CHAPTER OVERVIEW - Crawford's World



chapter twelve

introduction to gdp, growth, and instability

ANSWERS TO END-OF-CHAPTER QUESTIONS

12-1 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?

If it is impossible to summarize oranges and apples as one statistic, as the saying goes, it is surely even more impossible to add oranges and, say, computers. If the production of oranges increases by 100 percent and that of computers by 10 percent, it does not make any sense to add the 100 percent to the 10 percent, then divide by 2 to get the average and say total production has increased by 55 percent.

Since oranges and computers have different values, the quantities of each commodity are multiplied by their values or prices. Adding together all the results of the price times quantity figures leads to the aggregate figure showing the total value of all the final goods and services produced in the economy. Thus, to return to oranges and computers, if the value of orange production increases by 100 percent from $100 million to $200 million, while that of computers increases 10 percent from $2 billion to $2.2 billion, we can see that total production has increased from $2.1 billion (= $100 million + $2 billion) to $2.4 billion (= $200 million + $2.2 billion). This is an increase of 14.29 percent [= ($2.4 billion - $2.1 billion)/$2.1 billion)]—and not the 55 percent incorrectly derived earlier.

Comparing market values over time has the disadvantage that prices change. If the market value in year 2 is 10 percent greater than in year 1, we cannot say the economy’s production has increased 10 percent. It depends on what has been happening to prices; on whether the economy has been experiencing inflation or deflation.

To resolve this problem, statisticians deflate (in the case of inflation) or inflate (in the case of deflation) the value figures for the total output so that only “real” changes in production are recorded. To do this, each item is assigned a “weight” corresponding to its relative importance in the economy. Housing, for example, is given a high weight because of its importance in the average budget. A book of matches would be given a very low weight. Thus, the price of housing increasing by 5 percent has a much greater effect on the price index used to compare prices from one year to the next, than would the price of a book of matches increasing by 100 percent.

12-2 Why only include final goods in measuring GDP for a particular year? Why isn’t the value of the used furniture bought and sold?

The dollar value of final goods includes the dollar value of intermediate goods. If intermediate goods were counted, then multiple counting would occur. The value of steel (intermediate good) used in autos is included in the price of the auto (the final product).

Used furniture was produced in some previous year; it was counted as GDP then. Its resale does not measure new production.

12-3 What are the three main types of consumption expenditures? Why are purchases of new houses considered to be investment expenditures rather than consumption expenditures?

The three types of consumption expenditures are for durable goods (expected to last more than 3 years), nondurable goods (expected to last less than 3 years), and services.

Purchases of new houses are considered to be investment rather than consumption because the houses could be used as income generating assets.

12-4 Why are changes in inventories included as part of investment spending? Suppose inventories declined by $1 billion during 2004. How would this affect the size of gross private domestic investment and gross domestic product in 2004? Explain.

Anything produced by business that has not been sold during the accounting period is something in which business has invested—even if the “investment” is involuntary, as often is the case with inventories. But all inventories in the hands of business are expected eventually to be used by business—for instance, a pile of bricks for extending a factory building—or to be sold—for instance, a can of beans on the supermarket shelf. In the hands of business both the bricks and the beans are equally assets to the business, something in which business has invested.

If inventories declined by $1 billion in 2004, $1 billion would be subtracted from both gross private domestic investment and gross domestic product. A decline in inventories indicates that goods produced in a previous year have been used up in this year’s production. If $1 billion is not subtracted as stated, then $1 billion of goods produced in a previous year would be counted as having been produced in 2004, leading to an overstatement of 2004’s production.

12-5 Suppose foreigners spend $7 billion on American exports in a specific year and Americans spend $5 billion on imports from abroad in the same year. What is the amount of United States’ net exports? Explain how net exports might be a negative amount.

If American exports are $7 billion and imports are $5 billion, then American net exports are +$2 billion. If the figures are reversed, so that Americans export $5 billion and import $7 billion, then net exports are -$2 billion—a negative amount.

12-6 Which of the following are included in this year’s GDP? Explain your answer in each case.

a. The services of a commercial painter in painting the family home.

b. An auto dealer’s sale of a new car to a nonbusiness customer.

c. The money received by Smith when she sells her biology textbook to a used-book buyer.

d. The publication and sale of a new economics textbook.

e. A $2 billion increase in business inventories.

f. Government purchases of newly produced aircraft.

(a) Included. Payment for a final service received by a household.

(b) Included. Purchase of a final good by a household.

(c) Excluded. Secondhand sales are not counted; the textbook is counted only when sold for the first time.

(d) Included. Purchase of a final good by a household.

(e) Included. Represents production that occurred during the year.

(f) Included. Purchases of final goods by government are included.

12-7 Using the following NIPA data, compute GDP. All figures are in billions.

| | |

|Personal consumption expenditures |$245 |

|Wages and salaries |223 |

|Imports |18 |

|Corporate profits |42 |

|Consumption of fixed capital (depreciation) |28 |

|Gross private domestic investment |86 |

|Government purchases |82 |

|Exports |9 |

| | |

GDP = $404 = [$245 + 86 + 82 + (9-18)]

12-8 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 2004 the price per bucket of chicken was $16 and that 22,000 buckets were purchased. Determine real GDP for 1984 and 1996, in 1984 prices.

Real GDP for 1984 = 7,000 x $10 = $70,000.

Real GDP for 1996 (in 1984 prices) = 22,000 x $10 = $220,000.

12-9 Suppose an economy’s real GDP is $30,000 in year 1 and $31,200 in year 2. What is the growth rate of its real GDP? Assume that population was 100 in year 1 and 102 in year 2. What is the growth rate of GDP per capita?

Growth rate of real GDP = 4 percent (= $31,200 - $30,000)/$30,000). GDP per capita in year 1 = $300 (= $30,000/100). GDP per capita in year 2 = $305.88 (= $31,200/102). Growth rate of GDP per capita is 1.96 percent = ($305.88 - $300)/300).

12-10 Use the following data to calculate (a) the size of the labor force and (b) the official unemployment rate: total population, 500; population under 16 years of age or institutionalized, 120; not in labor force, 150; unemployed, 23; part-time workers looking for full-time jobs, 10.

Labor force = 500 – 120 – 150 = 230.

Official unemployment rate = (23/230) x 100 = 10%.

12-11 Since the U.S. has an unemployment compensation program which provides income for those out of work, why should we worry about unemployment?

The unemployment compensation program merely gives the unemployed enough funds for basic needs, and it is only temporary. Furthermore, many of the unemployed do not qualify for unemployment benefits. The programs apply only to those workers who were covered by the insurance, and this may be as few as one-third of those without jobs. Most of the unemployed get no sense of self-worth or accomplishment out of drawing this compensation. Moreover, from the economic point of view, unemployment is a waste of resources and potential output is lost; when the unemployed go back to work, nothing is forgone except undesired leisure. Finally, unemployment could be inflationary and costly to taxpayers: The unemployed are producing nothing—their supply is zero – but the compensation helps keep demand in the economy high

12-12 What is the Consumer Price Index (CPI) and how is it determined each month? What effect does inflation have on the purchasing power of a dollar? How does it explain differences between nominal and real interest rates? How does deflation differ from inflation?

The CPI is constructed from a “market basket” sampling of goods that consumers typically purchase. Prices for goods in the market basket are collected each month, weighted by the importance of the good in the basket (cars are more expensive than bread, but we buy a lot more bread), and averaged to form the price level.

Inflation reduces the purchasing power of the dollar. Facing higher prices with a given number of dollars means that each dollar buys less than it did before.

The rate of inflation in the CPI approximates the difference between the nominal and real interest rates. A nominal interest rate of 10% with a 6% inflation rate will mean that real interest rates are approximately 4%.

Deflation means that the price level is falling, whereas with inflation overall prices are rising. Deflation is undesirable because the falling prices mean that incomes are also falling, which reduces spending, output, employment, and, in turn, the price level (a downward spiral). Inflation in modest amounts ( ................
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