Question

Consider the Country of Econoland, which specializes in producing computers and bicycles. In 1998 Econoland produced 30 bicycles which were priced at $10 a bike and 2 computers which were priced at $100 a computer. In 1999 Econoland produced 30 bicycles at $11 a bike and 5 computers at $90 a computer. e. If the nominal inters rate was 8% from 1998 to 1999 what was the real interest rate if inflation was computed using the GDP Deflator with base year of 1998? f. suppose the government of Econoland measure inflation using a bundle of 2 bikes and 1 computer. What would they have measured the inflation rate being from 1998 to 1999?

If nominal interest rate was 8% from 1998 to 1999 what was the real interest rate if inflation was computed using the GDP Deflator with base year of 1998?

Suppose the government of econoland measured inflation using a bundle of 2 bikes and 1 computer. What would they have measured the inflation rate being from 1998 to 1999?

Answer 1

The real interest rate for Econoland from 1998 to 1999 using the GDP Deflator with a base year of 1998 was -48%. When using a fixed bundle method for inflation calculation, there was deflation of -6.67%, resulting in a real interest rate of 14.67%.

Step-by-step explanation:

To calculate the real interest rate in Econoland from 1998 to 1999 using the GDP Deflator with the base year of 1998, we must first compute the nominal GDP for both years and then the GDP Deflator for 1999. The formula for real interest rate is: Real Interest Rate = Nominal Interest Rate - Inflation Rate.

In 1998, the nominal GDP = (30 bicycles × $10/bicycle) + (2 computers × $100/computer) = $300 + $200 = $500.

In 1999, the nominal GDP = (30 bicycles × $11/bicycle) + (5 computers × $90/computer) = $330 + $450 = $780.

The GDP Deflator for 1999 is (Nominal GDP 1999 / Nominal GDP 1998) × 100 = ($780 / $500) × 100 = 156.

Using the GDP Deflator, the inflation rate from 1998 to 1999 is (Deflator 1999 - 100) = 56%.

Therefore, the real interest rate = Nominal Interest Rate - Inflation Rate = 8% - 56% = -48%.

To answer part f, if inflation is measured with a fixed bundle of goods containing 2 bicycles and 1 computer, we calculate the cost of this bundle in both years. In 1998, the cost equals (2 × $10) + (1 × $100) = $120, and in 1999, it is (2 × $11) + (1 × $90) = $112. The rate of inflation using this bundle method is (($112 - $120) / $120) × 100 = -6.67%, indicating deflation. Thus, the real interest rate using this method would be 8% - (-6.67%) = 14.67%.