GDP: A Measure of Total Production and Income 5 CHECKPOINTS 2

Checkpoint 5.1 Checkpoint 5.2 Checkpoint 5.3 Problem 1 Problem 1

Practice Problem 1 CHECKPOINT 5.1 Classify each of the following items as a final good or an intermediate good and identify which is a component of consumption expenditure, investment, or government expenditure on goods and services. Banking services bought by a student. New cars bought by Hertz, the car rental firm Newsprint bought by USA Today from International Paper. The purchase of a new aircraft for the Vice-president New house bought by the family of Al Gore 4

CHECKPOINT 5.1 Solution The student’s banking service is a final service and part of consumption expenditure. Hertz’s new cars are additions to capital, so they are part of investment and final goods. Newsprint is a component of the newspaper, so it is an immediate good. The purchase of a new aircraft for the Vice-president is a final good and is part of government expenditure. The new house is a final good and part of investment. 5

Practice Problem 2 CHECKPOINT 5.1 The figure shows the flows of expenditure and income on Lotus Island. In 2008: R was $10 billion W was $30 billion U was $12 billion X was $15 billion Z was $3 billion. Calculate total expenditure and total income. 6

CHECKPOINT 5.1 Solution Total expenditure is the sum of red flows: C, I, G, and NX. On the figure: C is the flow W I is the flow X G is the flow U NX is the flow Z 7

CHECKPOINT 5.1 So total expenditure equals W + X + U + Z. Total expenditure equals $(30 + 15 + 12+ 3) billion, which is $60 billion. Total income is the blue flow, Q. But total income equals total expenditure, so total income is $60 billion. 8

Practice Problem 3 CHECKPOINT 5.1 U.S. economy shrinks modestly GDP fell at a 1 percent annual rate in the second quarter of 2009. Businesses cut investment by 8.9 percent, consumers cut spending by 1.2 percent, purchases of new houses fell 38 percent, and exports fell 29.9 percent. Source: Reuters, July 31, 2009 Use the letters on the circular flow figure to indicate the flows in which the items in the news clip occur. How can GDP have fallen by only 1.0 percent with the big cuts in expenditure reported? 9

Solution CHECKPOINT 5.1 GDP is the sum of flows W, X, U, and Z. Business investment and purchases of new housing are part of X, Consumption expenditure is W, and Exports are part of Z. 10

CHECKPOINT 5.1 The fall in GDP is smaller than the cuts in expenditures because either government expenditure increased or imports decreased. 11

Practice Problem 1 CHECKPOINT 5.2 The table shows some of the items in the U.S. National Income and Product Accounts in 2005. Use the expenditure approach to calculate U.S. GDP in 2005. 12

CHECKPOINT 5.2 Solution The expenditure approach sums the expenditure on final goods and services. That is, GDP = C + I + G + NX. In 2005: GDP = ($8.7 + $2.0 + $2.3  $0.7) trillion GDP was $12.3 trillion. 13

Practice Problem 2 CHECKPOINT 5.2 The table shows some of the items in the U.S. National Income and Product accounts in 2005. What was U.S. GDP as measured by the income approach in 2005? By how much did gross product and net product differ in 2005? 14

CHECKPOINT 5.2 Solution GDP as measured by the income approach equals GDP as measured by the expenditure approach plus the statistical discrepancy. The statistical discrepancy is zero, so GDP is $12.3 trillion. GDP as measured by the income approach was $12.3 trillion. 15

CHECKPOINT 5.2 Gross product minus net product equals depreciation, which was $1.5 trillion in 2005. 16

Practice Problem 3 CHECKPOINT 5.2 The table shows some of the items in the U.S. National Income and Product Accounts in 2005. Calculate U.S. GNP and U.S. national income in 2005. 17

Solution CHECKPOINT 5.2 GNP = GDP + Net factor income from abroad. In 2005, GNP = $(12.3 + 0.1) trillion, which was $12.4 trillion. 18

CHECKPOINT 5.2 National income = GNP  Depreciation  Statistical discrepancy. The statistical discrepancy is zero, so in 2005, National income = $(12.4  $1.5) trillion, which is $10.9 trillion. 19

Practice Problem 4 CHECKPOINT 5.2 The table shows some data for an economy. If the base year is 2006, calculate the economy’s nominal GDP and real GDP in 2008. 20

CHECKPOINT 5.3 Solution Nominal GDP in 2008 at 2008 prices equals (160 apples x $1.00) + (220 oranges x $2.00), which equals $600. Real GDP in 2008 at 2006 prices equals (160 apples x $0.50) + (220 oranges x $0.25), which equals $135. 21

Practice Problem 5 CHECKPOINT 5.2 As consumers reduce their spending, inventories are rising The Commerce Department reported that sales of nondurable goods fell 0.6 percent, while sales of durable goods decreased 1.5 percent in August. Inventories of durable goods increased 1.4 percent. Source: Reuters, October 9, 2008 Which component of GDP changed when (i) sales of non-durable goods fell, (ii) sales of durable goods decreased, and (iii) inventories of durable goods increased? Provide an example of each item of expenditure. 22

CHECKPOINT 5.2 Solution Sales of nondurable goods such as strawberries are bought by households and are part of consumption expenditure, C. Sales of durable goods such as iPhones that are bought by households are part of consumption expenditure, C, and sales of durable goods such as tower cranes bought by firms are part of investment, I. An inventory of durable goods, such as the auto parts at a Ford plant, is part of investment, I. 23

Practice Problem 1 CHECKPOINT 5.3 The UN reported the following real GDP per person in 2002: China $4,580; Russia $8,230; Canada $29,480; and the United States $35,750. In Canada and the United States, household production is similar and smaller than in China and Russia. The underground economy is largest in Russia and China and a similar proportion of these economies. Canadians and Americans enjoy more leisure hours than do the Chinese and Russians. 24

CHECKPOINT 5.3 In which pair (or pairs) of these four countries is it easiest to compare the standard of living? In which pair (or pairs) of these four countries is it most difficult to compare the standard of living? Why? 25

CHECKPOINT 5.3 Solution Two pairs—Canada and the United States, and China and Russia—are easy to compare because household production, the underground economy, leisure hours, and the environment are similar in the countries in each pair. The most difficult comparison is Canada and the United States with either China or Russia. Household production and the underground economy narrow the differences, but leisure hours and the environment widen them. 26

Practice Problem 2 CHECKPOINT 5.3 The UN reported the following real GDP per person in 2002: China $4,580; Russia $8,230; Canada $29,480; and the United States $35,750. In Canada and the United States, household production is similar and smaller than in China and Russia. The underground economy is largest in Russia and China and a similar proportion of these economies. Canadians and Americans enjoy more leisure hours than do the Chinese and Russians. 27

CHECKPOINT 5.3 Do the differences in real GDP per person rank the standard of living in these four countries? What additional information would we need to be able to make an accurate assessment of the relative standard of living in these four countries? 28

CHECKPOINT 5.3 Solution Differences in real GDP per person probably correctly rank the standard of living in these four countries because where the gap is small (Canada and the United States), other factors are similar, and where other factors differ, the gaps are huge. We would need more detailed information on the value of household production, the underground economy, the value of leisure, and the value of environmental differences to make an accurate assessment of relative living standards. 29

Practice Problem 3 CHECKPOINT 5.3 Economists look to expand GDP to include the quality of life Robert Kennedy, when seeking the Democratic presidential nomination 40 years ago, remarked that GDP measures everything except that which makes life worthwhile. Source: The New York Times, September 1, 2008 Which items did Robert Kennedy probably think were missing? 30

CHECKPOINT 5.1 Solution GDP measures production that is traded in markets. GDP does not include household production, leisure time, health and life expectancy, political freedom, and social justice. These items are probably the ones that Kennedy believed were missing from GDP as a measure of the quality of life. 31