Tutorial 1 (Answers are provided as a guide but not limited to the following)

1. Explain the three ways how GDP can be measured.

Suggested answer:

GDP can be measured three ways.

First, GDP represents the market value of the final goods and services produced in the
economy during a given period. This would be obtained by adding C, I, G, and NX.

Second, GDP is the sum of the value added by firms. The value added for a firm equals the
value of the production (at that stage of the production process) minus the value of the
intermediate goods (excluding labor services). The final value of aggregate output can be
calculated by either summing the value of all final goods and services OR by summing the
value added of all goods and services at each stage of production.

And finally, GDP is also the sum of all incomes (profit, interest, wages, rental etc.) earned in
a given period.
Both the final market values and value-added ways of measuring GDP is based on the
production or output approach while the third way of measurement is based on the income
approach.

In any economy, the usage of factors of production (eg labour) in production or output will be
an expenses to the firm in terms of salary or wage paid to labour and this wage in return
becomes the income for labour (revisit the simple economy concept illustrated by Circular
Flow diagram)

2. Define nominal GDP and real GDP. Is it possible for nominal GDP in a year to be less
than real GDP in a particular year? Explain.

Suggested answer:

Nominal GDP represents the value of goods and services produced using current prices.

Real GDP measures the value of the same goods and services using a base year price (constant
price).

Yes, it is possible for nominal GDP to be less than real GDP in any given year. Based on the
definitions of the two variables of P (price) and Q (quantity) earlier, this situation will occur if
prices in a particular year are less than prices in the base year.

In the example below, assuming the price of car in 2010 is $23,999 instead of $26,000. Then
the nominal GDP for 2010 will be $23,999 x 13 units = $311,987 which is now smaller than
the real GDP in 2010 (at 2009 base price) at $312,000.
3. Explain whether it is possible for nominal GDP to increase while real GDP to decrease
in the same period. Will such situation continue to occur in long run?

Suggested answer:

Nominal GDP can rise because either due to rising price level or the real quantity of goods and
services produced has increased. Nominal GDP can increase while real GDP falls if the
increase in the aggregate price level is larger (in a proportionate sense) than the decline in
real economic activity (negative GDP growth). This phenomenon of rising price accompanied
by low output (high unemployment) is known as stagflation in economy.

To sum up, nominal GDP can rise but real GDP decline at the same period only if the following
conditions are fulfilled:

1. There is high inflation condition occurring in the economy. This will automatically
increase the nominal GDP without any real increase in GDP or output (as prices of
all goods and services will be increased).

2. real GDP will decrease only when there is negative GDP growth (economic
downturn heading towards recession). This will reduce the GDP size of the economy.

The above situation can happen only in the short run (short run business cycle or economics
shocks either from the demand or supply side) as appropriate economic policies will be
implemented to bring economy out from the short-term fluctuation and back to full
employment in medium run and long run with price stability (ie manageable inflation rate
generally deemed between 1%-3%).
4. Explain the difference between the unemployment rate and the participation rate.

Suggested answer:

The unemployment rate is the percentage of employed over total labor force (those employed
and unemployed).

The participation rate is the percentage of labor force over total adult population that is in the
labor force.

5. Explain how the existence of discouraged workers alters the extent to which the official
unemployment rate provides an accurate measure of the use of labor resources.

Suggested answer:

Discouraged workers are those individuals who have decided to stop searching for employment
because they have become "discouraged" about employment opportunities (no longer keen to
seek employment, lost hope). At some point, these individuals will no longer be considered as
part of the labor force.

The existence of discouraged workers (if included as part of those unemployed) will cause the
official unemployment rate (as unemployment rate = unemployed / labor force) be inaccurate
=> under-stating the utilization of labor (or employment) or overstating unemployment rate
(since L = N + U)

6. What are the social and economic implications of unemployment? Explain.

Suggested answer:

Economic implications: signal of economic activity and measure of the utilization of labor.
When unemployment is high, there exist “inefficiency” in the use of resources within an
economy, in this case, there are idle labors with no job.

Social implications: the emotional and psychological suffering that occurs because of being
unemployed. Could possibly lead to more complicated social illness like drug dealing, burglary
etc., to earn a living.

7. Can an economy maintain high output growth, low unemployment, and low inflation
at the same time? Explain from the perspective of Okun’s Law and Philip’s curve.

Indicative answer:

It would be very hard to achieve the three objectives at the same time. According to Okun’s
Law, high output growth leads to low unemployment, which is likely to put pressure on
inflation as consumption drives aggregate demand up.

Philips curve advocated that when unemployment becomes very low, the economy is likely to
overheat and this will lead to upward pressure on inflation, while Okun’s Law explained that
when output growth is high, unemployment will decrease.
Hence, it is possible to have high output growth with low unemployment (Okun’s Law
supported this) but unlikely to have low inflation at the same time (as this is against Philips
Curve).
8. Explain what factors cause changes in output in: (1) the short run; (2) medium run;
and (3) long run.

Suggested answer:

In the short run, demand factors primarily cause changes in output. Slower demand leads to
accumulation of inventory, hence reduction in production and vice versa in accordance to
business cycle.

In the medium run, factors such as existing technology, amount of capital, and the skill and
size of the labor force (supply factors) affect changes in output.

And in the long run, ability to innovate, introduction of new technologies, ability of education
system in driving human capital, saving rate (ability of people to save as this will drive ability
to invest), and role of government affect economic activity.