Answer to Question 1:

Consider an economy that produced 100 bottles of beer and 100 pounds of beans in 1980. In that year beer sold for $2 per bot- tle and beans for $1 per pound. In 1990 the economy produced 120 bottles of beer and 200 pounds of beans. The prices were $5 for beer and $2 for beans. In 1990, nominal output, real output in 1980 dollars and the implicit output deflator are, respectively

1. $320, $200 and 160.

2. $320, $200 and 1.60.

3. $1000, $440 and 227.3.

4. $1000, $440 and 2.273.

Choose the correct answer.

The correct answer is 3 . The nominal or money value of output in 1980 was (100 x $2) + (100 x $1) = $300. The nominal value of output in 1990 was (120 x $5) + (200 x $2) = $1000. The real value of 1990 output in 1980 dollars was (120 x $2) + (200 x $1) = $440. The implicit output deflator in 1990 is therefore ($1000/$440) x 100 = 227.3.

If you chose any answer but 3 , you probably made one of two errors. Either you forgot to multiply the ratio of nominal to real output by 100 and ended up with the implicit output deflator on a base of 1980 = 1.0 instead of 1980 = 100. Or in calculating income you added together the quantities without multiplying them by their prices. The calculations are straight forward---nominal output is the sum of the nominal values of the two goods produced and real output is the sum of the values based on 1980 prices rather than 1990 prices. The implicit output deflator is the ratio of nominal output to real output, put on a base of 1980 = 100.

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