MODULE: MACROECONOMICS BB106 Unit 2: Circular Flow and National Income Accounting

TUTORIAL 2

Short-answer Problems

1) Of what use is national income accounting to economists and to policy makers?

Answer:
 It gives us a measure of the state of the economy at a particular point in time.
 It permits us to track the conditions of the economy over a period of time to see whether it has
given or stagnated.
 Provides the bases for economic policy decisions.

2) Discuss the merits and demerits of GDP as a measure of the economy’s output performance and as a
measure of its standard of living.

Answer:
GDP is a reasonably accurate measure of output performance especially for purposes of comparison with
past performance and with other nations. As long as measurement is done in a consistent manner from
year to year and from country to country then such comparisons are valid and useful.

As a measure of standard of living, GDP has more shortcomings, but there still is a strong positive
correlation between real GDP per capita and standard of living. As a tool to compare living standard
across countries GDP per capita is useful.

The shortcomings of GDP as a measure of standard of living include some cases where GDP may
overstate real output and some cases where GDP may understate it. In the category of overstating the
standard of living, GDP measures do not deduct for environment pollution, for product quality
deterioration and for production of what one might call necessary evils like devices and services to
protect against crime. In the category of understanding the standard of living, GDP measures do not
reflect improvements in product quality, increased leisure time, non-market production services and all of
the production both legal and illegal which falls into the category of the underground economy.

3) Which of the following are included and which are excluded in calculating this year’s GDP?
Explain in each instance.
(a) Social Security checks received by a retired person

Answer: Excluded. Social Security payment is a transfer payment, not payment for current productive
services.
(b) An increase in business inventories

Answer: Included. It is part of business investment.

(c) The income of a tax accountant working for a business

Answer: Included. It is payment for productive services (accounting)

 (d) Income received from interest on a corporate bond

Answer: Included. It is payment for use of capital resources during that year
(e) The cashing in of a U.S. savings bond

Answer: Excluded. It represents a financial transaction only

4) The following table shows the price of a specific stereo receiver for a five-year period. Using year 3
as the base year, calculate the price index for each year.

Year Price Price

index
1 $88
2 100
3 120
4 132
5 14

Answer:

Year Price Price index

1 $88 88/120 = 0.73
2 100 100/120 = 0.83
3 120 120/120 = 1
4 132 132/120 = 1.1
5 140 120/120 = 1.1667
5) The following data show nominal GDP and the appropriate price index for several years. Compute
real GDP for each year and indicate whether you have “inflated” or “deflated” nominal GDP in
finding real GDP. All GDP are in billions.

Nominal Price level Inflated (I)

GDP index
Year Real GDP Deflated (D)

1 $117 120 _____ _____

2 124 104 _____ _____

3 143 85 _____ _____

4 149 96 _____ _____

5 178 112 _____ _____

6 220 143 _____ _____

Answer:

Year Nominal GDP Price level Real GDP Inflated (I)/ Deflated
index (D)
1 $117 120 117/120 = 97.5 -
2 124 104 124/104 = 119.23 22.3 % (I)
3 143 85 143/85 = 168.24 41.1% (I)
4 149 96 149/96 = 155.21 -7.7% (D)
5 178 112 178/112 = 158.93 2.4% (I)
6 220 143 220/143 = 153.85 -3.2% (D)
6) The following is a list of figures for a given year in billions of dollars. Using this data, compute: (a)
GDP; (b) NDP; (c) NI; (d) PI; (e) DI; (f) Net exports.
Billions of dollars
$16
Transfer payments
Government purchases 80
38
Personal taxes
Corporate income taxes 28
15
Taxes on production and imports
Social Security contributions 8
19
Undistributed corporate profits
Proprietors’ income 25
258
Compensation of employees = Wages
Personal consumption expenditures 322
Consumption of fixed capital = 4
Depreciation
10
Rents
U.S. Exports 14
70
Corporate profits
Interest 12
23
Dividends
Imports to U.S. 17
63
Gross private domestic investment
Net foreign factor income 10
35
Statistical discrepancy

Answer:
(a) GDP = C + I + G + Xnet
= 322 + 63 + 80 + (14 – 17)
= 462

(b) NDP = GDP – Consumption of fixed capital/ Depreciation of capital

= 462 – 4
= 458

(c) NI = NDP – Statistical Discrepancy + Net foreign factor income

= 458 – 35 +10
= 433

(d) PI = NI – Social security contributions – Corporate taxes – Undistributed corporate

profits – Taxes on production and imports + Transfer payments
= 433 – 8 – 28 – 19 – 15 + 16
= 379

(e) DI = PI – Personal taxes

= 379 – 38
= 341
True / False Questions (Students to complete this section in CN online quizzes)

1) Both intermediate and final goods are counted as part of GDP.

Answer: False

2) Disposable income measures the before-tax income received by resource suppliers.

Answer: False

3) NDP can be determined by adding taxes on production and imports to GDP.

Answer: False

4) Welfare payments to low-income families are included in national income.

Answer: False

5) The value of the personal labor time spent repairing a home is included in GDP.

Answer: False

6) Within the circular flow model, the level of total resource income and total spending on output will
be approximately equal.

Answer: True

7) The simplest way to calculate GDP is to sum the total sales of all business firms.

Answer: False

8) A product that was produced in 2006 and not sold until 2007 is counted as part of GDP in 2007.

Answer: False

9) GDP tends to understate economic welfare because it does not take into account increases in
leisure.

Answer: True

10) If real GDP is 50 and nominal GDP is 100, the GDP price index is 200.

Answer: True