Questions for Review

1. Explain why an economys income must equal its expenditure? A buyer who spends

$1 will be a sellers income of $1; this will make the GDP rise by $1.
2. Which contributes more to GDP-the production of an economy car or the production

of a luxury car? A luxury cars production would contribute to the GDP more than an

economy car. An economy car costs less to produce than a luxury car.
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? The

GDP is equal when the baker bought the bread from the farmer for $2 but rises $3

when the baker sells the bread for $3.

4. Many years ago, Peggy paid $500 to put together a record collection. Today, she sold

her albums at a garage for $100. How does this sale affect current GDP? Because the

records were used when they were sold in the garage sale, the effect on the GDP

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

are consumption, investment, government spending, and net exports. Consumption

would be spending on household goods; investment would be purchasing a new

house; government spending would be spending on goods by local, state, and federal

governments; net exports would be exports minus imports. Exports are spending on

indigenously produced goods by foreigners. Imports would be spending on foreign

goods by indigenous citizens.

6. Why do economists real GDP rather than nominal GDP to gauge economic well-

being? Economists use real GDP rather than nominal GDP to gauge economic well-

being because real GDP is not affected by changes in prices, so it reflects only

changes in the amounts being produced.

7. In the year 2013, the economy produces 100 loaves of bread that sell for $2 each. In

the year 2014, the economy produces 200 loaves of bread that sell for $3 each.

Calculate nominal GDP, real GDP, and the GDP deflator for each year. (Use 2013 as

the base year.) by what percentage does each of these three statistics rise from one

year to the next?

Loaves of Bread
Years Price Quantity Produced
2013 $2 100
2014 $3 200

Years Nominal GDP

2013 2(100) = 200
2014 3(200) = 600
Inflation Rate (600-200)/200 = 2
Years 2Real GDP= 200%
* 100%
2013 2(100) = 200
2014 2(200) = 400
Inflation Rate (400-200)/200 = 1

1 * 100% = 100%

Years GDP Deflator

NGDP/RGDP *100
2013 (200/200) * 100 = 100
2014 (600/400) * 100 = 150
Inflation Rate (150-100)/100 = 0.5

0.5 *100% = 50%

8. Why is it desirable for a country to have a large GDP? GDP (per capita) seems a

natural measure of the economic well-being of the average individual -- higher living

standards. Give an example of something that would raise GDP and yet be

undesirable. Something that could raise GDP and yet be undesirable would be
massive increases to production, because that would contribute to worse pollution of

the environment.
Quick Check Multiple Choice
1. If the price of a hotdog is $2 and the price of a hamburger is $4, then 30 hotdogs

contribute as much to GDP as _________ hamburgers.

a. 5
b. 15
c. 30
d. 60
2. Angus the sheep farmer sells wool to Barnaby the knitter for $20. Barnaby

makes 2 sweaters, each of which has a market price of $40. Collette buys one of

the them, while the other remains on the shelf of Barnabys store to be sold later.

What is GDP here?

a. $40
b. $60
c. $80
d. $100
3. Which of the following does NOT add to U.S. GDP?
a. Air France buys a plane from Boeing, the U.S. aircraft manufacturer.
b. General Motors builds a new auto factory in North Carolina.
c. The city of New York pays a salary to a policeman.
d. The federal government sends a Social Security check to your grandmother.
4. An American buys a pair of shoes manufactured in Italy. How does the U.S.

national income account treat the transaction?

a. Net exports and GDP both rise.
b. Net exports and GDP both fall.
c. Net exports fall, while GDP is unchanged.
d. Net exports are unchanged, while GDP rises.
5. Which is the largest component of GDP?
A. Consumption
B. Investment
C. Government purchases
D. Net exports
6. If all quantities produced rise by 10% and all prices fall by 10%, which of the

following occurs?
a. Real GDP rises by 10%, while nominal GDP falls by 10%.
b. Real GDP rises by 10%, while nominal GDP is unchanged.
c. Real GDP is unchanged, while nominal GDP rises by 10%.
d. Real GDP is unchanged, while nominal GDP falls by 10%.
 Problems and Applications
1. What components of GDP (if any) would each of the following transaction affect?

Explain.
a. A family buys a new refrigerator. Consumption increases because a refrigerator is a

good purchased by a household.

b. Aunt Jane buys a new home. Investment increases because a house is an investment

good.
c. Ford sells a mustang from its inventory. Consumption increases because a car is a

good purchased by a household, but inventory decreases because the car was sold

from Fords inventory.

d. You buy a pizza. Consumption increases because pizza is a good purchased by a

household.
e. California repaves Highway 101. Government purchases increases because the

government spent money to provide a good to the public.

f. Your parents buy a bottle of French wine. Consumption increases because the bottle is

a good purchased by a household, but net exports decreases because the bottle was

imported.
g. Honda expands its factory to Marysville, Ohio. Investment increases because new

structures and equipment were built.

2. The government purchases component of GDP does not include spending on transfer

payments such as Social Security. Think about the definition of GDP, explain why

transfer payments are excluded. With transfer payments, nothing is produced, so there is

no contribution to GDP.
3. Below are some data from the land of milk and honey.

Year Price of Milk Quantity of Price of Quantity of

Milk Honey Honey

2013 $1 100 Quarts $2 50 Quarts
2014 $1 200 $2 100
2015 $2 200 $4 100
A. Compute nominal GDP, real GDP, and the GDP deflator of each year, using 2013 as

the base year.

Nominal GDP
Year Milk Honey
2013 1(100) = 100 2(50) = 100
2014 1(200) = 200 2(100) = 200
2015 2(200) = 400 4(100) = 400

Real GDP
Year Milk Honey
2013 1(100) = 100 2(50) = 100
2014 1(200) = 200 2(100) = 200
2015 1(200) = 200 2(100) = 200

GDP Deflator (NGDP/RGDP)100

Year Milk Honey
2013 (100/100)100 = 100 (100/100)100 = 100
2014 (200/200)100 = 100 (200/200)100 = 100
2015 (400/200)100 = 200 (400/200)100 = 200

B. Compute the percentage change in nominal GDP, real GDP, and the GDP deflator in

2014 and 2015. From the preceding year. For each year, identify the variable that does

not change. Explain why your answer makes sense.

Inflation Rate
Nominal GDP
Milk
((2014-2013)/2013)100
((200-100)/100)100=(100/100)100=1(100)=100%
((2015-2014)/2014)100
((400-200)/200)100=(200/200)100=1(100)=100%
Honey
((2014-2013)/2013)100
((200-100)/100)100=(100/100)100=1(100)=100%
((2015-2014)/2014)100
 ((400-200)/200)100=(200/200)100=1(100)=100%
Real GDP
Milk
((2014-2013)/2013)100
((200-100)/100)100=(100/100)100=1(100)=100%
((2015-2014)/2014)100
((200-200)/200)100=(0/200)100=0(100)=0%
Honey
((2014-1013)/2013)100
((200-100)/100)100=(100/100)100=1(100)=100%
((2015-2014)/2014)100
((200-200)/200)100=(0/200)100=0(100)=0%
GDP Deflator
Milk
((2014-2013)/2013)100
((100-100)/100)100=(0/100)100=0(100)=0%
((2015-2014)/2014)100
((200-100)/100)100=(100/100)100=1(100)=100%
Honey
((2014-2013)/2013)100
((100-100)/100)100=(0/100)100=0(100)=0%
((2015-2014)/2014)100
((200-100)/100)100=(100/100)100=1(100)=100%
C. Did economic well-being rise more in 2014 or 2015?