978-1259723223 Chapter 27

Chapter 27 – Measuring Domestic Output and National Income

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Chapter 27 – Measuring Domestic Output and National Income

McConnell, Brue, and Flynn 21e

DISCUSSION QUESTIONS

1. In what ways are national income statistics useful? LO1

2. Why do national income accountants compare the market value of the total outputs in various

years rather than actual physical volumes of production? What problem is posed by any

comparison over time of the market values of various total outputs? How is this problem

resolved? LO1

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3. Which of the following goods are usually intermediate goods and which are usually final

goods: running shoes; cotton fibers; watches; textbooks; coal; sunscreen lotion; lumber? LO1

4. Why do economists include only final goods and services in measuring GDP for a particular

year? Why don’t they include the value of the stocks and bonds bought and sold? Why don’t they

include the value of the used furniture bought and sold? LO1

5. Explain why an economy’s output, in essence, is also its income. LO1

6. Provide three examples of each: consumer durable goods, consumer nondurable goods, and

services. LO2

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Answer: Durable goods are products that have expected lives of three years or more.

Examples are refrigerators, new cars, etc…

Nondurable goods are products with less than three years of expected life. Examples are

peanut butter, clothes, etc…

Services are the work done by lawyers, accountants, etc…

The students’ answers will vary.

7. Why are changes in inventories included as part of investment spending? Suppose inventories

declined by $1 billion during 2014. How would this affect the size of gross private domestic

investment and gross domestic product in 2014? Explain. LO2

8. What is the difference between gross private domestic investment and net private domestic

investment? If you were to determine net domestic product (NDP) through the expenditures

approach, which of these two measures of investment spending would be appropriate? Explain.

LO2

9. Use the concepts of gross investment and net investment to distinguish between an economy

that has a rising stock of capital and one that has a falling stock of capital. Explain: “Though net

investment can be positive, negative, or zero, it is impossible for gross investment to be less than

zero.” LO2

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10. Define net exports. Explain how U.S. exports and imports each affects domestic production.

How are net exports determined? Explain how net exports might be a negative amount. LO2

11. Contrast the ideas of nominal GDP and real GDP. Why is one more reliable than the other for

comparing changes in the standard of living over a series of years? What is the GDP price index

and what is its role in differentiating nominal GDP and real GDP? LO5

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12. Which of the following are included or excluded in this year’s GDP? Explain your answer in

each case. LO6

a. Interest received on an AT&T corporate bond.

b. Social Security payments received by a retired factory worker.

c. Unpaid services of a family member in painting the family home.

d. Income of a dentist from the dental services provided.

e. A monthly allowance a college student receives from home.

f. Money received by Josh when he resells his nearly brand-new Honda automobile to Kim.

g. The publication and sale of a new college textbook.

h. An increase in leisure resulting from a 2-hour decrease in the length of the workweek, with no

reduction in pay.

i. A $2 billion increase in business inventories.

j. The purchase of 100 shares of Google common stock.

13. Why does gross output do a better job than GDP of measuring overall economic activity?

How could you construct a new statistic that focused only on non-final economic activity? Given

what you know about the behavior of GO and GDP during the Great Recession, would you

expect your new statistic to show more or less volatility than GO and GDP? Why? How would

you rank the three in terms of volatility? LO6

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which varies relatively little. In terms of most volatile to least volatile, the statistics

would rank as follows: New statistic, GO, GDP.

14. LAST WORD What government agency compiles the U.S. NIPA tables? In what U.S.

department is it located? Of the several specific sources of information, name one source for each

of the four components of GDP: consumption, investment, government purchases, and net

exports.

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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.

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.

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consent of McGraw-Hill Education.

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

winter, and Karen buys a new car.

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

a final good or service. By contrast, the other transactions have nothing to do with the

current production of final goods and services.

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

production of anything at all. It is simply a transfer of purchasing power from the Federal

government to one of its beneficiaries. But that transfer of purchasing power does not by

itself lead to anything being produced. Thus, it does not count in GDP.

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

is simply the transfer of wealth from one person to another. It does not involve the

production of any goods and services and hence does not get counted in GDP.

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

of a property right (part ownership of Google) from one person to another. Since nothing

is produced, her stock sale would also be excluded from GDP.

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

and services. We simply have a change in who owns a previously produced item. So this

transaction also fails to meet the definition of what should be included in GDP.

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.

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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.

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.

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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.

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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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.

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.

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Answers:

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

c. Revenue generated by legal medical marijuana sales in California

e. Robert paying Ted $20 for a haircut in Chicago

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

waste site in Ohio, revenue generated by legal medical marijuana sales in California,

and Robert paying Ted for a haircut in Chicago.

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

a paper trail that will flow to the accountants who compile the U.S. GDP statistics.

By contrast, the other choices are incorrect because they involve transactions that do not

involve money, are illegal, or involve social costs for which there are no market

transactions. As a result, they will generate no paper trail for the accountants who

compile the U.S. GDP statistics.

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

by the illegal growers so that no data will flow to the accountants who compile the GDP

statistics.

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

annoyance felt by local citizens living near a noisy airport in Georgia because no market

transaction has taken place and thus there is nothing to include in GDP.

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

not have any effect on GDP because their trading of one service for another does not

involve money and, hence, does not generate a paper trail for the accountants who

compile the GDP statistics. Those accountants will, in fact, have no way of knowing

whether this transaction even took place.

10. Suppose GDP is $5.0 trillion, resource extraction is $0.5 trillion, production is $1.5 trillion,

and distribution is $1.0 trillion.

a. How big is GO?

b. How big is GO minus GDP?

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

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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

Bottles of Shampoo

$3.00

1

$3.00

2

$6.00

Jars of Peanut Butter

$2.00

3

$6.00

$2.00

2

$4.00

Nominal GDP

NA

$21.00

NA

$30.00

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

quarts is $12.00 (=$4.00 x 3). This calculation is applied to each good for each year.

The second step is to add up the nominal value for the goods for each year separately.

The nominal value of goods for year 1 is $21.00 (= $12.00 + $3.00 + $6.00).

The nominal value of goods for year 2 is $30.00 (= $20.00 + $6.00 + $4.00).

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

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

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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

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.

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Answer: a. GDP = $388, NDP = $361; b. NI = $357; c. PI = $291; d. DI = $265

Part a:

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

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

(the sum of these two components measures gross investment = $60)] + [$72

(Government purchases)] + [$11 (net exports)] = $245 + $60 + $72 + $11 = $388.

The income approach: GDP = $223 (compensation of employees) + $14 (Rents) + $13

(Interest) + $33 (Proprietor’s income) + $56 (Corporate profits) + $18 (Taxes on

production and imports) + $27 (Consumption of fixed capital, depreciation) – $4 (Net

foreign factor income) + $8 (Statistical discrepancy) = $223 + $14 + $13 + $33 + $56 +

$18 + $27 -$4 + $8 = $388

Both methods will give us the same answer.

Net Domestic Product equals GDP minus Consumption of fixed capital (depreciation).

NDP = $388 – $27 = $361.

Part b:

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

(Statistical discrepancy) + $4 (Net foreign factor income) = $357.

Income and Taxes Approach: National Income = $223 (Compensation of employees) +

$14 (Rents) + $13 (Interest) + $33 (Proprietor’s income) + $56 (Corporate profits) + $18

(Taxes on production and imports) = $357.

Part c:

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

(Social security contributions) – $19 (Corporate income taxes) – $21 (Undistributed

corporate profits) + $12 (Transfer payments) = $291.

Part d:

Disposable Income = $291 (Personal Income) – $26 (Personal Taxes) = $265.

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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Feedback:

Part a:

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

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

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

GDP by the year’s price index (remember to convert the price index back into decimal

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

Real GDP 1968 = $4,133.58 (inflating)

Real GDP 1978 = $5,677.72 (inflating)

Real GDP 1988 = $7,614.81 (inflating)

Real GDP 1998 = $10,283.59 (inflating)

Real GDP 2008 = $13,312.50 (deflating)

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)

Real GDP 1978 = $2293.8/(40.40/100) = $5677.72 (inflating)

Real GDP 1988 = $5100.4/(66.98/100) = $7614.81 (inflating)

Real GDP 1998 = $8793.5/(85.51/100) = $10,283.59 (inflating)

Real GDP 2008 = $14,441.4/(108.48/100) = $13,312.50 (deflating)

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