Chapter 27. Measuring Domestic Output and National Income

The following table shows the data for a hypothetical economy in a specific year. All figures are in billions of dollars. Category Value Personal consumption expenditures $50 Purchases of stocks and bonds 30 Net exports -10 Government purchases 20 Sales of secondhand items 8 Gross investment 25 What is the country's GDP for the year?

85 billion Explanation 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.

Statistics derived from national income accounting

are useful to assess the health of an economy and formulate policies to maintain and improve that health. Explanation National income accounting does for the economy as a whole what private accounting does for businesses. Firms measure income and expenditures to assess their economic health. The national income accounting system measures the level of production in the economy at some particular time and helps explain that level. By comparing national accounts over a number of years, we can track the long-run course of the economy. Information supplied by national accounts provides a basis for designing and applying public policies to improve the performance of the economy. Without national accounts, economic policy would be guesswork. National income accounting allows us to assess the health of an economy and formulate policies to maintain and improve that health.

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. Explanation 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.

Tina walks into Ted's sporting goods store and buys a punching bag for $100. That $100 payment counts as _______________ for Tina and _______________ for Ted.

expenditure; income. Explanation Expenditure; income: The $100 paid for the punching bag counts as expenditure for Tina and income for Ted. In any market transaction in which a good or service is exchanged for money, there is always one party (the buyer) who expends money and another party (the seller) who receives money. Thus, it is possible to total up GDP in two ways. One way is by adding up all of the expenditures made by buyers as they purchase final goods and services. The other is by adding up all of the income received by sellers as they sell final goods and services. These equally good strategies for calculating GDP are known, respectively, as the expenditures approach and the income approach.

A small economy starts the year with $1 million in capital. During the course of the year, gross investment is $150,000 and depreciation is $50,000. How big is the economy's stock of capital at the end of the year?

$1,100,000 Explanation $1,100,000: The economy's stock of capital at the end of the year will be $1,100,000 (= $1 million initial stock of capital + $150,000 of gross investment - $50,000 of depreciation). Keep in mind the difference between stocks and flows. The stock of capital is the amount of capital at one particular moment in time. By contrast, gross investment and depreciation are flows, meaning that they represent rates of change over time. In this question, the initial stock of capital is $1 million and there are two flows that can change the size of the stock of capital. One is gross investment, which increases the stock of capital. The other is depreciation, which decreases the stock of capital. In this question, gross investment is proceeding at the rate of $150,000 per year while depreciation is proceeding at the rate of $50,000 per year. With these two flows happening simultaneously, the net (combined) change in the stock of capital is going to be $100,000 because we have a flow of $150,000 of gross investment increasing the stock of capital while at the same time we have a flow of $50,000 of depreciation decreasing the stock of capital. Thus, the total stock of capital at the end of the year will be $1,100,000, which is the initial $1 million stock of capital plus the net change of $100,000 that results over the course of the year from the two flows (gross investment and depreciation).

Suppose GDP is $15 trillion, with $8 trillion coming from consumption, $2.5 trillion coming from gross investment, $3.5 trillion coming from government expenditures, and $1 trillion coming from net exports. Also suppose that across the whole economy, personal income is $12 trillion. If the government collects $1.5 trillion in personal taxes, then disposable income will be:

$10.5 trillion. Explanation $10.5 trillion: The correct answer to this question is that disposable income will be $10.5 trillion. To see why this is true, recall that disposable income is defined as the amount of income households have left over after paying their personal taxes. So, disposable income is personal income less personal taxes. In this case, that comes out to be $10.5 trillion (= $12 trillion in personal income - $1.5 trillion in personal taxes). Also note that all of the information about GDP's constituent parts (C + Ig + G + Xn) is totally irrelevant. The only two numbers you need to calculate disposable income are personal income and personal taxes.

Suppose GDP is $16 trillion, with $10 trillion coming from consumption, $2 trillion coming from gross investment, $3.5 trillion coming from government expenditures, and $500 billion coming from net exports. Also suppose that across the whole economy, depreciation (consumption of fixed capital) totals $1 trillion. From these figures, we see that net domestic product equals:

$17.0 trillion. $16.0 trillion. $15.5 trillion. None of these are correct. = the right answer Explanation None of these are correct: This economy's net domestic product (NDP) will be equal to $15.0 trillion (which is not one of the three specific numerical choices that are given by the question as possible answers). To see where that $15.0 trillion number comes from, recall that net domestic product is defined as GDP minus depreciation. So, in this case, NDP will be equal to $15.0 trillion (= $16 trillion of GDP - $1 trillion of depreciation). Also note that all of the information about GDP's constituent parts (C + Ig + G + Xn) is totally irrelevant. The only two numbers you need to calculate NDP are GDP and depreciation.

Suppose that this year a small country has a GDP of $100 billion. Also assume that Ig = $30 billion, C = $60 billion, and Xn = - $10 billion. How big is G?

$20 billion Explanation G equals $20 billion. To see why this is true, we can rearrange the GDP equation, which is normally presented as GDP = C + Ig + G + Xn. Rearranging the equation to solve for G reveals that G = GDP - C - Ig - Xn. With that version of the equation in hand, we can plug in our values for GDP, consumption, gross investment, and net exports. Doing so, we see that G = $100 billion - $60 billion - $30 billion - (- $10 billion). Taking into account the fact that a "negative times a negative is a positive," we see that G = $20 billion.

Which of the following transactions would count in GDP?

Kerry buys a new sweater to wear this winter. Karen buys a new car Explanation Only two of the transactions would count in GDP: Kerry buys a new sweater to wear this winter and Karen buys a new car. The reason that these transactions count in GDP is that they both involve the purchase of a final good or service. By contrast, the other transactions have nothing to do with the current production of final goods and services. For example, the receipt by Patricia of a Social Security check does not involve the production of anything at all. It is simply a transfer of purchasing power from the federal government to one of its beneficiaries. But that transfer of purchasing power does not by itself lead to anything being produced. Thus, it does not count in GDP. A similar thing holds true when Roberto gives his daughter $50 for her birthday. His gift is simply the transfer of wealth from one person to another. It does not involve the production of any goods and services and hence does not get counted in GDP. Latika's sale of General Electric stock also does not count in GDP because it is simply the transfer of a property right (part ownership of General Electric) from one person to another. Since nothing is produced, her stock sale would also be excluded from GDP. Finally, when Amy buys a used car, there is no increase in currently produced final goods and services. We simply have a change in who owns a previously produced item. So this transaction also fails to meet the definition of what should be included in GDP.

Which of the following items will be included in official U.S. GDP statistics?

Robert paying Ted for a haircut in Chicago. Revenue generated by legal medical marijuana sales in California. Money spent to clean up a local toxic waste site in Ohio. Explanation There are three correct choices to this question: money spent to clean up a local toxic waste site in Ohio, revenue generated by legal medical marijuana sales in California, and Robert paying Ted for a haircut in Chicago. Those three items would all be included in official U.S. GDP statistics because they all involve legal market transactions paid for with money. As a result, each one will generate a paper trail that will flow to the accountants who compile the U.S. GDP statistics. By contrast, the other choices are incorrect because they involve transactions that do not involve money, are illegal, or involve social costs for which there are no market transactions. As a result, they will generate no paper trail for the accountants who compile the U.S. GDP statistics. For example, revenue generated by illegal marijuana growers in Oregon will be hidden by the illegal growers so that no data will flow to the accountants who compile the GDP statistics. Similarly, no data will flow to the GDP accountants about the dollar value of the annoyance felt by local citizens living near a noisy airport in Georgia because no market transaction has taken place and thus there is nothing to include in GDP. Finally, Emily and Rhonda trading an hour of dance lessons for a haircut in Dallas will not have any effect on GDP because their trading of one service for another does not involve money and, hence, does not generate a paper trail for the accountants who compile the GDP statistics. Those accountants will, in fact, have no way of knowing whether this transaction even took place.

Using the following national income accounting data, compute (a) GDP, (b) NDP, and (c) NI. All figures are in billions. Category Value Compensation of employees $194.2 U.S. exports of goods and services 17.8 Consumption of fixed capital 11.8 Government purchases 59.4 Taxes on production and imports 14.4 Net private domestic investment 52.1 Transfer payments 13.9 U.S. imports of goods and services 16.5 Personal taxes 40.5 Net foreign factor income 2.2 Personal consumption expenditures 219.1 Statistical discrepancy 0 a. GDP = b. NDP= c. NI=

a. $343.7 b. $331.9 c. $334.1. Explanation a. Using the expenditures approach, GDP = $219.1 (personal consumption expenditures) + $52.1 (net private domestic investment) + $11.8 (consumption of fixed capital) + $59.4 (government purchases) + $17.8 (U.S. exports of goods and services) - $16.5 (U.S. imports of goods and services) = $343.7 billion. b. NDP = $343.7 (GDP) - $11.8 (consumption of fixed capital) = $331.9 billion. c. NI = $331.9 (NDP) + $2.2 (net foreign factor income) - $0 (statistical discrepancy) = $334.1 billion. We have the following table summarizing these steps. Category Value (a) Personal consumption expenditures (C) $219.1 Government purchases (G) 59.4 Gross private domestic investment (Ig) 63.9 (52.1 + 11.8) Net exports (Xn) (17.8 - 16.5) 1.3 Gross domestic product (GDP) $343.7 (b) Consumption of fixed capital - 11.8 Net domestic product (NDP) $331.9 (c) Net foreign factor income earned in U.S. 2.2 Statistical discrepancy 0 National income (NI) $334.1 Next Visit question mapQuestion 23 of 25 Total23 of 25 Prev

The annual output and prices of a 3-good economy are shown in the table below. Good Price Year 1 Quantity of Goods Year 1 Price Year 2 Quantity of Goods Year 2 Quarts of ice cream $4.00 3 $4.00 5 Bottles of shampoo 3.00 1 3.00 2 Jars of peanut butter 2.00 3 2.00 2 a. What was this economy's GDP in year 1? b. What was its GDP in year 2?

a. 21 b. 30 Explanation Using the following table: Good Price Year 1 Quantity of Goods Year 1 Nominal Value of Goods Year 1 Price Year 2 Quantity of Goods Year 2 Nominal Value of Goods Year 2 Quarts of ice cream $4.00 3 $12.00 $4.00 5 $20.00 Bottles of shampoo 3.00 1 3.00 3.00 2 6.00 Jars of peanut butter 2.00 3 6.00 2.00 2 4.00 — — $21.00 — — $30.00 The first step is to find the value of each good consumed. For example, in year 1, the price of a quart of ice cream is $4.00. Since three quarts are consumed, the value of these three quarts is $12.00 (= $4.00 × 3). This calculation is applied to each good for each year. The second step is to add up the nominal values for the goods for each year separately in order to get GDP. a. The nominal value of the goods for year 1 is $21.00 (= $12.00 + $3.00 + $6.00). b. The nominal value of the goods for year 2 is $30.00 (= $20.00 + $6.00 + $4.00).

The data for the country of Upper Mongoose are given below. All figures are in billions of dollars. Category Value Net exports $50 Value of new goods and services produced in the underground economy 75 Personal consumption expenditures 300 Value of the services of stay-at-home parents 25 Gross domestic investment 100 Government purchases 50 Total 600 a. What is Upper Mongoose's GDP for the year? b. What is the size of the underground economy as a percentage of GDP? c. By what percentage would GDP be boosted if the value of the services of stay-at-home spouses were included in GDP?

a. 500 billion b. 15 percent c. 5 percent Explanation a. Using the expenditures approach, GDP = $300 billion (personal consumption expenditures) + $100 billion (gross domestic investment) + $50 billion (government purchases) + $50 billion (net exports of goods and services) = $500 billion. b. The size of the underground economy is $75 billion. Thus, the size of the underground economy as a percentage of GDP equals 15 percent (= ($75 billion/$500 billion) × 100). c. If the GDP measure incorporated the value of the services of stay-at-home spouses, the new GDP amount would equal $525 billion (= $500 billion (from above) + $25 billion (stay-at-home spouses)). The increase in GDP is 5 percent (= (($525 billion - $500 billion)/$500 billion) × 100).

Suppose that in 1984 the total output in a single-good economy was 7,000 buckets of chicken. Also suppose that in 1984 each bucket of chicken was priced at $10. Finally, assume that in 2005 the price per bucket of chicken was $16 and that 22,000 buckets were produced. Instructions: In part a, enter your answer as an index number rounded to 1 decimal place. In parts b-c, enter your answers as whole numbers. a. What is the GDP price index for 1984, using 2005 as the base year? b. By what percentage did the price level, as measured by this index, rise between 1984 and 2005? c. What were the amounts of real GDP in 1984 and 2005? In 1984, real GDP = In 2005, real GDP =

a. 62.5 b. 60 percent c. In 1984, real GDP = 112,000 In 2005, real GDP = 352,000 Explanation a. To determine the GDP price index for 1984, using 2005 as the base year, we proceed as follows: Given that we only have one good in the economy, the simple approach is to take the price in 1984, divide by the price in 2005, and multiply by 100. This gives us ($10/$16) × 100 = 62.5. A version that extends to multiple goods is as follows: First, multiply the buckets of chicken in 2005 by the price of a bucket of chicken in 2005, which gives us a value of $352,000 (= $16 × 22,000). (We would do this for all goods and add up each value.) Second, multiply the buckets of chicken in 2005 by the price of a bucket of chicken in 1984, which gives us $220,000 (= $10 × 22,000). (We would do this for all goods and add up each value. Be sure to use 2005 quantities and 1984 prices.) This process fixes quantity in the base year and varies price (CPI). Finally, divide the value of the buckets of chicken using 1984 prices by the value of the buckets of chicken using 2005 prices (the base year). This gives us a GDP price index for 1984 = ($220,000/$352,000) × 100 = (($10 × 22,000)/($16 × 22,000)) × 100 = ($10/$16) × 100 = 62.5. In both cases, the price level increased by 60 percent (= (100 - 62.5)/62.5) = ((16 - 10)/10) × 100). b. Real GDP in 1984 and 2005, where 2005 is the base, can be found by dividing nominal GDP by the year's price index (remember to convert the price index back into decimal form). c. c. Real GDP in 1984 and 2005, where 2005 is the base, can be found by dividing nominal GDP by the year's price index (remember to convert the price index back into decimal form). Nominal GDP in 1984 is $70,000 = $10 (price 1984) × 7,000 (output 1984). The price index for 1984 is 62.5 (found above). Thus, real GDP = $70,000 (nominal output 1984)/(62.5/100) (the price index in 1984 scaled to decimal form) = $70,000/0.625 = $112,000. Nominal GDP in 2005 is $352,000 = $16 (price 2005) × 22,000 (output 2005). The price index for 2005 is 100 (by definition, the base year). Thus, real GDP = $352,000 (nominal output 2005)/(100/100) (the price index in 2005 scaled to decimal form) = $352,000/1 = $352,000.

Provide examples of each: consumer durable goods, consumer nondurable goods, and services. Instructions: You may select more than one answer. Click the box with a check mark for correct answers and click to empty the box for the wrong answers. a. Which of the following are consumer durable goods? b. Which of the following are consumer nondurable goods? c. Which of the following are services?

a. A new Ford Fiesta . A dining room table b. Mashed potatoes A pair of jeans A burrito c. Your completed taxes Repairs to your truck Explanation a. Durable goods are products that have expected lives of three years or more. Examples are refrigerators, new cars, etc. b. Nondurable goods are products with less than three years of expected life. Examples are peanut butter, clothes, etc. c. Services are the work done by lawyers, accountants, etc.

a. What government agency compiles the U.S. NIPA tables? b. Which of the following statements is true?

a. Bureau of Economic Analysis (BEA) b. The Census Bureau provides survey data for consumption, investment, and government purchases. Explanation a. The Bureau of Economic Analysis (BEA) in the Department of Commerce compiles GDP statistics. b. The Census Bureau provides survey data for consumption, investment, and government purchases. Consumption figures also come from industry trade sources as does some investment data. The U.S. Office of Personnel Management provides data on government spending on services. Net export figures come from the U.S. Customs Service and BEA surveys on service exports and imports.

Below is a list of domestic output and national income figures for a certain year. All figures are in billions. The questions that follow ask you to determine the major national income measures by both the expenditures and the income approaches. The results you obtain with the different methods should be the same. Category Value Category Value Personal consumption expenditures $245 Personal saving 20 Net foreign factor income 4 Dividends 16 Transfer payments 12 Compensation of employees 223 Rents 14 Taxes on production and imports 18 Consumption of fixed capital (depreciation) 27 Undistributed corporate profits 21 Statistical discrepancy 8 Personal taxes 26 Social Security contributions 20 Corporate income taxes 19 Interest 13 Corporate profits 56 Proprietors' income 33 Government purchases 72 Net exports 11 Net private domestic investment 33 a. Using the above data, determine GDP by both the expenditures and the income approaches. Then determine NDP. GDP using the expenditures approach = GDP using the income approach = NDP = b. Now determine NI in two ways: first, by making the required additions or subtractions from NDP (method 1); and second, by adding up the types of income and taxes that make up NI (method 2). Method 1 = billion. Method 2 = billion. c. Adjust NI (from part b) as required to obtain PI. PI= billion d. Adjust PI (from part c) as required to obtain DI. DI= billion

a. GDP using the expenditures approach = 388 billion GDP using the income approach = 388 billion NDP = 361 billion b.Method 1 = 357 billion. Method 2 = 357 billion. c. PI= 291 billion d.DI= 265 billion Explanation a. Both methods will give us the same answer. The expenditures approach: GDP = $245 (personal consumption expenditures) + ($33 (net private domestic investment) + $27 (consumption of fixed capital, depreciation) (the sum of these two components measures gross investment = $60)) + $72 (government purchases) + $11 (net exports) = $245 + $60 + $72 + $11 = $388 billion. The income approach: GDP = $223 (compensation of employees) + $14 (rents) + $13 (interest) + $33 (proprietors' income) + $56 (corporate profits) + $18 (taxes on production and imports) + $27 (consumption of fixed capital, depreciation) - $4 (net foreign factor income) + $8 (statistical discrepancy) = $223 + $14 + $13 + $33 + $56 + $18 + $27 - $4 + $8 = $388 billion. Net domestic product = GDP - consumption of fixed capital (depreciation). NDP = $388 - $27 = $361 billion. b. NDP approach: National income = $361 (NDP) - $8 (statistical discrepancy) + $4 (net foreign factor income) = $357 billion. Income and taxes approach: National income = $223 (compensation of employees) + $14 (rents) + $13 (interest) + $33 (proprietors' income) + $56 (corporate profits) + $18 (taxes on production and imports) = $357 billion. c. Personal income = $357 (national income) - $18 (taxes on production and imports) - $20 (Social Security contributions) - $19 (corporate income taxes) - $21 (undistributed corporate profits) + $12 (transfer payments) = $291 billion. d. Disposable income = $291 (personal income) - $26 (personal taxes) = $265 billion.

a. Net exports are b. U.S. exports and imports each affects domestic production because c. Suppose foreigners spend $7 billion on American exports in a given year and Americans spend $5 billion on imports from abroad in the same year. What is the amount of U.S. net exports? d. Net exports might be a negative amount if Americans

a. a country's exports of goods and services less its imports of goods and services. b. imports are subtracted from U.S. GDP and exports are added. c. + $2 billion d. decrease their holdings of foreign currencies, borrow from foreigners, or do a little of both. Explanation a. Net exports are a country's exports of goods and services less its imports of goods and services. b. U.S. exports are as much a part of the nation's production as are the expenditures of its own consumers on goods and services made in the United States. Therefore, U.S. exports must be counted as part of GDP. On the other hand, imports, being produced in foreign countries, are part of those countries' GDPs. When Americans buy imports, these expenditures must be subtracted from U.S. GDP, for these expenditures are not made with U.S. production. c. If American exports are $7 billion and imports are $5 billion, then American net exports are + $2 billion. If the figures are reversed so that Americans export $5 billion and import $7 billion, then net exports are − $2 billion, a negative amount. d. For net exports to be a negative amount, Americans must either decrease their holdings of foreign currencies or borrow from foreigners—or do a little of both. (Another option is to sell back to foreigners some of the previous American investments abroad.)

a. Changes in inventories are included as part of investment spending because b. If inventories declined by $1 billion during 2014, then $1 billion would be

a. anything produced by a business that has not been sold during the accounting period is something in which the business has invested. b. subtracted from both gross private domestic investment and gross domestic product. Explanation a. Anything produced by a business that has not been sold during the accounting period is something in which the business has invested—even if the "investment" is involuntary, as often is the case with inventories. But all inventories in the hands of businesses are expected eventually to be used by the business—for instance, a pile of bricks for extending a factory building—or to be sold—for instance, a can of beans on the supermarket shelf. In the hands of the business, both the bricks and the beans are assets to the business, something in which the business has invested. b. If inventories declined by $1 billion during 2014, then $1 billion would be subtracted from both gross private domestic investment and gross domestic product. A decline in inventories indicates that goods produced in a previous year have been used up in this year's production. If $1 billion is not subtracted as stated, then $1 billion of goods produced in a previous year would be counted as having been produced in 2014, leading to an overstatement of 2014's production.

Which of the following goods are usually intermediate goods and which are usually final goods? a. Running shoes: b.. Cotton fibers: c. Watches: d. Textbooks: e. Coal: f. Sunscreen lotion: g. Lumber:

a. final b. intermediate c. final d. final e. intermediate f. final g. intermediate Explanation a. Running shoes are usually a final good. The person purchasing the running shoes is typically the individual who will use the shoes. b. Cotton fibers are usually an intermediate good. The cotton fibers are used to produce other goods that will be sold on the market. c. Watches are usually a final good. The person purchasing the watch is typically the individual who will use the watch. d. Textbooks are usually a final good. The person purchasing the textbook is typically the individual who will use the textbook. e. Coal is usually an intermediate good. The coal is used to produce other goods, primarily electricity, that will be sold on the market. f. Sunscreen lotion is usually a final good. The person purchasing the sunscreen lotion is typically the individual who will use the sunscreen lotion. g. Lumber is an intermediate good. Lumber is used to build houses, furniture, and the like.

a. Economists include only final goods and services when measuring GDP for a particular year because b. Gross domestic product does not include the value of the stocks and bonds bought and sold because these sales and purchases are not c. When measuring GDP for a particular year, economists exclude the value of the used furniture bought and sold because

a. if intermediate goods were counted, then multiple counting would occur. b. economic investment and should not be counted as production of final goods and services. c. it was counted in GDP in some previous year. Explanation a. 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). b. 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. c. Used furniture was produced in some previous year; it was counted in GDP then. Its resale does not measure new production.

Which of the following are included or excluded in this year's GDP? a. Interest received on an AT&T corporate bond: b. Social Security payments received by a retired factory worker: c. The unpaid services of a family member in painting the family home: d. Income of a dentist from the dental services provided: e. A monthly allowance a college student receives from home: f. Money received by Josh when he resells his nearly brand-new Honda automobile to Kim: g. The publication and sale of a new college textbook: h. An increase in leisure resulting from a 2-hour decrease in the length of the workweek, with no reduction in pay: i. A $2 billion increase in business inventories: j. The purchase of 100 shares of Google common stock:

a. included b. excluded c. excluded d. included e. excluded f. excluded g. included h. excluded i. included j. excluded Explanation a. Included: Income received by the bondholder for the services derived by the corporation for the loan of money. b. Excluded: A transfer payment from taxpayers for which no service is rendered (in this year). c. Excluded: Nonmarket production. d. Included: Payment for a final service. You cannot pass on a tooth extraction! e. Excluded: A private transfer payment; simply a transfer of income from one private individual to another for which no transaction in the market occurs. f. Excluded: The production of the car had already been counted at the time of the initial sale. g. Included: It is a new good produced for final consumption. h. Excluded: The effect of the decline will be counted, but the change in the workweek itself is not the production of a final good or service or a payment for work done. i. Included: The increase in inventories could only occur as a result of increased production. j. Excluded: Merely the transfer of ownership of existing financial assets.

a. Use the concepts of gross investment and net investment to distinguish between an economy that has a rising stock of capital and one that has a falling stock of capital. To answer this question, evaluate the following statement: "In 1933 net private domestic investment was minus $6 billion. This means that in that particular year the economy produced no capital goods at all." This statement is b. Consider this statement: "Though net investment can be positive, negative, or zero, it is impossible for gross investment to be less than zero." This statement is

a. incorrect, because negative net investment does not mean the economy produced no new capital goods in that year. b. correct, because depreciation on the existing capital stock is positive. Explanation a. When gross investment exceeds depreciation, net investment is positive and production capacity expands; the economy ends the year with more physical capital than it started with. When gross investment equals depreciation, net investment is zero and production capacity is said to be static; the economy ends the year with the same amount of physical capital. When depreciation exceeds gross investment, net investment is negative and production capacity declines; the economy ends the year with less physical capital. The statement is incorrect. Just because net investment was minus $6 billion in 1933 does not mean the economy produced no new capital goods in that year. It simply means depreciation exceeded gross investment by $6 billion. So the economy ended the year with $6 billion less capital. b. The statement is correct because net investment = gross investment - depreciation. In typical years, gross investment exceeds depreciation. Thus, net investment is positive and the nation's stock of capital rises by the amount of net investment. Gross investment need not always exceed depreciation, however. When gross investment and depreciation are equal, net investment is zero and there is no change in the size of the capital stock. When gross investment is less than depreciation, net investment is negative. The economy then is disinvesting—using up more capital than it is producing—and the nation's stock of capital shrinks. That happened in the Great Depression of the 1930s. If only one $20 spade is bought by a construction firm in the entire economy in a year and no other physical capital is bought, then gross investment is $20—a positive amount. This is true even if net investment is highly negative because depreciation is well above $20.

a. National income accountants compare the market value of the total outputs in various years rather than actual physical volumes of production because b. Comparing market values over time has the

a. it is impossible to add two different goods, say, oranges and computers. b. disadvantage that prices change over time. Explanation a. 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. Since oranges and computers have different values, the quantities of each commodity are multiplied by their values or prices. Adding together all the results of the price times quantity figures leads to the aggregate figure showing the total value of all the final goods and services produced in the economy. Thus, to return to oranges and computers, if the value of orange production increases by 100 percent from $100 million to $200 million while that of computers increases by 10 percent from $2 billion to $2.2 billion, we can see that total production has increased from $2.1 billion (= $100 million + $2 billion) to $2.4 billion (= $200 million + $2.2 billion). This is an increase of 14.29 percent (= ($2.4 billion - $2.1 billion)/$2.1 billion)—and not the 55 percent incorrectly derived earlier. b. 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.

a. Nominal GDP is b. In order to compare changes in the standard of living over a series of years, we would use c. The GDP price index is d. Which of the following statements is true?

a. 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. b. real GDP. c. 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. d.Real GDP is nominal GDP divided by the price index.Correct Explanation a. 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. We use money or nominal values as a common denominator in order to sum that heterogeneous output into a meaningful total. Suppose the value of money itself changes in response to inflation (rising prices) or deflation (falling prices). We can compare the market values of GDP from year to year by adjusting nominal GDP to take into account potential changes in prices. This results in real GDP, where nominal GDP has been deflated or inflated to reflect changes in the price level (also called adjusted GDP). b. We use real GDP to compare standards of living over time. Individuals are concerned about the amount of actual goods consumed rather than the nominal value of the goods. Would you prefer to have two candy bars priced at $1.00 each or one candy bar priced at $2.00? Both have the same nominal value of consumption! c. A price index is a measure of the price of a specified collection of goods and services called a "market basket" in a given year as compared to the price of an identical (or highly similar) collection of goods and services in a reference year. d. To find real GDP we divide the nominal GDP by the price index.