Question

We have observed an economy for two years. In the first year, average nominal income was $48,000 and average nominal income was $50,000 in the second year. The CPI was 110 in the first year and 115 in the second year a. What was the growth rate for nominal average income between the two years? b. Compute the value of real average income for each year. c. What was the growth rate for real average income between the two years? d. Did consumers have a higher purchasing power in the first year or the second year? What is the reason for the observed change in purchasing power?

Answer 1

Nominal Income in first year = 48,000

Nominal Income in second year = 50,000

CPI in first year = 110

CPI in second year = 115

a) Growth rate of nominal income = [(50,000 - 48,000) / 48,000] * 100 = 4.61%

b) Real income in first year = (48,000 / 110) * 100 = 43,636.36

Real income in second year = (50,000 / 115) * 100 = 43,478.26

c) Growth rate of real GDP = [(43,478.26 - 43,636.36) / 43,636.36] * 100 = -0.36%

d) There is fall in purchasing power due to fall in real GDP. It is due to rise in overall price of all goods which result in rise in CPI.