CALIFORNIA STATE UNIVERSITY, SACRAMENTO
Department of Economics

Economics 100A  
Prof. Yang

Solutions to Homework Problems

Chapter:  1  2  3  4  5   6  7  8  9  12


Chapter 1

Numerical

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        b) Real GDP grew by 2.2% on average between 1960 and 1991.

        c) There were only three periods in which GDP declined: the 1973-75 recession, the 1980-81 recession,
            and the 1991 recession.   Those were recessions in the U.S. as well.  The U.K. did not experience
            the smaller 1969-70 recession.

3. a, b, and c)

           Year         Inflation        p e = .5 (p -1 + p -2)         R = i - p e          p e = p         R = i - p e

            1978            7.6%                                                                                   7.6%                 0.0%
            1979           11.3                                                                                    11.3                  -1.3
            1980           13.5                     9.4%                             2.0%                 13.5                  -2.1
            1981           10.3                   12.4                                1.4                    10.3                    3.5
            1982             6.2                   11.9                                -.8                      6.2                    4.9
            1983             3.2                     8.2                                  .6                     3.2                     5.6
            1984             4.3                     4.7                                5.2                     4.3                     5.5
            1985             3.6                     3.7                                3.9                     3.6                     4.0
            1986             1.9                     3.9                                2.1                     1.9                     4.1
            1987             3.6                     2.7                                3.4                     3.6                     2.5
            1988             4.1                     2.7                                4.2                     4.1                     2.8
            1989             4.8                     3.8                                4.2                     4.8                     3.2
            1990             5.4                     4.5                                3.0                     5.4                     2.1
            1991             4.2                     5.1                                  .4                     4.2                     1.3
            1992             3.0                     4.8                              -1.2                     3.0                       .6
            1993             3.0                     3.6                              -   .5                     3.0                       .2
            1994             2.6                     3.0                                1.7                     2.6                      2.1
            1995             2.8                     2.8                                2.8                     2.8                      2.8

d)    The real interest rate is defined as the nominal interest rate minus expected inflation.  But economists
        have no way of drectly observing agents' expectations of inflation.  Therefore, economists' estimates
        of the real rate can vary widely depending on how they model expectations.

e)     People try to forecast inflation rates using all the information that is available to them at the time of  forecast.
        They use all kinds of information: economic, political, environmental, etc.  Naturally, they do not
        systematically understimate changes in the level of prices.  Sometimes they underestimate and sometimes
        they overestimate.

Analytical

1.     In the flexible price model, output is determined by aggregate sypply.  Only fluctuations in aggregate
        supply can produce fluctuations in output.   In the sticky price model, by contrast, output is completely
        demand determined.

2.     a) While such a view could explain a fall in output, it cannot explain the increase in unemployment rates
            that occurred in the early 1980s.  This is the new classical or flexible price view of macroeconomic
            fluctuations.

        b) Interest rates, particularly real rates, were very high, a result of restrictive monetary policy.  This depressed               aggregate demand, and hence both output and the demand for labor.  This accounts for the high levels of               unemployment.   This is a sticky price or Keynesian view of output fluctuations.  The challenfe for this view
            is to explain why wages do not adjust quickly.