Microeconomics Chapter 2 Answer Sheet

Chapter 2: Answers to selected questions

Review:

5. The four components of spending are consumption, investment, government purchases, and net exports. Imports must be subtracted, because they are produced abroad and we want GDP to count only those goods and services produced within the country. For example, suppose a car built in Japan is imported into the United States. The car counts as consumption spending in U.S. GDP, but is subtracted as an import as well, so on net it does not affect U.S. GDP. However, it is counted in Japan’s GDP as an export.

9. The CPI is a price index that is calculated as the value of a fixed set of consumer goods and services at current prices divided by the value of the fixed set at base-year prices. CPI inflation is the growth rate of the CPI. CPI inflation overstates true inflation because it is hard to measure changes in quality, and because the price index doesn’t account for substitution away from goods that become relatively more expensive towards goods that become relatively cheaper.

10. The nominal interest rate is the rate at which the nominal (or dollar) value of an asset increases over time. The real interest rate is the rate at which the real value or purchasing power of an asset increases over time, and is equal to the nominal interest rate minus the inflation rate. The expected real interest rate is the rate at which the real value of an asset is expected to increase over time. It is equal to the nominal interest rate minus the expected inflation rate. The concept that is most important to borrowers and lenders is the expected real interest rate, because it affects their decisions to borrow or lend.

Numerical:

4. (a) Expenditure approach: $2  $28 consumption spending plus inventory investment of $26.

(b) Expenditure approach: $60,000 counts as residential investment made by the homebuyer (i.e. the broker provided a final service and was paid a commission rate of 6% on the $1,000,000 transaction). The...