Professional Documents
Culture Documents
By :
a. A Numerical Example
The table shows some data for economy that produces only two goods:
fried rice and satay. The table shows the prices and quantities produced of two
goods in the years 2017,2018, and 2019. To compute total spending in this
economy, we multiply the quantities of fried rice and satay by their prices. In
the year 2017, 50 fried rice are sold at the price of $2 per fried rice, so
expenditure on fried rice equals $100. In the same year, 100 satay are sold for
$1 per satay, so expenditure on satay equals $100. Total expenditure in
economy is the sum of expenditure on fried rice and expenditure on satay is
$200. This amount, the production of goods and services valued at current
price, is called nominal GDP.
The table also shows the calculation of nominal GDP for the three
years. Total spending rises from $200 in 2017 to $600 in 2018 and then to
$1.200 in 2019. It’s because the increase in the quantities of fried rice and
satay and in the other hand It’s because the increase in the price of fried rice
and satay. To get a measure of the amount produced that is not affected by the
changes in prices, use the first designating one year as a base year to calculate
real GDP. Then use the price of fried rice and satay in the base year to compute
the value of goods and services in all the year. Assume that we choose 2017
to be the base year. We found that real GDP has risen from $200 in 2017 to
$350 in 2018 and then to $500 in 2018 and also we know that the increase in
attributable to an increase in the quantities produced because the prices are
being held fixed at base year levels.
Nominal GDP uses current prices to place a value on the economy’s
production of goods and services. Real GDP uses constant base year prices to
place a value on the economy’s production of goods and services. The real
GDP is not affected by changes in prices, changes in real GDP shows only
changes in the amounts being produced. The reason why we have to count
GDP is to know how well the overall economy is performing. Because of that,
real GDP is a measure of the economy’s production of goods and services. It’s
will show us the economy’s ability to satisfy people needs and desires. Thus,
real GDP is a better gauge of economic well-being rather than is nominal
GDP.
b. The GDP Deflator
GDP deflator is a measure of the price level calculated as the ratio of
nominal GDP to real GDP times 100. GDP deflator reflect only the price of
goods and services.
Nominal GDP
GDP deflator = 𝑥 100
Real GDP
The GDP deflator measure the current level of prices relative to the
level of prices in the base year. For example: First, imagine that the quantities
produced in the economy rise over time but prices remain the same. In this
case, both nominal and real GDP rise at the same rate, so the GDP deflator is
constant. Now, supposed, instead, that prices rise over time but the quantities
produced stay the same. Second case, nominal GDP raises but real GDP
remains the same, so the GDP deflator rises. Notice that, in both cases, the
GDP deflator reflects what is happening to prices, not quantities. Economists
use the term inflation to describe a situation in which the economy’s overall
price level is rising. The inflation rate is the percentage change in some
measure of the price level from one period to the text. Using the GDP deflator,
the inflation rate between two consecutive years is computed as follows:
GDP deflator in year 2−GDP deflator in year 1
GDP deflator = 𝑥 100
GDP deflator in year 1
E. Is GDP a Good Measure of Economic Well-Being?
GDP measures both the total income and total expenditure of economy’s
on goods and services. Therefore, GDP per person tells the income and
expenditure of the average person in the economy. GDP per person seems a
natural measure of the economy well-being of the average individual, because
most people would prefer to receive higher income and enjoy higher expenditure.
Yet some people dispute the validity of GDP as a measure of well-being.
When Senator Robert Kennedy was running for president in 1986, he gave a
critique of such economic measure:
“[Gross domestic product] does not allow for the health of our children,
the quality of their education, or their education, or the joy of their play. It does
not include the beauty of our poetry or the strength of our marriages, the
intelligence of our public debate or the integrity of our pubic officials.it measures
neither our courage, nor our wisdom, nor our devotion to country. It measures
everything, in short, except that which makes life worthwhile, and it can tell us
everything about America except why we are proud that we are Americans.”
Much of what Robert Kennedy said is correct. We care about GDP because
in fact a large GDP help us to lead good lives. Nation with larger GDP can afford
better healthcare for their people, afford better educational systems, and afford to
teach more of their citizens. GDP does not directly measure those things that make
life worthwhile, but it does measure our ability to obtain many of the inputs for a
worthwhile life.
GDP omits the value of the goods and services that produced at home.
Because GDP uses market prices to value the goods and services, it excludes the
value of almost all activity that takes place outside the markets. For example,
when a chef prepared the meal and sells it at her restaurant, the value of the meal
is part of GDP. But if the chef prepares the same meal for her family the value of
the meal is not part of GDP. Volunteer work also contributed to the well-being of
those in the society, but GDP does not reflect the contributions.
Quality of the environment is another thing that GDP excludes. GDP
might rise if the government eliminated all environmental regulations because the
firms could then produce goods and services without considering the pollution
they create. Yet well-being would most likely fall because the deterioration in the
quality of air and water would more than offset the gains from greater production.
GDP also says nothing about the distribution of income. GDP per person
tells us what happens to the average person, but behind the average lies a large
variety of personal experiences.
The conclude is that GDP is a good measure of economic well-being for
most, but not a perfect measure of well-being.
Question for review
1. Explain why an economy’s income must equal its expenditure.
Answer:
An economy income must equal its expenditure because of every
transaction has two parties, a buyer and a seller. Thus, expenditure by
buyers must equal income to sellers. Everyone one dollar of spending
becomes one dollar of someone’s income.
3. A farmer sells wheat to a baker for $2. The baker uses the wheat to make bread,
which is sold for $3. What is the total contribution of these transactions to GDP?
Answer:
The contribution to GDP is $3, the market value of the bread, which is the
final good that is sold. The $2 wheat is an intermediate good and its market
value has been included into the market value of the bread. To avoid
double counting the value of intermediate goods, a government only
collects the market values of final goods.
4. Many years ago, Peggy paid $500 to put together a record collection. Today, she
sold her albums at a garage sale for $100. How does this sale affect current GDP?
Answer:
Peggy’s albums do not currently affect GDP because they were not
produced within the given period of time. The effect of the GDP would
have been at the time of the original sale, when the album was marketed
as new.
5. List the four components of GDP. Give an example of each.
Answer:
a. Consumption
Example: purchase of a refrigerator
b. Investment
Example: purchase of new housing
c. Government purchases
Example: salaries of government workers
d. Net exports
Example: the sale of Indonesian handicraft to America
6. Why do economists use real GDP rather than nominal GDP to gauge economic
well-being?
Answer:
Economists use real GDP rather than nominal GDP to gauge economic
well-being because real GDP is not affected by changes in prices, so it
reflects only changes in the amounts being produced. You cannot
determine if a rise in nominal GDP has been caused by increased
production on higher prices.
7. In the year 2017, the economy produces 100 loaves of bread that sell for $2 each.
In the year 2018, the economy produces 200 loaves of bread that sell for $3 each.
Calculate nominal GDP, real GDP, and the GDP deflator for each year. (use 2017
as the base year) by what percentage does each of these three statistics rise from
one year to the next?
Answer:
Year Nominal GDP Real GDP GDP Deflator
2017 100 x $2 = $200 100 x $2 = $200 ($200/$200) x 100 = 100
2018 200 x $3 = $600 200 x $2 = $400 ($600/$400) x 100 = 150
The percentage change in nominal GDP is (600 - 200)/200 x 100 = 200%. The
percentage change in real GDP is (400 - 200)/200 x 100 = 100%. The percentage
change in the deflator is (150 – 100)/100 x 100 = 50%.
8. Why is it desirable for a country to have a large GDP? Given an example of
something that would raise GDP? And yet be undesirable.
Answer:
GDP (per capita) seems a natural measure of the economic well-being of
the average individual, higher living standards. Something that could raise
GDP and yet be undesirable would be massive increases to production,
because that would contribute to worse pollution of the environment.
Problems and Application
1. What components of GDP (if any) would each of the following transactions
affect? Explain.
a. Uncle Henry buy a new refrigerator from a domestic manufacturer
b. Aunt Jane buys a new house from a local builder.
c. The Jackson family buys an old Victorian house from the Walker family.
d. You pay a hairdresser for a haircut
e. Ford sells a Mustang from its inventory to the Martinez family
f. Ford manufactures a Focus and sells it to Avis, the car rental company.
g. California hires worker to repave highway 101
h. The federal government needs your grandmother a social security check
i. Your parents buy a bottle of French wine
j. Honda expands its factory in Ohio
Answer:
a. Consumption increases because a refrigerator is a good purchased by a
household
b. Investment increases because a house is an investment good
c. Investment increases because a house is an investment good
d. Consumption increase because a haircut is a services purchased by a
household
e. Consumption increases because a car is a good purchased by a household, but
investment decreases because the car in Ford’s inventory had been counted as
an investment good until it was sold.
f. Investment decrease because ford’s inventory has been sold, but the
investment of car rental company’s increase because the car is an investment
good.
g. Government purchases increase because the government spent money to pay
the worker
h. Government purchases increase because the government spent money to
provide a service to public
i. Consumption increases because the bottle is a good purchased by a household,
but net exports decrease because the bottle of french wine was imported.
j. Investment increases because new structures and equipment were built.
Answer:
Real GDP Nominal GDP GDP deflator
Year (in 2000 dollars) (in current dollars) (base year 2000)
1970 3,000 1,200 40
1980 5,000 3,000 60
1990 6,000 6,000 100
2000 ______ 8,000 ______
2010 7500 15,000 200
1020 10,000 30000 300
2030 20,000 50,000 250
5. Below are some data from the land of milk and honey
a. Compute nominal GDP, real GDP, and the GDP deflator for each year, using
2016 as the base year.
b. Compute the percentage change in nominal GDP, real GDP, and the GDP
deflator in 2017 and 2018 from the preceding year. For each year, identify the
variable that does not change. Explain why your answer makes sense.
c. Did economic well-being increase more in 2017 or 2018 explain.
Answer:
a. Calculating nominal GDP:
2016: ($1 per qt. of milk × 100 qts. milk) + ($2 per qt. of honey × 50 qts.
honey) = $200
2017: ($1 per qt. of milk × 200 qts. milk) + ($2 per qt. of honey × 100 qts.
honey) = $400
2018: ($2 per qt. of milk × 200 qts. milk) + ($4 per qt. of honey × 100 qts.
honey) = $800
Calculating real GDP (base year 2016):
2016: ($1 per qt. of milk × 100 qts. milk) + ($2 per qt. of honey × 50 qts.
honey) = $200
2017: ($1 per qt. of milk × 200 qts. milk) + ($2 per qt. of honey × 100 qts.
honey) = $400
2018: ($1 per qt. of milk × 200 qts. milk) + ($2 per qt. of honey × 100 qts.
honey) = $400
c. Economic well-being rose more in 2016 than in 2017, since real GDO rose in
2017 but not in 2018. In 2017, real GDP rose but prices did not. In 2010, real
GDP did not rise but prices did.
6. Consider an economy that produces only chocolate bars. In year 1, the quantity
produced is 3 bars and the price $4. In year 2, the quantity produced is 4 bars and
the price $5. In year 3, the quantity produced is 5 bars and the price $6. Year 1 is
the base year.
a. What is nominal GDP for each of these three years?
b. What is real GDP for each of these years?
c. What is the GDP deflator for each of these years?
d. What is the percentage growth rate of real GDP from year 2 to year 3?
e. What is the inflation rate as measured by the GDP deflator from year 2 to year
3?
f. In this one-good economy, how might you have answered parts (d) and (e)
without first answering parts (b) and (c)
Answer:
a. Nominal GDP:
Year 1: ($4 x 3 bars) = $12
Year 2: ($5 x 4 bars) = $20
Year 3: ($6 x 5 bars) = $30
b. Real GDP:
Year 1: ($4 x 3 bars) = $12
Year 2: ($4 x 4 bars) = $16
Year 3: ($4 x 5 bars) = $20
c. GDP Deflator:
Year 1: ($12/$12) x 100 = 100
Year 2: ($20/$16) x 100 = 125
Year 3: ($30/$20) x 100 = 150
d. Growth Percentage from year 2 until year 3:
GP: (20 – 16)/16 x 100% = 25%
e. Inflation:
- (GDP deflator year 3 – GDP deflator year 2)/GDP deflator year 2 x 100
- (150 – 125)/125 x 100
- 25/125 x 100 = 20%
f.
b. What was the growth rate of the GDP deflator between 1994 and 2014?
c. What was real GDP in 1994 measured in 2009 prices?
d. What was real GDP in 2014 measured in 2009 prices?
e. What was the growth rate of real GDP between 1994 and 2014?
f. Was the growth rate of nominal GDP higher or lower than the growth rate if
real GDP? Explain.
Answer:
a. The Growth Rate:
b. The Growth Rate of the GDP deflator:
(17,419 - 7,309)/7,309 x 100% = 10,11/7,309 x 100% = 138,3%
c. The Real GDP in 2014: (17,419/108,3) x 100 = 16,08
d. The Real GDP in 1994: (7,309/73,8) x 100 = 9,904
e. The growth rate: (16,08 – 9,904)/9,904 x 100% = 63,36%
f. Yes
8. Revised estimates of U.S. GDP are usually released by the government near the
end of each month. Find a newspaper article that reports on the most recent
release, or read the news release yourself at http://www.bea.gov, the website of
the U.S. Bureau of Economic Analysis. Discuss the recent changes in real and
nominal GDP and in the components of GDP.
9. A farmer grows wheat, which she sells to a miller for $100. The miller turns the
wheat into flour, which she sells to a baker for $150. The baker turns the wheat
into bread, which she sells to consumers for $180. Consumers eat the bread.
a. What is GDP in this economy? Explain.
b. Value added is defined as the value of a producer’s output minus
the value of the intermediate goods that the producer buys to make
the output. Assuming there are no intermediate goods beyond those
described above, calculate the value added of each of the three
producers.
c. What is total value added of the three producers in this economy?
How does it compare to the economy’s GDP? Does this example
suggest another way of calculating GDP?
Answer:
a. GDP is the market value of the final good sold, $180.
b. Value added for the farmer: $100.
Value added for the miller: $150 – $100 = $50.
Value added for the baker: $180 – $150 = $30
c. Together, the value added for the three producers is $100 + $50 +
$30 = $180. This is the value of GDP
10. Goods and services that are not sold in markets, such as food produced and
consumed at home, are generally not included in GDP. Can you think of how this
might cause the numbers in the second column on table 3 to be misleading in a
comparison of the economic well-being of the United States and India? Explain.
Answer:
In countries like India, people produce and consume a fair amount of food
at home that is not included in GDP. So GDP per person in India and the
United States will differ by more than their comparative economic well-
being.
11. The participation of women in the U.S. labor force has risen dramatically since
1970.
a. How do you think this rise affected GDP?
b. Now imagine a measure of well-being that includes time spent
working in the home and taking leisure. How would the change in
this measure of well-being compare to the change in GDP?
c. Can you think of other aspect of well-being that are associated with
the rise in women’s labor-force participation? Would it be practical
to construct a measure of well-being that includes these aspects?
Answer:
a. The increased labor-force participation of women has increased
GDP in the United States, because it means more people are
working and production has increased.
b. If our measure of well-being included time spent working in the
home and taking leisure, it would not rise as much as GDP, because
the rise in women's labor-force participation has reduced time
spent working in the home and taking leisure.
c. Other aspects of well-being that are associated with the rise in
women's increased labor-force participation include increased self-
esteem and prestige for women in the workforce, especially at
managerial levels, but decreased quality time spent with children,
whose parents have less time to spend with them. Such aspects
would be quite difficult to measure
12. One day, Berry the Barber, Inc., collects $400 for hair-cuts. Over this day, his
equipment depreciates in value by $50. Or the remaining $350, Barry sends $30
to the government in sales taxes, takes home $220 in wages, and retains $100 in
his business to add new equipment in the future. From the $220 that Barry takes
home, he pays $70 in income taxes. Based on this information, compute Barry’s
contribution on the following measures of income.
a. Gross domestic product
b. Net national product
c. National income
d. Personal income
e. Disposable personal income
Answer:
a. GDP equals the dollar amount Barry collects, which is $400
b. NNP = GDP – depreciation = $400 − $50 = $350
c. National income = NNP – sales taxes = $350 − $30 = $320
d. Personal income = national income – retained earnings = $320 −
$100 = $220
e. Disposable personal income = personal income – personal income
tax = $220 − $70 = $150
REFERENCE