ECON 2302 Exam 2

Calculate GDP of Chart

Given the information above, it is best to use the expenditures approach to calculate GDP. This approach adds personal consumption expenditures, gross investment, government purchases, and net exports. Thus, GDP equals $85 billion for this country [= $50 billion + $25 billion + $20 billion + (- $10 billion)]. Note that the purchase of stocks and bonds and sales of secondhand items are not part of GDP. This information is extraneous to the question.

If GDP is $15 trillion, how many years will it take for GDP to increase to $30 trillion if annual growth is 2 percent?

If GDP is $15 trillion and annual growth is 2 percent, it will take 70/2 (or 35 years) to double to $30 trillion. The total is 35 years.

If a country's economic size is growing faster than the rest of the world, then

If a country's economic size is growing faster than the rest of the world, then this country will gain influence in the international sector. China is a classic example of this phenomenon in the last decade. This is because a greater share of the world's goods and services are produced in this country.

If a country's standard of living is growing by 5 percent per year, it implies that

If a country's standard of living is increasing at 5 percent, it implies that output is increasing at a rate of 5 percent above the population growth. If this rate of growth is greater than that in other countries, political influence will increase as well.

If firms expect the future returns for an investment to be very low, all else equal, they will

If firms expect low returns on their investments, all else equal, they will typically invest less. If firms expect high returns on their investments, they will typically invest more. However, these results depend on how households respond to interest rates and the availability of savings for investment purposes.

Given that the company cannot change the price of sweaters, consider the number of sweaters it orders each month from the company that makes its sweaters. If inventories become very high, will the catalog company increase orders, decrease orders, or keep orders the same?

If inventories start to accumulate, then this company will reduce its orders from the production company.

Suppose that work hours in New Zombie are 200 in year 1, and productivity is $8 per hour worked. What is New Zombie's real GDP?

New Zombie's real GDP in a given year equals hours worked multiplied by productivity. New Zombie's real GDP in year 1 equals $1,600 (= 200 × $8).

Suppose that work hours in New Zombie are 200 in year 1, and productivity is $8 per hour worked. If work hours increase to 210 in year 2 and productivity rises to $10 per hour, what is New Zombie's rate of economic growth?

New Zombie's real GDP in year 2 equals $2,100 (= 210 × $10). We now use these values to find the rate of economic growth. New Zombie's rate of economic growth equals 31.25 percent = [($2,100 - $1,600)/$1,600] × 100.

Are all prices in the economy equally inflexible?

No, all prices are not equally inflexible. Prices are controlled primarily from the demand and supply in their respective market, while only some goods/services are flexible.

Has economic output always grown faster than the population?

No. Rapid and sustained economic growth is a modern phenomenon.

Free rider problem

Occurs when people benefit from the public good without contributing to the cost (tax revenue proportionate to the benefit received)

Nonexcludability

Once the goods are produced, nobody-including free riders-can be excluded from the goods benefits

Nonrivalry

One person's consumption does not prevent consumption by another

Market demand curves are too far to the left (too low) (N/P Externality)

Positive Externality

Resources are underallocated: (N/P Externality)

Positive Externality

Tammy installs a very nice front garden, raising the property values of all the other houses on her block (N/P Externality)

Positive Externality

Does quadratic voting allow voters to directly express differences in strengths of preference?

Quadratic voting is an alternative voting mechanism that leads to fewer inefficient voting outcomes than 1p1v. Under quadratic voting, the winning side of an election (Yes or No) is still determined by the "50 percent plus 1" majority voting rule that you are familiar with. But under a quadratic voting system, voters can purchase and then cast as many votes as they desire. Naturally, voters with strong preferences will wish to buy more votes because the outcome matters more for them than for people with weak preferences.

Which of the following statements is true?

Real GDP is nominal GDP divided by the price index.

Suppose a country's real GDP is $18 trillion and the population is 400 million. What is this country's real GDP per capita?

Real GDP per capita = real GDP/population Real GDP per capita is $45,000 [= $18,000,000,000,000 (real GDP)/400,000,000 (population)].

Example of Private Good

Satellite TV

Suppose a country's real GDP is $18 trillion and the population is 400 million. Now suppose that during the next 10 years, real GDP doubles and the population triples. At the end of this 10-year period, what will be its real GDP per capita?

Suppose that during the next 10 years, real GDP doubles to $36 trillion and the population triples to 1,200 million. At the end of this 10-year period, real GDP per capita will be $30,000 [= $36,000,000,000,000 (real GDP)/1,200,000,000 (population)].

In 140 years What annual growth rate is needed?

The annual growth rate needed for a country to double its output in 140 years is 0.5 percent (= 70/140).

In 35 years What annual growth rate is needed?

The annual growth rate needed for a country to double its output in 35 years is 2 percent (= 70/35).

In 7 years What annual growth rate is needed?

The annual growth rate needed for a country to double its output in 7 years is 10 percent (= 70/7).

In 70 years What annual growth rate is needed?

The annual growth rate needed for a country to double its output in 70 years is 1 percent (= 70/70).

What is the efficiency factor?

The level of economic efficiency and full employment needed to reach full production potential.

What is the demand factor?

The level of purchases needed to maintain full employment

Why is it in the interest of new homebuyers and builders of new homes to have government building codes and building inspectors?

The reason is related to the lack of information and education on the part of most new homebuyers and builders with regard to every aspect of home construction. To make sure that a new building conforms to adequate safety and construction standards, building codes have been created.

Assume that a grower of flower bulbs sells its annual output of bulbs to an Internet retailer for $70,000. The retailer, in turn, brings in $160,000 from selling the bulbs directly to final customers. What amount would these two transactions add to personal consumption expenditures and thus to GDP during the year?

These two transactions would add $160,000 to personal consumption expenditures and thus to GDP during the year. The reason that we do not count the $70,000 is that this first sale is an intermediate step toward the final sale and value of the flower bulbs sold to consumers. This final price includes the cost of the bulbs purchased by the Internet retailer.

Is the statement correct/incorrect - "Majority voting ensures that government will produce only those public goods for which benefits exceed costs."

This statement is incorrect. A number of government failures and voting paradoxes can lead to situations in which government overprovides a public good and produces beyond the amount at which MB = MC. Inefficient voting outcomes and the paradox of voting may be to blame.

How might the government correct (positive/negative) externalities?

Through regulation by internalizing external costs, or it might tax the externality until it becomes too expensive for the firm to incur the costs.

Does traditional one-person-one-vote (1p1v) majority voting allow voters to directly express differences in strengths of preference?

Traditional one-person-one-vote (1p1v) majority voting does NOT allow voters to directly express differences in strengths of preference because a single voter's vote only counts once regardless of the strength of preference (or how much the voter stands to gain or lose from a public good).

Example of Public Good

U.S. border Patrol

Discuss the differences (1P1V & Quad) and then explain which system you prefer, and why.

Under quadratic voting, the cost of purchasing votes is quadratic, meaning that it increases exponentially with the square of the number of votes purchased. With quadratic voting, each voter will purchase votes up to the point where the marginal benefit from purchasing additional votes equals the marginal cost of purchasing additional votes. Thus, this system would yield more socially efficient outcomes than the one-person-one-vote system, which does not enable voters to express the strength of their preferences.

GDP calculation from year 1 to year 2

What is the growth rate of real GDP from year 1 to year 2? 50 percent b. What is the growth rate of real GDP per capita from year 1 to year 2? 25 percent

The GDP price index is

a measure of the price of a specified collection of goods and services compared to the price of a highly similar collection of goods and services in a reference year.

Spillover costs

are also called negative externalities, because they are externalities to the participants in the transaction and reduce the utility of affected third parities (thus "negative")

Spillover Benefits

are also called positive externalities, because they are external to the participants in the transaction and increase the utility of affected third parties

Evaluate: "Though net investment can be positive, negative, or zero, it is impossible for gross investment to be less than zero." This statement is

correct, because depreciation cannot be less than zero.

Comparing market values over time has the

disadvantage that prices change over time. Comparing market values over time has the disadvantage that prices change. If the market value in year 2 is 10 percent greater than in year 1, we cannot say the economy's production has increased by 10 percent. It depends on what has been happening to prices—on whether the economy has been experiencing inflation or deflation.

Gross domestic product does not include the value of the stocks and bonds bought and sold because these transactions are considered

economic investment and should not be counted as production of final goods and services. The value of the stocks and bonds bought and sold is not included in GDP because such sales and purchases simply transfer the ownership of existing assets; such sales and purchases are not themselves (economic) investment and thus should not be counted as production of final goods and services.

Investment as defined by economists differs from investment as defined by the general public in that

economic investment refers to the purchase of machinery, whereas financial investment is the purchase of financial assets.

Running Shoes (F/I Good)

final good. The person purchasing the running shoes is typically the individual who will use the shoes.

Sunscreen Lotion (F/I Good)

final good. The person purchasing the sunscreen lotion is typically the individual who will use the sunscreen lotion.

Textbooks (F/I Good)

final good. The person purchasing the textbook is typically the individual who will use the textbook.

Watches (F/I Good)

final good. The person purchasing the watch is typically the individual who will use the watch.

Net exports are a country's export of

goods and services less its imports of goods and services.

When negative externalities are present, equilibrium output will be ________ than efficient output. This is because the producer, who is not bearing the full cost of production, will be able to produce more at a lower price than the efficient level that would exist if true costs were reflected in the production decision.

greater

Banks and other financial institutions

help allocate resources to the most productive investments.

Typically, a higher saving rate is associated with

higher investment rates and higher rates of growth.

There is a trade-off between the amount of consumption that people can enjoy today and the amount of consumption that they can enjoy in the future because

households must save today if they want to increase their future consumption, thus providing funds for investment.

Economists include only final goods and services when measuring GDP because

if intermediate goods were counted, then multiple counting would occur. The dollar value of final goods includes the dollar value of intermediate goods. If intermediate goods were counted, then multiple counting would occur. For example, the value of steel used in the production of automobiles (an intermediate good) is included in the price of the final product (the automobile).

Evaluate: "In 1933 net private domestic investment was negative $6 billion. This means that in that particular year the economy produced no capital goods at all." This statement is:

incorrect, because negative net investment does not mean the economy produced no new capital goods in that year.

Lumber (F/I Good)

intermediate good. Lumber is used to build houses, furniture, and the like.

Coal (F/I Good)

intermediate good. The coal is used to produce other goods, primarily electricity, that will be sold on the market.

Cotton Fibers (F/I Good)

intermediate good. The cotton fibers are used to produce other goods that will be sold on the market.

The Rule of 70

is to divide 70 by the rate of growth, gives us the time it takes for a country to double its output: Years to double = (70/rate of growth). Rearranging this equation: Rate of growth = (70/years to double).

National income accountants compare the market value of the total outputs in various years rather than actual physical volumes of production because

it is impossible to summarize two different goods, say, oranges and computers, as a single statistic. If it is impossible to summarize oranges and apples as one statistic, as the saying goes, it is surely even more impossible to add oranges and, say, computers. If the production of oranges increases by 100 percent and that of computers by 10 percent, it does not make any sense to add the 100 percent to the 10 percent, then divide by 2 to get the average and state total production has increased by 55 percent.

Macroeconomists focus on just a few key statistics when trying to understand the health and trajectory of an economy because

it is too difficult to process all of the information in each market or for every good or service in the economy.

Producing __________ than the equilibrium level means that potential surplus is left unrealized.

less

Consumer Surplus Equation

max price willing to pay - Actual Price (Equilibrium Price)

Taxes can correct ________ externalities

negative

What are the two characteristics of public goods?

nonrivalry and nonexcludability

External benefits example

outdoor Christmas lights, music from the stereo down the hall, or attractive landscaping in the neighborhood

Subsidies can correct ___________ externalities

positive

An increase in __________ GDP guarantees that more goods and services are being produced by an economy.

real

Macroeconomists focus their attention on three key economic statistics—

real GDP, unemployment, and inflation

The more reliable measure for comparing changes in the standard of living over a series of years is

real GDP.

External costs example

second-hand smoke, noise from the stereo down the hall, or road congestion

When positive externalities are present, equilibrium output will be _________ than efficient output because the consumer is willing to pay a price equal to the consumer's individual marginal benefit, but no more.

smaller

What are the four phases of the business cycle? How long do business cycles last?

starting at the bottom, are trough, expansion, peak, and recession. Although all business cycles pass through the same phases, they vary greatly in duration and intensity.

Overproduction ___________ from the surplus because society values the use of the additional resources in other pursuits more than it values them in the consumption of that good.

subtracts

Nominal GDP is

the market or money value of all final goods and services produced by the economy in a given year, whereas real GDP is adjusted for inflation.

Nominal GDP is a measure of

the market or money value of all final goods and services produced by the economy in a given year.

An economy's output, in essence, is also equal to its income because

the value of everything that is produced is also the value of everything sold. Everything that is produced is sold, even if the "selling" in the case of inventory is to the producing firm itself. Since the same amount of money paid out by buyers of the economy's output is received by sellers as income (looking only at a private-sector economy at this point), an economy's output is also its income.

Shocks to the economy force people to make changes because

their actual income may be different than their previous expected income.

When measuring GDP, economists don't include the value of the used furniture bought and sold because

this value was already counted in GDP in some previous year. Used furniture was produced in some previous year; it was counted in GDP then. Its resale does not measure new production.

Nominal GDP Calculation

(Quantity of Goods) ( Price of Year X) + etc...

If foreigners spend $7 billion on U.S. exports in a given year and Americans spend $5 billion on imports from abroad in the same year, what is the value of U.S. net exports?

+ $2 billion

What are the four supply factors of economic growth?

- The stock of capital goods - The quality & quantity of human resources - The level of technology - The quality & quality of natural resources

Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient. Why are below- or above-equilibrium levels of output inefficient, according to these two ideas?

- When consumers' utility exceeds the price paid, consumer surplus is generated. - When producers receive a price greater than marginal cost, producer surplus is created. By producing up to MB = MC, the maximum potential consumer surplus and producer surplus are generated.

Suppose an economy's real GDP is $30,000 in year 1 and $31,200 in year 2. Assume that the population is 100 in year 1 and 102 in year 2. What is the growth rate of real GDP per capita?

1.96% Real GDP per capita year 1 = $30,000/100 = $300. Real GDP per capita year 2 = $31,200/102 = $305.88. GDP per capita equals 1.96 percent = [($305.88 - $300)/$300 × 100].

Suppose an economy's real GDP is $30,000 in year 1 and $31,200 in year 2. What is the growth rate?

4% 4 percent = [($31,200 - $30,000)/$30,000 × 100].

Resources are overallocated (N/P Externality)

Negative Externality

Water pollution from a factory forces neighbors to buy water purifiers: (N/P Externality)

Negative Externality

Net exports might be a negative amount if

Americans spend more on imports than foreign countries spend on American exports.

Do prices tend to become more flexible or less flexible as time passes?

As the length of time increases so will the flexibility in prices. In the very short run, prices tend to be completely inflexible. As time moves on, prices become more and more flexible. This can be seen when an economy reacts to demand shocks with price changes as well as with output and employment changes. If prices are stuck, we use the aggregate expenditures model, which assumes perfectly inflexible prices (and wages). But if prices are flexible, we use the aggregate demand-aggregate supply model.

When did modern economic growth begin?

During the Industrial Revolution in the late 1700s.

Assume that the hypothetical economy of Econoland has 10 workers in year 1, each working 2,000 hours per year (50 weeks at 40 hours per week). The total input of labor is 20,000 hours. Productivity (average real output per hour of work) is $10 per worker. Between year 1 and year 2, what will be Econoland's rate of economic growth?

Econoland's rate of economic growth will be about 5.04 percent [= ($210,080 − $200,000)/200,000)] for the year.

Why is economic growth important?

Economic growth means a higher standard of living, provided population does not grow even faster. And if it does, then economic growth is even more important to maintain the current standard of living. Economic growth allows the lessening of poverty even without an outright redistribution of wealth.

How is economic growth measured?

Economists define and measure economic growth as either: an increase in real GDP occurring over some time period, or an increase in real GDP per capita occurring over some time period. With either definition, economic growth is calculated as a percentage rate of growth per quarter (3-month period) or per year.

Given what the catalog company does with its orders, what is likely to happen to employment and output at the sweater manufacturer?

Employment will fall and output will fall Given this reduction in the purchase of sweaters by the catalog company, the firm producing the sweaters will reduce output and in most cases reduce employment. Thus, output and employment are likely to decline for the sweater manufacturer.

Why could the difference between a 2.5 percent and a 3 percent annual growth rate be of great significance over several decades?

If population is growing at 2.5 percent a year—and it is in some of the poorest nations—then a 2.5 percent growth rate of real GDP means no change in living standards. A 3.0 percent growth rate means a gradual rise in living standards. For a wealthy nation, such as the United States, with a GDP in the neighborhood of $10 trillion, the 0.5 percentage point difference between 2.5 and 3.0 percent amounts to $50 billion a year, or more than $150 per person per year. Using the rule of 70, it would take 28 years for output to double with a 2.5 percent growth rate, and just over 23 years with 3.0 percent growth.

Assume that the hypothetical economy of Econoland has 10 workers in year 1, each working 2,000 hours per year (50 weeks at 40 hours per week). The total input of labor is 20,000 hours. Productivity (average real output per hour of work) is $10 per worker. What is real GDP in Econoland?

If productivity (average real output per hour of work) is $10, then real GDP in Econoland will be $200,000 (= 20,000 × $10).

If the company could change the price of sweaters, would it raise the price, lower the price, or keep the price the same?

If the company could change the price of sweaters, it would lower the price in order to increase the quantity of sweaters demanded.

The LoJack car recovery system allows the police to track stolen cars. As a result, they not only recover 90 percent of LoJack-equipped cars that are stolen but also arrest many auto thieves and shut down many "chop shops" that rip apart stolen vehicles to get their parts. Thus, LoJack provides both private benefits and positive externalities. Should the government consider subsidizing LoJack purchases?

If the government were to subsidize LoJack purchases, this would reduce the private cost of the anti-theft devices. In turn, this reduction in the private cost would increase purchases of the LoJack system. The fact that this good is underutilized in the private sector without the subsidy (because part of the benefit accrued to society, not the individual, is in the form of reduced crime by shutting down the "chop shops") implies this subsidy is appropriate

If a catalog company finds its inventory of sweaters rising, what does that tell you about the demand for sweaters?

If the inventories are rising for sweaters, then we know that demand for sweaters must be falling. This is because prices are fixed, so this implies that people are buying less of the good due to a decrease in demand. In most circumstances, this accumulation of inventories suggests that the demand for sweaters was unexpectedly low since companies try to smooth out production to minimize costs.

Assume that the hypothetical economy of Econoland has 10 workers in year 1, each working 2,000 hours per year (50 weeks at 40 hours per week). The total input of labor is 20,000 hours. Productivity (average real output per hour of work) is $10 per worker. Suppose work hours rise by 1 percent to 20,200 hours per year and labor productivity rises by 4 percent to $10.40. In year 2, what will be Econoland's real GDP?

If work hours rise by 1 percent to 20,200 hours and labor productivity rises by 4 percent to $10.40 per worker, Econoland's real GDP will increase to $210,080 (= 20,200 × $10.40) in year 2.

Example of using the Coase Theorem

It will be to the advantage of individual apple growers and beekeepers to negotiate so that beekeepers (whose hives can be moved) locate their production in or near apple orchards.

Which ones show large amounts of short-run flexibility? Which ones show a great deal of inflexibility even over months or years?

Majority of private goods are flexible, while most of the public goods are inflexible in pricing. Short-run Flexibility: - Utilities - Retail - Agriculture Long-run Flexibility: - Services - Manufacturing - Finance