1.Consider a developing country, experiencing a high rate of growth in GDP. In y
ID: 1174230 • Letter: 1
Question
1.Consider a developing country, experiencing a high rate of growth in GDP. In your view, would this mean an increase in economic wellbeing? Explain why/why not (provide TWO reasons).
2.Explain how inflation leads to redistribution of wealth between borrowers and lenders. Will such redistribution take place if interest rate is specified in real rather than nominal terms?
3.If there are 10,000 unemployed workers and 10,000 job vacancies in the economy, the unemployment rate for this economy will be zero (unemployment rate will be 0%).
Explain whether you agree or disagree with the statement.
Explanation / Answer
(1) Growth rate in GDP does not necessarily indicate economic well-being for following reasons:
(a) GDP includes expenditures on goods or services that do not directly contribute to residents' standard of living. For example, increase in government spending on military goods will increase GDP but will not increases residents' general economic well-being, and
(b) GDP excludes some crucial parameters of standard of living. For example GDP does not include the effects of pollution or lack of sustainable development that lowers the standard of living.
(2) When inflation is high (low), real value of loan decreases (increases). Therefore, the value of asset decreases (increases) for the lenders (for whom loans are assets) and the value of liability decreases (increases) for the borrowers (for whom loans are liabilities). As a result, high (low) inflation redistributes wealth from lenders (borrowers) to lenders (borrowers).
If interest rate is stated in real terms, this redistribution does not occur since real value of the loan remains constant.
(3) I disagree with the statement.
Unemployment rate will never be zero because there is always some structural unemployment (caused by skill and expectation mismatch between employers and employees) and frictional unemployment (which arises when an employee is looking for a job in between two jobs). Since instantaneous vacancy fulfilment is not possible, there is always some frictional unemployment in the economy, so unemployment rate cannot be zero.
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