Economics Chapter 7 1 Why is it important to account for the net foreign factor income

Chapter 07 – Measuring Domestic Output and National Income

7-1

CHAPTER 07

Measuring Domestic Output

and National Income

A. Short-Answer, Essays, and Problems

1. Of what use is national income accounting to economists and to policy makers?

2. Define GDP and its characteristics.

3. How would the value of output produced at an American-owned factory in the United States and a foreign–

owned factory in the United States be treated in GDP accounting?

4. Why is GDP a monetary measure?

5. Explain the difference between final and intermediate goods, and give an example of each.

6. Why do economists worry about “multiple counting” and calculate only the “value added” in the

production process?

7. What is the value added by all the firms A–E from the production of a product as described below? What

did each firm add separately in value and what does it total?

Stage of production Sales value of product

Firm A $1600

Firm B 2500

Firm C 3700

Firm D 5200

Firm E 7600

8. What is the value added by all the firms A–E from the production of a product as described below? What

did each firm add separately in value and what does it total?

Stage of production Sales value of product

Firm A $ 4,500

Firm B 8,600

Firm C 14,700

Firm D 20,100

Firm E 32,300

9. Identify the two major types of nonproduction transactions that are not included in GDP.

10. Are Social Security payments included in GDP? Explain why or why not.

11. Why is the value of the sales of stocks and bonds excluded from GDP?

12. Which of the following are included and which are excluded in calculating this year’s GDP? Explain in

each instance.

(a) A monthly scholarship check received by an economics student

(b) The purchase of a new truck by a trucking company

(c) Government purchase of missiles from a private business

(d) The purchase of a used tractor by a farmer

(e) The value of the purchase of shares of Microsoft by an individual

13. Which of the following are included and which are excluded in calculating this year’s GDP? Explain in

each instance.

Chapter 07 – Measuring Domestic Output and National Income

7-2

(a) Social Security checks received by a retired person

(b) An increase in business inventories

(c) The income of a tax accountant working for a business

(d) Income received from interest on a corporate bond

(e) The cashing in of a U.S. savings bond

14. Which of the following are included and which are excluded in calculating this year’s GDP? Explain in

each instance.

(a) A homeowner who mows her own lawn

(b) A decline in the average hours worked per week

(c) Business expenditures on pollution control equipment

(d) Income from illegal drug activities

(e) The person who purchases a health care product

15. Which of the following are included and which are excluded in calculating this year’s GDP? Explain in

each instance.

(a) An auto mechanic who fixes his own car at home

(b) Cash received from selling a corporate bond

(c) Spending by a city government on a waste treatment plant

(d) The pleasure that people obtain from working at jobs they like

(e) A veteran’s payment made to a retired military officer

16. Explain the two different ways of looking at GDP.

17. Define the four categories of expenditures which comprise GDP.

18. Describe the three basic types of personal consumption expenditures.

19. Is the United States a service economy? Explain based on the types of personal consumption expenditures.

20. Give the three categories which comprise gross investment and explain the differences among them.

21. Net investment can be positive, negative, or zero, but gross investment can never be less than zero.

Explain.

22. (Consider This) Explain how a reservoir can serve as an analogy for thinking about a nation’s capital

stock, investment, and depreciation.

23. Explain what is and what is not included in government purchases in GDP.

24. Define net exports.

25. What is national income? List its components.

26. What are the components of national income? What is the relative share going to wages and salaries and to

corporate profits?

27. What adjustments need to be made to go from national income to GDP?

28. How does NDP differ from GDP?

29. Why is it important to account for the net foreign factor income when calculating domestic income instead

of national income?

30. How does the personal income measure differ from the disposable income measure?

Chapter 07 – Measuring Domestic Output and National Income

7-3

31. How do you calculate personal income from national income?

32. How do you calculate disposable income from personal income?

33. State an equation for the two main uses of disposable income.

34. The following is a list of figures for a given year in billions of dollars. Using this data, compute: (a) GDP;

(b) NDP; (c) NI; (d) PI; (e) DI; (f) Net exports.

Billions

of dollars

Transfer payments $ 16

Government purchases 80

Personal taxes 38

Corporate income taxes 28

Taxes on production and imports 15

Social Security contributions 8

Undistributed corporate profits 19

Proprietors’ income 25

Compensation of employees 258

Personal consumption expenditures 322

Consumption of fixed capital 4

Rents 10

U.S. Exports 14

Corporate profits 70

Interest 12

Dividends 23

Imports to U.S. 17

Gross private domestic investment 63

Net foreign factor income 10

Statistical discrepancy 35

35. What is the GDP index?

36. Differentiate between nominal and real GDP.

37. How is a price index computed?

38. The next four questions refer to the following price and output data over a five-year period for an economy

that produces only one good. Assume that year 2 is the base year.

Year Units of output Price

per unit

1 16 $2

2 20 3

3 30 4

4 36 5

5 40 6

(a) If year 2 is the base year, give the price index for year 3.

(b) Give the nominal GDP for year 4.

(c) What is the real GDP for year 4?

(d) Tell which years you would deflate nominal GDP and which years you would inflate nominal GDP in

finding real GDP.

39. The following table shows the price of a specific stereo receiver for a five-year period. Using year 3 as the

base year, calculate the price index for each year.

Year Price Price index

1 $ 88 _____

2 $100 _____

3 $120 _____

4 $132 _____

Chapter 07 – Measuring Domestic Output and National Income

7-4

5 $140 _____

40. What are the two basic ways of deriving real GDP from nominal GDP?

41. In 1997, GDP in the tiny country of Lindora was $4 million and the price of a market basket of goods was

$15. In 2008, GDP in Lindora was $5 million and the price of a market basket of goods was $35. Given

this information, it is clear that Lindora GDP had a higher level of production in 2008 than 1997. Evaluate

this statement.

42. The following table shows the price of a specific stereo receiver for a five-year period. Using Year 1 as the

base year, calculate the price index for each year.

Year

Price Price index

(answers using Year 1 = 100)

1 $112 _____

2 144 _____

3 160 _____

4 176 _____

5 200 _____

43. What is the relationship between real GDP, nominal GDP, and the price index?

44. The following data show nominal GDP and the appropriate price index for several years. Compute real

GDP for each year and indicate whether you have “inflated” or “deflated” nominal GDP in finding real

GDP. All GDP are in billions.

Year Nominal GDP Price level index

Real GDP Inflated (I)

Deflated (D)

1 $117 120 _____ _____

2 124 104 _____ _____

3 143 85 _____ _____

4 149 96 _____ _____

5 178 112 _____ _____

6 220 143 _____ _____

45. How have the values of nominal GDP, real GDP and GDP price index changed in the United States since

the year 2005?

46. Discuss the merits and demerits of GDP as a measure of the economy’s output performance and as a

measure of its standard of living.

47. A witness told a congressional committee that if the United States doubled its real GDP, it would be a

much less livable society than it is today. Explain this view.

48. The expanding “underground” economy creates problems for economic policy makers. Explain.

49. Why is GDP overstated in terms of the environment?

50. (Last Word) Where do government economists get the data for the national income accounts?

Chapter 07 – Measuring Domestic Output and National Income

7-5

B. Answers to Short-Answer, Essays, and Problems

1. Of what use is national income accounting to economists and to policy makers?

2. Define GDP and its characteristics.

3. How would the value of output produced at an American-owned factory in the United States and a foreign-

owned factory in the United States be treated in GDP accounting?

4. Why is GDP a monetary measure?

5. Explain the difference between final and intermediate goods, and give an example of each.

6. Why do economists worry about “multiple counting” and calculate only the “value added” in the

production process?

Chapter 07 – Measuring Domestic Output and National Income

7-6