1.

Define carefully the following and give an example of each:

- consumption

Ans. Consumption is one of the components of GDP. It is a spending by household on goods and services
on good and services to satisfy current want. The main influence of consumption is in the level of
disposable income. When the income rises, total spending usually rises with. For example- spending on
food, clothes, travel and entertainment.

- government consumption and investment purchases (in GDP)

Ans. It is a measure of government where it buys the product that are produced within the country and
it helps to increase the GPD of the country. This helps the citizen of country to work more and better as
they earn from their production. E.g. transportation project

- government transfer payments(not in GDP)

Ans. Transfer payment are payments from tax revenue that are received by certain members of the
community. Their function is to provide a more equitable distribution of income. E.g. old age pension,
unemployment benefits

2. Here are data from the manufacturer of chocolate and cookies.

Year Price of Packet of Price of cookies Packet of cookies

chocolate chocolate

2012 Rs 100 200 Rs 200 150

2013 Rs 150 350 Rs 225 180

2014 Rs 175 400 Rs 275 200

a. Calculate nominal GDP, Real GDP and GDP deflator for each year, assuming 2012 as
the base year.
b. Calculate the percentage chage in nominal GDP, real GDP and the GDP deflator in 2013
and 2014 from the preceding year.
c. Calculate inflation rate in 2013 and 2014 using GDP deflator.
3. A farmer sells oranges to a juice maker for Rs 100. The juice maker makes a litre of
orange juice from those oranges, which is then sold for Rs 150. What is the total
contribution of these transactions to GDP?

Ans. The total contribution to the GDP would be Rs. 150 because from definition we can see
that- ‘it is the market value of all final good and services produced within the country in a given
time period’. The market value of final good produced is Rs. 150 therefore the total contribution
form this transaction would be Rs.150
4. Explain why an economy’s income must equal its expenditure. Which contributes more
to GDP—the production of an economy car or the production of a luxury car? Why?

Ans. Economy’s income must equal its expenditure because every transaction has two parties: buyer
and seller. Every rupee spent would be an income to another individual. When we buy a good at market
then we pay money that would be our expenditure and income to that seller. As the income becomes
equal to the expenditure the money would flow within the country. The only act occurring would be
transfer of money within the country. As firms produces goods, household would buy that goods which
means money flows from household to firms now firms pay wages or salary to the employee which
comes from household. Then firms pay money to household. In this way, if income equals expenditure
than money would just flow within the country and it helps to increase our GDP.

The production of economy car would contribute more to GDP than luxury car because most of the
people from the country cannot afford to buy a luxury car. They would prefer car but that would be
cheap and help them to travel from one place to another. As country produces economic car then most
of the people would prefer that as it would be cheap and they could afford it. This would mean that
people would buy that product and money would go to firms whereas in case of luxury car most of
people would not prefer that as it would be more costly and requires high maintenance. This would
mean that people would buy less luxury car. Therefore, economic car contributes more to GDP rather
than luxury cars.
5. An small economy of 100 people only produce and consume pasta and bread, in the following
amounts:

Pasta Bread

Quantity Price Quantity Price

2011 10 Rs 40 30 Rs10

2012 12 60 50 12
a. Using consumer price index, compute the percentage change in the overall price level. Use 2011 as
the base year, and fix the basket at 100 packet pasta and 300 packet Bread.

b. Using the GDP deflator, compute the percentage change of the overall price level. Also use 2011 as
the base year.
c. Is the inflation rate in 2012 the same using the two methods? Explain why or why not.

Ans. No it is different because in CPI index we calculate keeping quantity constant while, in GDP deflator
we keep price constant in calculation.