978-0077660772 Chapter 7 Solution Manual Part 2

Chapter 07 – Measuring Domestic Output and National Income

REVIEW QUESTIONS

1. Tina walks into Ted’s sporting goods store and buys a punching bag for $100 dollars. That

$100 payment counts as ________________ for Tina and _______________ for Ted. LO1

a. Income; Expenditure.

b. Value added; Multiple Counting.

c. Expenditure; Income.

d. Rents; Profits.

Answer: c. Expenditure; Income.

The $100 paid for the punching bag counts as expenditure for Tina and income for Ted. In

2. Which of the following transactions would count in GDP? LO1

Select one or more of the answers from the choices shown.

a. Kerry buys a new sweater to wear this winter.

b. Patricia receives a Social Security check.

c. Roberto gives his daughter $50 for her birthday.

d. Latika sells $1,000 of Google stock.

e. Karen buys a new car.

f. Amy buys a used car.

Answers:

a. Kerry buys a new sweater to wear this winter

e. Karen buys a new car

Only two of the transactions would count in GDP: Kerry buys a new sweater to wear this

The reason that these transactions count in GDP is that they both involve the purchase of

For example, the receipt by Patricia of a Social Security check does not involve the

A similar thing holds true when Roberto gives his daughter $50 for her birthday. His gift

Latika’s sale of Google stock also does not count in GDP because it is simply the transfer

Finally, when Amy buys a used car, there is no increase in currently produced final goods

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Chapter 07 – Measuring Domestic Output and National Income

3. 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? LO2

a. $1,150,000.

b. $1,100,000.

c. $1,000,000.

d. $850,000.

e. $800,000.

Answer: b. $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 plus $150,000 of gross investment minus $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

4. 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? LO3

a. $0.

b. $10 billion.

c. $20 billion.

d. $30 billion.

Answer: c. plus $20 billion.

G equals $20 billion.

To see why this is true, we can rearrange the GDP equation, which is normally presented

Rearranging the equation to solve for G reveals that

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,

Taking into account the fact that a “negative times a negative is a positive”, we see that G

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Chapter 07 – Measuring Domestic Output and National Income

5. Suppose that California imposes a sales tax of 10 percent on all goods and services. A

Californian named Ralph then goes into a home improvement store in the state capital of

Sacramento and buys a leaf blower that is priced at $200. With the 10 percent sales tax, his total

comes to $220. How much of the $220 paid by Ralph will be counted in the national income and

product accounts as private income (employee compensation, rents, interest, proprietor’s income,

and corporate profits)? LO3

a. $220.

b. $200.

c. $180.

d. None of the above.

Answer: b. $200.

Of the $220 paid by Ralph, $200 will be counted in the national income and product

accounts as private income.

6. 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: LO4

a. $17.0 trillion.

b. $16.0 trillion.

c. $15.5 trillion.

d. None of the above.

Answer: d. None of the above.

The correct answer to this question is none of the above because this economy’s net

domestic product (NDP) will be equal to $15.0 trillion (which is not one of the three

7. 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:

LO4

a. $13.5 trillion.

b. $12.0 trillion.

c. $10.5 trillion.

d. None of the above.

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Chapter 07 – Measuring Domestic Output and National Income

The correct answer to this question is that disposable income will be $10.5 trillion.

To see why this is the case, recall that disposable income is defined as the amount of

8. Suppose that this year’s nominal GDP is $16 trillion. To account for the effects of inflation, we

construct a price-level index in which an index value of 100 represents the price level five years

ago. Using that index, we find that this year’s real GDP is $15 trillion. Given those numbers, we

can conclude that the current value of the index is: LO5

a. Higher than 100.

b. Lower than 100.

c. Still 100.

Answer: a. higher than 100.

This must be true because the only way that this year’s nominal GDP could be higher

This can be understood by looking at the formula for real GDP. Looking at this formula,

9. Which of the following items will be included in official U.S. GDP statistics? LO6

Select one or more answers from the choices shown.

a. Revenue generated by illegal marijuana growers in Oregon.

b. Money spent to clean up a local toxic waste site in Ohio.

c. Revenue generated by legal medical marijuana sales in California.

d. The dollar value of the annoyance felt by local citizens living near a noisy airport in Georgia.

e. Robert paying Ted for a haircut in Chicago.

f. Emily and Rhonda trading an hour of dance lessons for a haircut in Dallas.

Answers:

b. Money spent to clean up a local toxic waste site in Ohio

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Chapter 07 – Measuring Domestic Output and National Income

There are three correct choices to this question: money spent to clean up a local toxic

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

For example, revenue generated by illegal marijuana growers in Oregon will be hidden

Similarly, no data will flow to the GDP accountants about the dollar value of the

Finally, Emily and Rhonda trading an hour of dance lessons for a haircut in Dallas will

PROBLEMS

1. Suppose that annual output in year 1 in a 3-good economy is 3 quarts of ice cream, 1 bottle of

shampoo, and 3 jars of peanut butter. In year 2, the output mix changes to 5 quarts of ice cream, 2

bottles of shampoo, and 2 jars of peanut butter. If the prices in both years are $4 per quart for ice

cream, $3 per bottle of shampoo, and $2 per jar of peanut butter, what was the economy’s GDP in

year 1? What was its GDP in year 2? LO1

Feedback:

Sometimes it is easier to use a table to attack this type of problem.

Good

Price

Year 1

Number

of

Goods

Year 1

Nominal

Value of

Goods

Year 1

Price

Year 2

Number

of

Goods

Year 2

Nominal

Value of

Goods

Year 2

Quarts of Ice Cream $4.00 3 $12.00 $4.00 5 $20.00

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

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Chapter 07 – Measuring Domestic Output and National Income

2. Assume that a grower of flower bulbs sells its annual output of bulbs to an Internet retailer for

$70,000. The retailer, in turn, brings in $160,000 from selling the bulbs directly to final

customers. What amount would these two transactions add to personal consumption expenditures

and thus to GDP during the year? LO1

Feedback: These two transactions would add $160,000 to personal consumption

expenditures and to GDP during the year. The reason that we do not count the $70,000 is

3. If in some country personal consumption expenditures in a specific year are $50 billion,

purchases of stocks and bonds are $30 billion, net exports are -$10 billion, government purchases

are $20 billion, sales of second-hand items are $8 billion, and gross investment is $25 billion,

what is the country’s GDP for the year? LO2

Feedback: 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 (=

4. 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. LO4

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Chapter 07 – Measuring Domestic Output and National Income

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Chapter 07 – Measuring Domestic Output and National Income

a. Using the above data, determine GDP by both the expenditures and the income approaches.

Then determine NDP.

b. Now determine NI in two ways: first, by making the required additions or subtractions from

NDP; and second, by adding up the types of income and taxes that make up NI.

c. Adjust NI (from part b) as required to obtain PI.

d. Adjust PI (from part c) as required to obtain DI.

Part a:

The expenditures approach: GDP = [$245 (Personal consumption expenditures)] + [$33

(Net private domestic investment) + $27 (Consumption of fixed capital, depreciation)

Both methods will give us the same answer.

Part b:

Net Domestic Product Approach: National Income = $361 (Net Domestic Product) – $8

Part c:

Personal Income = $357 (National Income) – $18 (Taxes on production and imports) -$20

Part d:

5. Using the following national income accounting data, compute (a) GDP, (b) NDP, and (c) NI.

All figures are in billions. LO4

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Chapter 07 – Measuring Domestic Output and National Income

Feedback:

Part a:

Using the expenditures approach, GDP = $219.1 (Personal consumption expenditures) +

Part b:

Part c:

We have the following table summarizing these steps.

(a)Personal consumption expenditures (C) $219.1

(b)Consumption of fixed capital -11.8

(c)Net foreign factor income earned in

U.S.

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Chapter 07 – Measuring Domestic Output and National Income

6. 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. Determine the

GDP price index for 1984, using 2005 as the base year. By what percentage did the price level, as

measured by this index, rise between 1984 and 2005? What were the amounts of real GDP in

1984 and 2005? LO5

Answer: GDP Price Index = 62.5; price level increased by 60%; Real GDP in 1984 =

Feedback: To determine the GDP price index for 1984 using 2005 as a base year we

A version that extends to multiple goods is as follows:

add up each value.)

Second, multiply the buckets of chicken in 2005 by the price of a bucket of chicken in

Finally, divide the value of the buckets of chicken using 1984 prices by the value of the

bucket of chicken using 2005 prices (the base year). This gives us a GDP price index for

100.

Real GDP in 1984 and 2005, where 2005 is the base, can be found by dividing nominal

Nominal GDP in 2005 is $352,000 = $16 (price 2005) x 22,000 (output 2005). The price

Nominal GDP in 1984 is $70,000 = $10 (price 1984) x 7,000 (output 1984). The price

7. The following table shows nominal GDP and an appropriate price index for a group of selected

years. Compute real GDP. Indicate in each calculation whether you are inflating or deflating the

nominal GDP data. LO5

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Chapter 07 – Measuring Domestic Output and National Income

Answer: The table should be updated with the following values for Real GDP:

Real GDP 1968 = $4,133.58 (inflating)

Feedback: Real GDP can be found by dividing nominal GDP by the price index (decimal

form) for that year. If the price index is below 100 you inflating GDP and if the price

level is above 100 you are deflating GDP

Real GDP 1968 = $909.8/(22.01/100) = $4133.58 (inflating)

8. Assume that the total value of the following items is $600 billion in a specific year for Upper

Mongoose: net exports = $50 billion; value of new goods and services produced in the

underground economy = $75 billion; personal consumption expenditures = $300 billion; value of

the services of stay-at-home parents = $25 billion; gross domestic investment = $100 billion;

government purchases = $50 billion. What is Upper Mongoose’s GDP for the year? What is the

size of the underground economy as a percentage of GDP? By what percentage would GDP be

boosted if the value of the services of stay-at-home spouses were included in GDP? LO6

Feedback:

Using the expenditures approach, GDP = $300 billion (Personal consumption

expenditures) + $100 billion (Gross domestic investment) + $50 billion (Government

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