ECO121 Macroeconomics

Class: IB1604
Term: Summer2021
Handed out:
Submission due:
Format: .pdf file
Submission mode:
Email to:

Student Information
Name: ĐINH TRANG LINH Roll number: 28
Room No: Class: IB1604

FOR TEACHER ONLY

MARK MARKED BY Signature of Proctor
(NAME AND SIGNATURE)

Assignment 3

Question 1 (4 points) The land of milk and honey has the following data
Year Milk price Milk quantity Honey price Honey quantity
2010 $3 20 $2 10
2011 $3 40 $2 20
2012 $6 40 $4 20
a) Given the base year of 2011, calculate nominal GDP, real GDP, and GDP deflator for each year.
b) Calculate percentage changes in nominal GDP, real GDP, and GDP deflator in 2011 and 2012
from the previous year.
c) In 2011, among nominal GDP, real GDP, and GDP deflator, identify the variable that does not
change. Explain your answer.
d) Does the overall economic activity increase more in 2011 or 2012? Explain your answer.

Question 2 (6 points)
1/2
a. What is the difference between the real exchange rate and the nominal exchange rate? Why does
the real exchange rate vary?

b. How does the real exchange rate respond to:

+ A decrease in the relative demand for US goods. Explain
+ An increase in relative output supply in the rest of the world. Explain.

c. If a country has a fixed exchange rate it loses the ability to have an independent monetary policy.
Do you agree or disagree? Explain

ANSWER:

Ex1:
a) Given the base year of 2011, calculate nominal GDP, real GDP, and GDP deflator for each year.
The Nominal GDP in each year:
Nominal GDP in 2010 = (20 * $3) + (10 * $2) = $80
Nominal GDP in 2011 = (40 * $3) + (20 * $2) = $160
Nominal GDP in 2012 = (40 * $6) + (20 * $4) = $320

The Real GDP in each year:

Real GDP in 2010 = (20 * $3) + (10 * $2) = $80
Real GDP in 2011= (40 * $3) + (20 * $2) = $160
Real GDP in 2012= (40 * $3) + (20 * $2) = $160

The GDP deflator in each year:

GDP deflator in 2010=100 * ($80 / $80) = 100
GDP Deflator in 2011=100 * ($160 / $160) = 100
GDP Deflator in 2012=100 * ($320 / $160) = 200

b) Calculate percentage changes in nominal GDP, real GDP, and GDP deflator in 2011 and 2012
from the previous year.
The percentage changes in nominal GDP year by year:
2011 = [($160-$80)/$80]x 100% = 100%
2012 = [($320-$160)/$160] x 100% = 100 %
The percentage changes in real GDP year by year:
2011 = [($160-$80)/$80] x 100% = 100%
2012 = [($160-$160)/$160] x 100% = 0%
The percentage changes in GDP deflator year by year:
2011 = [(100-100)/100] x 100% = 0%
2012 = [(200-100)/100] x 100% = 100%

2/2
c) In 2011, among nominal GDP, real GDP, and GDP deflator, identify the variable that does not
change.
- Comparing both quantity and price over the years, the price does not change between 2010 and 2011
while the quantity does not change between 2011 and 2012. This also makes an impact and is shown
in the change of Real GDP. The only change between the two years, 2010 and 2011, was a percentage
change due to a change in the quantity of goods. Similarly, the GDP deflator only shows a percentage
increase between years 2011 and 2012 (a reflection of the increase in prices). Thus, the GDP deflator
demonstrates that prices doubled between 2011 and 2012.

d) Does the overall economic activity increase more in 2011 or 2012?

- Economic well-being rose more in 2010 than in 2011, since real GDP rose in 2011 but not in 2012.
In 2011, real GDP rose but prices did not. In 2012, real GDP did not rise but prices did.

Ex2:

a. What is the difference between the real exchange rate and the nominal exchange rate? Why does
the real exchange rate vary?

- The difference between the real exchange rate and the nominal exchange rate:
Basis NOMINAL EXCHANGE RATE REAL EXCHANGE RATE
Meaning It tells the currency that can be It compares general price level of
bought by 1 unit of other currency. 2 countries.
Calculation Determined by macro factors & Nominal exchange rate is used to
demand, supply of currency determine real exchange rate.
Exports Used to price exports as well as Used to assess export
imports competitiveness of country.
Use Used in everyday foreign Used in case of overall economy.
transactions.

+ The real exchange rate is a bit more complicated than the nominal exchange rate. While the
nominal exchange rate tells how much foreign currency can be exchanged for a unit of domestic
currency, the real exchange rate tells how much the goods and services in the domestic country
can be exchanged for the goods and services in a foreign country.

- Explain: An important relationship exists between net exports and the real exchange rate
within a country. When the real exchange rate is high, the relative price of goods at home is
higher than the relative price of goods abroad. In this case, import is likely because foreign
goods are cheaper, in real terms, than domestic goods. Thus, when the real exchange rate is
high, net exports decrease as imports rise. Alternatively, when the real exchange rate is low,
net exports increase as exports rise. This relationship helps to show the effects of changes in
the real exchange rate.

b. How does the real exchange rate respond to:

3/2
 + A decrease in the relative demand for US goods. Explain.

When there is depreciation, and the exchange rate goes down: Exports will be cheaper & Imports will
become more expensive.
For example, a depreciation of the dollar makes US exports more competitive but raises the cost of
importing goods into the US.
Therefor, there will be an increase in exports and a decrease in the number of imports.
Domestic firms will benefit from increased sales. This may lead to job creation and lower
unemployment, especially in export industries.
The increase in (X-M will) help increase Aggregate Demand (AD) and therefore lead to higher
economic growth.

+ An increase in relative output supply in the rest of the world. Explain.

Between 1980 and 2002, world trade has more than tripled while world output has ‘only’ doubled.
The rise in trade relative to output is common across countries and regions, although the relative
growth in trade and output varies greatly. This indicates that there has been an increasing integration
of the world economy in the past few decades through the increase of international trade. The volume
of world trade has increased significantly relative to world output between 1980 and 2002. Some of
this increase can be accounted for by the fact that traded goods have become cheaper over time
relative to those goods that are not traded.

c. If a country has a fixed exchange rate it loses the ability to have an independent monetary policy.
Do you agree or disagree? Explain

As we known, Fixed Exchange Rates provide greater certainty for exporters and importers. Fixed
rates also help the government maintain low inflation, which, in the long run, keep interest rates down
and stimulates trade and investment.

However, Fixed Exchange Rates have many disadvantage. Developing economies often use a fixed-
rate system to limit speculation and provide a stable system. A stable system allows importers,
exporters, and investors to plan without worrying about currency moves.

Moreover, a fixed-rate system limits a central bank's ability to adjust interest rates as needed for
economic growth. A fixed-rate system also prevents market adjustments when a currency becomes
over or undervalued. Effective management of a fixed-rate system also requires a large pool of
reserves to support the currency when it is under pressure.

A large gap between official and unofficial rates can divert hard currency away, which can lead to
forex shortages and periodic large devaluations. These can be more disruptive to an economy than the
periodic adjustment of a floating exchange rate regime.

Based on the above knowledge and the current economy of Vietnam (Vietnam's exchange rate policy
is Float Exchange Rates). I am sure that "If a country has a fixed exchange rate it loses the ability to
have an independent monetary policy".

4/2