NOVA School of Business and Economics

Fall Semester 2022/2023

Principles of Macroeconomics
1st Problem Set
2.

Real GDP of Portugal at 2015 prices (Millions of euros) Real GDP of Italy at 2015 prices (Millions of euros)

Considering the graphs shown, we can claim that, when considering the real GDP
(base 2015) Portugal's and Italy's economies maintained themselves relatively
stable from the third quarter of 2017 to the fourth quarter of 2019, showing small
variations around the value of 430000 Million euros, in Italy’s case, and varying
between approximately 48000 and 51000 Million euros, in Portugal’s case. However,
from the fourth quarter of 2019 to the second of 2020, the real GDP of both
economies harshly declined. In Italy’s case it dropped from 438306.65 to 357651.19
M€, approximately, and in Portugal’s case, from 50507.17 to 41269.15 M€. After
these declines, both economies started recovering, eventually getting back to
numbers close to those presented before, in the fourth quarter of 2021, and, in
Portugal’s case, even achieving slightly higher numbers, in the second quarter of
2022 (51771.56 M€).

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3.

The pandemic had a huge impact on both the Portuguese and Italian
economies. Both countries had their containment measures, both economically and
in terms of health. Firstly, both Italy and Portugal suffered a downturn in their
economy.
The number of contaminations in Italy had many more peaks than in Portugal.
At the beginning of the pandemic, Italy was one of the countries with the most
contaminations, with 5,600 daily cases in March 2020. In comparison, Portugal
recorded about 450 cases. It was also during this period that an emergency status
was declared in both countries and prevention measures were placed, much more
incisive in Italy due to too many contagions. Furthermore, the impact was much
more notable in Italy with its GDP dropping €70B in the first quarter of 2020
compared to the previous quarter, around 15%, then falling in the second quarter to
375B€, a 21% decrease compared to the beginning of 2020. In relation to Portugal,
its economy has better withstood the impact, with a fall of €5B from the first to the
second quarter of 2020, around 9%, followed by a stabilization in the second quarter
of 2020.

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To mitigate the impacts on the economies, both countries took measures not
to let most private companies collapse, such as financing subsidies to small
businesses affected by COVID-19 with tax breaks, as well as facilitating credit to
SMEs. There was also a maintenance on employment to encourage people to work,
such as telecommuting and salary increases in various sectors.

4.

The consumer confidence index is directly related to the GDP growth rate. In
fact, until 2019 the evolution of both was basically the same and from 2019 to 2020,
it decreased a lot. Since 2020, this value has been increasing significantly until
2022, when consumer confidence started to decrease again. The consumer

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confidence index is decreasing because of the slowdown that these countries are
overtaking. This slowdown is related to the inflation caused by the tension between
Russia and Ukraine. This inflation surged because for the same demand the supply
decreases, namely cereals and energy. The GDP in the incoming quarters will
continue to decrease if the present situation doesn't change.

II

1.

Nominal wage increase regards the variation of income in a given time period.
Assuming a yearly basis, if the value is positive the value that the household is
receiving at a given year is higher than the value they received the year before. The
value of nominal wage increases in 2022, according to BdP, is 5.4%.

If we take into account inflation, that is, a general increase in the prices of
goods and services, it would result in a household spending more money to buy the
same amount of goods. If the nominal wage increase rate is higher than the inflation
rate, the household’s final income would increase, due to the fact that the wages
increased more than the price of goods. If the inflation rate increases more than the
nominal wage increase rate, the final income would decrease, because wages didn’t
increase as much as the price of goods.

According to the BdP, the nominal wage increased 5.4% in 2022 and it
expects an HICP (main inflation indicator) to be 7.8%. This means that the
household final income or real wage would not only estagnate but would even
decrease.

2.

In this specific graph it is possible to claim that the top line, highlighted in
yellow, represents the nominal wages and the bottom line, highlighted in blue,

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represents the real wages. This is certain because, considering that the variation of
prices was positive throughout this period of time (inflation), it does not matter how
much the nominal wages increase, the real wages will never be able to keep up,
being, for this reason, represented by the blue line.

Knowing this, it is also possible to evaluate the evolution of prices. From 2014
to 2020 both wages were increasing, with nominal wages increasing more than the
real wage. This shows that the inflation rate was positive but not as significant as the
increase in the nominal wages, because the real wage was also increasing. In the
second and third quarters of 2020, real wages decreased, but nominal wages also
decreased around the same amount, meaning that the prices kept considerably
consistent, probably developing an inflation rate close to 0%. After 2020 we have
again a situation in which the wages both increase, with the nominal wage
increasing more than real one, meaning once again a positive inflation rate with less
impact than the nominal, however, in the second and third quarters of 2022 the real
wages decreased, even with the increase shown in the nominal wages, which
means that inflation was positive and considerably more significant than the
increase of the nominal wages, bringing real wages down.

3.

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An inflation rate is how much the prices of goods and services increased in
comparison to a base year’s prices. In the graph above, the deflators are calculated
with the 2015 prices, which means that, for example, in the 1st quarter of 2020 the
prices were 1.1 times the 2015 prices in the same quarter and for the same
quantities of services and goods. Therefore, the inflation rate is the deflator minus
100%. With that in mind, the GDP deflator and the private consumption deflator in
the graph have the same base prices (2015), so why are they different?

The Gross domestic product calculated with the expenditure approach, has
the private consumption expenditure as one of its components, along with public
consumption, gross investment, and net exports, i.e., the inflation rate of the GDP
not only considers the prices of goods and services that are consumed by the
private sector. So, the inflation of prices of goods and services from the public
sector, the net exports and how much the investment in a certain period has
changed the economy, will also have a huge impact on the GDP inflation rate. That’s
why the two inflation rates are similar but not equal.

4.

Analyzing the real and nominal wages graph curve, we can conclude that the
real wages are calculated by deflating the nominal wages with an inflation rate
based on the consumer prices index, similar to the private consumption deflator.
With the information that we get with the graph in the previous answer, we can
notice that after the 2nd quarter of 2021 the GDP inflation rate is always above the
private consumption inflation rate.

Reverting the process and using the GDP deflator as a base to the inflation
rate used in the real wages, we can deduce that the curve will change, because the
inflation rate of the GDP is different, as we said before and confirmed in the previous
answer. Therefore, if we use the GDP inflation rate to compute the real wages
instead, the real wages will decrease in that period of time. That happens, because
as the inflation rate increases, the goods and services prices also do. So, the
purchasing power will decrease making the real wages decrease too.

5.

The UK Government’s official measure of inflation is based on changes in the

cost of a basket of goods and services. While the price of some items rising

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increases the inflation rate, the impact is diluted if the price of other items falls or
stays the same. One of the UK’s measures was to switch people to search cheaper
alternatives while the others were rising. However, “That’s impossible if a household
is already buying as cheaply as it can or has special needs for example due to
health issues.”

These measures help some people to not lose their purchasing power. For
example, for people that were accustomed to buy branded products, with the same
money they will buy the same quantities of a cheapear good or service. However, for
those that usually buy the cheapest one’s, they will probably lose their purchasing
power, i.e, with the same money they will be able to buy less quantities of a good or
a service. In consequence, the public finance will at first increase, but in a long time
it will decrease, because of the increase of unemployment, taxes and subsidies to
firms and households.

The whole economy will suffer with inflation and with these measures if in a
long time the inflation continues to increase or if there’s not a slowdown. This article
is both positive and normative, because for the first example it describes the UK with
facts (“The UK Government’s latest data shows UK price inflation has risen by 4.8%
year-on-year”) but for the second one it gives examples of how the UK should be
helping its population. (“That’s impossible if a household is already buying as
cheaply as it can or has special needs for example due to health issues.”)

The real impact of inflation on individual households | Faculty of Arts and Social
Sciences (open.ac.uk)

Daniela Ferreira | Manuel Franco | Miguel Laureano | Vasco Nobre