Assignment # 1

Chapter 23
Measuring a Nation’s Income
Questions for Review

1. Explain why an economy’s income must equal its expenditure?

ANS: An economy's income must equal its expenditure due to the macroeconomic
principle that every financial transaction involves both a buyer and a seller. The amount
paid by the consumer is the same amount received by the seller. This equality extends
to the macroeconomic level, where a government's spending exceeds its revenue
leading to a budget deficit, potentially resulting in a growing public debt over time.

2. Which contributes more to GDP—the production of an economy

car or the production of a luxury car? Why?
ANS: The contribution of a luxury car to the GDP is more substantial because of its
higher market prices compared to an economy car. The elevated prices lead to a
significant boost in GDP. Conversely, while the production of an economy car also
contributes to GDP, its impact is not as pronounced as that of luxury cars due to their
lower prices.

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?

ANS:The total contribution of these transactions to GDP is $3. The GDP includes the
final value of goods and services, and in this case, the final product is the bread, which
is sold for $3. The initial transaction between the farmer and the baker for $2 is part of
the production process but is not directly counted in the GDP, as GDP focuses on the
value of the final goods and services produced.
The total contribution of baker’s transactions to GDP is $3.

The purchase of wheat, as an intermediate good, is the first transaction, but not
calculated in GDP, as GDP only calculates the value of final goods and services.

The sale of bread, as the final good, is the second transaction, and it is calculated in
GDP.

The bread is sold for $3, and that is for what GDP is increased.

The intermediate good implemented in bread are not calculated, as everything is

summed up in the final value of the bread.

Therefore, the price of wheat itself in an amount of $2 is not calculated / added to GDP.

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?

ANS: It is stated that many years ago, Peggy paid $500 to put together a record
collection, today she sold the albums at a garage sale for $100.

Today sale of Peggy's record collection does not affect the current GDP, because
Peggy's record collection was produced and sold for the first time a long time ago.

As resold goods are not calculated in GDP, this transaction is also out of the current
GDP calculation.

5. List the four components of GDP. Give an example of each.

ANS: GDP has four components and they are: consumption, investment, government
purchase, and net exports.

Consumption (C) Consumption can be any everyday spending like buying books or
food.
Investment (I) Investment spending is a type of "long-term" spending where effects will
have an impact today but also on the future, like buying houses or equipment for
factories.

Government purchases (G) Government purchase is spending by the government (on

any level) when it gives salaries to doctors, judges, building roads, etc.

Net exports (NX) Net exports is a difference between goods that are imported and goods
that are exported, for example, we export chips while we import cars.

6. Why do economists use real GDP rather than nominal GDP to

gauge economic well-being?

ANS: The nominal GDP measures the production of goods and services using the
current prices while the real GDP measures the production of goods and services using
a constant price from a base year. Thus, economists use real GDP since it only
measures the changes in the production of goods and services since the price is
constant unlike nominal GDP where price is volatile and changes constantly.

8. Why is it desirable for a country to have a large GDP? Give an

example of something that would raise GDP and yet be
undesirable.
ANS: A country wants to have a large GDP since it means that the people are having a
comfortable life since GDP measures the total income and expenditures of the country.
A large GDP means that people have higher income and can spend more on luxurious
items such as healthcare in the United States.
One example that can increase GDP is the removal of laws against pollution since it will
increase the production of the market, however, government tends to not go in that
direction since it will also increase pollution that will negatively impact the environment
and people.

Problems and Applications

 1. What components of GDP (if any) would each of the following
transactions affect? Explain.

1a. A family buys a new refrigerator.

Ans: A family buys a new refrigerator increases the consumption component of GDP,
and thus positively affects the GDP, since the transaction causes an increase spending
on household goods.

1b. Aunt Jane buys a new house.

Ans: Aunt Jane buys a new house increases the investment component of GDP, and
thus positively affects the GDP, since the structure is considered a capital purchase.

1c. Ford sells a Mustang from its inventory.

Ans: When Ford sells a mustang from its inventory, it decreases the investment
component of GDP since the company sold it from their inventory. However, the
consumption or expenditure of the buyer offsets this transaction and results to no
change in the GDP.

1d. You buy a pizza.

Ans: A purchase of pizza increases the consumption component of GDP, and thus
positively affects the GDP, since this counts as a spending for food.

1e. California repaves Highway 101.

Ans: The repavement of Highway 101 by the California State increases government
spending, and thus positively affects the GDP, since the State will pay for the laborers
and materials that will be used.

f. Your parents buy a bottle of French wine.

Ans: The expenditure of your parents on bottle of French wine increases the
consumption component of GDP since this counts as a spending for food, and
decreases net exports since the wine was imported from France. These activities does
not affect the GDP.

g. Honda expands its factory in Marysville, Ohio.

Ans: When Honda expands its factory in Marysville, Ohio, it increases the investment
component of GDP, and thus positively affects the GDP, since the company will use this
to produce and manufacture more goods and services.

2. The government purchases component of GDP does not include

spending on transfer payments such as Social Security. Thinking
about the definition of GDP, explain why transfer payments are
excluded.
Ans: Gross Domestic Product (GDP) is the total value of all goods and services
produced in a given year and it measures all the income from the production and selling
of the goods and services. Transfer of payments on the other hand like the Social
Security benefit are given as payment but there is no transaction of goods and services,
hence, it is not counted in the GDP.

3. As the chapter states, GDP does not include the value of used
goods that are resold. Why would including such transactions make
GDP a less informative measure of economic well-being?

Ans: Used goods that are resold are not included in the current GDP since it was
already included in the GDP where it was first produced and sold. Counting the used
goods in the GDP will result to it being included twice (double counting) and that would
make the GDP less informative measure if economic-well-being.

5. Consider an economy that produces only chocolate bars. In year 1,

the quantity produced is 3 bars and the price is $4. In year 2, the
quantity produced is 4 bars and the price is $5. In year 3, the quantity
produced is 5 bars and the price is $6. Year 1 is the base year.

5a. What is nominal GDP for each of these three years?

ANS: Based on the given data we are going to calculate Nominal GDP for three years
in the following way:

Nominal GDP year 1 =3×4=12

Nominal GDP year 2 =4×5=20
Nominal GDP year 3 =5×6=30

5b. What is real GDP for each of these years?

ANS: In this step we are going to calculate Real GDP for all three years with year 1 is
the base year:

Real GDP year 1 =3×4=12

Real GDP year 2 =4×4=16

Real GDP year 3 =5×4=20

5c. What is the GDP deflator for each of these years?

ANS: . GDP deflator is calculated as follows:

GDP deflator= NominalGDP / RealGDP ×100

hence the GDP deflator for all three years is:

GDP deflator year 1 =12/12×100

=1×100

=100

GDP deflator year 2 =20/16×100

=1.25×100

=125

GDP deflator year 3 =30/20×100

 =1.5×100

=150

5d. What is the percentage growth rate of real GDP from year 2 to year
3?

ANS: the percentage growth rate formula:

Real GDP year 3−Real GDP year 2 / Real GDP year 2 ×100

thus,

Real GDP = 20−16/16×100

= 0.25×100

= 25

The growth rate from year 2 to year 3 is 25%.

5e. What is the inflation rate as measured by the GDP deflator from
year 2 to year 3?

ANS: To calculate inflation we must take a look at the GDP deflator and the following
formula:

GDP deflator year 3−GDP deflator year 2 / GDP deflator year 2 ×100

hence,

GDP deflator =150−125/125×100

=0.2×100

=20

The inflation rate measured by the GDP deflator, from year 2 to year 3, is 20%.
5f. In this one-good economy, how might you have answered parts (d)
and (e) without first answering parts (b) and (c)?
ANS: Both Real GDP and the GDP deflator, are increased by 25% and 20%,
respectively, meaning that the growth rate and inflation rate measured by the GDP
deflator, are equal to the growth rate of production and inflation.

8- 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.

8a. what is GDP in this economy? Explain

ANS: The GDP is the total value of goods and services produced in an economy in a
given period of time. As bread is the only final product, the GDP is $180.

8b. 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.
ANS: Step 1
For this problem, we are tasked to determine the value added of each of the given three
producers considering that there are no intermediate goods used in each.

Step 2
Value added is the value of a producer’s output minus the value of the intermediate
goods. Intermediate goods are products used by producers to produce a finished
product. In an equation, we can write the value added as follows:
Value Added= Value of Producer’s Output−Value of Intermediate Goods

Step 3
In this case, the intermediate goods would only be applied to the miller and baker
because there are no other mentioned intermediate goods that are used to produce
wheat. Specifically, the intermediate good for the miller's product — flour — would be
the wheat and the intermediate good for the baker’s product — bread — would be the
flour.

Step 4
Since there are no intermediate goods for the wheat, the value of the intermediate good
becomes 0. As a result, the value-added of the farmer would simply be the value of its
output. That is $100.

Step 5
For the miller, the value of the flour is $150 and the value of the intermediate good
(wheat) is $100. Hence, the value added would be:
Value Added=$150−$100
=$50

Step 6
For the baker, the value of the bread is $180 and the value of the intermediate good
(flour) is $150. Hence, the value added would be:
Value Added=$180−$150=$30

Step 7
In summary, the value added for the farmer, miller, and baker would be $100, $50, and
$30, respectively.

8c. 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?
ANS: Step 1
For this problem, we are tasked to determine the total value added to the economy of
the three producers.

Step 2
In the previous item, we determined that the value added for the farmer, miller, and
baker are $100, $50, and $30, respectively. To calculate the total value added by the
three producers, we simply add their value-added quantities.

Step 3
The total value added would be:
Total Value Added=$100+$50+$30=$180

Step 4
In the GDP computation, the components added are consumption, investment,
government purchases, and net exports. In the total value added computation, we can
think of the separate value added by each producer as the components of the GDP,
which are added to calculate thereof.

Step 5
This comparison may have a similar method of computing an aggregate value (the
addition method) but it does not mean that the computation for value-added can be
used to calculate GDP. This is simply because the value-added quantities only account
for the goods and services that producers purchases to form final goods and services.
In the GDP, the economy considers all the mentioned GDP components above.