The ABC Corporation had a nominal profit of $300,000 in 1980 and a nominal profit of $330,000 in 1982. The CPI was 246.8 in 1980 and 289.1 in 1982. How much did ABC’s real profits change?
- ABC’s real profits in 1980 were $121,556 ($300,000/2.468), and in 1982 $114,147 ($330,000/2.891). Real profits went down by $7,409.
If inflation continues for twenty years at a 6% rate, by how much will prices increase?
- If the price level starts at 1, then at the end of one year, it will be at 1.06. Then prices will grow 6% more, or 1.06 times 1.06, to 1,1236 by the end of the second year. By the end of twenty years, the price level will grow to 1.06 times itself twenty times, or to 3.21. Prices will have risen 221%.
In 1981, the news media was alarmed over high interest rates when the Treasury Bill rate equaled 14%. But many economists said that interest rates were not high. Use the concepts of real and nominal interest rates to explain this apparent paradox.
- Nominal (or “the newspaper”) interest rates were very high in 1981. But what matters to the economy is the real rate, which equals the nominal rate minus the rate of inflation. The rate of inflation was 10% in 1981, so the real rate of interest was only 4% (and probably lower since many people were expecting higher rates of inflation).
Indicate the labor-force status of the following persons:
a. A doctor who is too sick to work.
b. A mechanic who couldn’t find a job needing this skills and is waiting for the economy to improve before he looks for work again.
c. A full-time student.
d. A laid-off steel worker waiting to return to work.
e. A laid-off executive who is making ends meet by working at a car wash.
f. An executive given a year off to have a baby.
b. The mechanic is not in the labor force (and is a discouraged worker).
c. The student is not in the labor force.
d. The steel worker is unemployed.
e. The laid-off executive is employed.
f. The executive having a baby is not in the labor force.
This example illustrates the index number problem. Suppose John consumes only bread. In Year 0, John buys four loaves of white bread and four of dark bread, all at $1 each. John likes both equally. In Year 1, white bread costs $2 but dark bread still costs $1. So John switches to dark bread.
a. What has happened to John’s cost of living?
b. What will the values be for a price index using Year 0 as the base year?
a. John’s cost of living remains unchanged since John has avoided the price rise by
In 1982-83, real GNP was below its potential (full-employment) level by about 4% each year. According to Okun’s Law, how much should the unemployment rate have changed?
- The unemployment rate should have increased by two percentage points each year, or by four percentage points over the two-year period. It actually increased from 7.5% to 10.4%, an increase of about 3%.
This problem illustrates what is called "bracket creep": the increase in income taxes through inflation. Suppose the first $5,000 earned is tax-free, the next $5,000 is taxed at 10%, and the next $5,000 at 20%.
a. A worker earned $7,000 in 1980. Calculate the worker’s taxes, average tax rate
b. Now suppose that over the next five years, all prices and earnings doubled (so
a. In 1980, the worker paid $200 in taxes (10% of the income exceeded $5,000), an average tax rate of 2.86%, and had an after-tax income of $6,800.
b. In 1985, the worker paid $1,300 in taxes, an average tax rate of 9.29%, and had an after-tax income of $12,700. The worker’s real after tax income is $6,350 ($12,700/2.00, where 2.00 reflects the doubling of prices since 1980). Even though the worker earns the same real before-tax income, the worker’s after-tax income has gone down due to inflation pushing the worker into a higher tax bracket.
Copyright 2008 by Sujanto Rusli
http://economicslessons.blogspot.com http;//become-debt-free.blogspot.com http://humorandwit.blogspot.com
