Answers to review quizzes marcroeconomics 12e parkin chapter 4

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W H AT I S E C O N O M I C S ? 67 MEASURING GDP AND ECONOMIC GROWTH** Answers to the Review Quizzes Page 124 (page 532 in Economics) Define GDP and distinguish between a final good and an intermediate good Provide examples GDP is the market value of all the final goods and services produced within a country in a given time period A final good or service is an item that is sold to the final user, that is, the final consumer, government, a firm making investment, or a foreign entity An intermediate good or service is an item that is produced by one firm, bought by another firm, and used as a component of a final good or service For instance, bread sold to a consumer is a final good, but wheat sold to a baker to make the bread is an intermediate good Distinguishing between final goods and services and intermediate goods and services is important because only final goods and services are directly included in GDP; intermediate goods must be excluded to avoid double counting them For example, counting the wheat that went into the bread as well as the bread would double count the wheat—once as wheat and once as part of the bread Why does GDP equal aggregate income and also equal aggregate expenditure? GDP equals aggregate income because one way to value production is by the cost of the factors of production employed The cost of the factors production employed —wages, interest, rent, and profit—equal aggregate income and therefore aggregate income equals GDP GDP equals aggregate expenditure because another way to value production is by the price that buyers pay for the production in the market Aggregate expenditure equals the sum of consumption expenditure, investment, government expenditure, and exports minus imports, which is the total amount spent buying the production in the market Therefore GDP equals aggregate expenditure What are the distinctions between domestic and national, and gross and net? “Domestic” means that the production being measured is within a country no matter by whom; “national” means that the production is produced by residents of the nation anywhere within the world “Gross” means before subtracting depreciation “Net” means after subtracting depreciation The terms apply to investment, business profit, and aggregate production 67 68 Page 127 (page 535 in Economics) What is the expenditure approach to measuring GDP? The expenditure approach measures GDP by focusing on aggregate expenditures Data are collected on the different components of aggregate expenditure and then summed Specifically, the Bureau of Economic Analysis collects data on consumption expenditure, C, investment, I, government expenditure on goods and services, G, and net exports, X − M These expenditures are valued at the prices paid for the goods and services, called the market price GDP is then calculated as C + I + G + X − M 68 What is the income approach to measuring GDP? The income approach measures GDP by focusing on aggregate income This approach sums all the incomes paid to households by firms for the factors of production they hire The National Income and Product Accounts divide income into five categories: compensation of employees; net interest; rental income; corporate profits; and proprietors’ income Adding these income components does not quite equal GDP, because it values the output at factor cost rather than the market price and omits depreciation So, further adjustments must be made to calculate GDP: Indirect taxes and depreciation must be added and subsidies subtracted What adjustments must be made to total income to make it equal GDP? Total income is net domestic product at factor cost To convert it to gross domestic product at market prices, we must add the depreciation of capital and add indirect taxes minus subsidies What is the distinction between nominal GDP and real GDP? Nominal GDP is the value of final goods and services produced in a given year valued at the prices of that year Real GDP is the value of final goods and services produced in a given year when valued at the prices of a reference base year By comparing the value of production in the two years at the same prices, we reveal the change in production How is real GDP calculated? The traditional method of calculating real GDP is to value each year’s production using the constant prices of a fixed base year and then sum all the values Page 133 (page 541 in Economics) Distinguish between real GDP and potential GDP and describe how each grows over time Real GDP is the value of final goods and services produced in a given year when valued at the prices of a reference base year Potential GDP is the maximum amount of real GDP that can be produced while avoiding shortages of labor, capital, land, and entrepreneurial ability that would bring rising inflation So real GDP is the actual amount produced with the actual level of employment of the nation’s factors of production while potential GDP is the amount that would be produced if there were full employment of all factors of production with no shortages Real GDP fluctuates from one year to the next, though it grows more often than it shrinks Potential GDP grows from one year to the next because the quantity of the nation’s resources and technology increase from one year to the next How does the growth rate of real GDP contribute to an improved standard of living? A benefit of long-term economic growth is the increased consumption of goods and services that is made possible Growth of real GDP also allows more resources to be devoted to areas such as health care, research, and environmental protection What is a business cycle and what are its phases and turning points? The business cycle is a periodic but irregular up-and-down movement of total production and other measures of economic activity A business cycle has two phases: recession and expansion The turning points are the peak and the trough A business cycle runs from a trough to an expansion to a peak to a recession to a trough and then back to an expansion What is PPP and how does it help us to make valid international comparisons of real GDP? MEASURING GDP AND ECONOMIC GROWTH PPP is purchasing power parity To make the most valid international comparisons of real GDP, we need to value each nation’s production using the same prices rather than by using exchange rates and the prices within each country because relative prices within different countries can vary widely As a result, if the real GDP of each country is valued using the same prices then the comparison of real GDP among the countries is more accurate 53 54 CHAPTER Explain why real GDP might be an unreliable indicator of the standard of living Real GDP is sometimes used to measure the standard of living but real GDP can be misleading for several reasons Real GDP does not include household production, productive activities done in and around the house by the homeowner Because these tasks often are an important component of people’s work, this omission creates a major measurement problem Real GDP omits the underground economy, economic activity that is legal but unreported or that is illegal In many countries the underground economy is an important part of economic activity, and its omission creates a serious measurement problem The value of leisure time is not included in real GDP People value their leisure hours and an increase in people’s leisure that enhances people’s economic welfare can lower the nation’s real GDP Environmental damage is excluded from real GDP So an economy wherein real GDP grows but at the expense of its environment, as was the case with Eastern European countries under communism, falsely appears to offer greater economic welfare than a similar economy that grows slightly more slowly but at less environmental cost MEASURING GDP AND ECONOMIC GROWTH Answers to the Study Plan Problems and Applications Classify each of the following items as a final good or service or an intermediate good or service and identify each item as a component of consumption expenditure, investment, or government expenditure on goods and services: • Airline ticket bought by a student • Airline tickets are intermediate goods that are used for the final service, airline flights They are part of consumption expenditure New airplanes bought by Southwest Airlines New airlines purchased by Southwest Airlines are a final good They are part of investment • Cheese bought by Domino’s Cheese bought by Domino’s is an intermediate good • Your purchase of a new iPhone • New house bought by Bill Gates This purchase is a final good It is part of consumption expenditure A new house purchased by Bill Gates is a final good It is part of investment Use the following figure illustrates the circular flow model During 2014, flow A was $13.0 trillion, flow B was $9.1 trillion, flow D was $3.3 trillion, and flow E was –$0.8 trillion Calculate (i) GDP and (ii) Government expenditure (i) Flow A is aggregate income GDP equals aggregate income, so GDP is $13.0 trillion (ii) Government expenditure is $1.4 trillion Aggregate expenditure equals GDP, which from part (i) is $13.0 trillion Aggregate expenditure is the sum of consumption expenditure (Flow B), investment (Flow D), government expenditure (Flow C), and net exports (Flow E) Therefore government expenditure equals aggregate expenditure minus consumption expenditure minus investment minus net exports Government expenditure equals $13.0 trillion minus $9.1 trillion minus $3.3 trillion 55 56 CHAPTER minus −$0.8 trillion, which is $1.4 trillion • • • • • Use the following data to calculate aggregate expenditure and imports of goods and services Government expenditure: $20 billion Aggregate income: $100 billion Consumption expenditure: $67 billion Investment: $21 billion Exports of goods and services: $30 billion Aggregate expenditure equals aggregate income, so aggregate expenditure equals $100 billion Aggregate expenditure also equals consumption expenditure plus investment plus government expenditures on goods and services plus exports of goods and services minus imports of goods and services , so imports of goods and services equals consumption expenditure plus investment plus government expenditure on goods and services plus exports minus aggregate expenditure Using this formula gives imports of goods and services equals $67 billion + $21 billion + $20 billion + $30 billion − $100 billion, which is $38 billion The table lists some national accounts data for the United States in 2008 a Calculate U.S GDP in 2008 GDP equals consumption expenditure plus investment plus government expenditure plus net exports, so GDP equals $10,000 billion + $2,000 billion + $2,800 billion − $700 billion, or $14,100 billion b Explain the approach (expenditure or income) that you used to calculate GDP Item Wages paid to labor Consumption expenditure Net operating surplus Investment Government expenditure Net exports Depreciation Billions of dollars 8,000 10,000 3,200 2,000 2,800 −700 1,800 The expenditure approach was used Use the following data to work Problems and Tropical Republic produces only bananas and coconuts The base year is 2013, and the tables give the quantities produced and the prices Calculate nominal GDP in 2013 and 2014 Quantities Bananas Coconuts 2013 800 bunches 400 bunches 2014 900 bunches 500 bunches Prices Bananas Coconuts 2013 $2 a bunch $10 a bunch 2014 $4 a bunch $5 a bunch In 2013, nominal GDP is $5,600 In 2014, nominal GDP is $6,100 Nominal GDP in 2013 is equal to total expenditure on the goods and services produced by Tropical Republic in 2013 Expenditure on Tropical Republic on bananas is 800 bunches of bananas at $2 a bunch, which is $1,600 Expenditure on coconuts is 400 bunches at $10 a bunch, which is $4,000 Total expenditure is $5,600, so nominal GDP in 2013 is $5,600 Nominal GDP in 2014 is equal to total expenditure on the goods and services produced by Tropical Republic in 2014 Expenditure on Tropical Republic on bananas is 900 bunches of bananas at $4 a bunch, which is $3,600 Expenditure MEASURING GDP AND ECONOMIC GROWTH on coconuts is 500 bunches at $5 a bunch, which is $2,500 Total expenditure is $6,100, so nominal GDP in 2014 is $6,100 Calculate real GDP in 2014 expressed in base-year prices Real GDP in 2014 using base-year prices is $6,800 The base-year prices method calculates the market value of the 2014 quantities at the base-year prices of 2013 To value the 2014 output at 2013 prices, real expenditure on Tropical Republic on bananas is 900 bunches at $2 a bunch, which is $1,800, and real expenditure on coconuts is 500 bunches at $10 a bunch, which is $5,000 Adding these two expenditures shows that real GDP in 2014 using the base-year prices method is $6,800 Use the table to work out in which year the U.S standard of living (i) increases and (ii) decreases Explain your answer The standard of living is measured by real GDP per person The standard of living increased in 2007 because real GDP per person increased The standard of living decreased in 2008 and 2009 because in both years real GDP per person decreased An island economy produces only fish and crabs Calculate the island’s chained-dollar real GDP in 2014 expressed in 2013 dollars Year 2006 2007 2008 2009 Quantitie s Fish Crabs Real GDP $13.0 trillion $13.2 trillion $13.2 trillion $12.8 trillion Population 300 million 302 million 304 million 307 million 2013 2014 1,000 tons 500 tons 1,100 tons 525 tons Real GDP in 2014 is $27,300 The chained-dollar method uses the Prices prices of 2013 and 2014 to calculate Fish $20 a ton $30 a ton the growth rate in 2014 The value Crabs $10 a ton $8 a ton of the 2013 quantities at 2013 prices is $25,000 The value of the 2014 quantities at 2013 prices is $1,100 tons of fish × $20 a ton + 525 tons of crab × $10 a ton, which is $27,250 Using 2013 prices, the increase in GDP for these two years is $2,250, so the percentage increase is ($2,250 ÷ $25,000) × 100, which is 9.0 percent Next the value of the 2013 quantities at 2014 prices is 1,000 tons of fish × $30 a ton + 500 tons of crab × $8 a ton, which is $34,000 The value of the 2014 quantities at 2014 prices is $37,200 Using 2014 prices, the increase in GDP for these two years is $3, 200 so the percentage increase is ($3,200 ÷ $34,000) × 100, which is 9.4 percent The chained dollar method calculates the growth rate as the average of these two percentage growth rates, which means that the growth rate in 2014 is 9.2 percent So real GDP in 2014 is equal to $25,000, which is real GDP in the base year (and is equal to nominal GDP in that year) multiplied by one plus the growth rate Real GDP in 2014 is $27,300 57 58 CHAPTER Answers to Additional Problems and Applications Classify each of the following items as a final or an intermediate good or service, and identify which is a component of consumption expenditure, investment, or government expenditure on goods and services: • Financial services bought by China Investment Corporation The financial services are an intermediate service • Desktop computers bought by Barclays • New taximeters imported from China by the London Taxi Company Desktop computer bought by Barclays are a final good It is part of investment New taximeters bought from China by the London Taxi Company are a final good They are part of China’s exports and Britain’s imports • New DVD bought by a student from Virgin Megastore A new DVD bought by a student from Virgin Megastore is a final good It is part of consumption expenditure Use Figure 4.2 to work Problems 10 and 11 10 In 2013, flow A was $1,000 billion, flow C was $250 billion, flow B was $650 billion, and flow E was $50 billion Calculate investment Investment is $50 billion Aggregate expenditure equals aggregate income, which is flow A, $1,000 billion Aggregate expenditure is the sum of consumption expenditure (Flow B), investment (Flow D), government expenditure (Flow C), and net exports (Flow E) Therefore investment equals aggregate expenditure minus consumption expenditure minus government expenditure on goods and services minus net exports Investment equals $1,000 billion minus $650 billion minus $250 billion minus $50 billion, which is $50 billion MEASURING GDP AND ECONOMIC GROWTH 11 In 2014, flow D was $2 trillion, flow E was –$1 trillion, flow A was $10 trillion, and flow C was $4 trillion Calculate consumption expenditure Consumption expenditure is $5 trillion Aggregate expenditure equals aggregate income, which is flow A, $10 trillion Aggregate expenditure is the sum of consumption expenditure (Flow B), investment (Flow D), government expenditure (Flow C), and net exports (Flow E) Therefore consumption expenditure equals aggregate expenditure minus investment minus government expenditure on goods and services minus net exports Consumption expenditure equals $10 trillion minus $2 trillion minus $4 trillion minus −$1 trillion, which is $5 trillion Use the following information to work Problems 12 and 13 The French state-owned DCNS shipyard provides parts and equipment for Brazilian submarines Renault Brasil produces cars for the Brazilian market in Paraná 12 Explain where these activities appear in the Brazilian National Income and Product Accounts When the parts and equipments for Brazilian submarines provided by DCNS are sent to Brazil, they are counted in the Brazilian National Income and Product Accounts as imports, which is a negative entry in the expenditure approach to Brazil’s GDP Renault Brasil’s production of cars is included in Brazil’s GDP and expenditure on the cars is counted as part of consumption expenditure (if the cars are purchased by Brazilian consumers) or investment (if the cars are purchased by Brazilian firms) or government expenditure (if the cars are purchased by a government) in the expenditure approach to GDP If any of the parts of the cars are imported from France, the value of these parts is included among Brazil’s imports 13 Explain where these activities appear in France’s National Income and Product Accounts The French state-owned DCNS shipyard will sell parts and equipments produced in France to Brazil Thus, they will enter France’s National Income and Product Accounts as exports In international trade, the seller of such goods is referred to as an “exporter” and is based in the country of export, in this case France, whereas the overseas-based buyer is referred to as an “importer”, in this case Brazil Exports will increase France’s GDP since they are positive entries in the expenditure approach The incomes earned by the factors of production that produce the parts and equipments for Brazil are part of the wages, interest, rent, and profit income that are used in the income approach to GDP Since Renault Brazil is a subsidiary of Renault but operates outside the French territory, the profit it generates will not be part of France’s GDP but its GNP Use the following news clip to work Problems 14 and 15, and use the circular flow model to illustrate your answers Boeing Bets the House Boeing is producing some components of its new 787 Dreamliner in Japan and is assembling it in the United States Much of the first year’s production will be sold to ANA (All Nippon Airways), a Japanese airline Source: The New York Times, May 7, 2006 14 Explain how Boeing’s activities and its transactions affect U.S and Japanese GDP Goods and services produced within the United States are part of U.S GDP Boeing’s decision to produce part of its new 787 airliner in Japan means that this production is not produced within the United States and so it is not part of U.S 59 60 CHAPTER GDP This production is, however, part of Japan’s GDP The parts of the Dreamliner that are assembled in Japan and sent to the United States for final assembly add to Japan’s GDP as exports and subtract from U.S GDP as imports Then the Dreamliners that Boeing sells to All Nippon Airways in Japan are counted as U.S exports and Japanese imports so they add to U.S GDP and subtract from Japan’s GDP In terms of the circular flow diagram in Figure 4.3 and U.S GDP, Boeing’s purchase of parts of the Dreamliner from firms in Japan is flow is Flow A, an import into the United States This flow travels through the goods market and goes to Boeing as Flow B In terms of Japanese GDP, the purchase of parts from Japanese firms is a Japanese export This flow is the reverse of Flow B and of flow A because this flow is an export for the Japanese economy Flows C and D indicate that the Japanese firms are paying Japanese household for the factors of production they supply 15 Explain how ANA’s activities and its transactions affect U.S and Japanese GDP ANA’s purchase of Dreamliners is counted in U.S GDP as exports and is counted in Japan’s GDP as imports In terms of the circular flow, Boeing sells some Dreamliners to ANA The airliners travel from Boeing through the goods market and are exported to ANA in Japan In Figure 4.3 and for the U.S economy, these are the reverse of flow B and then of flow A because the Dreamliners are a U.S export Flows C and D indicate that Boeing is paying households (through the factor market) for the factors of production the households supply to Boeing For the Japanese economy, the imports are represented by Flow A and then flow B Use the following data to work Problems 16 and 17 The table lists some macroeconomic data for the United States in 2009 16 Calculate U.S GDP in 2009 GDP equals consumption expenditure plus investment plus government expenditure plus net Item Wages paid to labor Consumption expenditure Other factor incomes Investment Government expenditure Net exports Billions of dollars 8,000 10,000 3,400 1,500 2,900 −340 MEASURING GDP AND ECONOMIC GROWTH exports, so GDP equals $10,000 billion + $1,500 billion + $2,900 billion − $340 billion, or $14,060 billion 17 Explain the approach (expenditure or income) that you used to calculate GDP The expenditure approach was used Use the following data to work Problems 18 to 19 An economy produces only apples Quantities and oranges The base year is Apples 2012, and the table gives the quantities produced and the prices Oranges 18 Calculate nominal GDP in 2012 and 2013 Prices Apples Oranges 2012 60 80 2013 160 220 2012 $0.50 $0.25 2013 $1.00 $2.00 In 2012 nominal GDP is $50 and in 2013 nominal GDP is $600 Nominal GDP in 2012 is equal to total value of the goods and services produced in 2012 The value of apples is 60 apples at $0.50 each, which is $30, and the value of oranges is 80 oranges at $0.25 each, which is $20 The total value is $50 so nominal GDP in 2012 is $50 Nominal GDP in 2013 is equal to total value of the goods and services produced in 2013 The value of apples is 160 apples at $1.00 each, which is $160 and the value of oranges is 220 oranges at $2.00 each, which is $440 The total value is $600 so nominal GDP in 2013 is $600 19 Calculate real GDP in 2012 and 2013 expressed in base-year prices Real GDP in 2012 is $50 and in 2013 is $135 Real GDP in the base year, 2012, is equal to nominal GDP Real GDP in 2013 using base-year prices is equal to the quantities produced in 2013 valued at base-year, 2012, prices Real GDP in 2013 is 160 apples at $0.50 each, which is $80, and the value of oranges is 220 oranges at $0.25 each, which is $55 The total value of 2013 production using 2012 prices is $135, so real GDP in 2013 is $135 20 GDP Expands 11.4 Percent, Fastest in 13 Years China’s gross domestic product grew 11.4 percent last year and marked a fifth year of double-digit growth The increase was especially remarkable given that the United States is experiencing a slowdown due to the sub-prime crisis and housing slump Citigroup estimates that each percent drop in the U.S economy will shave 1.3 percent off China’s growth, because Americans are heavy users of Chinese products In spite of the uncertainties, China is expected to post its sixth year of double-digit growth next year Source: The China Daily, January 24, 2008 Use the expenditure approach for calculating China’s GDP to explain why “each percent drop in the U.S economy will shave 1.3 percent off China’s growth.” China’s GDP growth will drop because U.S demand for China’s exports will decrease China’s GDP equals its aggregate expenditure and the fall in China’s exports decreases China’s aggregate expenditure 61 62 21 CHAPTER The United Nations’ Human Development Index (HDI) is based on real GDP per person, life expectancy at birth, and indicators of the quality and quantity of education a Explain why the HDI might be better than real GDP as a measure of economic welfare The HDI might be a better measure of economic welfare because it includes some important factors that affect welfare and which are omitted from GDP In particular, life expectancy is included in the HDI but not in GDP and on this count the HDI is superior The HDI also includes direct measures of the quality and quantity of education These are indirectly included in GDP because they affect GDP per person, but it might be the case that the direct inclusion in the HDI is better b Which items in the HDI are part of real GDP and which items are not in real GDP? The HDI is based on real GDP per person and so directly includes GDP In addition, the quality and quantity of education affect people’s productivity, which is closely related to GDP per person So real GDP indirectly includes some of the education effects explicitly included in the HDI MEASURING GDP AND ECONOMIC GROWTH c Do you think the HDI should be expanded to include items such as pollution, resource depletion, and political freedom? Explain Ideally factors such as pollution, political freedom, and so forth should be included in a broad measure of welfare Two difficulties, however, occur One difficulty comes when trying to measure these variables For instance, how can political freedom be measured in a way that is accepted by all? A second difficulty is weighting these factors For instance, how much political freedom should be weighted relative to GDP per person? d What other items should be included in a comprehensive measure on economic welfare? Aside from the factors listed above, potentially some measure of culture might be included Another set of factors might attempt to take into account sustainability Religious freedom, discrimination, and civil and international conflict might also matter But all these factors are hard to measure and to weight 22 China is About to Overtake the US to Become World’s Largest Economy Figures published by the IMF show that China is set to overtake the US to become the world’s largest economy Purchasing power parity or PPP of China will climb to $17.632 trillion this year, compared with $17.416 trillion for the US But analysis by IHS points out that China is not expected to rise above the US until 2024 in terms of nominal GDP Source: Telegraph, October 9, 2014 If PPP of China becomes greater than that of the U S but the GDP of the U.S remains higher, does this comparison of PPP really tell us which country has the higher standard of living? What does the news clip mean by ‘nominal GDP’? Nominal GDP is GDP in US dollars at the market exchange rate Real GDP per person is used as an indicator of the standard of living but PPP is more appropriate when comparing the standard of living of one country with respect to another because it values goods and services at same prices in both economies Also, it must be noted that a more accurate analysis would not only use PPP but also other factors that influence the living standards such as household production, underground economic activity, leisure time, environmental quality, access to health services, educational standards and so on It is also important to consider the command that each country has over world’s resources 23 Use the news clip in Problem 20 a Why might China’s recent GDP growth rates overstate the actual increase in the level of production taking place in China? China’s GDP, similar to all nations’ GDPs, omits the value of home production As more of China’s economy moves to being traded in markets, China’s GDP and therefore the growth rate of China’s GDP increases even though the actual production is not changing b Explain the complications involved with attempting to compare the economic welfare in China and the United States by using the GDP for each country China’s GDP is calculated using prices in China while U.S GDP is calculated using prices in the United States But relative prices in China and the United States are quite different When looking at prices of identical or near-identical goods, more of these prices are lower in China than in the United States So even if China and the United States produced the exact same quantities of these goods and services, 63 64 CHAPTER China’s GDP, using China’s lower prices, would value China’s production at a smaller value than would U.S GDP, using U.S higher prices To have a valid comparison of Chinese and U.S GDP, purchasing power parity (PPP) prices must be used to value Chinese and U.S production because then prices are the same for China and the United States 24 Poor India Makes Millionaires at Fastest Pace India, with the world’s largest population of poor people, created millionaires at the fastest pace in the world in 2007 India added another 23,000 more millionaires in 2007 to its 2006 tally of 100,000 millionaires measured in dollars That is millionaire for about 7,000 people living on less than $2 a day Source: The Times of India, June 25, 2008 a Why might real GDP per person misrepresent the standard of living of the average Indian? There are a few reasons why this measurement of real GDP per person misrepresents the standard of living of the average Indian First GDP includes only goods and services bought and sold in markets In India many goods and services are produced by the household itself and this home production, while boosting the household’s standard of living, is not included in GDP Second the prices used to value Indian production and thereby calculate Indian GDP are likely quite different than the prices used to value U.S production and calculate U.S GDP When looking at prices of identical or near-identical goods, it is likely that more of these prices are lower in India than in the United States So, even if the actual quantities produced are the same, using Indian prices means that India’s production would be valued less than U.S production and India’s GDP would be less than U.S GDP If the same prices, such as purchasing power parity prices, were used to value India’s GDP and U.S GDP, India’s GDP per person would be closer to U.S GDP per person b Why might $2 a day underestimate the standard of living of the poorest Indians? One important reason why the $2 a day estimate undervalues the standard of living of the poorest Indians is because much of these people’s transactions not occur in markets GDP is calculated using only goods and services bought and sold in markets So if a poor, self-sufficient farmer grows only enough food for his or her family and does not buy or sell food in the market, the farmer will be estimated to have a very low income But this low income vastly understates the farmer’s standard of living because it omits all the food the person produced on his or her land Another reason why the standard of living of the poorest Indians is under estimated is because the estimate is made using prices that prevail in India and then compared to the standard of living in the United States Prices in India are often much lower than in the United States, so comparing what the income can purchase in the United States understates the standard of living Economics in the News 25 After you have studied Economics in the News on pp 134–135 (542–543 in Economics), answer the following questions a By what percentage did real GDP grow from the second quarter of 2013 to the second quarter of 2014? (You can find the data you need to calculate this percentage change on p 135 [543 in Economics].) Real GDP in the second quarter of 2014 was $15,986 billion It had increased by $379 billion since the second quarter of 2013, so in the second quarter of 2013 real GDP equaled $15,986 billion − $379 billion, which is $15,607 billion MEASURING GDP AND ECONOMIC GROWTH Consequently the percentage growth rate equals [$379 billion/$15,607 billion] × 100, which is 2.4 percent b Comparing the increase in the second quarter with the year-on-year increase, what can you say about the change in the real GDP growth rate? Is it slowing or speeding up? The more recent change in GDP, from the first quarter of 2014 to the second quarter of 2014, was at an annualized rate of percent, well above the year-onyear increase of 2.4 percent The growth rate of real GDP was speeding up c Describe the relationship between the fluctuations in the change in real GDP and business inventory investment Why might inventory changes sometimes lag real GDP changes? Generally business inventories and real GDP change in the same direction Inventory changes sometimes lag because it takes time to change the inventory to the desired level For example, iinventories increase during recessions When an economy moves into expansion it takes some time to move the inventories down to target levels before businesses start producing more inventory 26 Totally Gross GDP has proved useful in tracking both short-term fluctuations and long-run growth Which isn’t to say GDP doesn’t miss some things Amartya Sen, at Harvard, helped create the United Nations’ Human Development Index, which combines health and education data with per capita GDP to give a better measure of the wealth of nations Joseph Stiglitz, at Columbia, advocates a “green net national product” that takes into account the depletion of natural resources Others want to include happiness in the measure These alternative benchmarks have merit but can they be measured with anything like the frequency, reliability, and impartiality of GDP? Source: Time, April 21, 2008 a Explain the factors that the new clip identifies as limiting the usefulness of GDP as a measure of economic welfare GDP focuses on the amount of goods and services produced While goods and services lead to improving people’s welfare, there are other factors that also come into play The Human Development Index includes people’s education and health, which are obvious factors that affect people’s wellbeing Mr Stiglitz is suggesting that sustainability issues should be included Others have recommended that people’s overall happiness be a factor in measuring economic welfare b What are the challenges involved in trying to incorporate measurements of those factors in an effort to better measure economic welfare? There are two major difficulties First, measuring some of these variables, especially “happiness”, would be very difficult Second, even if the variables could be accurately measured determining the weighting scheme to be used is very difficult For instance, how much should depletion of copper be weighted relative to GDP per person? c What does the ranking of the United States in the Human Development Index imply about the levels of health and education relative to other nations? Because the U.S ranking in the Human Development Index is below its ranking of per person real GDP, the levels of health and education in the United States must be lower than those in many other advanced countries 65 66 27 CHAPTER Use the information in Problem 18 to calculate the chained-dollar real GDP in 2013 expressed in 2012 dollars Real GDP in 2013 is $135.70 The chained-dollar method uses the prices of 2012 and 2013 to calculate the growth rate in 2013 The value of the 2012 quantities at 2012 prices is $50 The value of the 2013 quantities at 2012 prices is $135 Using 2012 prices, the increase in GDP for these two years is $85, so the percentage increase is ($85 ữ $50) ì 100, which is 170.0 percent Next the value of the 2012 quantities at 2013 prices is 60 apples × $1.00 per apple + 80 oranges × $2.00 an orange, which is $220 The value of the 2013 quantities at 2013 prices is $600 Using 2013 prices, the increase in GDP for these two years is $380 so the percentage increase is ($380 ÷ $220) × 100, which is 1.727 × 100, which is 172.7 percent The chained dollar method calculates the growth rate as the average of these two percentage growth rates, which means that the growth rate in 2013 is 171.4 percent So real GDP in 2013 is equal to $50, which is real GDP in the base year (and is equal to nominal GDP in that year) multiplied by one plus the growth rate Real GDP in 2013 is $135.70 ... million 2013 20 14 1,000 tons 500 tons 1,100 tons 525 tons Real GDP in 20 14 is $27,300 The chained-dollar method uses the Prices prices of 2013 and 20 14 to calculate Fish $20 a ton $30 a ton the growth... quantities at 20 14 prices is 1,000 tons of fish × $30 a ton + 500 tons of crab × $8 a ton, which is $ 34, 000 The value of the 20 14 quantities at 20 14 prices is $37,200 Using 20 14 prices, the increase... time to change the inventory to the desired level For example, iinventories increase during recessions When an economy moves into expansion it takes some time to move the inventories down to target
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