Question

You are given the following information about the economy of Freedonia. The country produces 10 of X with PX=1 and 4 of Y with Py=2 in year 1. In year 2, the country produced 12 of X with PX=.5 and 6 of Y with Py=3. Based on this information answer the following 2 questions. In Freedina, considering year 2 as the base year, the CPI in year 1 is

Select one:

a. 110

b. 100

c. 73

d. 80

e. 105

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Based on the information about the economy of Freedonia, the GDP deflator for years 1 and 2 is

Select one:

a. 106 and 100

b. 100 and 100

c. 100 and 105

d. 105 and 106

e. 100 and 106

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In freedonia, real GDP in years 1 and 2 is

Select one:

a. None of the above

b. 17 and 24

c. 18 and 24

d. 24 and 18

e. 24 and 24

Answer 1

Q1) Cost of year 2 basket in year 1 price = 12*1 + 6*2 = 24

Cost of year 2 basket in year 2 price = 12*0.5 + 6*3 = 24

Thus CPI in year 1 = (cost in year 1/ cost in year 2)*100 = (1/1)*100 = 100 (b)

Q2) GDP deflator = (Nominal GDP/ Real GDP)*100

year 1 = (10*1 + 4*2 / 10*0.5 + 4*3)*100 = 105.88 = 106

GDP deflator is always 100 in the base year as real GDP = nominal GDP

Thus, the answer is (a)

Q3) From Q2), we have real GDP in year 1 = 17

real GDP in year 2 = 24

Thus, the answer is (a)