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real GNP96 = (5 x 21) + (10 x 27) + (15 x 11) = 105 + 270 + 165 = 540

real GNP index: GNP95 = 100

GNP96 = (540 / 500) x 100 = 108

real growth rate = (real GNP96 - real GNP95) / real GNP95 = (540 - 500) / 500 = 40 / 500 = 0.08 = 8%

GNP price deflator = (nominal GNP / real GNP) x 100 = (637 / 540) x 100 = 118

inflation rate = (nominal GNP - real GNP) / real GNP = (637 - 540) / 540 = 18%

Q4. Use diagrams to explain the following statement:

Outward shifts in the aggregate demand curve affect output only temporarily, whereas outward shifts in the aggregate supply curve affect output permanently. And, whereas a positive demand shock raises prices, a positive supply shock reduces them

As shown in figure 11.4, the effect of an outward shift in the AD curve depends on the time period under consideration. In the short term, rigidities in the price and wage structure might affect the slope of the AS curve, being upward sloping when these bottlenecks exist. The consequence is an increase in both price and output levels of equilibrium (from point A to point B in figure 11.4 -a).

Since AS is vertical in the long run (as implied by the classical assumption of no money illusion), a shift outwards of the AD curve has only the effect of increasing the price level from P­0 to P2, since wages fully adjust to movements in prices. The policy consequence of this model is clear: Expansionary monetary and fiscal policies, which move the AD curve outwards, are effective only in the short period; in the long term, since economic agents are rationale and freed from money illusion, these policies only create inflation.

On the other side, as shown in figure 11.4 - b, a movement to the right of the AS curve (due to more flexibility in the labour or capital markets, low real wages or technological improvements) shifts the equilibrium level of output to the right and pushes down the price level from P0 to P1.  Even here, the policy implication of the classical model is clear. Only changes in the productive structure can increase national income. If unemployment exists, this is caused by rigidities in the labour market. More flexibility and pay moderation are the keys to reduce unemployment and, through shifts to the right of the AS curve, to boost GNP.

Q5. Suppose the national accounts for a country showed the following figures:

wages and salaries: £400

investment: £200

money supply: £450

corporate profits: £100


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