1. Consider an economy consisting of two people, a butcher and a baker who trade with each other. Every week the butcher trades 5 lbs. of meat for 10 loaves of bread.
a. If they carry out this exchange by barter, what is the price of bread in terms of meat? What is the price of meat in terms of bread?
b. If you wanted to calculate GDP in terms of bread (in other words, find the value of all goods produced measured in bread) what would it be? What would it be if you calculated it in terms of meat?
2. Now imagine that these two conduct the same trade but using a third good. Let's say that this good is gold. There is one gold coin in the economy which weighs 1 oz. Every Monday the butcher takes this nugget to the baker and trades it for 10 loaves of bread. Then on
Friday, the baker takes the coin to the butcher and trades it for 5 lbs. of meat.
a. What are the prices of bread and meat measured in gold?
b. What is GDP measured in units of gold?
c. How many times does the gold coin change hands per week? What is this called?
3. Now imagine that every weekday (they are closed on the weekend) in the morning, the butcher buys 2 loaves of bread from the baker and then in the afternoon, the baker buys 1 lb. of meat from the butcher. There are two ways that this can be done with 1 oz. of gold between them.
a. One way is for them to trade the same 1 oz. gold coin every day. In this case, what will the price of each good in terms of gold be? How many times will the coin change hands in a week? What is nominal GDP (measured in gold)?
b. Another way is to melt down the 1 oz. gold coin into several smaller coins. If they want to keep the prices of bread and meat (in terms of gold) the same as those in number 2 above, and trade one coin each day, how many coins will they need to divide it into? How many times (on average) will each of those coins change hands in a week?
4. Now imagine that, due to some technological breakthroughs, the butcher and baker both become able to produce twice as many goods, so that each week, the butcher buys 20 loaves of bread and the baker buys 10 lbs. of meat.
a. If the coin (or coins, depending on how you want to look at it) changes hands the same number of times in a week, what must happen to the price of bread and wheat?
b. If the prices of bread and wheat remain the same, what must happen to the number of times that the coin(s) must change hands in a week?
5. Now let's assume that they are trading 10 lbs. of meat and 20 loaves of bread per week but they have discovered some more gold. They now have 5 oz. of gold between them.
a. If they trade this entire quantity of gold two times (one time each) every week, what will the prices of meat and bread be? What will NGDP be?
b. If, instead, the prices stay the same as they were in number2, how many times will this quantity of gold need to change hands per week?