Chapter in a nutshell

• Because every transaction has a buyer and a goods and services by local, state, and federal
seller, the total expenditure in the economy governments. Net exports equal the value of
must equal the total income in the economy. goods and services produced domestically and
• Gross domestic product (GDP) measures an sold abroad (exports) minus the value of
economy’s total expenditure on newly goods and services produced abroad and sold
produced goods and services and the total domestically (imports).
income earned from the production of these • Nominal GDP uses current prices to value
goods and services. More precisely, GDP is the economy’s production of goods and
the market value of all final goods and services. Real GDP uses constant base-year
services produced within a country in a given prices to value the economy’s production of
period of time. goods and services. The GDP deflator -
• GDP consists of four components of calculated from the ratio of nominal GDP to
expenditure: consumption, investment, real GDP - measures the level of prices in the
government purchases, and net exports. economy.
Consumption includes spending on goods and • GDP is a good measure of economic well-
services by households, with the exception of being because people prefer higher to lower
purchases of new housing. Investment incomes. But it is not a perfect measure of
includes spending on business capital, well-being. For example, GDP excludes the
residential capital, and inventories. value of leisure and the value of a clean
Government purchases include spending on environment.

I. QuickQuiz
1. An economy’s gross domestic product is
a. the excess of spending over income.
b. the excess of income over spending.
c. total income and total spending.
d. total income times total spending.

2. Sam bakes a cake and sells it to Carla for $10. Woody pays Diane $30 to tutor him. In this
economy, GDP is
a. $10.
b. $20.
c. $30.
d. $40.

3. If the price of a hot dog is $2 and the price of a hamburger is $4, then 30 hot dogs
contribute as much to GDP as _________ hamburgers.
a. 5
b. 15
c. 30
d. 60
4. Angus the sheep farmer sells wool to Barnaby the knitter for $20. Barnaby makes two
sweaters, each of which has a market price of $40. Collette buys one of them, while the other
remains on the shelf of Barnaby’s store to be sold later. What is GDP here?
a. $40
b. $60
c. $80
d. $100

5. After graduation, an American college student moves to Japan to teach English. Her salary
is included
a. only in U.S. GDP.
b. only in Japan’s GDP.
c. in both U.S. GDP and Japan’s GDP.
d. in neither U.S. GDP nor Japan’s GDP.

6. Which of the following does NOT add to U.S. GDP?

a. Boeing manufactures and sells a plane to Air France.
b. General Motors builds a new auto factory in North Carolina.
c. The city of New York pays a salary to a policeman.
d. The federal government sends a Social Security check to your grandmother.

7. An American buys a pair of shoes made in Italy. How do the U.S. national income accounts
treat the transaction?
a. Net exports and GDP both rise.
b. Net exports and GDP both fall.
c. Net exports fall, while GDP does not change.
d. Net exports do not change, while GDP rises.

8. Which is the largest component of GDP?

a. consumption
b. investment
c. government purchases
d. net exports

9. An economy produces 10 cookies in year 1 at a price of $2 per cookie and 12 cookies in year
2 at a price of $3 per cookie. From year 1 to year 2, real GDP increases by
a. 20 percent.
b. 50 percent.
c. 70 percent.
d. 80 percent.

10. If all quantities produced rise by 5 percent and all prices fall by 5 percent, which of the
following best describes what occurs?
a. Real GDP rises by 5 percent, while nominal GDP falls by 5 percent.
b. Real GDP rises by 5 percent, while nominal GDP is unchanged.
c. Real GDP is unchanged, while nominal GDP rises by 5 percent.
d. Real GDP is unchanged, while nominal GDP falls by 5 percent.

11. If Mr. Keating quits his job as a teacher to home school his own children, GDP
a. stays the same because he is engaged in the same activity.
b. rises because he now pays lower income taxes.
c. falls because his market income decreases.
d. could rise or fall, depending on the value of home schooling.

12. GDP is an imperfect measure of well-being because it

a. includes physical goods produced but not intangible services.
b. excludes goods and services provided by the government.
c. ignores the environmental degradation from economic activity.
d. is not correlated with other measures of the quality of life.

II. Multiple Choice

1. Which of the following is not a question addressed by macroeconomists?
a. Why is average income high in some nations but low in others?
b. What, if anything, can the government do to promote growth in incomes, low inflation, and stable
employment?
c. What is the impact of foreign competition on VN auto industry?
d. Why do production and employment expand in some years and contract in others?

2. Which of the following statistics is usually regarded as the best single measure of a society’s
economic wellbeing?
a. the unemployment rate
b. the inflation rate
c. gross domestic product
d. the trade deficit
3. For an economy as a whole,
a. the market value of production must equal expenditure.
b. investment must equal the value of stocks and bonds purchased.
c. wages must equal income.
d. consumption must equal saving.

4. Which of the following statements about GDP is correct?

a. GDP measures two things at once: the total income of everyone in the economy and the total
expenditure on the economy’s output of goods and services.
b. Money continuously flows from households to firms and then back to households, and GDP
measures this flow of money.
c. GDP is generally regarded as the best single measure of a society’s economic wellbeing.
d. All of the above are correct.

5. For an economy as a whole, income must equal expenditure because

a. the number of firms is equal to the number of households in an economy.
b. individuals can only spend what they earn each period.
c. every dollar of spending by some buyer is a dollar of income for some seller.
d. every dollar of saving by some consumer is a dollar of spending by some other consumer.

6. If an economy’s GDP rises, then it must be the case that the economy’s
a. income rises and saving falls.
b. income and saving both rise.
c. income rises and expenditure falls.
d. income and expenditure both rise.

7. In the actual economy, households

a. spend all of their income.
b. divide their income among spending, taxes, and saving.
c. buy all goods and services produced in the economy.
d. Both (a) and (c) are correct.

8. According to the circular-flow diagram GDP

a. can be computed as either the revenue firms receive from the sales of goods and services or the
payments they make to factors of production.
b. can be computed as the revenue firms receive from the sales of goods and services but not as the
payments they make to factors of production.
c. can be computed as payments firms make to factors of production but not as revenues they
receive from the sales of goods and services.
d. cannot be computed as either the revenue firms receive or the payments they make to factors of
production.

9. Which of the following is a way to compute GDP?

a. total income earned.
b. total expenditures on final goods.
c. add up the market values of all final goods and services.
d. All of the above are correct.

10. Angus the sheep farmer sells wool to Barnaby the knitter for $20. Barnaby makes two
sweaters, each of which has a market price of $40. Collette buys one of them, while the other
remains on the shelf of Barnaby’s store to be sold later. What is GDP here?
a. $40
b. $60
c. $80
d. $100

11. If all quantities produced rise by 10 percent and all prices fall by 10 percent, which of the
following occurs?
a. Real GDP rises by 10 percent, while nominal GDP falls by 10 percent.
b. Real GDP rises by 10 percent, while nominal GDP is unchanged.
c. Real GDP is unchanged, while nominal GDP rises by 10 percent.
d. Real GDP is unchanged, while nominal GDP falls by 10 percent.

12. A country produces only ice cream and pie. Quantities and prices of these goods for the
last several years are shown below. The base year is 2008.
Price of ice Quantity of ice
Year Price of pie Quantity of pie
cream cream
2008 $2.50 40 $5.00 20
2009 $3.00 50 $6.00 25
2010 $4.00 40 $6.00 30
In 2009, this country’s
a. real GDP was $250, and the GDP deflator was 125.
b. real GDP was $250, and the GDP deflator was 120.
c. real GDP was $240, and the GDP deflator was 125.
d. real GDP was $240, and the GDP deflator was 120.
13. If all quantities produced rise by 10 percent and all prices fall by 10 percent, which of the
following occurs?
a. Real GDP rises by 10 percent, while nominal GDP falls by 10 percent.
b. Real GDP rises by 10 percent, while nominal GDP is unchanged.
c. Real GDP is unchanged, while nominal GDP rises by 10 percent.
d. Real GDP is unchanged, while nominal GDP falls by 10 percent.

14. A recession has traditionally been defined as a period during which

a. nominal GDP declines for two consecutive quarters.
b. nominal GDP declines for four consecutive quarters.
c. real GDP declines for two consecutive quarters.
d. real GDP declines for four consecutive quarters.

15. GDP does not reflect

a. the value of leisure.
b. the value of goods and services produced at home.
c. the quality of the environment.
d. All of the above are correct.

16. Suppose that twenty five years ago a country had nominal GDP of $1,000, a GDP deflator
of 200, and a population of 100. Today it has nominal GDP of $3,000, a GDP deflator of 400,
and population of 150. What happened to the real GDP per person?
a. It more than doubled.
b. It increased, but it less than doubled.
c. It was unchanged.
d. It decreased.
Solve: 100*Nominal GDP/GDP Deflator/Population
Twenty five years ago real GDP per person was 100*$1,000/200/100 = $5 per person.
Today its real GDP is 100*$3,000/400/150 = $5 per person.
So real GDP per person is unchanged.

17. GDP is $10 million, consumer spending is $6 million, government spending is $3 million,
exports are $2 million, and imports are $3 million. How much is spent for investments?
a. $1 million
b. $2 million
c. $3 million
d. $4 million
18. The country of Hykania does not trade with any other country. Its GDP is $20 billion. Its
government purchases $3 billion worth of goods and services each year, collects $3 billion in
taxes, and provides $2 billion in transfer payments to households. Private saving in Hyrkania
is $4 billion. What is investment in Hyrkania?
a. $2 billion
b. $4 billion
c. $3 billion
d. There is not enough information to answer the question.
Solve:
 The equilibrium GDP (Y) in an economy is computed as: Y = C + I + G.
 The disposable income (Yd) for Hykania can be computed as:
Yd = GDP - Taxes + Transfer payments
Yd = $20 billion - $3billion + $2 billion
Yd = $19 billion
 The consumption (C) in Hykania can be computed as:
C = Yd - Savings (S)
C = $19 billion - $4 billion
C = $15 billion
 Substituting these values in the equation for computing GDP, the value for investment is
computed as:
Y=C+I+G
$20 billion = $15 billion + I + $3 billion
I = $2 billion.

19. Which of the following transactions would be counted in GDP?

a. The wage you receive from babysitting your neighbor’s kids
b. The sale of illegal drugs
c. The resale of a sweater you received from your great aunt at Christmas that you never wore on
eBay
d. The sale of a pound of tomatoes at a supermarket

20. If an economy’s GDP falls, then it must be the case that the economy’s
a. income and saving fall.
b. income and market value of all production both fall.
c. income falls and market value of all production rises.
d. income rises and market value of all production falls.