# Economics 304 Homework #1 – A ride into reality!

Economics 304 Homework #1 – A ride into reality!Question

125 points total

Instructions: Please show all work or points will be taken off. Good luck! In this first homework assignment, we are getting our ‘hands dirty’ to get familiar with

some of the major macroeconomic variables that we will be using and working with

throughout the semester. Our first chapter with ‘something to sink our teeth into’ is

chapter 3 in the packet and it is all about the factors of production, the labor market, and

of course, the production function. Major variables in this part of the macroeconomy

(i.e., the supply side of the economy) include, but certainly are not limited to,

employment (denoted N), real wages (denoted w = W/P where W = nominal wage and P

is the price index – typically the CPI or the PCE index) and real GDP (denoted Y). When

we move to the demand side of the economy we encounter many more major

macroeconomic variables including consumption (C), investment (I), and the real interest

rate (denoted r), among others. We are going to use FRED as our source of data (many

professional economists use this site, nice clean data!)1 1 FRED stands for Federal Reserve Economic Data.- click Here for the FRED website YOU MUST SHOW ALL WORK, IF YOU SIMPLY PUT THE ANSWER DOWN

YOU GET ZERO POINTS – I know for a fact that many students copy each others

homework! Take all calculations to two decimal places.

1.(35 points total) The Peanuts comic below motivated parts a) and b) of this question –

as you may know, Charles Shulz was the creator of peanuts and wrote the strip for nearly

50 years. I am not sure when the comic below was written so let’s assume (economists

love to assume!) that it was written in May of 1958. a)(5 points) Snoopy mentions that coffee is eighty-nine referring to the price of a pound

of coffee back in May of 1958 = 89 cents. Using the CPI data (link below), what was the

real price of coffee back in May of 1958?

CPI

b) (5 points) Now let’s fast forward to the present. What would the price of coffee need

to be now to equal the real price of coffee back in May of 1958? (use July of 2017 for

your work)

Use the following link to answer part c) below

Click Here for data on the MW

c) (5 points) What is the rate of inflation between 1996 and 1997? (please take inflation

rate to two decimals)

d) (5 points) What would the nominal minimum wage have to be in 1967 to equal the real

purchasing power of the minimum wage in 2015? 2 Use the two links below to answer questions e) and f)

Wage Data

CPI

e)(5 points) Calculate the percent change in nominal wages between October of 2011

and October 2012 and compare to the percent change in nominal wages between July of

2016 and July of 2017. Which does Janet Yellen and the Fed prefer and why?

f) (10 points) Calculate the percent change in the real wage between October of 2011 and

October 2012 and compare to the percent change in the real wage between July of 2016

and July of 2017. Use the formula %?(W/P) = %?W – %?P

2. (45 points) We discussed the port in the cruise ship analogy and the associated dual

mandate given to the Fed by Congress (click Here for more). We also mentioned that we

are doing quite well, at least statistically, with regard to achieving the dual mandate, the

best in many years.

In terms of achieving the dual mandate, we have a real goal and a nominal goal. One of

the real goals is for real GDP to be at potential GDP and/or real GDP growth to equal

potential GDP growth. You will need the following two links to answer this question:

Potential GDP

Real GDP

a)(5 points) Using the most recent data (2017:Q2), calculate the GDP gap as defined as:

[(Real GDP – Potential GDP)/ Potential GDP] x 100

b)(5 points) Is your answer in part a) above consistent with the Fed raising interest rates,

why or why not? Hint: the term lag needs to be in your answer.

c) (5 points) Calculate what the GDP Gap was at the trough of the great recession – click

Here to identify when the trough was.

d) (5 points) Calculate what the GDP Gap was at the trough of the 2001 recession – click

Here to identify when the trough was. 3 e) (5 points) Let us look at the previous 2 recessions in the US by looking at the

unemployment gap as defined by the actual unemployment rate minus NAIRU. Returning

to the troughs of each recession, estimate the unemployment gap for each recession. Use

the links below.

NAIRU

Unemployment Rate

f)(10 points) The average age for the students in econ 304 is probably around 20 years

old. Using the links below, calculate the real wage 20 years ago (July 1997) as well as the

real wage using the most recent data (July 2017).

Wage Data

CPI

Employment

g)(10 points) Now draw a graph locating point A as the conditions in July of 1997 and

point B with the latest conditions. In the vertical axis is the real wage and on the

horizontal axis is N – employmnet. Make sure you label the graph completely. How

many more people are working now relative to 20 years ago???

3. (45 points total)

a) (5 points) Using the links below, calculate the most recent one year ex-post real rate of

interest. Note that the most previous actual rate of inflation is from July 2016 – July 2017.

one year interest rate

CPI

inflation expectations

b) (5 points) Now calculate the most recent one year ex-ante real rate of interest.

c)(5 points) My father and I used to discuss the difference between real and nominal

interest rates. He would always refer to the good ole times when nominal rates were high

in the 1980s. Let’s go back top July of 1984. Calculate the ex-post real rate of interest for

the period July 1984 to July of 1985. Use the same links as above. 4 d)(10 points) Draw two baskets (like we did in class) of goods and services, one for July

1984 and one for July of 1985. Let the basket in July of 1984 equal $100. Show the real

return as calculated above – be specific and use the correct numbers!

We discussed the evils of deflation.

e) (10 points) From a macroeconomic perspective, why is deflation so bad? Please refer

to consumer behavior and the corresponding behavior of firms in a deflationary

environment. Please explain completely.

f) (10 points)Now discuss the fact that persistent deflation is the central bank’s worst

nightmare Why is this environment such a nightmare for the central bank and monetary

policy and why is persistent deflation such a nightmare? Explain using the Fisher

equation for the real rate of interest and refer to both the ex-post and ex-ante real rate of

interest. 5