Second Edition Textbook Chapter Problem Answers - 07 PDF

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7 GDP and the CPI: Tracking the Macroeconomy 1.

Below is a simplified circular-flow diagram for the economy of Micronia. (Note that there is no investment spending in Micronia.) a. What is the value of GDP in Micronia? b. What is the value of net exports? c. What is the value of disposable income? d. Does the total flow of money out of households—the sum of taxes paid and consumer spending—equal the total flow of money into households? e. How does the government of Micronia finance its purchases of goods and services?

Government purchases of goods and services = $100 Government Taxes

Consumer spending = $6

Households

Wages, profit, interest, rent = $750 Factor markets

Markets for goods and services Gross domestic product

Wages, profit, interest, rent = $750 Firms

Exports = $20

Imports = $20

Rest of world

1. Solution

a. We can measure GDP in Micronia as the sum of all spending on domestically produced final goods and services. Spending consists of consumer spending, government purchases of goods and services, and exports less imports, or $750 ($650 + $100 + $20 – $20).

b. Net exports are exports less imports. In Micronia, net exports equal zero ($20 – $20). c. Disposable income is income received by households less taxes plus government transfers. In Micronia, disposable income equals $650 ($750 – $100).

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d. Yes. Consumer spending plus taxes equals $750—the same as the wages, profit, interest, and rent received by households. e. The government finances its purchases of goods and services with tax revenue.

2.

A more complex circular-flow diagram for the economy of Macronia is shown below. (Note that Macronia has investment spending and financial markets.) a. What is the value of GDP in Macronia? b. What is the value of net exports? c. What is the value of disposable income? d. Does the total flow of money out of households—the sum of taxes paid, consumer spending, and private savings—equal the total flow of money into households? e. How does the government finance its spending?

Government purchases of goods and services = $15

Government borrowing = $60 Government

Taxes =

Consumer spending = $51

nment transfers = $10 Private savings = $200 Wages, profit, interest, rent = $800

Households

Markets for goods and services

Factor markets oss domestic product

Investmen spending = $

Wages interest, rent = $800

Borrowing and stock issues by firms = $110

Firms

Foreign borrowing and sales of stock = $130

Exports = $50

Imports = $20

Financial markets

Rest of world

Foreign lending and purchases of stock = $100

Solution 2.

a. We can measure GDP in Macronia as the sum of all spending on domestically produced final goods and ser vices. Spending consists of consumer spending, investment spending, government purchases of goods and services, and exports less imports, or $800 ($510 + $110 + $150 + $50 - $20).

b. Net exports are exports less imports. In Macronia, net exports equal $30 ($50 - $20). c. Disposable income is income received by households less taxes plus government transfers. In Macronia, disposable income equals $710 ($800 - $100 + $10). d. Yes. Consumer spending plus taxes plus private savings equals $810—the same as the wages, profit, interest, rent, and government transfers received by households. e. In Macronia, the government needs to finance $160 in spending ($150 on purchases of goods and services and $10 in government transfers). The government finances $100 of its spending with tax revenue and the other $60 through borrowing in financial markets.

GDP AN D T HE CPI : T RACKI N G T HE MACROECON OMY

3.

Consider the following table for Canada’s GDP in 2011. Category

Components of GDP in 2011 (billions of dollars)

Personal expenditure on consumer goods and services Durable goods Semi-durable goods

$113.7 72.6

Non-durable goods

240.3

Services

556.0

Business gross fixed capital formation Residential structures

118.5

Non-residential structures

104.1

Machinery and equipment

97.8

Business investment in inventories

4.7

Government purchases of goods and services and investment spending Expenditure on goods and services

367.6

Gross fixed capital formation and inventories

67.0

Export of goods and services Goods Services

458.2 77.5

Imports of goods and services Goods

455.9

Services

100.9

Source: Statistics Canada.

a. Calculate 2011 consumer spending. b. Calculate 2011 private investment spending. c. Calculate 2011 net exports. d. Calculate 2011 government purchases of goods and services and investment spending. e. Calculate 2011 gross domestic product. f. Calculate consumer spending on services as a percentage of total consumer spending. g. Calculate 2011 exports as a percentage of imports. h. Calculate 2011 exports and imports as a percentage of gross domestic product. Was there a trade surplus or trade deficit in 2011? How large was this as a percentage of GDP?

3. Solution

All numbers below are in billions of dollars.

a. Consumer spending in 2011 is the sum of the four components of personal expenditures on consumer goods and services: $982.6. b. Private investment spending was the sum of the three components of business gross fixed capital formation ($320.4) plus business investment in inventories ($4.7) = $325.1. c. Net exports = exports – imports = ($458.2 + $77.5) – ($455.9 + $100.9) = -$21.1. d. Total government spending in 2011 was $434.6, the sum of expenditures on goods and services as well as on capital formation and inventories. e. Because GDP = C + I + G + (X – IM), it is the sum of what we have calculated in parts a through d of this question: $982.6 + $325.1 + $434.6 - $21.2 = $1,721.1.

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f. Consumers’ spending on services is the following percentage of GDP: 100 × 556/1721.1 = 32.3%. g. Exports are $535.7 and imports are $556.8, so exports are 100 × 535.7/556.8 or 96.2% of imports. h. As a percentage of GDP, exports are 100 × 535.7/1,721.1 or 31.1%. Imports are 100 × 556.8/1,721.1 = 32.4%. We saw in part c that there was a trade deficit in 2011: imports were larger than exports. But as a percentage of GDP, the deficit was small: 100 × 21.1/1,721.1 = 1.2%.

4.

The small economy of Pizzania produces three goods (bread, cheese, and pizza), each produced by a separate company. The bread and cheese companies produce all the inputs they need to make bread and cheese, respectively. The pizza company uses the bread and cheese from the other companies to make its pizzas. All three companies employ labour to help produce their goods, and the difference between the value of goods sold and the sum of labour and input costs is the firm’s profit. The accompanying table summarizes the activities of the three companies when all the bread and cheese produced are sold to the pizza company as inputs in the production of pizzas. Bread company

Cheese company

Pizza company

Cost of inputs

$0

$0

$50 (bread) 35 (cheese)

Wages

15

20

75

Value of output

50

35

200

a. Calculate GDP as the value added in production. b. Calculate GDP as spending on final goods and services. c. Calculate GDP as income earned from production.

Solution 4.

a. To calculate GDP as the value added in production, we need to sum all value added (value of output less input costs) for each company. Value added in the bread company is $50; in the cheese company, $35; and in the pizza company, $115 ($200 – $50 – $35). The total value added in production is $200 ($50 + $35 + $115).

b. To calculate GDP as spending on final goods and services, we only need to estimate the value of pizzas because all bread and cheese produced are intermediate goods used in the production of pizzas. Spending on final goods and services is $200. c. To calculate GDP as factor income, we need to sum factor income (wages and profits) for each firm. For the bread company, factor income is $50: labour earns $15 and profit is $35. For the cheese company, factor income is $35: labour earns $20 and profit is $15. For the pizza company, factor income is $115: labour earns $75 and profit is $40 ($200 – $75 – $50 – $35). Factor income is $200 ($50 + $35 + $115).

5.

In the economy of Pizzania (from Problem 4), bread and cheese produced are sold both to the pizza company for inputs in the production of pizzas and to consumers as final goods. The accompanying table summarizes the activities of the three companies.

GDP AN D T HE CPI : T RACKI N G T HE MACROECON OMY

Cost of inputs Wages Value of output

Bread company

Cheese company

Pizza company

$0

$0

$50 (bread) 35 (cheese)

25

30

75

100

60

200

a. Calculate GDP as the value added in production. b. Calculate GDP as spending on final goods and services. c. Calculate GDP as income earned from production.

S5.OLUTION

a. To calculate GDP as the value added in production, we need to sum all value added (value of output less input costs) for each company. Value added in the bread company is $100; in the cheese company, $60; and in the pizza company, $115 ($200 – $50 – $35). The total value added in production is $100 + $60 + $115 = $275.

b. To calculate GDP as spending on final goods and services, we need to sum the value of bread, cheese, and pizzas sold as final goods. GDP equals $275 because the bread company sells $50 worth as final goods, the cheese company sells $25 worth as final goods, and all $200 worth of pizzas are final goods. c. To calculate GDP as income earned from production, we need to sum income earned from production (labour and profits) for each firm. For the bread company, income earned from production is $100: labour earns $25 and profit is $75. For the cheese company, income earned from production is $60: labour earns $30 and profit is $30. For the pizza company, income earned from production is $115: labour earns $75 and profit is $40 ($200 – $75 – $50 – $35). As income earned from production, GDP equals $275 ($100 + $60 + $115).

6.

Which of these transactions should be included in Canada’s GDP? a. Canada Dry builds a new bottling plant in Canada. b. Air Canada sells one of its existing airplanes to Korean Air. c. Ms. Moneybags buys an existing share of Telus Corporation. d. A softwood lumber firm in British Columbia sells softwood lumber to a construction firm in California. e. A Canadian buys a bottle of French perfume in Paris. f. A Canadian book publisher produces too many copies of a new book. The books don’t sell this year, so the publisher adds the surplus books to inventories.

6. Solution

a. A new bottling plant is investment and is counted in GDP.

b. The sale of a used airplane to Korean Air is not included in GDP because it does not represent production during the current time period. If it had been produced in Canada, the airplane would have been included in GDP when it was produced. c. When an individual buys an existing share of stock, the transaction is not included in GDP because there is no production. d. This is an export and is included in Canadian GDP. e. When a Canadian buys a bottle of French perfume, it is a consumption expenditure as measured by GDP. But because it does not represent production in Canada of either perfume manufacture or perfume retailing, it is also deducted from GDP as an import. The net effect of the transaction does not change GDP in Canada because it does not involve anything that was produced there.

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f. If a book publisher produces copies of a new book and some don’t sell in the year they are produced, the publisher adds the surplus books to inventories. These books are considered investment spending and added to GDP. It is as if the publisher bought the books itself.

7.

The economy of Britannica produces three goods: computers, DVDs, and pizza. The accompanying table shows the prices and output of the three goods for the years 2010, 2011, and 2012. Computers Year

Price

Quantity

DVDs Price

10

Pizzas

Quantity

Price

Quantity

2010

$900

$10

100

$15

2

2011

1,000

10.5

12

105

16

2

2012

1,050

12

14

110

17

3

a. What is the percent change in production of each of the goods from 2010 to 2011 and from 2011 to 2012? b. What is the percent change in prices of each of the goods from 2010 to 2011 and from 2011 to 2012? c. Calculate nominal GDP in Britannica for each of the three years. What is the percent change in nominal GDP from 2010 to 2011 and from 2011 to 2012? d. Calculate real GDP in Britannica using 2010 prices for each of the three years. What is the percent change in real GDP from 2010 to 2011 and from 2011 to 2012?

7. Solution

a. From 2010 to 2011, the percent change in the production of computers is 5.0% (equal to ((10.5 – 10)/10) × 100); of DVDs, 5.0% (equal to ((105 – 100)/100) × 100); and of pizza, 0% (equal to ((2 – 2)/2) × 100). From 2011 to 2012, the percent change in the production of computers is 14.3% (equal to ((12 – 10.5)/10.5) × 100); of DVDs, 4.8% (equal to ((110 – 105)/105) × 100); and of pizza, 50.0% (equal to ((3 – 2)/2) × 100).

b. From 2010 to 2011, the percent change in the price of computers is 11.1% (equal to (($1,000 – $900)/$900) × 100); of DVDs, 20.0% (equal to (($12 – $10)/$10) × 100); and of pizza, 6.7% (equal to (($16 – $15)/$15) × 100). From 2011 to 2012, the percent change in the price of computers is 5.0% (equal to (($1,050 – $1,000)/$1,000) × 100); of DVDs, 16.7% (equal to (($14 – $12)/$12) × 100); and of pizza, 6.25% (equal to (($17 – $16)/$16) × 100). c. Nominal GDP for each year is calculated by summing up the value of the three goods produced in that year: Year

Nominal GDP

Percent change in nominal GDP

2010

$10,030

2011

11,792

17.6% = (($11,792 - $10,030)/$10,030) × 100

2012

14,191

20.3% = (($14,191 - $11,792)/$11,792) × 100

d. Real GDP in 2010 prices is calculated by summing up the value of the three goods produced each year using 2010 prices: Year

Real GDP (2005 dollars)

2010

$10,030

2011

10,530

5.0% = (($10,530 - $10,030)/$10,030) × 100

2012

11,945

13.4% = (($11,945 - $10,530)/$10,530) × 100

Percent change in real GDP

GDP AN D T HE CPI : T RACKI N G T HE MACROECON OMY

8.

The accompanying table shows data on nominal GDP (in billions of 2002 dollars) and population (in thousands) of Canada in 1960, 1970, 1980, 1990, 2000, and 2010. The Canadian price level rose consistently from 1960 to 2010.

Year

Nominal GDP (billions of dollars)

Real GDP (billions of 2002 dollars)

1960

$39.8

$257.2

1970

90.2

420.4

21,297

1980

314.4

625.4

24,516

1990

679.9

825.3

27,691

2000

1076.6

1100.5

30,686

2010

1624.6

1325.0

34,126

Population (thousands)

17,870

Source: Statistics Canada.

a. Why is real GDP greater than nominal GDP for all years until 2000 and lower for 2010? b. Calculate the percent change in real GDP from 1960 to 1970, 1970 to 1980, 1980 to 1990, 1990 to 2000, and 2000 to 2010. Which period had the highest growth rate? c. Calculate real GDP per capita for each of the years in the table. d. Calculate the percent change in real GDP per capita from 1960 to 1970, 1970 to 1980, 1980 to 1990, 1990 to 2000, and 2000 to 2010. Which period had the highest growth rate? e. How do the percent change in real GDP and the percent change in real GDP per capita compare? Which is larger? Do we expect them to have this relationship?

Solution 8.

a. Real GDP is greater than nominal GDP for all years until 2000 because the base year is 2002, and from 1960 to 2000, prices rose. So to calculate real GDP for the years 1960, 1970, 1980, 1990, and 2000, we would multiply output in those years by the higher prices that existed in 2002. To calculate nominal GDP, we would multiply output by the lower prices that existed in those particular years. Since prices rose from 2002 to 2010, valuing the output in 2010 using 2002 prices (real GDP) will result in a lower number than valuing the output in 2010 using 2010 prices (nominal GDP). By the way, real GDP would equal nominal GDP in 2002 because 2002 is the base year and we use the same set of prices to value both real and nominal GDP in that year.

b. The accompanying table shows the percent change in real GDP from 1960 to 1970, 1970 to 1980, 1980 to 1990, 1990 to 2000, and 2000 to 2010. The percent change in real GDP was the highest during the 1960s.

Year

Real GDP (billions of 2002 dollars)

Percentage change in real GDP

1960

$257.2

---

1970

420.4

63.5%

1980

625.4

48.8%

1990

825.3

32.0%

2000

1,100.5

33.3%

2010

1,325.0

20.4%

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c. Year

Real GDP per capita (2005 dollars)

1960

$14,393

1970

19,740

1980

25,510

1990

29,804

2000

35,863

2010

38,827

d. The years from 1960 through 1970 had the highest growth rate, as shown in the table. Year

Percent change in real GDP per capita

1960

---

1970

37.2%

1980

29.2%

1990

16.8%

2000

20.3%

2010

8.3%

The 1960s had the highest growth rate in per capita incomes, as shown in the table. e. The growth rate of real GDP is greater than the growth of real GDP per capita. We should expect this because the population has been growing steadily.

9.

Kwantlen Polytechnic University is concerned about the rising price of textbooks that students must purchase. T...