1.Gross domestic product measures two things at once: (1) the total income of everyone in the economy and (2) the total expenditure on the economy’s output of final goods and services. It can measure both of these things at once because all expenditure in the economy ends up as someone’s income.
2.The production of a pound of caviar contributes more to GDP than the production of a pound of hamburger because the contribution to GDP is measured by market value and the price of a pound of caviar is much higher than the price of a pound of hamburger.
3.The four components of expenditure are: (1) consumption; (2) investment; (3) government purchases; and (4) net exports. The largest component is consumption, which accounts for more than two-thirds of total expenditure.
4.Real GDP is the production of goods and services valued at constant prices. Nominal GDP is the production of goods and services valued at current prices. Real GDP is a better measure of economic well-being because changes in real GDP reflect changes in the amount of output being produced. Thus, a rise in real GDP means people have produced more goods and services, but a rise in nominal GDP could occur either because of increased production or because of higher prices.
5.Although GDP is not a perfect measure of well-being, policymakers should care about it because a larger GDP means that a nation can afford better healthcare, better educational systems, and more of the material necessities of life.
Questions for Review:
1.An economy's income must equal its expenditure, because every transaction has a buyer and a seller. Thus, expenditure by buyers must equal income by sellers.
2.The production of a luxury car contributes more to GDP than the production of an economy car because the luxury car has a higher market value.
3.The contribution to GDP is $3, the market value of the bread, which is the final good that is sold.
4.The sale of used records does not affect GDP at all because it involves no current production.
5.The four components of GDP are consumption, such as the purchase of a music CD; investment, such as the purchase of a computer by a business; government purchases, such as an order for military aircraft; and net exports, such as the sale of American wheat to Russia. (Many other examples are possible.)
6.Economists use real GDP rather than nominal GDP to gauge economic well-being because real GDP is not affected by changes in prices, so it reflects only changes in the amounts being produced. You cannot determine if a rise in nominal GDP has been caused by increased production or higher prices.
|Year |Nominal GDP |Real GDP |GDP Deflator | |2010 |100 X $2 = $200 |100 X $2 = $200 |($200/$200) X 100 = 100 | |2011 |200 X $3 = $600 |200 X $2 = $400 |($600/$400) X 100 = 150 |
The percentage change in nominal GDP is (600 − 200)/200 x 100 = 200%. The percentage change in real GDP is (400 − 200)/200 x 100 = 100%. The percentage change in the deflator is (150 − 100)/100 x 100 = 50%.
8.It is desirable for a country to have a large GDP because people could enjoy more goods and services. But GDP is not the only important measure of well-being. For example, laws that restrict pollution cause GDP to be lower. If laws against pollution were eliminated, GDP would be higher but the pollution might make us worse off. Or, for example, an earthquake would raise GDP, as expenditures on cleanup, repair, and rebuilding increase. But an earthquake is an undesirable event that lowers our welfare.
Problems and Applications
1.a.Consumption increases because a refrigerator is a good purchased by a household. b.Investment...