Economics Chapter 2 Homework The Calculated Follows Answers Textbook Questions

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Questions for Review

1. GDP measures the total income earned from the production of the new final goods and

services in the economy, and it measures the total expenditures on the new final goods

2. The consumer price index measures the overall level of prices in the economy. It tells

us the price of a fixed basket of goods relative to the price of the same basket in the

base year.

3. The Bureau of Labor Statistics classifies each person into one of the following three cat-

egories: employed, unemployed, or not in the labor force. The unemployment rate,

4. Every month, the Bureau of Labor Statistics (BLS) undertakes two surveys to measure

employment. First, the BLS surveys about 60,000 households and thereby obtains an

Problems and Applications

1. A large number of economic statistics are released regularly. These include the follow-

ing:

Gross Domestic Product—the market value of all final goods and services produced in a

year.

The Unemployment Rate—the percentage of the civilian labor force who do not have a

CHAPTER 2The Data of Macroeconomics

forming at its long-run average level. Looking at the economic statistics released in

early 2009, the unemployment rate was rising and had reached 8 percent, the inflation

rate was near zero, and GDP growth in the last quarter of 2008 was –6.3 percent. This

of course indicated the economy was still in the midst of a major recession.

2. Value added by each person is the value of the good produced minus the amount the

person paid for the materials needed to make the good. Therefore, the value added by

3. When a woman marries her butler, GDP falls by the amount of the butler’s salary. This

happens because measured total income, and therefore measured GDP, falls by the

amount of the butler’s loss in salary. If GDP truly measured the value of all goods and

4. a. The airplane sold to the Air Force counts as government purchases because the

Air Force is part of the government.

b. The airplane sold to American Airlines counts as investment because it is a capi-

5. Data on parts (a) to (g) can be downloaded from the Bureau of Economic Analysis

(www.bea.doc.gov—follow the links to Gross Dometic Product). Most of the data

(not necessarily the earliest year) can also be found in the

Economic Report of the

President

. By dividing each component (a) to (g) by nominal GDP and multiplying

by 100, we obtain the following percentages:

1950 1980 2005

a. Personal consumption expenditures 65.5% 63.0% 70.0%

b. Gross private domestic investment 18.4% 17.2% 16.9%

c. Government consumption purchases 15.9% 20.3% 18.9%

(a) Personal consumption expenditures have been around two-thirds of GDP, although the

share increased markedly between 1980 and 2005.

(b) The share of GDP going to gross private domestic investment fell slightly from 1950 to

2005.

6Answers to Textbook Questions and Problems

but has receded somewhat since then.

(g) Imports have grown rapidly relative to GDP.

6. a. i. Nominal GDP is the total value of goods and services measured at current

prices. Therefore,

Nominal GDP2000 = (

) + (

)

= ($50,000 ×100) + ($10 ×500,000)

= $5,000,000 + $5,000,000

= $10,000,000.

Real GDP for 2000 is calculated by multiplying the quantities in 2000 by the

prices in 2000. Since the base year is 2000, real GDP2000 equals nominal

GDP2000, which is $10,000,000. Hence, real GDP stayed the same between

2000 and 2010.

iii. The implicit price deflator for GDP compares the current prices of all goods

and services produced to the prices of the same goods and services in a base

year. It is calculated as follows:

This calculation reveals that prices of the goods produced in the year 2010

increased by 52 percent compared to the prices that the goods in the economy

sold for in 2000. (Because 2000 is the base year, the value for the implicit

price deflator for the year 2000 is 1.0 because nominal and real GDP are the

same for the base year.)

iv. The consumer price index (CPI) measures the level of prices in the economy.

The CPI is called a fixed-weight index because it uses a fixed basket of goods

Chapter 2The Data of Macroeconomics 7

2000

cars 2000

cars

2000

bread 2000

bread

CPI2010 =

This calculation shows that the price of goods purchased in 2010 increased by 60

percent compared to the prices these goods would have sold for in 2000. The CPI

for 2000, the base year, equals 1.0.

b. The implicit price deflator is a Paasche index because it is computed with a chang-

ing basket of goods; the CPI is a Laspeyres index because it is computed with a

fixed basket of goods. From (6.a.iii), the implicit price deflator for the year 2010 is

1.52, which indicates that prices rose by 52 percent from what they were in the

year 2000. From (6.a.iv.), the CPI for the year 2010 is 1.6, which indicates that

prices rose by 60 percent from what they were in the year 2000.

2000. The implicit price deflator weights the price of goods by the quantities pur-

chased in the year 2010. The quantity of bread consumed was higher in 2000 than

in 2010, so the CPI places a higher weight on bread. Since the price of bread

increased relatively more than the price of cars, the CPI shows a larger increase

7. a. The consumer price index uses the consumption bundle in year 1 to figure out how

much weight to put on the price of a given good:

= 2.

According to the CPI, prices have doubled.

8Answers to Textbook Questions and Problems

()( )

(

PQ PQ

cars cars bread bread

cars c

2010 2000 2010 2000

2000

aars bread bread

2000 2000 2000

)( )+PQ

b. Nominal spending is the total value of output produced in each year. In year 1 and

year 2, Abby buys 10 apples for $1 each, so her nominal spending remains con-

stant at $10. For example,

c. Real spending is the total value of output produced in each year valued at the

prices prevailing in year 1. In year 1, the base year, her real spending equals her

nominal spending of $10. In year 2, she consumes 10 green apples that are each

valued at their year 1 price of $2, so her real spending is $20. That is,

Real Spending2= (

) +(

)

Thus, the implicit price deflator suggests that prices have fallen by half. The rea-

son for this is that the deflator estimates how much Abby values her apples using

prices prevailing in year 1. From this perspective green apples appear very valu-

able. In year 2, when Abby consumes 10 green apples, it appears that her con-

sumption has increased because the deflator values green apples more highly than

red apples. The only way she could still be spending $10 on a higher consumption

bundle is if the price of the good she was consuming fell.

e. If Abby thinks of red apples and green apples as perfect substitutes, then the cost

of living in this economy has not changed—in either year it costs $10 to consume

10 apples. According to the CPI, however, the cost of living has doubled. This is

8. a. Real GDP falls because Disney does not produce any services while it is closed.

This corresponds to a decrease in economic well-being because the income of work-

ers and shareholders of Disney falls (the income side of the national accounts),

and people’s consumption of Disney falls (the expenditure side of the national

accounts).

Chapter 2The Data of Macroeconomics 9

red 2

red 1

green 2

green

c. Real GDP falls because with fewer workers on the job, firms produce less. This

accurately reflects a fall in economic well-being.

f. Real GDP rises because the high-school students go from an activity in which they

are not producing market goods and services to one in which they are. Economic

well-being, however, may decrease. In ideal national accounts, attending school

would show up as investment because it presumably increases the future produc-

tivity of the worker. Actual national accounts do not measure this type of invest-

ment. Note also that future GDP may be lower than it would be if the students

stayed in school, since the future work force will be less educated.

g. Measured real GDP falls because fathers spend less time producing market goods

and services. The actual production of goods and services need not have fallen,

however. Measured production (what the fathers are paid to do) falls, but unmea-

sured production of child-rearing services rises.

9. As Senator Robert Kennedy pointed out, GDP is an imperfect measure of economic per-

formance or well-being. In addition to the left-out items that Kennedy cited, GDP also

ignores the imputed rent on durable goods such as cars, refrigerators, and lawnmowers;

many services and products produced as part of household activity, such as cooking and

10 Answers to Textbook Questions and Problems