Please provide a guided answer or a brief explanation, your help is very appreci

Question

Please provide a guided answer or a brief explanation, your help is very appreciated.

The figure below illustrates nominal (in current prices) and real (in prices of previous year) GDP of Latvia irn 2005-2015, in billion euro 30 a) Why is nominal and real GDP calculated? What do these variables represent? b) Using the figure above, highlight 4 stages of business cvcle and describe each stage c) What the problem was observed in national economy of Latvia in 2008? Prove your answer by calcula d) What the problem was observed in national economy of Latvia in 2009- 2010? What should the government and the Central bank do in this situation? 20 tio In current prices In pricesofprevious year

Explanation / Answer

Nominal GDP is the total dollar spending on final goods and services within a nation’s boundary, evaluated at current year prices and it carries great weightage in countries which are not experiencing hyperinflation such as US. Nominal GDP must be used when other variables don't exclude for inflation. For example, if you are comparing debt to GDP ratio, you've got to use nominal GDP since a country's debt is also nominal. Nominal GDP matters for earnings and revenue. If nominal GDP doesn't grow, revenue can only be raised by taking market share from the competitors, or diverting customer spending from other industries into your own industry.

Real GDP measures economic output that accounts for the effects of inflation. It gives a more realistic assessment of growth since it calculates GDP as if the prices never fluctuated. This can help in country comparison to understand why one country is growing at a faster pace whereas others are not.

The four stages of business cycle include expansion, peak, contraction and trough. Each country’s economic growth goes through these stages of business cycle but not necessarily in the same interval. From 2005 till 2007, Latvia’s economy was in the expansion stage where GDP (nominal as well as real) was growing at an increasing rate and it increased from 13.6% in 2005 to 22.6% in 2007. In 2008, the GDP of Latvia reached its highest at 24.4%. Thus, Latvia’s economy entered the peak stage which is the highest point of the business cycle, when the economy is producing at maximum allowable output, employment is at or above full employment, and inflationary pressures on prices are evident. Following a peak, the economy sees a contraction where growth slows, unemployment increases, and pricing pressures subside. This phase occurred in 2009 when Latvia’s economy entered into a typical correction stage. The slowing of growth ends at the trough and at this point the economy has hit a bottom from which the next phase of expansion and contraction will emerge. The trough stage of Latvia was in 2010 when the GDP was the lowest at 17.9%. After this stage, from 2011 the economy again entered into the expansion stage of the cycle where GDP kept on increasing.

In 2008, because of credit-based speculation and unrealistic inflation of real estate values or the housing market bubble , Latvia faced a rapidly weakening economy, resulting in a budget, wage and unemployment crisis. The government of Latvia adopted an “internal devaluation” strategy that included massive fiscal tightening, rising real interest rates, depression-level unemployment rates, and deflation. Latvia resumed growth in the later part of 2010 because of economic stabilization measures, while maintaining a fixed exchange rate with the euro, which was accompanied by a favorable situation in external markets and rise in market confidence.

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