1.WhatcomponentsofGDP(ifany)wouldeachofthefollowingtransactionsaffect?Explain.

GDPcanbebrokendowninto4components.Thesecomponentsare:
Consumptionspendingbyhouseholds.
Investmentpurchasesthatwillbeusedinthefuture.
GovernmentSpendingspendingbylocalandnationalgovernments.
Net Exports Purchases of goods by foreigners (exports) minus domestic
purchasesofforeigngoods(imports).

a.Afamilybuysanewrefrigerator.

Answer:Consumption.Thisrefrigeratorispurchasedbyahousehold.

b.AuntJanebuysanewhouse.

Answer:Investment.Onemightarguethatthisshouldcountasconsumption,but
byconventioneconomistscountthisasinvestmentanditisreportedassuchin
nationalstatistics.Countingthisasinvestmentisreasonable,however.Owninga
houseisastoreofvalueandonehopesitcanbesoldatahigherpriceinthe
future.

c. AstonMartinsoldfewervehiclesthisyearthanitproduced. Theunsoldvehiclesare
storedandwillhopefullybesoldnextyear.

Answer:Investment.TheleftovervehicleswillgointoAstonMartinsinventory.

d.Ayearlater,AstonMartinsellssomevehiclesfromtheirinventory.

Answer: Consumption increases because a car is a good purchased by a

household; but investment decreases because the car had been counted as an
investmentgoodwhenitwasbuiltandputintostock.GDPdoesnotincreaseasa
result of this transaction as the increase in consumption and the decrease in
investmentwillcancelout. GDPonlyincreasesintheyearthatthevehiclewas
produced.

e.Youboughtapizza10yearsago.

Answer: ThiswillcountasconsumptionintheGDPstatisticsof10yearsago.
ThisdoesnotcounttowardstodaysGDP.

f.Thegovernmentbuildsanewmotorway.

Answer:Governmentspending.

g.Thegovernmentincreasesunemploymentbenefits.

Answer:ThisdoesnotcountasGDP.Unemploymentbenefitsrepresenttransfer
payments(takingmoneyfromonepersonandgivingittoanother).Nothingnewis
produced.

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 h.AndyMurraybuysabottleofCalifornianWine.

Answer: Consumption increases because the bottle is a good purchased by a

household,butnetexportsdecreasebecausethebottlewasimported.

2.ThefollowingtabledepictsthegrossdomesticproductperpersonoftheUKmeasuredincurrent
poundsandtheGDPdeflatorforvariousyears.Basedonthis,inwhichyearwereUKresidentsthe
bestoff?(Source:UNSTATS).

GDPpercapita(currentpounds) GDPdeflator

2006 21,999 102.90

2007 23,153 105.18

2008 23,316 108.37

Answer:NominalGDPistheproductionofgoodsandservicesvaluedatcurrentprices.It
isthefacevalueofwhatwasproduced.ItisdifficulttocomparenominalGDPovertime
(oracrosscountries)becauseitisimpossibletosaywhetherchangesareduetodifferences
inproductionorjustdifferencesinprices.

RealGDP,ontheotherhand,measuresthevalueofproductionadjustingforchangesin
prices.Whencomparingstandardsofliving,youshoulduserealGDP.

Toanswerthisquestion,wemustsomehowturnnominalGDPpercapitaintorealGDP
percapitausingtheGDPdeflator,whichmeasureshowpriceshavechangedovertime.To
doso,justdividenominalGDPpercapitabytheGDPdeflatorandmultiplyby100.Real
GDPpercapitaindifferentyearsisasfollows:

2006:(21,999/102.9)*100=21,379
2007:(23,153/105.18)*100=22,013
2008:(23,316/108.37)*100=21,515

21999IS102.9%
XIS100

GDPpercapitainrealtermswasthehighestintheyear2007.Notethatinthiscase,2005
wastakentobethebaseyear(anarbitrarydecision)implyingthattheGDPdeflatorin
2005was100.
YOUMUSTTAKEBASEYEARSOMEYEAR,E.G.2005

3.Considerthefollowingfigurewhichdepictstheevolutionofrealgrossdomesticproduct(GDP),
nominal gross domestic product, and nominal gross national product (GNP) for the Republic of
Irelandfrom20032012(Source:WorldDevelopmentIndicators,valuesinmillionsofdollars).

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a. InIreland,nominalGDPhasbeenconsistentlylargerthannominalGNP.Whatdoesthis
tellyou?Whydoyouthinkthisis?

Answer: Nominal GNPmeasures the incomeearnedby acountrysnationals.

TheeconomicactivityofIrishcitizensoutsideoftheRepublicofIrelandiscounted
aspartofGNP,buttheeconomicactivityofnonIrishresidentsinIrelandisnot
counted as GNP. GDP, on the other hand, accounts for all activity within a
countrysbordersandignoresissuesofnationality/citizenship.(Refertopage442
ofyourtextbookformoreinformationonGNP).

ThefactthatGDPisgreaterthanGNPtellsusthatforeignersproducemorein
IrelandthanIrishcitizensproduceabroad.InthecaseofIreland,thisdifferenceis
extremelylarge.ThisismostlybecausetheIrishgovernmenthashistoricallyset
lowcorporateincometaxrates. ManynonEUcompanies(especiallyAmerican
ones)setupbusinessinIrelandanduseitasahubtoserveallofEurope.

GOOGLE,DELL,LOWCORPORATIONTAXMAKESITATTRACTIVE

b.WhencalculatingrealGDP,whichyearwasusedasthebaseyear?

Answer: RealGDPmeasuresGDPatpricesthatprevailedinaparticularbase
year.NominalGDPandrealGDPwillbeidenticalinthebaseyear.Inthiscase,
thebaseyearwas2005.ItalmostlookslikeReal/NominalGDParethesamein
2012,butnominalGDPwasjustslightlyhigher.

c.ShouldeconomistscaremoreaboutrealGDP(asdepictedabove)orrealGDPpercapita?
ThefollowingfiguredepictspopulationgrowthinIrelandoverthesametimeinterval(data

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 from same source). Does this information change how one should view the economic
situationinIrelandduringthisperiod?

Answer:EconomistsshouldcaremoreaboutrealGDPpercapitaasitisabetter
measureofwellbeing. Averypopulouscountry(e.g.Bangladesh)mighthavea
larger GDP than a very small country (e.g. Luxembourg) despite being poorer
economically. Therefore, when looking at Ireland, we should also consider
populationsize. WecanseethatduringtheperiodofIrelandsrapideconomic
growthpriorto2007,populationwasalsogrowingveryrapidly.Thismeansthat
thatGDPpercapitawasgrowingatarelativelyslowerratethanwastotalGDP
(althoughitwasstillgrowingquiterapidly).

Whilethepopulationgrowthratedeclinedsubstantiallyafter2007,itwasalways
positive.ThispaintsanevenbleakerpicturebecausenotonlywasIrelandsreal
GDPdecreasingbetween2007and2010,itspopulationwasalsogrowing.

4.In2009,nearly75%ofthoseinBurkinaFasolivedonlessthan$2(about1.30)aday.Doyou
thinkthestandardoflivinginBurkinaFasoreflectsthis?Thatis,would1.30adayintheUKimply
thesamestandardoflivingasitwould1.30adayinBurkinaFaso?
BURKINAFASOMOREAGRICULTURAL

Answer: GDP figures only account for market activity. Informal production is not
counted. Ifyoupaysomebody100tobuildyourfence,thiscountstowardsGDP. If,
however,yourneighbourhelpsyoubuildyourfencebecauseyouarefriends,thisdoesnot
counttowardsGDP(howcouldstatisticalofficesevenmeasurethis?).Furthermore,ifyou
growtomatoestobesoldatthemarket,thiscountsasGDP.Ifyougrowtomatoesforyour
ownconsumption,thisdoesnot.

Inlessdevelopedcountries,alotmorenonmarketactivitytakesplace.Itofcourseistrue
thatthestandardoflivingoftheaveragepersoninBurkinaFasoisfarlowerthanwhatit
isintheUK,butitisnotquiteasbadaswhatthisfiguresuggests.

5.Whymightinternationaltradepromoteeconomicgrowth?

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 Answer:Economistsgenerallybelievethattradeisgoodforgrowth.Consideracountry
whichisparticularlygoodatproducingwheatandacountrythatisparticularlygoodat
producingsteel. Supposethatthefirstcountryisbadatproducingsteelandthesecond
countryisbadatproducingwheat. Ifthefirstcountryexportswheatandimportssteel
fromthesecondcountry,itisasiftherehadbeenasuddenimprovementintechnology.
This countrycannoweasilyturnwheat (whichthey are goodatproducing)intosteel
(which they are bad at producing). A country that eliminates trade restrictions will,
therefore,experiencethesamekindofeconomicgrowththatwouldoccurafteramajor
technologicaladvance.

COMPARATIVEADVANTAGEORABSOLUTEADVANTAGE,BASICALLYDOWHATYOU
AREGOODAT,INTERESTINGIDEAHOWCOUNTRIESCANPROGRESSIFTHEYGROW
BANANASONLY,OFCOURSE,USTRADEWITHCHINAPROMOTESUSGROWTH,BUTI
DOUBTTHATTHEREADVANTGEISEQUALLYMUTUALLYBENEFICIAL,ADVANCES
COUNTRIESWILLUSUALLYBENEFITMORE.
6.Inthepastyear,theUKhasseriouslycrackeddownonillegalfilesharing.Nearlyalltorrentsites
havebeenblockedbyUKinternetserviceprovidersbydecreeofthegovernment(thesearewebsites
wherebooks,videogames,music,filmsandalmostanythingelsecanbesharedanddownloaded
illegally).DoyouthinkthissortofpolicymightimpacttheUKsfutureeconomicgrowth?Why?

INTELLECTUAL PROPERTY IS IMPORTANT TO STIMULATE GROWTH, AND PROVIDE

E.G.ARTISTWITHTHEINCENTIVETOCREATEKNOWINGHEWILLBEREWARDED.
ESPECIALLY IN THE HEALTH SECTOR, THEY GET PATENTS FOR NEW DRUGS,
THISSTIMULATESECONOMICGROWTH.PFIZERWOULDHAVEMOREDIFFUCULT
TIMESOTHERWISE.PHARMACEUPTICALCOMPANIES.

Answer: Propertyrightsarecrucialforeconomicgrowth. Supposeyouareconsidering

whetherornottobuildafarm.Yousurelywillnotdosoifyouexpectyourharvesttobe
stolen. Likewise, writers, video game developers, musicians and soforth will be more
inclinedtoproduceiftheycanbeassuredthatwillreceivethefullbenefitsoftheirwork.A
greatdealofconvincingworkhasbeendoneregardingtherelationshipbetweenthelegal
protectionofproducersandeconomicgrowth.

7.Thefollowingfiguredepictstherelationshipbetweenincomeperpersonandinvestment.Eachdot
representsacountry.Explainthisrelationship.

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 Answer:Capital(factories,machines,etc)isaninputintotheproductionprocess.The
morefactoriesandmachinesacountryhas,themorewillbeproducedperworker. But
howdoesacountryget thisnewcapital? Itobtainsmore capital throughsavingand
investment.Countriesthatinvestmoreoftheirincomethereforetendtogrowthefastest.

8.Ineachofthefollowingcases,assesswhichcountry(AorB)shouldexperiencealargergrowthin
GDPpercapita.Explainwhy.

a.IncountryA,thepopulationgrowthrateis5%ayear.IncountryB,thepopulationgrowth
rateis1%peryear.

Answer:Productionrequiresmorethanjustlabour.Toproduce,acountryneeds
factories,machines,land,andsoforth.Forafixedsupplyoflandorforagiven
investmentrate,ahigherpopulationgrowthratewillstretchthinotherfactorsof
production. Therewillbelesslandandfewermachinestogoaroundandeach
workerwillproducelessonaverage.WewouldexpectcountryBtogrowfaster.

b. IncountryA,theGDPperworkeris10.IncountryB,theGDPperworkeris100,000.

IWOULDARGUE.THEYSAYADDINGONEEXTRAPOUNDCANWORKWONDERS,YES,
LOOKATPOORBRICSCOUNTRIES,THEYGROWAT8%RATE.US,UKAT2%INGOOD
TIMES.CATCHUPEFFECT,BUTTHISCOUNTRIESASIANTIGERSIN1997ROSEFAST
ANDDECLINESFAST,SODEPENDSIFWETALKABOUTLRGROWTHORGROWTHIN
THESR.

Answer:Economistsbelievethatcapitalissubjecttodiminishingreturns.Thatis,
forafixedlaboursupply,thefirstunitofcapitalisfarmoreusefulthanthe100 th
unitofcapital.Supposeyouhaveanofficewith10secretaries.Thefirsttelephone
inthisofficewilldowonderstoproductivity.The2 ndtelephonewillbelessuseful.
The100thtelephonewillnotbeofmuchuseatall.

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 Inpoorcountries,workerslacktools. Justalittlebitofextracapitalinthese
countries will do a lot for their productivity. In rich countries, extra capital
investmentwillnothaveaslargeofanimpact. Hence,poorcountrieshavethe
abilitytogrowquickerthanrichcountries.Thisissometimesreferredtoasthe
catchupeffect.

c. IncountryA,thecapitalgainstaxis10%. IncountryB,thecapitalgainstaxis1%.
(Capitalgainsrefertothereturnsoninvestment)

Answer:Refertotheanswerinquestion7:investmentisimportantforgrowth.
Higher capital gains taxes are bad for growth in this sense because they will
discourageinvestmentintonewcapital.Atthesametime,however,highercapital
gainstaxeslowerinequalitywhichraisestrustandsocialcohesioninasociety
(whichisgoodforgrowth).Whetherornotahighercapitalgainstaxisbadfor
growthissubjecttodebate.Irelandgood,USSOMEISLANDSWHERETHEY
FLY TO REGISTER NEW PLANE PAY LOW TAXES AND COME BACK,
MANYCARRIBEANISLANDS,JERSEYISLANDS?ITHINKITISGOOD