is \$40, real GDP (i.e. valuing output using year 2 prices ) is \$60. Therefore, P1 = 2/3, P2=1 and inflation is (1-2/3)/ (2/3)= ½, or 50%. For a CPI, the basket of goods is composed of 5 loaves of bread and 5 cans of beer. The price of this basket is 60 dollars in year 1 and 50 dollars in year 2. This implies a deflation of 17%.

3. The problem with inflation made evident from the previous two questions is that different base years give different measures of inflation. Inflation is not invariant to the basket composition used to create the price index. The only assumption that can get rid of this problem is that relative prices between goods in the basket do not change over time.

4. One example of another obstacle in measuring inflation is change in the quality of the goods. A computer in the early nineties is quite different from a computer today.

3.

i. C = 50 + 0.6(Y -100) where c1 = 0.6

1. Z = 50 + 0.6(Y - 100) + 30 +100

2. Y = 50 + 0.6(Y-100) +30 +100

3. Autonomous consumption = 50 - 0.6*100 +30 +100 = 120. The multiplier is equal to 2.5

4. GDP = 2.5*(120) = 300 and C = 170

5. Output increases in 25 (delta * multiplier).

6. Output increases in 25 (delta * multiplier).

7. Autonomous consumption increases in 10 - 0.6*10 = 4 therefore Y increases in 10. Although you can say it was only a transfer from one agent (consumer) to another (Government), they have different propensities to consume (0.6 and 1 respectively) therefore net demand increases.

8. In this case the multiplier is 1/0.6 and autonomous consumption = 180. Therefore an increase of 10 in Gov. spending will increase output in 10/0.6 = 16.7.

9. Remember, total savings always equals investment. In part vi, investment rises by 10, so total savings goes up by 10 as well. In all the other subsections, investment has not changed so savings stay the same and equal to 30. Note total savings is the sum of private savings (S) and public savings (T-G).