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# Chapter 09 - Gross Domestic Product

## Key to Chapter 09 End of Chapter Questions

1. b
2. d
3. a
4. c
5. a
6. a
7. d
8. b
9. d
10. a
11. a
12. b
13. c
14. d
15. a
16. c (b is acceptable)
17. d
18. b
19. b
20. b
21. c
22. d
23. c
24. a
25. b
26. c
27. d
28. a
29. d
30. a

1. GDP
3. depreciation
4. 7
5. 4
6. 16
7. current production (goods and services produced this year)
8. GDP
9. underground
10. production
11. psychic cost
12. Real GDP by population
13. less

1. GDP (\$5 trillion) Depreciation (\$500 billion) = NDP (\$4.5 trillion).
2. NDPC (\$6 trillion) + depreciation (\$400 billion) = GDP (\$6.4 trillion)
3. -5%
4. 0
Chapter 09 - Gross Domestic Product
5. Consumption (\$3 trillion) + Investment (\$800 billion) + Government spending
(\$1 trillion) + Net exports (\$300 billion) = GDP (\$4.5 trillion). (Note: Net
exports = Exports of \$900 billion minus Imports of \$1.2 trillion = \$300 billion.)
6. Consumption (\$3.8 trillion) + Investment (\$1.1 trillion) + Government spending
(\$1.1 trillion) + Net exports (\$200 billion) = GDP (\$5.8 trillion).

7.
Percentage change in real GDP from 1986 to 1989:
percent 4.2
4,000
167
number Original
Change

8.

5,000
100
1
50
00 1
140
7,000
100
deflator GDP
GDP nominal
GDP Real

Percentage change in real GDP from 1990 to 1994: from 5,000 to 5,000 = 0 percent

9. (a) \$21 trillion; (b) percentage change = \$1 trillion/\$20 trillion = 1/20 = 5%

10. \$20,000
0 100,000,00
000,000 2,000,000,
Population
GDP
GDP capita Per

x 100
GDP deflator
Nominal GDP
167 , 4
100
1
41.67

100
120
5,000
GDP Real

Chapter 09 - Gross Domestic Product
11. 000 , 5 \$
000 , 000 , 300
000 , 000 , 000 , 500 , 1
Population
GDP
GDP capita Per
12. 000 , 5 \$
000 , 000 , 300
000 , 000 , 000 , 500 , 1
Population
GDP
GDP capita Per
(1) Real GDP = (nominal GDP) / (GDP deflator) x 100
(20,000 / 125) x 100 = 16,000

% 5 . 45
333 , 33 \$
152 , 15 \$
number original
change
change Percentage ) 4 (
333 , 33 \$
.3
10,000
Population
GDP Real
GDP Real Capita Per ) 3 (
485 , 48 \$
33 .
000 , 16
Population
GDP Real
GDP Real Capita Per (2)
2007
2007
2007
2027
2027
2027

13.

000 , 1 100
150
1,500
100
deflator GDP
GDP nominal
GDP Real ) 1 (

% 3 . 33
000 , 15 \$
000 , 5 \$
number original
change
change Percentage ) 4 (
000 , 15 \$
040 .
600
Population
GDP Real
GDP Real Capita Per ) 3 (
000 , 20 \$
050 .
1000
Population
GDP Real
GDP Real Capita Per ) 2 (
2005
2005
2015
2015

14. Percentage change in GDP = percentage change in real GDP + percentage
change in GDP deflator.
4% = 3% + percentage change in GDP deflator
1% = rise in GDP deflator

Chapter 09 - Gross Domestic Product
15. Percentage change in GDP = percentage change in real GDP + percentage
change in GDP deflator
Percentage change in GDP = 3.7% + 1.6% = 5.3%

16. Both nominal and real GDP fall; nominal GDP falls more than real GDP.
Numerical example could be: Real GDP: \$15 trillion; GDP: \$14.5 trillion.

Answers to Questions for Further Thought and Discussion

1. Suppose we want to compare this years GDP with those of previous years. As we
go back in timeto 2000, to 1980, to 1960, and to still earlier years, what
happens to the validity of those comparisons? Why does this happen?

The farther we go back, the less valid the GDP comparisons. A 1960 car is hardly
comparable to todays computerized model. Back in the 60s my uncle drove a
1960 Plymouth that my cousins used to call the forerunner of the modern car.
And they were right! In fact, many of the goods and services we routinely use
today were not available 50 years agoand some were not even available 10
years ago. Economists are fond of saying that certain comparisons are as invalid
as comparing apples and oranges. In this case, were comparing todays flat
screen TVs with those 17-inch black and white clunky tube 1960s models, or
todays high-speed copying machines with the earliest models that took about a
minute a copy, not counting the time you waited for the paper to dry after it came
out of the copier.

2. If our GDP rose from 14,000 to 14,500, there could be a few different
explanations. List each of these possibilities.

The entire rise is due to an increase in output (or Real GDP); the entire rise is due
to inflation; the rise is due to a combination of both. There are two other
possibilities, which are more unlikely. Real GDP fell, but prices rose by a greater
percentage. The most unlikely possibility would be that prices fell, but real GDP
rose by a greater percentage.

3. Which has been increasing faster, GDP or real GDP? Explain your answer.

GDP has been increasing faster than real GDP. Since the percentage increase in
GDP = the percentage increase in real GDP + the inflation rate, as long as the
price level is rising each year, GDP must rise more quickly than real GDP.

4. GDP is not an ideal measure of national economic well-being. Make a list of all
the things you would do to improve this concept. Include in your list the goods
and services that GDP does not count.

Chapter 09 - Gross Domestic Product
GDP does not include leisure time, psychic cost and benefits, illegal goods and
services, household production, the underground economy, and the two Tobin and
Nordhaus terms, economic bads (congestion, pollution, and littering) and
regrettable necessities (defense spending, police protection, and private security
spending).

5. Americans enjoy the highest standard of living in the world. Discuss why this
statement is not perfectly accurate.

According to Figure 6, we are number 6 out of the countries listed in terms of per
capita GDP. But international comparisons are not completely accurate, so it
would be fair to say that we are probably in the top 10, but it is unlikely that we
are number 1. That said, there are a couple of other factors to be considered.
Denmark and Norway have very high tax rates, but cradle-to-grave social welfare
systems. The U.S. is a low-tax country with only a minimal social welfare system.
And then too, if we were to compare the American standard of living with that of
Japan, we would need to take into account that American families have three to
four times the living space of the average Japanese family. In sum, we have a very
high standard of living, but it is unlikely that it is the worlds highest.

6. Under what circumstances could real GDP for a given year be greater than GDP
for that same year? For example, if 2015 were the base year and 2016 were the
current year, how could real GDP in 2016 exceed GDP for 2016?

Lets say GDP was 10,000 in 2015 and there was no increase in output in 2016.
How much would GDP be in 2016? That would depend entirely on the rate of
inflation. OK, what if there were deflation? What if the price level fell by 5%?
Then GDP would be 9,500 and real GDP would be 10,000 (i.e., unchanged). Or
suppose that real GDP rose by 2% and the price level fell by 2%. Then real GDP
would be 10,200 (an increase of 2%) and GDP would remain the same (10,000).
Again, real GDP would be greater than GDP. So real GDP can be greater than
GDP in a given year if there were deflation.

7. Explain how GDP is affected by the sale of (a) a new house.

GDP is increased by the price of the new house.

Explain how GDP is affected by the sale of (b) an hour session with a physical
trainer.

GDP is increased by the price of an hour session with a physical trainer.

Explain how GDP is affected by the sale of (c) 1,000 shares of Microsoft.

The sale of 1,000 shares of Microsoft is a financial transaction that has no direct
affect on GDP.
Chapter 09 - Gross Domestic Product

Explain how GDP is affected by the sale of (d) an antique, oak roll-top desk.

The sale of that desk was counted in GDP in the year when it was originally sold.
GDP might be affected very slightly in the current year if we add to it the money
paid to cover the cost of the sale (assuming that the sale was reported).

8. If you were comparing the economic well-being of two countries and had a choice
of using one of the following four measures, which one would you choose and why
would you choose it?

(a) GDP
(b) Real GDP
(c) Per capita GDP
(d) Per capita real GDP

I would choose per capita real GDP for two reasons: Real GDP removes inflation
over time from GDP and measures just output changes. And per capita GDP
allows for population differences, since GDP must be divided by a nations
population (i.e., we want to compare the size of each countrys slice than each
countrys entire pie). Choice (d) combines the advantages of (b) and (c).

9. Do you think we should switch from using GDP to GPI as our basic measure of
national well-being?

Ideally, it would be transparent if all nations published both measures. Multiple
measures is always more reliable than publishing just one.

Despite its flaws, GDP is widely used and recognized. Although support for
switching to GPI is growing, only a small minority of economists and other users
of GDP would support switching to GPI. Second, GDP is a reasonably accurate
accounting of marking transitions. Although it does not take into account
nonmarket activities, however important, GDP can be quite easily and
transparently complied.

GPI would possibly be a more accurate measure of national well-being. Surely we
do need to take into account the effects of wars, crime, leisure, household
production, and environmental degradation. But how accurately does GPI do that?
Indeed, can we put accurate dollar value on most nonmarket activities?

I doubt very much if we will see GPI replacing GPD in our lifetime, but I would
support using GPI as a shadow measure of our national economic well being. The
well being of the average American has surely risen over the last 40 years,
although not as quickly as per capita GDP.

Chapter 09 - Gross Domestic Product
10. Practical Application: Make a list of the dollar value of everything you consume
during the next seven days. Then figure out the percentage that isnt counted in our
GDP. Dont forget home-cooked meals, pirated music, and other goods and services
are not counted. Counted in GDP: phone and internet connection (\$133.89); electric
bill (\$130.59); car insurance (\$116.00); health care premium (\$224.75); books
(\$102.77); groceries (\$88.63); clothing (\$164.52); postage (\$49.33); restaurant meals
(\$113.17); gasoline (\$33.20); stationery and office materials (\$129.94). Total:
\$1,285.79

Not counted in GDP: eBay purchases (\$159.10); jewelry (\$138.00); home-cooked
meals (\$24.00) Total: \$321.10

Total spending: \$1,285.79 + \$321.10 = \$1,606.89

Percentage not counted in GDP = \$321.10/\$1,606.89 = 20%

11. Practical Application: You have just been hired by the Bureau of Economic
Analysis of the U.S. Department of Commerce to come up with an improved
measure of national output. Use GDP as your starting point.

We need to measure not just how much we produce, but somehow take into
account what we produce. We might want to exclude from national output much of
the expenditure for defense, which contributes nothing to our well-being. We
should also subtract the cost of pollution, global warming, and crime.

12. Web Activity: Which country has the highest per capita GDP and which country has
the lowest? Go to Google.com and type in CIA GDP per capita, and then click
on The World Factbook-County Comparison GDP-per capita.