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Slides By John Dawson and Kevin Brady

Interactive Examples. Nominal vs. Real Growth. Begin. To navigate, please click the appropriate green buttons. (Do not use the arrows on your keyboard). Material from this presentation can be found in: Chapter 16. Slides By John Dawson and Kevin Brady. CoreEconomics, 2e.

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Slides By John Dawson and Kevin Brady

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  1. Interactive Examples Nominal vs. Real Growth Begin To navigate, please click the appropriategreenbuttons. (Do not use the arrows on your keyboard) Material from this presentation can be found in: Chapter 16 Slides By John Dawson and Kevin Brady CoreEconomics, 2e

  2. Interactive Examples Nominal vs. Real Growth • QUESTION 1: Escalator Clauses • Suppose you are negotiating a contract for a new job and, since you achieved an A in your economics course, your new employer agrees, at a minimum, to automatically adjust your salary by the rate of inflation each year. • What is the general formula for an escalator clause adjustment? • Assume your starting salary was $60,000. During the first year, you see that the CPI index goes from 112 to 114. What is the minimum salary you expect for the second year? • Assume your salary during the fourth year was $75,000. You are surfing the internet and hear that inflation was 2.7% during the year. What is the minimum salary you expect for the fifth year? Answer

  3. Interactive Examples Nominal vs. Real Growth Next • ANSWER: • New = Original X (Current Year Index / Original Year Index) • New = $60,000 X (114/112) = $60,000 x (1.0179) = $61,074 • If you know the rate of inflation, there is no need to search for the index values. Rather, take the prior year’s salary and multiply it by (1 + rate of inflation). Thus, the salary you expect, at a minimum, during the fifth year equals $75,000 X (1+.027) = $75,000 X 1.027 = $77,025 Back

  4. Interactive Examples Nominal vs. Real Growth Question 2: Deflating Series (Nominal vs. Real Growth) Your older brother, who graduated from college 5 years earlier than you with a degree in communications, tells you that his starting salary was $50,000. It is now 4 years later, and he is making $60,000. He is so proud of this fact and often uses it to needle you. From your economics course, you know that nominal values (such as your brother’s salary) can be misleading. A. What is a formula that can be used to transform nominal values into real values? B. If the GDP deflator was 100 in the base year (first year) and is now 115, does your brother have more purchasing power than he did four years ago? C. If the GDP deflator was 100 in the base year and is now 130, does your brother have more purchasing power than he did four years ago? Answer

  5. Interactive Examples Nominal vs. Real Growth ANSWER: A. Real = Nominal X (Base Year Index / Current Year Index) B. Yes! Real = $60,000 X (100/115) = $60,000 X (.8696) = $52,176. This is greater than $50,000 by $2,176, which represents an increase in real purchasing power. C. No! Real = $60,000 X (100/130) = $60,000 X (.7692) = $46,152. This is less than $50,000 by $3,848, which represents a decrease in real purchasing power. The End Back

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