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Ch 2.pdf

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ECON 2400
Sadia Mariam Malik

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CHAPTER 2 The Data of Macroeconomics 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 and services produced in the economy. GDP can measure two things at once because the total expenditures on the new final goods and services by the buyers must be equal to the income earned by the sellers of the new final goods and services. As the circular flow diagram in the text illustrates, these are alternative, equivalent ways of measur- ing the flow of dollars in the economy. 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, which is the percentage of the labor force that is unemployed, is computed as follows: Number of Unemployed Unemployment Rate = × 100. Labor Force Note that the labor force is the number of people employed plus the number of people unemployed. 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 estimate of the share of people who say they are working. The BLS multiplies this share by an estimate of the population to estimate the number of people working. Second, the BLS surveys about 160,000 business establishments and asks how many people they employ. Each survey is imperfect; so the two measures of employment are not identical. 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 job. Corporate Profits—the income of corporations after payments to workers and creditors. It gives an indication of the general financial health of the corporate sector. The Consumer Price Index (CPI)—a measure of the average price that consumers pay for the goods they buy; changes in the CPI are a measure of inflation. The Trade Balance—the difference between the value of goods exported abroad and the value of goods imported from abroad. In looking at the economic statistics, most people want to see a low and stable inflation rate of about 2–3 percent, a low and stable unemployment rate of about 5 percent, and GDP growth in the 3–4-percent range. This indicates the economy is “healthy” and per- 5 6 Answers to Textbook Questions and Problems 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 the farmer is $1.00 ($1 – 0 = $1). The value added by the miller is $2: she sells the flour to the baker for $3 but paid $1 for the flour. The value added by the baker is $3: she sells the bread to the engineer for $6 but paid the miller $3 for the flour. GDP is the total value added, or $1 + $2 + $3 = $6. Note that GDP equals the value of the final good (the bread). 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 services, then the marriage would not affect GDP since the total amount of economic activity is unchanged. Actual GDP, however, is an imperfect measure of economic activ- ity because the value of some goods and services is left out. Once the butler’s work becomes part of his household chores, his services are no longer counted in GDP. As this example illustrates, GDP does not include the value of any output produced in the home. Similarly, GDP does not include other goods and services, such as the imputed rent on durable goods (e.g., cars and refrigerators) and any illegal trade. 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- tal good sold to a private firm. c. The airplane sold to Air France counts as an export because it is sold to a foreigner. d. The airplane sold to Amelia Earhart counts as consumption because it is sold to a private individual. e. The airplane built to be sold next year counts as investment. In particular, the airplane is counted as inventory investment, which is where goods that are pro- duced in one year and sold in another year are counted. 5. Data on parts (a) to (g) can be downloaded from the Bureau of Economic Analysis (—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% d. Net exports 0.2% –0.5% –5.8% e. National defense purchases 6.7% 6.0% 4.7% f. State and local purchases 7.0% 11.6% 11.9% g. Imports 3.9% 10.5% 16.2% (Note: These data were downloaded April 17, 2006 from the BEA web site.) Among other things, we observe the following trends in the economy over the period 1950–2005: (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. Chapter 2 The Data of Macroeconomics 7 (c) The share going to government consumption purchases rose sharply from 1950 to 1980 but has receded somewhat since then. (d) Net exports, which were positive in 1950, were substantially negative in 2005. (e) The share going to national defense purchases fell from 1980 to 2005. (f) The share going to state and local purchases rose from 1950 to 1980. (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, 2000 2000 2000 2000 Nominal GDP 2000 = (P cars× Q cars) + (P bread× Q bread = ($50,000 × 100) + ($10 × 500,000) = $5,000,000 + $5,000,000 = $10,000,000. Nominal GDP = (P 2010 × Q 2010) + (P2010 × Q 2010) 2010 cars cars bread bread = ($60,000 × 120) + ($20 × 400,000) = $7,200,000 + $8,000,000 = $15,200,000. ii. Real GDP is the total value of goods and services measured at constant prices. Therefore, to calculate real GDP in 2010 (with base year 2000), multi- ply the quantities purchased in the year 2010 by the 2000 prices: 2000 2010 2000 2010 Real GDP 2010= (P cars× Q cars) + (P bread× Q bread = ($50,000 × 120) + ($10 × 400,000) = $6,000,000+ $4,000,000 = $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 GDP equals nominal 2000 GDP 2000 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: Nominal GDP Implicit Price Deflator 2010= 2010. Real GDP 2010 Using the values for Nominal GDP 2010and real GDP 2010calculated above: $15,200,000 Implicit Price Deflator 2010= $10,000,000 = 1.52. 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) measur
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