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5. Explain why real GDP might be an unreliable indicator of the standard of living.
Real GDP is sometimes used to measure the standard of living but real GDP can be misleading for
several reasons. Real GDP does not include household production, productive activities done in and
around the house by the homeowner. Because these tasks often are an important component of
people’s work, this omission creates a major measurement problem. Real GDP omits the underground
economy, economic activity that is legal but unreported or that is illegal. In many countries the
underground economy is an important part of economic activity, and its omission creates a serious
measurement problem. The value of leisure time is not included in real GDP. People value their leisure
hours and an increase in people’s leisure that enhances people’s economic welfare can lower the
nation’s real GDP. Environmental damage is excluded from real GDP. So an economy wherein real
GDP grows but at the expense of its environment, as was the case with Eastern European countries
under communism, falsely appears to offer greater economic welfare than a similar economy that grows
slightly more slowly but at less environmental cost.
2. During 2014, flow A was $13.0 trillion, flow B was $9.1 trillion, flow D was $3.3 trillion, and flow
E was –$0.8 trillion. Calculate (i) GDP and (ii) Government expenditure.
(i) Flow A is aggregate income. GDP equals aggregate income, so GDP is $13.0 trillion.
(ii) Government expenditure is $1.4 trillion. Aggregate expenditure equals GDP, which from part (i) is $13.0
trillion. Aggregate expenditure is the sum of consumption expenditure (Flow B), investment (Flow D),
government expenditure (Flow C), and net exports (Flow E). Therefore government expenditure equals
aggregate expenditure minus consumption expenditure minus investment minus net exports. Government
expenditure equals $13.0 trillion minus $9.1 trillion minus $3.3 trillion minus −$0.8 trillion, which is $1.4
trillion.
3. Use the following data to calculate aggregate expenditure and imports of goods and services.
• Government expenditure: $20 billion
• Aggregate income: $100 billion
• Consumption expenditure: $67 billion
• Investment: $21 billion
• Exports of goods and services: $30 billion
Aggregate expenditure equals aggregate income, so aggregate expenditure equals $100 billion.
Aggregate expenditure also equals consumption expenditure plus investment plus government
expenditures on goods and services plus exports of goods and services minus imports of goods and
services , so imports of goods and services equals consumption expenditure plus investment plus
government expenditure on goods and services plus exports minus aggregate expenditure. Using this
formula gives imports of goods and services equals $67 billion + $21 billion + $20 billion + $30 billion −
$100 billion, which is $38 billion.
4. The table lists some national accounts data
for the United States in 2008. Item Billions of dollars
a. Calculate U.S. GDP in 2008. Wages paid to labor 8,000
GDP equals consumption expenditure plus Consumption expenditure 10,000
investment plus government expenditure plus Net operating surplus 3,200
net exports, so GDP equals $10,000 billion + Investment 2,000
$2,000 billion + $2,800 billion − $700 billion, Government expenditure 2,800
or $14,100 billion. Net exports −700
b. Explain the approach (expenditure or Depreciation 1,800
income) that you used to calculate GDP.
The expenditure approach was used.
Use the following data to work Problems 5
and 6. Quantities 2013 2014
Tropical Republic produces only bananas and Bananas 800 bunches 900 bunches
coconuts. The base year is 2013, and the tables Coconuts 400 bunches 500 bunches
give the quantities produced and the prices.
Prices 2013 2014
5. Calculate nominal GDP in 2013 and
Bananas $2 a bunch $4 a bunch
2014.
In 2013, nominal GDP is $5,600. In
Coconuts $10 a bunch $5 a bunch
2014, nominal GDP is $6,100.
Nominal GDP in 2013 is equal to total expenditure on the goods and services produced by Tropical
Republic in 2013. Expenditure on Tropical Republic on bananas is 800 bunches of bananas at $2 a
bunch, which is $1,600. Expenditure on coconuts is 400 bunches at $10 a bunch, which is $4,000. Total
expenditure is $5,600, so nominal GDP in 2013 is $5,600.
Nominal GDP in 2014 is equal to total expenditure on the goods and services produced by Tropical
Republic in 2014. Expenditure on Tropical Republic on bananas is 900 bunches of bananas at $4 a
bunch, which is $3,600. Expenditure on coconuts is 500 bunches at $5 a bunch, which is $2,500. Total
expenditure is $6,100, so nominal GDP in 2014 is $6,100.
6. Calculate real GDP in 2014 expressed in base-year prices.
Real GDP in 2014 using base-year prices is $6,800. The base-year prices method calculates the market
value of the 2014 quantities at the base-year prices of 2013. To value the 2014 output at 2013 prices,
real expenditure on Tropical Republic on bananas is 900 bunches at $2 a bunch, which is $1,800, and
real expenditure on coconuts is 500 bunches at $10 a bunch, which is $5,000. Adding these two
expenditures shows that real GDP in 2014 using the base-year prices method is $6,800.
7. Use the table to work out in which year the U.S. standard of living (i) increases and (ii) decreases.
10. In 2013, flow A was $1,000 billion, flow C was $250 billion, flow B was $650 billion, and flow E
was $50 billion. Calculate investment.
Investment is $50 billion. Aggregate expenditure equals aggregate income, which is flow A, $1,000
billion. Aggregate expenditure is the sum of consumption expenditure (Flow B), investment (Flow D),
government expenditure (Flow C), and net exports (Flow E). Therefore investment equals aggregate
expenditure minus consumption expenditure minus government expenditure on goods and services
minus net exports. Investment equals $1,000 billion minus $650 billion minus $250 billion minus $50
billion, which is $50 billion.
11. In 2014, flow D was $2 trillion, flow E was –$1 trillion, flow A was $10 trillion, and flow C was $4
trillion. Calculate consumption expenditure.
Consumption expenditure is $5 trillion. Aggregate expenditure equals aggregate income, which is flow
A, $10 trillion. Aggregate expenditure is the sum of consumption expenditure (Flow B), investment
(Flow D), government expenditure (Flow C), and net exports (Flow E). Therefore consumption
expenditure equals aggregate expenditure minus investment minus government expenditure on goods
and services minus net exports. Consumption expenditure equals $10 trillion minus $2 trillion minus $4
trillion minus −$1 trillion, which is $5 trillion.
Use the following information to work Problems 12 and 13.
Mitsubishi Heavy Industries makes the wings of the new Boeing 787 Dreamliner in Japan. Toyota
assembles cars for the U.S. market in Kentucky.
12. Explain where these activities appear in the U.S. National Income and Product Accounts.
When the Dreamliner wings are sent from Japan to the United States, they are counted in the U.S.
National Income and Product Accounts as imports, which is a negative entry in the expenditure
approach to U.S. GDP.
Toyota’s production of cars in Kentucky is included in U.S. GDP because it represents production
within the United States. Expenditure on the cars is counted as part of consumption expenditure (if the
cars are purchased by U.S. consumers) or investment (if the cars are purchased by U.S. firms) or
government expenditure (if the cars are purchased by a government) in the expenditure approach to
GDP. If any of the parts of the cars are imported from Japan, the value of these parts is included among
U.S. imports. The incomes earned by the factors of production that produce the cars are part of the
wages, interest, rent, and profit income that are used in the income approach to GDP.
13. Explain where these activities appear in Japan’s National Income and Product Accounts.
Mitsubishi Heavy Industries’ production of Dreamliner wings in Japan is included in Japanese GDP
because it represents production within Japan. When these wings are sent to the United States, they
are counted in the National Income and Product Accounts as part of Japanese exports. If any of the
parts of wings are imported into Japan, the value of these parts is included among Japanese imports. The
incomes earned by the factors of production that produce the wings are part of the wages, interest,
rent, and profit income that are used in the income approach to GDP.
Toyota’s production of cars in Kentucky is not directly included in Japan’s GDP unless some of the
parts for these cars are exported from Japan to the United States. In that case the value of the parts are
included in Japan’s GDP as exports.
Use the following news clip to work Problems 14 and 15, and use the circular flow model to illustrate
your answers.
Boeing Bets the House
Boeing is producing some components of its new 787 Dreamliner in Japan and is assembling it in the
United States. Much of the first year’s production will be sold to ANA (All Nippon Airways), a Japanese
airline.
Source: The New York Times, May 7, 2006
14. Explain how Boeing’s activities and its transactions affect U.S. and Japanese GDP.
Goods and services produced within the United States are part of U.S. GDP. Boeing’s decision to
produce part of its new 787 airliner in Japan means that this production is not produced within the
United States and so it is not part of U.S. GDP. This production is, however, part of Japan’s GDP. The
parts of the Dreamliner that are assembled in Japan and sent to the United States for final assembly add
to Japan’s GDP as exports and subtract from U.S. GDP as imports. Then the Dreamliners that Boeing
sells to All Nippon Airways in Japan are counted as U.S. exports and Japanese imports so they add to
U.S. GDP and subtract from Japan’s GDP.
In terms of the circular flow diagram in Figure 4.3 and U.S. GDP, Boeing’s purchase of parts of the
Dreamliner from firms in Japan is flow is Flow A, an import into the United States. This flow travels
through the goods market and goes to Boeing as Flow B. In terms of Japanese GDP, the purchase of
parts from Japanese firms is a Japanese export. This flow is the reverse of Flow B and of flow A because
this flow is an export for the Japanese economy. Flows C and D indicate that the Japanese firms are
paying Japanese household for the factors of production they supply.
15. Explain how ANA’s activities and its transactions affect U.S. and Japanese GDP.
ANA’s purchase of Dreamliners is counted in U.S. GDP as exports and is counted in Japan’s GDP as
imports. In terms of the circular flow, Boeing sells some Dreamliners to ANA. The airliners travel from
Boeing through the goods market and are exported to ANA in Japan. In Figure 4.3 and for the U.S.
economy, these are the reverse of flow B and then of flow A because the Dreamliners are a U.S.
export. Flows C and D indicate that Boeing is paying households (through the factor market) for the
factors of production the households supply to Boeing. For the Japanese economy, the imports are
represented by Flow A and then flow B.
Use the following data to work Problems 16 and 17.
The table lists some macroeconomic data for the Item Billions of dollars
United States in 2009.
Wages paid to labor 8,000
16. Calculate U.S. GDP in 2009. Consumption expenditure 10,000
GDP equals consumption expenditure plus
Other factor incomes 3,400
investment plus government expenditure plus
Investment 1,500
net exports, so GDP equals $10,000 billion +
$1,500 billion + $2,900 billion − $340 billion,
Government expenditure 2,900
or $14,060 billion. Net exports −340
17. Explain the approach (expenditure or income) that you used to calculate GDP.
The expenditure approach was used.
Use the following data to work Problems 18 to 19.
c. Do you think the HDI should be expanded to include items such as pollution, resource
depletion, and political freedom? Explain.
Ideally factors such as pollution, political freedom, and so forth should be included in a broad measure
of welfare. Two difficulties, however, occur. One difficulty comes when trying to measure these
variables. For instance, how can political freedom be measured in a way that is accepted by all? A
second difficulty is weighting these factors. For instance, how much political freedom should be
weighted relative to GDP per person?
d. What other items should be included in a comprehensive measure on economic welfare?
Aside from the factors listed above, potentially some measure of culture might be included. Another set
of factors might attempt to take into account sustainability. Religious freedom, discrimination, and civil
and international conflict might also matter. But all these factors are hard to measure and to weight.
22. U.K. Living Standards Outstrip U.S.
Oxford analysts report that living standards in Britain are set to rise above those in America for
the first time since the nineteenth century. Real GDP per person in Britain will be £23,500 this
year, compared with £23,250 in America. But the Oxford analysts also point out that Americans
benefit from lower prices than those in Britain.
Source: The Sunday Times, January 6, 2008
If real GDP per person is greater in the United Kingdom than in the United States but Americans
pay lower prices, does this comparison of real GDP person really tell us which country has the
higher standard of living?
This comparison does not determine which nation has a higher standard of living. The analysis uses the
exchange rate to transform prices in one country into prices of the other country. But a more accurate
analysis would use purchasing power parity (PPP) prices to value the goods and services in both
countries. By using PPP prices, the analysis can better measure the goods and services available to
citizens of each country.
23. Use the news clip in Problem 20.
a. Why might China’s recent GDP growth rates overstate the actual increase in the level of
production taking place in China?
China’s GDP, similar to all nations’ GDPs, omits the value of home production. As more of China’s
economy moves to being traded in markets, China’s GDP and therefore the growth rate of China’s
GDP increases even though the actual production is not changing.
b. Explain the complications involved with attempting to compare the economic welfare in China
and the United States by using the GDP for each country.
China’s GDP is calculated using prices in China while U.S. GDP is calculated using prices in the United
States. But relative prices in China and the United States are quite different. When looking at prices of
identical or near-identical goods, more of these prices are lower in China than in the United States. So
even if China and the United States produced the exact same quantities of these goods and services,
China’s GDP, using China’s lower prices, would value China’s production at a smaller value than would
U.S. GDP, using U.S. higher prices. To have a valid comparison of Chinese and U.S. GDP, purchasing
power parity (PPP) prices must be used to value Chinese and U.S. production because then prices are
the same for China and the United States.
24. Poor India Makes Millionaires at Fastest Pace
India, with the world’s largest population of poor people, created millionaires at the fastest pace
in the world in 2007. India added another 23,000 more millionaires in 2007 to its 2006 tally of
100,000 millionaires measured in dollars. That is 1 millionaire for about 7,000 people living on less
than $2 a day.
Source: The Times of India, June 25, 2008
a. Why might real GDP per person misrepresent the standard of living of the average Indian?
There are a few reasons why this measurement of real GDP per person misrepresents the standard of
living of the average Indian. First GDP includes only goods and services bought and sold in markets. In
India many goods and services are produced by the household itself and this home production, while
boosting the household’s standard of living, is not included in GDP. Second the prices used to value
Indian production and thereby calculate Indian GDP are likely quite different than the prices used to
value U.S. production and calculate U.S. GDP. When looking at prices of identical or near-identical
goods, it is likely that more of these prices are lower in India than in the United States. So, even if the
actual quantities produced are the same, using Indian prices means that India’s production would be
valued less than U.S. production and India’s GDP would be less than U.S. GDP. If the same prices, such
as purchasing power parity prices, were used to value India’s GDP and U.S. GDP, India’s GDP per person
would be closer to U.S. GDP per person.
b. Why might $2 a day underestimate the standard of living of the poorest Indians?
One important reason why the $2 a day estimate undervalues the standard of living of the poorest
Indians is because much of these people’s transactions do not occur in markets. GDP is calculated using
only goods and services bought and sold in markets. So if a poor, self-sufficient farmer grows only
enough food for his or her family and does not buy or sell food in the market, the farmer will be
estimated to have a very low income. But this low income vastly understates the farmer’s standard of
living because it omits all the food the person produced on his or her land. Another reason why the
standard of living of the poorest Indians is under estimated is because the estimate is made using prices
that prevail in India and then compared to the standard of living in the United States. Prices in India are
often much lower than in the United States, so comparing what the income can purchase in the United
States understates the standard of living.
be measured with anything like the frequency, reliability, and impartiality of GDP?
Source: Time, April 21, 2008
a. Explain the factors that the new clip identifies as limiting the usefulness of GDP as a measure of
economic welfare.
GDP focuses on the amount of goods and services produced. While goods and services lead to
improving people’s welfare, there are other factors that also come into play. The Human Development
Index includes people’s education and health, which are obvious factors that affect people’s wellbeing.
Mr. Stiglitz is suggesting that sustainability issues should be included. Others have recommended that
people’s overall happiness be a factor in measuring economic welfare.
b. What are the challenges involved in trying to incorporate measurements of those factors in an
effort to better measure economic welfare?
There are two major difficulties. First, measuring some of these variables, especially “happiness”, would
be very difficult. Second, even if the variables could be accurately measured determining the weighting
scheme to be used is very difficult. For instance, how much should depletion of copper be weighted
relative to GDP per person?
c. What does the ranking of the United States in the Human Development Index imply about the
levels of health and education relative to other nations?
Because the U.S. ranking in the Human Development Index is below its ranking of per person real GDP,
the levels of health and education in the United States must be lower than those in many other
advanced countries.
27. Use the information in Problem 18 to calculate the chained-dollar real GDP in 2013 expressed in
2012 dollars.
Real GDP in 2013 is $135.70. The chained-dollar method uses the prices of 2012 and 2013 to calculate
the growth rate in 2013. The value of the 2012 quantities at 2012 prices is $50. The value of the 2013
quantities at 2012 prices is $135. Using 2012 prices, the increase in GDP for these two years is $85, so
the percentage increase is ($85 $50) 100, which is 170.0 percent.
Next the value of the 2012 quantities at 2013 prices is 60 apples × $1.00 per apple + 80 oranges ×
$2.00 an orange, which is $220. The value of the 2013 quantities at 2013 prices is $600. Using 2013
prices, the increase in GDP for these two years is $380 so the percentage increase is ($380 ÷ $220) ×
100, which is 1.727 100, which is 172.7 percent.
The chained dollar method calculates the growth rate as the average of these two percentage growth
rates, which means that the growth rate in 2013 is 171.4 percent. So real GDP in 2013 is equal to $50,
which is real GDP in the base year (and is equal to nominal GDP in that year) multiplied by one plus the
growth rate. Real GDP in 2013 is $135.70.
— Minullapas on.
*****
Vaikka Liisa oli kansan lapsi niinkuin hänkin, ei hän olisi ollut
taipuvainen mitään tällaista uskomaan.
Hannes kääntyi.
— Mitä on tapahtunut?
Varjot olivat taas hävinneet. Mutta Hannes oli varma siitä, että
ne ilmestyisivät uudelleen. Hän olisi tahtonut vielä puhua asiasta
Liisalle, muttei kehdannut tällä kertaa. Saisipahan toiste sanoa, että
Liisa tällä tavoin särki pala palalta kodin onnea ja rauhallisuutta.
Liisa oli virkeä ja iloinen. Kun verkot oli saatu lasketuksi, ehdotti
hän, että jäätäisi uimaan. Lahden vastaisella rannalla pulisi lapsia ja
aikuisia vedessä mekastaen ja hoilaten.
— Miten niin?
— Minä opin sen siellä tehtaassa. No, älä naura! Tämä on vakava
asia.
Väkivasarain jyskeessä minä aloin kasvattaa itseäni uudeksi
ihmiseksi.
Työ ja luonto minua paransi.
Hannes odotti.
Hannes tulistui.
— Minä lähden kaskeen. Mari saa jäädä kotiin, sanoi Liisa hänelle.
En minä suostu aina jäämään…
— Mutta eihän se käy… talo jäisi moneksi päiväksi vieraaseen
varaan, esteli Hannes. Ja muutenkin tulisi hankalaksi sinulle.
Voinhan minä käydä kotona joka yö.
— Jos minä jään, niin Mari jää myöskin, sinkosi Liisa tiukasti.
Sinne kuhertelemaan…
Hannes ei voinut tällä kertaa ottaa juttuihin osaa. Liisa oli jäänyt
sinne alakuloisena, ehken vihaisenakin. Oli saattanut itkeäkin. Taisi
tulla liian jyrkästi hänelle sanotuksi. Vaikka sanoihan hänkin. Olisi
kumminkin mukaan saanut tulla ja niinhän hän oli jo aikonutkin,
mutta kun katkerat, solvaavat sanansa sanoi, niin tuli niinkuin
äkäpäissä lähdetyksi.
Käki lensi koivuun, joka oli sille kasken keskellä lepopuuksi jätetty,
ja alkoi kukkua. Miehet heräsivät siihen ja lähtivät työhönsä.
Ei jaksanut olla, vaikka vasta illalla oli luvannut kotiutua. Liisa voisi
siellä taas tuhertaa kauniit silmänsä punaisiksi.