Ch 22 Study Guide Practice Problem #1 Year 1Year 2Year 3 GDP$4532$4804??? Consumption???$3320$3544 Investment$589$629$673 Govt. Purchase$861???$977 NX$-45$-58$-54 $5140 $3127 $913

1b. Largest expenditure component of GDP? Consumption C. does investment include the purchase of stocks and bonds? Why? No, they are financial transactions. There is no production of goods or services D. Do government purchases include government spending on unemployment checks? Why? No – considered transfer payments. No production or exchange of goods/services E. What does it mean when NX are negative? The country imports more goods than it exports NX = X-M ….so if –NX, then M>X

Practice Problem #2 Year Production of X Price X $ $ $20 a. Nominal GDP (P x Q) b. Real GDP (current year Q x base yr P) 2000 $ $ $ $ $ $100

Economic Growth? What does it tell us when NGDP increases? Could be increase in production Could be increase in price Could be combination of production and price What does it tell us when RGDP increases? …b/c P is held constant to base year ….increase is due to increase in Q ….= ECONOMIC GROWTH

Year Production of X Price X $ $ $20 Nominal GDP (P x Q) Real GDP (current year Q x base yr P) 2000 $ $ $ $ $ $100 Conclusions??? Economic growth? Price Levels? There was no economic growth. There was only an increase in price level

#3 Year P soda Q soda P jeans Q jeans NGDP RGDP 2000 $1 200 $ $1 220 $11 50 Mistake – avoid looking at each individual good – remember this is a model for the entire economy ex of wrong answer: conclude the economy grew for soda but not for jeans……this does not make sense e. Value of GDP Deflator in 2000? NGDP / RGDP x 100 : always 100 in base year f. Value of GDP Deflator in 2001? 770/720 x 100 = 107 GDP = $$$$$$ Deflator is NOT $$ nor % …IS index based on 100 a. $700b. $700 c. $770d. $720

g. from : prices rose approximately what percentage? Compare GDP deflators – measure the change in price level 2 nd -1 st / 1 st /100 = 7% h. was the increase in NGDP from mostly due to an increase in real output or prices? NGDP rose from $700 to $770 = 10% increase Increase in real output = RGDP 2000=$ = $ % (3%) Increase in prices = Deflator = 7% Conclude – 10%increase in NGDP was MOSTLY due prices (7%) vs. output (3%)

Evaluate Was there economic growth? Yes … RGDP…. Or – Real output…. Or ……the economy ……. Grew at a 3% rate The growth rate of the economy was 3% ….”normal growth” = 3% per year – long term trend since the 1950’s

………but……… Price level or inflation increased by 7% …..not good to have inflation outpace production “normal” inflation is 1%-2%

#4 Complete Table Year NGDPRGDPGDP Deflator $ $ $150$ Year 1 Math: Nom/Real x 100 = Deflator…$x / $100 x 100 = 100 = NGDP = $100 Year 2 Math: $120 /$x x100 = 120 RGDP = 100 Year 3 Math: $150/$125 x 100 = 120 a.What is base year? How can you tell ? If Nom and Real are always same in base year, then GDP Deflator will always be 100 in the base year…..so year 1 is base year $

Year NGDPRGDPGDP Deflator $ $ $150$ b. From year 1 to year 2, did real output rise or did prices rise? Explain The change from year 1 to 2 was due to price rising. The Nom and Deflator rose 20% but Real did not change at all..indicating no change in output(RGDP measures growth in output) …so prices rose by 20% c. From year 2 to year 3, did real output rise or did prices rise? Explain The change from year 2 to 3 was due to output rising. The Nom and Real both increased by 25% but the Deflator did not change….indicating no change in price….so output rose by 25% $

Year NGDPRGDPGDP Deflator $ $ $150$ $ BONUS: Evaluate the growth of this economy from year 1 to year 3 The economy grew by 25% (based on RGDP) …. …but prices also grew by 20% (based on the deflator)