Exercise 1Chapter 7 GDP: Measuring Total Production and Income

7.1 Gross Domestic Product Measures Total Production

1) In May 2009, Ford Motor Company's sales were down 20 percent from a year earlier. These events were caused byA) an economic recession.B) an economic expansion.C) a reduction in advertising.D) declining quality of service.Answer: ADiff: 2 Page Ref: 613/209Topic: The Business CycleObjective: LO1: Explain how total production is measured.Special Feature: Chapter Opener: Ford Motor Company Feels the Effects of the Recession

2) During a business cycle expansion, total production ________ and total employment ________.A) increases; increasesB) increases; decreasesC) decreases; increasesD) decreases; decreasesAnswer: AComment: RecurringDiff: 1 Page Ref: 617/213Topic: The Business CycleObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

3) Macroeconomics, as opposed to microeconomics, includes the study of what determines theA) average price levels of goods and services in the economy.B) price charged for laptop computers by Dell.C) wages paid to employees by Dell.D) quantity of Dell employees.Answer: AComment: RecurringDiff: 1 Page Ref: 614/210Topic: Macroeconomics vs. MicroeconomicsObjective: LO1: Explain how total production is measured.

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4) Which of the following headlines would be more closely related to what macroeconomists study than what microeconomists study?A) Avocado prices rise due to a late frost in California.B) The United Auto Workers sign a contract raising wages and benefits 7% over the next 3 years.C) Real GDP grows by 2.3% in the second quarter.D) Airlines raise ticket prices in response to rising fuel costs.Answer: CComment: RecurringDiff: 1 Page Ref: 614/210Topic: Macroeconomics vs. MicroeconomicsObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

5) Suppose, in 2010, you purchased a house built in 2003. Which of the following would be included in the gross domestic product for 2010?A) the value of the house in 2010 (the house is built in 2003, not current production!!!)B) the value of the house in 2003 (included in GDP for 2003, not 2010)C) the value of the house in 2010 minus depreciation (same as (A))D) the value of the services of the real estate agent (correct, the service is current production)Answer: DComment: RecurringDiff: 2 Page Ref: 615/211Topic: Measuring Total ProductionObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

6) Which of the following goods is directly counted in GDP?A) the lettuce that Subway purchases for its sandwichesB) the bread that Subway purchases for its sandwichesC) a 12-inch Subway sandwich purchased by a studentD) the plastic bags that Subway purchases to wrap its sandwichesAnswer: CComment: RecurringDiff: 2 Page Ref: 615/211Topic: Final vs. Intermediate GoodsObjective: LO1: Explain how total production is measured.

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7) Which of the following is not directly counted in GDP?A) investment expendituresB) government purchasesC) intermediate goodsD) consumer goodsAnswer: CComment: RecurringDiff: 1 Page Ref: 615/211Topic: Final vs. Intermediate GoodsObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

8) Which of the following would be directly counted in GDP in 2010?A) kitchen cabinets purchased from Home Depot in 2010 to be installed in a house built in 1997 (correct, even if this house was built during prehistory period)B) kitchen cabinets built in 1887, extracted from the 1887 home, and installed in a brand new country-style home (not current production)C) kitchen cabinets built in 1887, extracted from the 1887 home, and installed in a farm house built in 1950 (same as (B))D) none of the aboveAnswer: AComment: RecurringDiff: 2 Page Ref: 615/211Topic: Measuring Total ProductionObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

Table 7-2

Product Quantity PriceShoes 40 $60.00DVDs 100 18.00Tomatoes 2,000 1.00Ketchup 300 4.00

9) Refer to Table 7-2. Suppose that a simple economy produces only four goods and services: shoes, DVDs, tomatoes, and ketchup. Assume one half of the tomatoes are used in making the ketchup and the other half of the tomatoes are purchased by households. Using the information in the above table, nominal GDP for this simple

economy equalsA) $7,400.B) $6,400. (Assume one half of the tomatoes are used in making the ketchup and the other half of the tomatoes are purchased by households.)C) $5,800.D) 2,440 units.Answer: BDiff: 2 Page Ref: 616/212Topic: Measuring Total ProductionObjective: LO1: Explain how total production is measured.AACSB: Analytic SkillsSpecial Feature: Solved Problem: Calculating GDP

10) Which of the following is not an example of a transfer payment?(Payments by the government to individuals for which the government does not receive a new good or service in return. [not included in GDP] These payments include social security payments to retired and disabled people and unemployment insurance payments to unemployed workers.)A) unemployment insurance paymentsB) health insurance payments to an army private (receive health service in return)C) social security payments to retireesD) social security payments to disabled personsAnswer: BComment: RecurringDiff: 1 Page Ref: 618/214Topic: Measuring Total ProductionObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

11) Which of the following is not a durable good?A) furnitureB) automobileC) clothing (nondurable???)D) refrigeratorAnswer: CComment: RecurringDiff: 1 Page Ref: 618-619/214-215Topic: Components of GDPObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

12) Investment, as defined by economists, would include the purchase of a

(Investment in economists’ minds is much narrower than everyday use. It is reserved for the purchases of machinery, factories, and houses. Economists don’t include purchase of stock or bond in investment because those activities do not result in production of new goods and services.)A) corporate bond.B) government bond.C) share of stock in ExxonMobil. D) computer by an accounting firm.Answer: DComment: RecurringDiff: 1 Page Ref: 618-619/214-215Topic: Components of GDPObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

13) To calculate GDP by the expenditure method, one must addA) wages, rents, interest, and profits.B) consumption spending, investment spending, government spending and net exports.C) consumption spending, investment spending, government spending and exports.D) labor, natural resources, entrepreneurship, and capital.Answer: BComment: RecurringDiff: 1 Page Ref: 619-620/215-216Topic: Measuring Total ProductionObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

14) The purchase of a new house is included inA) consumption expenditures.B) investment expenditures.C) government purchases.D) net exports.Answer: BComment: RecurringDiff: 1 Page Ref: 618-619/214-215Topic: Components of GDPObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

15) The purchase by a foreign government of an airplane produced in the United

States is included in U.S.A) consumption expenditures.B) investment expenditures.C) government purchases.D) net exports.Answer: DComment: RecurringDiff: 1 Page Ref: 618-619/214-215Topic: Components of GDPObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

16) In 2008, which component of GDP had a negative value?A) consumption B) investmentC) government spendingD) net exportsAnswer: DDiff: 1 Page Ref: 618-619/214-215Topic: Components of GDPObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

17) In the United States since the mid-1980s, consumption as a percentage of GDP hasA) increased.B) slowly decreased.C) remained the same.D) dropped by more than half.Answer: ADiff: 1 Page Ref: 620-622/216-218Topic: Components of GDPObjective: LO1: Explain how total production is measured.Special Feature: Making the Connection: Will U.S. Consumers Be Spending Less?

18) In March 2009, automobile sales in the United States fell 35 percent from the previous month. The decrease in auto sales impacts GDP because new automobiles are counted as ________ when purchased by households and ________ when purchased by businesses.A) nondurable goods; durable goodsB) consumption; investmentC) investment; consumption

D) durable goods; nondurable goodsAnswer: BDiff: 2 Page Ref: 632/228Topic: Components of GDPObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: An Inside LOOK at Policy: Falling Auto Purchases Lead to Lower GDP

Table 7-3

Consumption expenditures $800Investment expenditures 200Government purchases 300Exports 100Imports 200Wages (should be excluded) 800

19) Refer to Table 7-3. Consider the data above (in billions of dollars) for an economy: Gross domestic product (in billions of dollars) for this economy equals A) $2,200.B) $1,600.C) $1,400.D) $1,200.Answer: DComment: RecurringDiff: 2 Page Ref: 619-620/215-216Topic: Components of GDPObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

20) Which of the following is not true about the composition of GDP in 2008?A) The majority of consumer spending is on durable goods.B) Purchases made by state and local governments are greater than purchases made by the federal government.C) Imports are greater than exports.D) Business fixed investment is the largest component of investment.Answer: ADiff: 2 Page Ref: 618-619/214-215Topic: Components of GDPObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

Table 7-5

Stage of Production Seller Buyer Price1 Steel mill Auto manufacturer $10,0002 Auto manufacturer Auto dealer 18,0003 Auto dealer Consumer 25,000

Consider the table above showing three stages of production of an automobile.

21) Refer to Table 7-5. The value added by the automobile dealer equalsA) $7,000. (25,000-18,000, valued added by dealer. Selling price in current stage of production minus that in previous stage of production.)B) $15,000. (25,000-10,000??? does not make sense)C) $18,000. (value of the car for manufacturer, not added value)D) $25,000. (value of the car for dealer, not added value by auto dealer)Answer: AComment: RecurringDiff: 2 Page Ref: 622/218Topic: Measuring GDP by the Value Added MethodObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

22) Refer to Table 7-5. The value of each automobile in gross domestic product equals (selling price in the final stage of production!!!, i.e. selling price for dealer)A) $7,000. (value added)B) $15,000. (does not make sense)C) $18,000. (not selling price in the final stage of production)D) $25,000.Answer: DComment: RecurringDiff: 2 Page Ref: 622/218Topic: Measuring GDP by the Value Added MethodObjective: LO1: Explain how total production is measured.AACSB: Analytic SkillsSpecial Feature: None

23) Why do we not count the value of intermediate goods and services in gross domestic product? Does the value of intermediate goods and services show up in gross domestic product? If so, how?Answer: We would double count if we counted directly the value of intermediate goods and services, because their value shows up in the value of the final goods and services in which they are a part.

Comment: RecurringDiff: 2 Page Ref: 615/211Topic: Measuring Total ProductionObjective: LO1: Explain how total production is measured.AACSB: Reflective ThinkingSpecial Feature: None

Table 7-7

Product Quantity PriceSweaters 50 $50.00CDs 150 10.00Sugar 600 1.00Soft drinks 800 0.75

24) Refer to Table 7-7. Suppose that a simple economy produces only four goods and services: sweaters, CDs, sugar, and soft drinks. Assume one half of the sugar is used in making the soft drinks and the other half of the sugar is purchased by households. Calculate nominal GDP for this simple economy.Answer: Nominal GDP equals (50 × $50) + (150 × $10) + ((600 × .5) × $1)) + (800 × 0.75) = $4,900.Diff: 3 Page Ref: 619-620/215-216Topic: Measuring Total ProductionObjective: LO1: Explain how total production is measured.AACSB: Analytic SkillsSpecial Feature: Solved Problem: Calculating GDP

7.2 Does GDP Measure What We Want It to Measure?

1) The Philippines and Vietnam have roughly the same size population. Suppose the GDP of the Philippines is $1,000 billion and the GDP of Vietnam is $10,000 billion. You should concludeA) a typical person in Vietnam is 10 times as well off as the typical person in the Philippines.B) a typical person in Vietnam is more than 10 times as well off as the typical person in the Philippines.C) a typical person in Vietnam is less than 10 times as well off as the typical person in the Philippines.D) it is not possible to make a good comparison of the economic well being of a typical individual in the 2 countries without additional information.Answer: DDiff: 2 Page Ref: 613/209Topic: Shortcomings in GDP as a Measure of Total ProductionObjective: LO2: Discuss whether GDP is a good measure of well-being.

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2) Gross domestic product understates the total production of final goods and services because of the omission ofA) the underground economy.B) intermediate goods.C) inflation.D) exports.Answer: AComment: RecurringDiff: 1 Page Ref: 623/219Topic: Shortcomings in GDP as a Measure of Total ProductionObjective: LO2: Discuss whether GDP is a good measure of well-being.AACSB: Reflective ThinkingSpecial Feature: None

3) The size of the underground economy would tend to increase if the government of a countryA) decreased government regulations on businesses.B) increased income tax rates.C) legalized prostitution.D) legalized marijuana.Answer: BComment: RecurringDiff: 2 Page Ref: 623/219Topic: Shortcomings in GDP as a Measure of Total ProductionObjective: LO2: Discuss whether GDP is a good measure of well-being.AACSB: Reflective ThinkingSpecial Feature: None

4) Which of the following statements about the underground economy is true?A) The underground economy in developing countries amounts to less than 10% of measured GDP.B) Most transactions that occur in the underground economy are included in the calculation of GDP.C) Excluding underground economy production from measured GDP causes errors in GDP growth estimates in the long run.D) Income that is earned but not reported as income for tax purposes is included in the calculation of GDP.Answer: CComment: RecurringDiff: 2 Page Ref: 623/219

Topic: Shortcomings in GDP as a Measure of Total ProductionObjective: LO2: Discuss whether GDP is a good measure of well-being.AACSB: Reflective ThinkingSpecial Feature: None

5) Which of the following statements is true?A) A decrease in the crime rate increases GDP as people will spend more on security. (spend less on security)B) Household production is counted in GDP as it amounts to real production. (household production is not counted, one of shortcomings of GDP)C) GDP accounting rules do not adjust for production that pollutes the economy.D) GDP growth distributes income equally to people in the economy. (GDP may not be a good measure of how pie is divided up.)Answer: CComment: RecurringDiff: 2 Page Ref: 623/219Topic: Shortcomings in GDP as a Measure of Total ProductionObjective: LO2: Discuss whether GDP is a good measure of well-being.AACSB: Reflective ThinkingSpecial Feature: None

6) The U.S. work week has declined from 60 hours in 1890 to 40 hours today. The impact of the decline in working hoursA) increases U.S. GDP and increases the well-being of a typical working person in the U.S.B) increases U.S. GDP and decreases the well-being of a typical working person in the U.S.C) decreases U.S. GDP and increases the well-being of a typical working person in the U.S.D) decreases U.S. GDP and decreases the well-being of a typical working person in the U.S.Answer: CComment: RecurringDiff: 2 Page Ref: 623/219Topic: Shortcomings in GDP as a Measure of Total ProductionObjective: LO2: Discuss whether GDP is a good measure of well-being.AACSB: Reflective ThinkingSpecial Feature: None

7) Increases in real GDP would overstate the increase in the well-being of a country over time if, over that time period, the(In other words, which of the followings implies a decrease in well-being?)A) average hours worked per week increased. (less leisure)B) amount of pollution decreased. (better off)

C) price level increased. (real GDP only uses base year price level)D) crime rate decreased. (better off)Answer: AComment: RecurringDiff: 2 Page Ref: 623/219Topic: Shortcomings in GDP as a Measure of Total ProductionObjective: LO2: Discuss whether GDP is a good measure of well-being.AACSB: Reflective ThinkingSpecial Feature: None

8) Increases in real GDP would understate the well-being of a country over time if, over that time period, the(In other words, which of the followings implies an increase in well-being?)A) crime rate increased. (worse off)B) percentage of people addicted to illegal drugs increased. (worse off)C) amount of pollution decreased. (better off)D) average hours worked per week decreased. (better off)Answer: C DComment: RecurringDiff: 2 Page Ref: 624-625/220-221Topic: Shortcomings in GDP as a Measure of Well-BeingObjective: LO2: Discuss whether GDP is a good measure of well-being.AACSB: Reflective ThinkingSpecial Feature: None

7.3 Real GDP versus Nominal GDP

1) Nominal GDP is GDP in a given yearA) adjusted for inflation.B) adjusted for anticipated inflation.C) valued in the prices of that year.D) valued in the prices of the base year.Answer: CComment: RecurringDiff: 1 Page Ref: 626-627/222-223Topic: Real GDP versus Nominal GDPObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Reflective ThinkingSpecial Feature: None

Table 7-8

YearGuns Produced Price of Guns

Butter Produced

Price of Butter

2002 80 $5 40 $4 2009 90 6 60 10

Consider the following data for Tyrovia, a country that produces only two products: guns and butter.

2) Refer to Table 7-8. Real GDP for Tyrovia for 2009 using 2002 as the base year equalsA) $1,140.B) $880.C) $690.D) $560.Answer: CDiff: 2 Page Ref: 627/223Topic: Calculating Real GDPObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Analytic SkillsSpecial Feature: Solved Problem: Calculating Real GDP

Table 7-9

YearNominal GDP Real GDP

2006 $7,400 $7,537 2007 (base) 7,813 7,813 2008 8,301 8,165 2009 8,760 8,516

3) Refer to Table 7-9. Consider the following data on nominal GDP and real GDP (values are in billions of dollars): The base year used in calculating real GDP is(In the base year, real GDP = nominal GDP)A) 2006.B) 2007.C) 2008.D) 2009.Answer: BComment: RecurringDiff: 2 Page Ref: 626-627/222-223Topic: Calculating Real GDPObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Reflective ThinkingSpecial Feature: None

Table 7-10

YearOranges Produced

Price of Oranges

Shirts Produced

Price of Shirts

2007 1,800 $0.90 110 $30.00 2009 2,000 1.00 110 35.00

Consider the data shown above for Vicuna, a country that produces only two products: oranges and shirts.

6) Refer to Table 7-10. Real GDP for Vicuna for 2007 using 2009 as the base year equalsA) $4,620.B) $5,100.C) $5,650.D) $5,850.Answer: CComment: RecurringDiff: 2 Page Ref: 626-627/222-223Topic: Calculating Real GDPObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Analytic SkillsSpecial Feature: None

7) Refer to Table 7-10. Nominal GDP for Vicuna for 2007 equalsA) $4,920.B) $5,100.C) $5,300.D) $5,850.Answer: AComment: RecurringDiff: 2 Page Ref: 626-627/222-223Topic: Measuring Total ProductionObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Analytic SkillsSpecial Feature: None

8) To examine how the total production of an economy has changed over time, it would be better to examineA) real GDP.B) nominal GDP.C) GDP at current prices.D) the GDP deflator.

Answer: AComment: RecurringDiff: 2 Page Ref: 626-627/222-223Topic: Real GDP versus Nominal GDPObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Reflective ThinkingSpecial Feature: None

9) Real GDP will increase(Real GDP holds price level constant, making it a better measure of total production and income. Indeed, economic growth is almost always measured by the real GDP growth. If a headline in Wall Street Journal states, “U.S. economy grew 5% last year”, it means that U.S. real GDP increases by 5% during the previous year.)A) only if the price level rises. (Real GDP holds price level constant)B) only if the price level falls. (Real GDP holds price level constant)C) only if the quantity of final goods and services produced rises.D) if either the price level rises or the quantity of final goods and services produced rises. (Real GDP holds price level constant)Answer: CComment: RecurringDiff: 3 Page Ref: 627-628/223-224Topic: Real GDP versus Nominal GDPObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Reflective ThinkingSpecial Feature: None

10) The GDP deflator is the A) difference between real GDP and nominal GDP multiplied by 100.B) difference between nominal GDP and real GDP multiplied by 100.C) ratio of real GDP to nominal GDP multiplied by 100.D) ratio of nominal GDP to real GDP multiplied by 100.Answer: DComment: RecurringDiff: 1 Page Ref: 628-629/224-225Topic: The GDP DeflatorObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Reflective ThinkingSpecial Feature: None

11) The GDP deflator is a measure of theA) total production of the economy adjusted for inflation.B) total production of the economy unadjusted for inflation.

C) average level of prices of final goods and services in the economy.D) average level of prices of intermediate goods and services in the economy.Answer: CComment: RecurringDiff: 1 Page Ref: 628-629/224-225Topic: The GDP DeflatorObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Reflective ThinkingSpecial Feature: None

12) The GDP deflator in year 2 is 105, using year 1 as the base year. This means that, on average, the cost of goods and services is A) 5% higher in year 2 than in year 1.B) 105% higher in year 2 than in year 1.C) 5% higher in year 1 than in year 2.D) 105% higher in year 1 than in year 2.Answer: AComment: RecurringDiff: 2 Page Ref: 628-629/224-225Topic: The GDP DeflatorObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Analytic SkillsSpecial Feature: None

Table 7-11

YearNominal GDP Real GDP

2007 14,078 13,254 2008 14,441 13,312

13) Refer to Table 7-11. Consider the following data on nominal GDP and real GDP (values are in billions of dollars): The GDP deflator for 2008 equalsA) 92.2.B) 102.6.C) 108.5.D) 109.1.Answer: CComment: RecurringDiff: 2 Page Ref: 628-629/224-225Topic: The GDP DeflatorObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Analytic SkillsSpecial Feature: None

14) If the GDP deflator is equal to 100, then for that year nominal GDP is equal to real GDPAnswer: TRUEComment: RecurringDiff: 1 Page Ref: 627-628/223-224Topic: The GDP DeflatorObjective: LO3: Discuss the difference between real GDP and nominal GDP.AACSB: Reflective ThinkingSpecial Feature: None