HOMEWORK

CHAPTER 23
QUESTIONS FOR REVIEW
1. Explain why an economy's income must equal its expenditure.
➔ Every economic transaction involves a buyer and a seller. Each dollar spent by a
buyer becomes a dollar of income for a seller. Therefore, total income must equal total
expenditure.
2. Which contributes more to GDP-the production of an economy car or the
production of a luxury car? Why?
➔ The production of a luxury car contributes more to GDP because it has a higher
market value. GDP measures the total market value of all final goods and services
produced..
3. A farmer sells wheat to a baker for $2. The baker uses the wheat to make bread,
which is sold for $3. What is the total contribution of these transactions to GDP?
➔ The total contribution to GDP is $3, the market value of the final product (bread).
4. Many years ago, Sophie paid $500 to put together a record collection. Today, she
sold her albums at a garage sale for $100. How does this sale affect current GDP?
➔ Selling used records does not affect current GDP because it involves no current
production. GDP measures the value of newly produced goods and services.
5. List the four components of GDP. Give an example of each.
➔ The four components of GDP are:
- Consumption: Spending by households on goods and services.
- Investment: Spending by businesses on capital goods (e.g., machinery,
equipment).
- Government Purchases: Spending by the government on goods and services.
- Net Exports: The value of exports minus the value of imports.
6. Why do economists use real GDP rather than nominal GDP to gauge economic
well-being?
➔ Economists use real GDP rather than nominal GDP to gauge economic well-being
because real GDP is adjusted for price changes. This allows us to measure changes in
output without being influenced by inflation.
 7. In the year 2020, the economy produces 100 loaves of bread that sell for $2 each.
In the year 2021, the economy produces 200 loaves of bread that sell for $3 each.
Calculate nominal GDP, real GDP, and the GDP deflator for each year. (Use 2020
as the base year.) By what percentage does each of these three statistics rise from
one year to the next?
➔ nominal GDP 2020--$200
real GDP 2017--$200
GDP deflator 2020--100%

nominal GDP 2021--$600

real GDP 2021--$400G
DP deflator 2021--150%

nominal GDP rises 200%, real GDP rises 100%, and GDP deflator rises 50%.
8. Why is it desirable for a country to have a large GDP?
Give an example of something that would raise GDP and yet be undesirable.
➔ A large GDP is generally desirable because it indicates a high standard of living, with
people enjoying more goods and services. However, GDP is not the only important
measure of well-being. For example, increased pollution or environmental damage can
raise GDP but lower overall quality of life.

PROBLEMS AND APPLICATIONS

1. What components of GDP (if any) would each of the following transactions affect?
Explain.
a. Uncle Fester buys a new refrigerator from a domestic manufacturer.
• Component Affected: Consumption (C)
• Explanation: This transaction represents household spending on a durable good.
b. Aunt Dolly hires a local contractor to build her a new house.
• Component Affected: Investment (I)
• Explanation: The contractor is investing in building materials and labor, which
contribute to the capital stock of the economy.
c. The Huang family buys an old Victorian house from the Ellis family.
 • Component Affected: None
• Explanation: This transaction is a transfer of ownership of an existing asset. It
does not involve the production of new goods or services.
d. You pay a hairdresser for a haircut.
• Component Affected: Consumption (C)
• Explanation: This is a household spending on a service.
e. Ford sells a Mustang from its inventory to the Martinez family.
• Component Affected: Consumption (C)
• Explanation: The Martinez family is purchasing a durable good for personal use.
f. Ford manufactures a Focus and sells it to Avis, the car rental company.
• Component Affected: Investment (I)
• Explanation: Avis is purchasing a capital good (car) for its business operations.
g. California hires workers to repave Highway 66.
• Component Affected: Government Purchases (G)
• Explanation: The state government is spending on infrastructure.
h. The federal government sends your grandmother a Social Security check.
• Component Affected: Government Purchases (G)
• Explanation: While Social Security is a transfer payment, it is included in
government purchases as it is considered a government expenditure.
i. Your parents buy a bottle of French wine.
• Component Affected: Net Exports (NX)
• Explanation: This is an import, which decreases net exports.
j. Honda expands its factory in Ohio.
• Component Affected: Investment (I)
• Explanation: Honda is investing in capital goods (the factory expansion).
2. Fill in the blank
3. The government purchases component of GDP does not include spending on transfer
payments such as Social Security. Thinking about the definition of GDP, explain why
transfer payments are excluded.
➔ Therefore government spending on goods and services (such as building roads or
buying weapons) will be counted in GDP, because they involve the creation of new
products or services.
In contrast, spending such as Social Security is a transfer of income from taxpayers to
recipients, without creating any new products or services. It is simply the circulation of
money between groups in society, not spending on goods or services. Therefore, these
transfers are not counted in GDP, because they do not reflect production or create new
value for the economy.

4, As the chapter states, GDP does not include the value of used goods that are resold.
Why would including such transactions make GDP a less informative measure of
economic well-being?
When calculating GDP, the goal is to measure the value of all final goods and services
produced in the economy.
➔ GDP only counts the value of new goods and services produced during a given period.
If you include the value of used goods (like used cars and houses) when they are resold,
you are double counting. These items were included in GDP when they were first
produced and sold, so re-counting them would not accurately reflect the new value
created in the economy. For example, when you sell a used car, no new production value
is created in the economy—the car has already been produced and counted in GDP.
Including the value of used goods would simply inflate GDP and not truly reflect current
economic activity. This would make GDP an inaccurate measure of the economy’s
growth and actual health.

5.

6.
8.
According to the latest data from the BEA, real US GDP grew by 3.0% in the second
quarter of 2024, up from the previous estimate of 2.8%. This growth was mainly driven
by consumer spending, especially services and durable goods. However, non-residential
fixed investment and exports were revised down, limiting growth.
Nominal GDP (not adjusted for inflation) increased by 5.5%, up from 5.2% in the
previous quarter. Inflation as measured by the PCE index increased by 2.5%, while core
inflation (excluding food and energy) increased by 2.8%, indicating that inflationary
pressures have eased. Corporate profits also increased by $57.6 billion after falling in the
first quarter, but the personal savings rate fell to 3.3%.

9.
a. What is GDP in this economy?
GDP measures the total value of final goods and services produced within an economy. In
this case, the final good is the bread, which is sold to consumers for $180. Since GDP
only counts the value of final goods (not intermediate goods like wheat and flour to avoid
double-counting), the GDP of this economy is $180.
b. Value added of each producer:
- Farmer's value added: The farmer sells the wheat for $100, and since there are no inputs
described before this stage, her value added is $100.
- Miller's value added: The miller buys wheat for $100 and sells flour for $150. The
miller’s value added is the difference between the flour’s selling price and the cost of
wheat: $150 - $100 = $50.
- Baker's value added: The baker buys flour for $150 and sells bread for $180. The
baker’s value added is the difference between the bread’s selling price and the cost of
flour: $180 - $150 = $30.
c. Total value added and its comparison to GDP:
- Total value added: The total value added by the three producers is the sum of their
individual value added: 100 + 50 + 30 = 180
- Comparison to GDP: The total value added of $180 is equal to the GDP calculated by
looking at the final sale of bread ($180). This demonstrates that another way of
calculating GDP is by summing the value added at each stage of production, which
ensures that the intermediate goods are not double-counted.