Chapter 5 Macroeconomics

List the four components of expenditure.

(1) consumption; (2) investment; (3) government purchases; and (4) net exports

What two things does gross domestic product measure?

(1) the total income of everyone in the economy; and (2) the total expenditure on the economy's output of goods and services

Why should policymakers care about GDP?

Although GDP is not a perfect measure of economic well-being, policymakers should care about it because a larger GDP means that a nation can afford better health care, better educational systems, and more of the material necessities of life.

Explain why an economy's income must equal its expenditure.

An economy's income must equal its expenditure since every transaction has a buyer and a seller. Thus, expenditure by buyers must equal income of sellers.

Why do economists use 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. If nominal GDP rises, you do not know if that is because of increased production and/or higher prices.

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

The growth rate of real GDP from Year 2 to Year 3 =(20-16)/16x100=25%

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. What is the real GDP for these years?

Year 1: (3 bars x $4) = $12 Year 2: (4 bars x $4) = $16 Year 3: (5 bars x $4) = $20

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 contribution to GDP is $3, the market value of the bread, which is the final good that is sold.

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

Year 1: (3 bars x $4) = $12 Year 2: (4 bars x $5) = $20 Year 3: (5 bars x $6) = $30

Give an example of government purchases

an order for military aircraft

How can GDP it measure two things at once?

because income must equal expenditure for the economy as a whole

Give an example of investment

the purchase of a computer by a business

Give an example of consumption

the purchase of a music CD

Give an example of net exports

the sale of Canadian wheat to Russia

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.

It is desirable for a country to have a large GDP because people could enjoy more goods and services. But GDP is not the only important measure of economic well-being. For example, laws that restrict pollution cause GDP to be lower. If laws against pollution were eliminated, GDP would be higher, but the pollution might make us worse off. Or, for example, an earthquake would raise GDP, as expenditures on cleanup, repair, and rebuilding increase. But an earthquake is an undesirable event that lowers our welfare.

What does it mean when net exports have a negative value?

Net exports are equal to the difference between the value of exports and the value of imports. When our country imports more than it exports, net exports are negative.

Is real or nominal GDP a better measure of economic well-being? Why?

Real GDP is a better measure of economic well-being because it reflects the economy's ability to satisfy people's needs and desires. Thus, a rise in real GDP means people have produced more goods and services, but a rise in nominal GDP could occur either because of increased production and/or because of higher prices.

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

The inflation rate from Year 2 to Year 3 = (150 - 125)/125 x 100 = 20% (year 3 - year 2) / 2

Which contributes more to GDP—the production of a kilogram of hamburger or the production of a kilogram of caviar? Why?

The production of a kilogram of caviar contributes more to GDP than the production of a kilogram of hamburger because the contribution to GDP is measured by market value and the price of a kilogram of caviar is much higher than the price of a kilogram of hamburger.

Define real GDP

The production of goods and services valued at constant prices.

Define nominal GDP

The production of goods and services valued at current prices.

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?

The sale of used records does not affect GDP at all because it involves no current production.

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. What is the GDP deflator?

Year 1: $12/$12 x 100 = 100 Year 2: $20/$16 x 100 = 125 Year 3: $30/$20 x 100 = 150 (nominal / real) x 100 = GDP Deflator