1. Consider an economy that produces only three types of fruit: apples, oranges,
ID: 1139972 • Letter: 1
Question
1. Consider an economy that produces only three types of fruit: apples, oranges, and bananas. Production and price data of year 1 are as follows: Fruit Apples Bananas Oranges Quantity 3000 bags 6000 bunches 8000 bags Price $2 per bag $3 per bunch $4 per bag Production and price data of year 2 are as follows: Price $3 per bag $5 per bag Fruit Quantity 4000 bags 14,000 bunches$2 per bunch 32,000 bags Apples Bananas Oranges Using year 1 as the base year, please answer the following questions: (a) Please find the real GDP of year 1 and year 2. (b) Please find the GDP deflator of year 1 and year 2. Based on the GDP deflator, what is the inflation rate of year 2? (c) Let the price index weight of apples be 0.2, bananas be 0.3 and oranges be 0.5, please find the CPI of year 1 and year 2. Based on the CPI, what is the inflation rate of year 2?Explanation / Answer
Answer 1
a) In order to calculate Real GDP we have to calculate value of goods and services in both Year 1 and Year 2 with Year 1 prices as base prices
Real GDP of Year 1 = 3000*2 + 6000*3 + 8000*4 = 56000
Real GDP of Year 2 = 4000*2 + 14000*3 +32000*4 = 178000. Note that Prices used are Year 1 prices.
b) GDP deflator = (Nominal GDP/ Real GDP)*100
As Base Year Prices are Year 1 Prices, Hence f or Year 1 Real GDP = Nominal GDP. Hence GDP deflator of Year 1 = 100
Nominal GDP of Year 2 = 4000*3 + 14000*2 +32000*5 = 200000
Hence GDP deflator of Year 2 = (200000/178000)*100 = 112.36
Inflation rate of year 2 = ((GDP deflator(Year2) - GDP Deflator (Year 1))/GDP Deflator (Year 1))*100
= ((112.36 - 100)/100)*100 = 12.36%
c)
CPI = (Current Price of basket /Price of basket in BaseYear)*100
CPI of Year 1 = ((0.2*2 + 0.3*3 + 0.5*4/(0.2*2 + 0.3*3 + 0.5*4)) = 100
Hence CPI of Year 1 = 100
CPI of Year 2 = ((0.2*3 + 0.3*2 + 0.5*5/(0.2*2 + 0.3*3 + 0.5*4))*100 = 112.12
Hence Inflation rate of Year 2 = ((112.12 - 100)/100)*100 = 12.12%
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