Chapter 5

Question 1

Why does production occur in stages?

Answer 1

It occurs in stages because, even though one firm might say that their product is “complete”, another firm might use that “completed” product in the production process of their own product. Therefore, some firm’s outputs can be considered as another firm’s inputs

Question 2

What is the error that would arise in estimating the nation’s output by adding all sales of all firms called?

Answer 2

Double counting

Question 3

What does double counting do?

Answer 3

It compares intermediate goods to final goods

Question 4

What are intermediate goods?

Answer 4

They are outputs used a inputs

Question 5

What are final goods?

Answer 5

They are goods produced to be sold for consumption (this includes investment goods, government goods, exports, etc.)

Question 6

How can we avoid double counting? (what equation can be used to prevent this?)

Answer 6

By using the concept of value added
Value added = sale revenue - cost of intermediate goods
or
Value added = Payments owed to the firm’s factors of production
Economy’s total output is the sum of all values added

Question 7

What are the three different ways of measuring national income?

Answer 7

The concept of value added
Sum of the total flow of expenditure on final domestic output
Sum of the total flow of income generated by the flow of domestic production

Question 8

What do the three ways of measuring national income yield?

Answer 8

They all yield the gross domestic product (GDP) which is the total value of goods and services produced in the economy during a given period

Question 9

How is GDP calculated from the expenditure side?

Answer 9

By adding all the expenditures needed to purchase the final output produced in that year

Question 10

What is consumption expenditure?

Answer 10

It is the household expenditure of goods and services

Question 11

What is investment expenditure?

Answer 11

It is the expenditure on the production of goods not for present consumption

Question 12

What is the equation for adding all expenditures needed to purchase the final output produced during the year?

Answer 12

GDP = C + I + G + X - imports

Question 13

What does C, I, G, and X stand for in the equation that calculates GDP through the expenditure method?

Answer 13

C = Consumption expenditure
I = Investment expenditure
G = Government purchases
X = Exports expediture

Question 14

What does investment expenditure include?

Answer 14

Inventories (stocks of raw materials, goods in process, finished goods to mitigate the effects of short-term fluctuations in production or sales)
Capitol goods (capitol stock is the economy’s total quantity of capital goods)
Residential housing

Question 15

What is fixed investment?

Answer 15

It is the creation of new capitol goods

Question 16

What is gross investment?

Answer 16

It is the total investment that occurs in the economy

Question 17

What is depreciation? (from the capitol stock perspective)

Answer 17

It is the amount by which the capitol stock depleted through the production process

Question 18

How do you calculate Net Investment?

Answer 18

Net Investment = Gross investment - Depreciation

Question 19

What is the economy’s total quantity of capital goods called?

Answer 19

Capitol stock

Question 20

What is the total investment in any given year?

Answer 20

It is the sum of the changes in inventories, the additions to the stock of plant equipment, and the new construction of residential housing units

Question 21

What are government purchases?

Answer 21

They are expenditures on currently produced goods and services not including government transfer payments

Question 22

What are government transfer payments and why are they not considered to the expenditures?

Answer 22

Transfer payments are payments to individuals/institutions (public and private)without any exchange for a good or service

Question 23

How do you calculate Net Exports?

Answer 23

Net Exports = Exports - Imports

Question 24

What is the equation the total expenditure on domestically produced output?

Answer 24

GDP = C (actual) + I (actual) + G (actual) + NX (actual)

Question 25

What do the variables in the total expenditure on domestically produced output equation represent?

Answer 25

C(actual) = Actual Consumption Expenditure
I(actual) = Actual Investment Expenditure
G(actual) = Actual Government Purchases
NX(actual) = Actual Net Exports

Question 26

What does GDP from the income side involve?

Answer 26

It involves adding up factor incomes and other claims on the value of output until all of that value is accounted for

Question 27

What are factor incomes?

Answer 27

It is the flow of income derived from the factors of production

Question 28

What are the three main components of factor incomes?

Answer 28

wages and salaries, interest, and business profits

Question 29

What are non-factor payments

Answer 29

They are indirect taxes and taxes on the production and sale of goods and services
(Subsidies are like negative taxes, they are payments from the government to firms)

Question 30

What is depreciation? (in relation to non-factor payments)

Answer 30

They are the portion of current output to pay for the replacement of worn out physical capitol

Question 31

What is GDP from the Income side?

Answer 31

It is the sum of factor income plus indirect taxes (net of subsidies) plus depreciation
GDP = factor income + indirect + depreciation

Question 32

What do we include when we calculate GDP from the income side?

Answer 32

We include a “fudge factor”, what is called a statistical discrepancy

Question 33

What does a statistical discrepancy do?

Answer 33

It makes sure that the independent measures of income and expenditure come to the same total because, even though national income and national expenditure are conceptually identical, in practice both are measure with slight error

Question 34

What is nominal GDP? Real GDP?

Answer 34

Nominal GDP: Total GDP valued at current prices is called nominal GDP
Real GDP: GDP valued at base-period prices is called real GDP

Question 35

What does the GDP deflator do?

Answer 35

It compares what has happened to nominal GDP and real GDP by calculating the GDP deflator which is an index number derive by dividing nominal GDP by real GDP which measures the average change in price of all the items in GDP

Question 36

What is the GDP deflator equation?

Answer 36

(Nominal GDP / Real GDP) x 100

Question 37

What is the equation for Net Domestic Income at Factor Cost?

Answer 37

Net Domestic Income at Factor Cost = Wage and Salaries + Interest Income + Business Profits

Question 38

What do movements in the CPI measure?

Answer 38

It measures the change in average price of consumer goods

Question 39

What do movements in the GDP deflator reflect?

Answer 39

It reflects the change in the average price of goods produced in Canada

Question 40

What is GDP an excellent measure of?

Answer 40

The flow of economic activity in organized markets in a given year

Question 41

What activities take place outside of these organized markets?

Answer 41

Illegal Activities (Cannabis now formally included)
The Underground Economy
Home Production, Volunteering, and Leisure
Free Products in the Digital World
Economic “Bads”

Question 42

Why is the current approach of measuring GDP useful?

Answer 42

1. It would be difficult to correct the major omissions.
2. The level of GDP may be inaccurate but the change
   in GDP is a good indication of the changes in
   economic activity.
3. To design policies to control inflation it is necessary to know the flow of money payments made to produce
   and purchase Canadian output. Modified measures
   that included non-market activities would distort these
   figures and likely lead to policy errors.

Question 43

What is a good measure of average material living standards?

Answer 43

GDP, or changes in real per capita income