BUSN 5620 Webster University David Euler - Instructor

Week #5 Assignment Solutions Unit 4

Problem #1 GDP refers to the total value of all final goods and services produced in a country during a given time period, regardless of who produces them. GNP refers to the total value of all final goods and services produced by the citizens and corporations of a specific country, regardless of where they produce them. In 1991, the U.S. converted its national accounting system from GNP to GDP for two important reasons. First, most other countries of the world were already using GDP. In the interest of standardization, it made sense for the U.S. to use GDP. Second, measuring goods and services produced inside the geographic borders of ones country more accurately reflects the economic activity of ones country. For instance, a Nissan truck plant in Tennessee must hire U.S. workers, pay U.S. taxes, and purchase U.S. materials, components, and contract services. All of those activities benefit the U.S. economy. Problem #2 Structural unemployment results from a fundamental change in the structure of the economy. Typewriter repair and toll booth operations are examples of the types of jobs that either have been eliminated or are in rapid decline. Technological change often creates structural unemployment, but that is not the only driving force. Long-term changes in consumer preferences or legislative action can bring about structural unemployment. For instance, NAFTA has eliminated some U.S. company operations in the U.S., a change that will not likely be reversed. What is so insidious about structural unemployment is the prolonged effects on certain segments of the workforce. Fiscal and monetary policy can be used to stimulate the economy to create new jobs and reduce cyclical unemployment. Those policies have little or no effect on structural unemployment. The reduction of structural unemployment requires targeted programs to retrain and reeducate those who have permanently lost their job positions. Problem #3 Inflation can redistribute wealth in the economy in several ways. First, unanticipated inflation rates can transfer wealth from lenders to borrowers, or vice versa. The nominal interest rate is composed of the real interest rate plus

BUSN 5620 Webster University David Euler - Instructor

the anticipated inflation premium. Lenders know that they will be paid in cheaper dollars during inflationary periods, and so an inflation premium is factored into nominal interest rates. If inflation becomes higher than anticipated, then wealth is transferred from lenders to borrowers. Second, inflation does not cause all prices to rise by the same percentage. Some products and services (e.g. college tuition, medical care) have experienced greater price increases than others. The CPI measures inflation for an average urban household, yet virtually no one purchases the average market basket of goods and services. We who purchase goods and services that have sustained little or no price increases benefit from inflation. Third, not all incomes rise at the same rate as inflation. Some individuals are on fixed retirement incomes and are injured the most by inflation. Union workers who have contracts that index wage increases to CPI changes are relatively immune to inflation. Problem #4 With the price of a Volkswagen increasing from $5,000 to $20,000 in a thirty year period, the price has increased by 300% as follows: ($20,000 - $5,000) / $5,000 = $15,000 difference / $5,000 base price = 3.00 or 300% increase The average annual inflation rate is not 300%/30 years, since compounding occurs each year. So calculating the average inflation rate is more complex. Using a financial time value of money formula: Future value = Present value x (1 + inflation rate) ^ 30 years Since Future value/Present value = $20,000/$5,000 = 4, the formula simplifies to: 4 = (1+Inflation Rate)^30 log 4 = 30 log (1 + Inflation Rate) 0.02006866 = log (1 + Inflation Rate) 10^0.02006866 = (1+ Inflation Rate) = 1.0473 Inflation rate = 0.0473 or 4.73% per year Problem #5 One of the limitations with the calculations in Problem #4 is that the specific Volkswagen price increase for each year is unknown. We only know the average price increases over a total thirty-year period. Also, in Problem #4 we are only addressing the price changes of a Volkswagen. Consumers buy many and varied goods and services that must be tracked in a market basket. The price increase for an automobile may be quite different from a price decrease in basic food items.

BUSN 5620 Webster University David Euler - Instructor

The last point is that the automobile that we purchase today is quite different from an automobile that was purchased thirty years ago. Crash protection, antilock brakes, microprocessor controls, enhanced stereo sound systems, and anti-theft devices make the vehicle quite a different product than what was produced thirty years ago. Continuing quality improvements are not reflected in the CPI. Problem #6 March 1991 marked the end of a recessionary period for this country. The period from March, 1991 to March, 2001 was an expansionary period (meaning that real GDP increased continuously throughout this period). That 10-year period marks the longest single expansion in U.S. history. March, 2001 was the beginning of our most recent recession. Real GDP declined for the next two quarters. Problem #7 1967 is the first year for which Household income data are available on this web site. From 1967 to 2005, real mean household income increased by 31%. The demographic information shows a wider separation over time between the higher and lower income levels. The lowest two quintiles actually saw a reduction in household income. Looking at race breakdown: Percentage Change in Real Median Income 2004-2005 All Households White Black Asian Hispanic Origin Problem #8 Change 68.4% 75.7% 79.8% 73.3% 684.1% 1995 $7397.7 $4975.8 $1144.0 $1369.2 -91.4 2005 $12455.8 $8742.4 $2057.4 $2372.8 -$716.7 +1.1% +0.7% -0.8% +2.8% +1.6%

Gross Domestic Product Personal Consumption Expenditures Gross Private Domestic Investment Govnmt Consumption Expenditures & Gross Invest Net Exports of Goods and Services

The first four categories have grown at similar rates. The last category shows that our Imports exceed our exports in 2005 by $716.7 billion. This continues to be a long-term trend in the U.S. in that we consume more than we produce.