You read in the newspaper that, compared to one year ago: nominal GDP increased

Question

You read in the newspaper that, compared to one year ago:

nominal GDP increased from $12 trillion to $12.6 trillion;

the GDP price index is up by 7%;

the CPI jumped from 203 to 219;

the number of civilians employed is 110 million and there are 10 million unemployed but actively seeking work. Another 5 million have given up looking for work and are considered “discouraged.”

What is happening to real GDP? How does this compare to the long-term trend for real GDP of 3%?

What is the inflation rate? How does this compare to the 2% rate of inflation that the Federal Reserve feels is "good" for the economy?

What is the unemployment rate? How does the unemployment rate compare to the natural rate of unemployment? Given that the unemployment rate is a lagging indicator, discuss reasons is it likely to be higher or lower in the near term.

Given your answers to 1-3, the economy appears to be in what part of the business cycle?

Assume half of the people living in this economy have accumulated wealth and live mostly off their savings and financial investments while the other half have no savings and live from pay check to pay check. Which group would want the government to focus on reducing inflation and why?

Explanation / Answer

1. Increase in nominal GDP = (12.6-12)/12 = 5%

Increase in inflation = (219-203)/203 = 7.9%

Increase in real GDP = 5% - 7.9% = -2.9%

Thus, real GDP has decreased because of high inflation.

This compares being no where close to long term growth rate of 3% increase expected.

2. Increase in inflation or change in CPI = (219-203)/203 = 7.9%

Since actual inflation is almost 4 times the 'good' level, it shows that the economy is facing severe inflation.

3. Unemployment rate = 10/(10+110) = 8.33%

Since unemployment rate is very low, it seems to be close to natural rate of unemployment

Being a lagging indicator, it is likely to increase in future.

4. Because of high inflation, the economy appears to be in expansionary phase

5. The group living off their savings will want government to focus on reducing inflation because these people have fixed money in hands with no variable source of income and will thus want prices to remain stable or low so that their purchasing power does not fall.

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