Reference no: EM131145681

Measurement error, inflation, and productivity growth

Suppose that there are only two goods produced in an economy: haircuts and banking services. Prices, quantities, and the number of workers occupied in the production of each good for year 1 and for year 2 are given below:

a. What is nominal GDP in each year?

b. Using year 1 prices, what is real GDP in year 2? What is the growth rate of real GDP?

c. What is the rate of inflation using the GDP deflator?

d. Using year 1 prices, what is real GDP per worker in year 1 and year 2? What is labor productivity growth between year 1 and year 2 for the whole economy? Now suppose that banking services in year 2 are not the same as banking services in year 1. Year 2 banking services include telebanking, which year 1 banking services did not include. The technology for telebanking was available in year 1, but the price of banking services with telebanking in year 1 was $13, and no one chose to purchase this package. However, in year 2, the price of banking services with telebanking was $12, and everyone chose to have this package (i.e., in year 2 no one chose to have the year 1 banking services package without telebanking). (Hint: Assume that there are now two types of banking services: those with telebanking and those without. Rewrite the preceding table but now with three goods: haircuts and the two types of banking services.)

e. Using year 1 prices, what is real GDP for year 2? What is the growth rate of real GDP?

f. What is the rate of inflation using the GDP deflator?

g. What is labor productivity growth between year 1 and year 2 for the whole economy?

h. Consider this statement: "If banking services are mismeasured-for example, by not taking into account the introduction of telebanking-we will overestimate inflation and underestimate productivity growth." Discuss this statement in light of your answers to parts (a) through (g).