Module 1: National Incom e Accounting Practice problems and illustrative test questions for the final exam (The

attached PDF file has better form atting.) This posting gives sam ple final exam problem s. Other topics from the textbook are asked as well; these problem s are just exam ples. All final exam problem s are m ultiple choice; som e practice problem s are not m ultiple choice so that the solutions m ethods can be explained with no distraction of wrong choices. ** Question 1.1: GDP and GNP U.S. GDP in 20X2 is 400,000. ! ! ! ! Jacob, a U.S. citizen, works in Paris and earns 30,000. Jacques, a French citizen, works in Boston and earns 40,000. Rachel, a U.S. citizen, owns a condom inium in Berlin which she rents to a Germ an fam ily for 20,000. Angela, a Germ an citizen, owns a warehouse in California which she rents to a U.S. firm for 70,000.

W hat is U.S. GNP in 20X2? A. B. C. D. E. 340,000 350,000 390,000 410,000 460,000

Answer 1.1: A 400,000 + 30,000 40,000 + 20,000 70,000 = 340,000 GDP (Gross Dom estic Product) is the wealth produced in the country, regardless who owns the wealth. GNP is the wealth produced by citizens of the country, regardless where the wealth is produced. Jacob: W hich is the better m easure, GDP or GNP? Rachel: Each m easure has advantages. GDP is the better m easure of the wealth produced in the country. W e dont care about the citizenship of the people producing the wealth. If Jacob and Jacque work as actuaries and each produces 50,000 of wealth, GDP increases the sam e am ount from each worker, even if Jacob is a citizen and Jacques is a foreigner. GDP is the better m easure of the wealth produced by the citizens. W e dont care where the people work. If Jacob and Rachel are oil engineers earning 50,000 apiece, GNP increases the sam e am ount from each worker, even if Jacob works in Texas and Rachel works in Libya. See Barro Macroeconomics Chapter 2 National Incom e Accounting, page 20

** Question 1.2: GDP vs Incom e W hich of the following is true regarding the national incom e accounts? A. B. C. D. E. GDP > GNP NNP > GNP Personal incom e > national incom e National incom e > NNP Personal incom e > disposable personal incom e

Answer 1.2: E Statement A: GDP m ay be m ore or less than GNP. For the world as a whole (com bining the national incom e accounts for all countris), GDP = GNP. Statement B: NNP = GNP depreciation, so NNP < GNP. Statement C: National incom e is m ore than personal incom e in the United States, though the relation depends on the size of personal transfer paym ents and corporate taxes. Statement D: National incom e = NNP (net national product), except for statistical discrepancies. Statement E: Personal incom e personal taxes = disposable personal incom e See Barro Macroeconomics Chapter 2 National Incom e Accounting, page 21

** Question 1.3: National incom e National incom e has the following pieces: ! ! ! Net factor incom e from abroad = 10 Incom e from private dom estic industries = 780 Incom e from governm ental industries = 100

The national accounts also show ! ! ! ! ! Personal consum ption expenditures = 500 Governm ent purchases = 250 Exports = 40 Im ports = 60 Depreciation = 30

W hat is gross private dom estic investm ent? A. B. C. D. E. 150 180 220 230 240

Answer 1.3: B Measuring by the production approach gives National incom e = NNP = 10 + 780 + 100 = 890. Subtract factor incom e from abroad to get NDP = 890 10 = 880. Add depreciation to get GDP = 880 + 30 = 910. Use expenditure approach: GDP = 500 + 250 + (40 60) + investm ent A investm ent = 910 (500 + 250 + 40 60) = 180 See Barro Macroeconomics Chapter 2 National Incom e Accounting, page 22

** Exercise 1.4: GDP and social welfare France has proposed a GDP yardstick that better m easures social welfare. A. W hy m ight real GDP not be a good m easure of social welfare? B. W hy are the criticism s of real GDP too subjective for scientific use? C. W hy m ight traditional real GDP be a good m easure of social welfare? Part A: The problem s of real GDP as a m easure of social welfare are shown by the Soviet satellites before the collapse of the Soviet Union, such as East Germ any. Industrial production was forced on com m unities with no concern for environm ental hazards. The social welfare costs of pollution often exceeded the welfare benefits of higher real GDP. Part B: Social welfare costs like global warm ing and degradation of the environm ent depend on the observer. Carbon dioxide em issions m ight expose the world to natural catastrophes and a less healthy environm ent m any years in the future, but these costs are unknown. Part C: Econom ic progress is often the best way to solve other problem s. W ealthier countries can afford better education and health care for their citizens; program s to reduce air and water pollution; and welfare paym ents to reduce incom e inequality. During the transition phase, developing countries m ay neglect non-econom ic goals, and they m ay have high growth rates of real GDP but poor results on other objectives. In the steady state phase, the wealthier countries have the best grades on other indices of social welfare. The textbook lists item s that are not in GDP but affect social welfare. See Barro Macroeconomics Chapter 2 National Incom e Accounting, page 15, colum n 2.

** Exercise 1.5: Inflation indices An econom y produces only two goods: bread and m uffins. Consum ers buy bread vs m uffins by their relative prices. From 2000 to 2010, the price of a loaf of bread increases from $1 to $2 and the price of a m uffin increases from $2 to $3. ! ! Index Y m easures inflation based on quantities in year 2000. Index Z m easures inflation based on quantities in year 2010.

A. W hich good has a greater increase in its relative price? B. W hich good has an increase in its equilibrium quantity? C. W hich inflation index is higher, Y or Z? Part A: In 2000, one loaf of bread can buy a m uffin; in 2010, one loaf of bread can buy b of a m uffin. The relative price of bread have increased b / 1 = 33.33%. In 2000, one m uffin can buy two loaves of bread; in 2010, one m uffin can buy 1.5 loaves of bread. The relative price of bread has decreased 1.5 / 2 1 = 25.00%. Alternatively, the absolute price of bread increased 100%, and the absolute price of m uffins increased 66.7%, so the relative price of bread increased and the relative price of m uffins decreased. Part B: The dem and curves for bread and m uffin rem ain the sam e in real term s. ! ! The relative price of bread increases, so its equilibrium quantity decreases. The relative price of m uffins decreases, so its equilibrium quantity increases.

Part C: The relative quantity of bread decreases from 2000 to 2010. Its relative price increases com pared to m uffins, so the inflation index that puts m ore weight on bread shows the higher inflation rate. Index Y uses the 2000 relative quantities, so it puts m ore weight on bread. Jacob: W hat does this illustration show? Rachel: An inflation index that uses quantities based on a m arket basket of goods at the beginning of the period overstates inflation (as the CPI does).