Exercise 1.2 CPM 3 Fred Thompson

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Exercise 1.2CPM 3Fred Thompson
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Question 2-aCompute the growth rates for defense
and non-defense outlays in current-year dollars
from 1990 to 1996. Divide that growth into its
real and price components.

• For the entire period 1990-1996, defense outlays
  in current (nominal) year dollars grew 11.4 and
  non-defense outlays 34.
• Real growth in defense outlays was 25.5 and the
  price component was 19.
• Real growth in non-defense outlays was 13 and
  the price component 18.6.

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Exhibit 1.
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Growth rate (average annual rate of growth) for
defense and non-defense outlays in current year
dollars, can be found using the following formula

• R (Y/X) (1/N) 1
• where
• R the growth rate,
• Y the end value,
• X the beginning value, and
• N the number of periods of growth.

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Solution

• Therefore the nominal growth rate for defense
  outlays is
• Rnominal (266.0/300.1)(1/6) 1
• .8866371211/6 1 -.02 or -2.0
• The real rate is
• R real (242/325)1/6 1 -. 048 or 4.8
• Subtracting the real rate from the nominal rate
  yields the rate of inflation
• -. 048 (- .02) .028

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Solution (cont.)

• The nominal growth rate for non-defense outlays
  is
• R nominal (268.4/200.3)(1/6) 1
• 1.04996-1 .05 or 5.0
• The real rate is
• R real (244/216)1/6 1 .02 or 2
• Subtracting the real rate from the nominal rate
  yields the rate of inflation
• .05 - .02 .03

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Question 2-b

• What was the real dollar (1992100) change in
  defense outlays from 1990 to 1996?
• Convert the base to 1996100 and recalculate that
  increase.
• Which of the two base years is more correct?
• Compute and compare the real percentage increases
  using the two different base years

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Answer

• The real dollar change in defense outlays from
  1990 to 1996 was 25.5, calculated with 1992 as
  a base year.
• Exhibit 2 shows calculations for the real dollar
  change between 1990 if 1996 is taken as a base
  year.
• This yields the identical real dollar decrease of
  25.5.

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Exhibit 2.
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Question 2-c

• Suppose prices are expected to change between
  1996 and 2000 at the same rate they did between
  1990 and 1996.
• What level of defense and non-defense outlays
  would leave real purchasing power the same in
  2000 as in 1996?
• D 266 (1 .028)4 297 in year 2000
• ND 268.4 (1 .03)4 302 in year 2000