ECO365H5 Study Guide - Government Budget Balance, Disposable And Discretionary Income, Money Supply

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27 May 2011
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ECO365 ± Summer 2011 Chapter 13 ± Problem Set
Michael Ho Page 1 of 4
1. What adjustments are needed to bring )02 equal to national income? Is it correct to simply assume the two
are equal without any adjustment? Why the difference between them is often ignored in macroeconomic
analyses? What are the adjustments to make )&2 and )02 equal each other? Why?
Some adjustments to the definition of )02 must be made, however, before the identification of )02 and
national income is entirely correct in practice.
(i) )02 does not take into account the economic loss due to the tendency of machinery and structures to wear
out as they are used (depreciation). )02 less depreciation is called net national product (002).
(ii) 1HWXQLODWHUDOWUDQVIHUVDUHSDUWRIDFRXQWU\¶VLQFRPHEXWDUHQRWSDUWRILWVSURGXFWDQGWKH\PXVWEHDGGHG
to 002 in calculations of national income.
(iii) National income depends on the prices producers receive for their goods while )02 uses the prices
purchasers pay. These two sets of prices need not, however, be identical when sales taxes make buyers pay
more than sellers receive, leading )02 to overestimate national income. The amount of this tax wedge, called
indirect business taxes, must therefore be subtracted from )02 in calculating true national income.
National income equals )02 less depreciation, plus net unilateral transfers, less indirect business taxes. The
difference between )02 and national income is by no means an insignificant amount, but macroeconomics has
little to say about it, and it is of little importance for macroeconomic analysis. Therefore, we usually use the
terms )02 and national income interchangeably, emphasizing the distinction between the two only when it is
essential.
)&2 measures the final value of all goods and services that are produced within a country in a given time
period. )&2 does not correct, as )02 GRHVIRUWKHSRUWLRQRIFRXQWULHV¶SURGXFWLRQFDUULHGRXWXVLQJVHUYLFHV
provided by foreign-owned capital. )02 equals )&2 plus net receipts of factor income from the rest of the
world. Thus, the adjustments are
)&2 L)02B=?PKNL=UIAJPOBNKIBKNAECJ?KQJPNEAOEB=?PKNL=UIAJPOPKBKNAECJ?KQJPNEAO
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