GDP

Question 1

what is the circular flow diagram?

Answer 1

illustrates the interdependence of the macroeconomy

Question 2

explain the circular flow of income and resources

Answer 2

*PICTURE

Question 3

what is the difference between income, output, and spending?

Answer 3

they are all the same

all output that’s produced gets sold at some market price, therefore the market value of total output must be equal to total spending

every dollar that someone spends is a dollar of income for someone else, hence total spending must be equal to total income

Question 4

what is GDP?

Answer 4

GDP is gross domestic product

the market value of all final goods and services produced within a country in a year

key measure of economic activity

Question 5

describe what it means by “GDP is the market value” in the definition of GDP

Answer 5

the value of each item is its market price times the quantity produced

the value of everything produced is added up

Question 6

what does it mean by “of all” in the GDP definition?

Answer 6

as a comprehensive measure, GDP includes everything produced and sold in markets

nonmarket (underground economy) goods and services are not included

Question 7

what does it mean by “final goods and services” in the GDP definition?

Answer 7

• intermediate goods and services are not included (ex. lumber used to make a couch)
• only final goods and services are included (ex. the couch)

Question 8

what does it mean by “produced” in the GDP definition?

Answer 8

• GDP measures production, so it does not count the resale of existing goods and services
• second hand sales change only the ownership of the product

Question 9

what does it mean by “within a country” in the GDP definition?

Answer 9

• US GDP measures what is collectively produced domestically (within the US)
• this includes products made in the US by foreign owned businesses
• US GDP does not include products made in foreign countries by American-owned businesses

Question 10

what does it mean by “in a year” in the GDP definition?

Answer 10

• we need a time frame for GDP
• a year is typically used, although measures are also reported quarterly

Question 11

what are the three ways of measuring GDP?

Answer 11

since GDP is total spending, total output, and total income, we can calculate GDP by either

1) add up all spending
2) add up every dollars worth of output produced
3) add up all income

Question 12

how is total output calculated?

Answer 12

value added = total sale - cost of intermediate inputs

Question 13

what does value added mean?

Answer 13

the amount by which the value of an item is increased at each stage of production

Question 14

how is total income measured?

Answer 14

total income = total wages + total profits

capital gains and losses are not counted as new income (your earnings or losses from selling an existing asset)

called gross domestic income

Question 15

what is labour share?

Answer 15

describes the share of total income goings to workers

Question 16

what is capital share?

Answer 16

describes the share of total income going to owners of capital

Question 17

what is the trend observed with labour share?

Answer 17

labour’s share of GDP is declining (more money is going to the firms rather than the labourers)

Question 18

how do you measure total spending?

Answer 18

Y = C + I + G + NX = C + I + G + (X-IM)

C = consumption = household purchases

I = investment = business purchases

G = government purchases

NX = net exports

X = exports

IM = imports

Question 19

what are some of the limitations of GDP?

Answer 19

1. prices are not values
2. nonmarket activities are excluded
3. the shadow economy is missing
4. environmental degradation isn’t counted
5. leisure doesn’t count
6. GDP ignores distribution

Question 20

what does it mean by prices are not values as a limitation?

Answer 20

GDP effectively assigns each good and service a value equal to its market price

price is not a good indicator of value when either consumer surplus or a market failure is present

Question 21

what does it mean by nonmarket activities are excluded as a limitation?

Answer 21

GDP does not measure all productive activity

non market activities are omitted from GDP

Question 22

what does it mean by the shadow economy is missing as a limitation?

Answer 22

the shadow economy includes economic activity purposely conducted out of view of the government

these activities are unmeasured and therefore are excluded from GDP

Question 23

what does it mean by environmental degradation isn’t counted as a limitation?

Answer 23

GDP treats natural resources as if they have no value until they are transformed into something else

the cost of environmental degradation is ignored

Question 24

what does it mean by “leisure doesn’t count” as a limitation?

Answer 24

GDP includes the benefit of work, which is more income

GDP does not include the cost of work, which is less leisure

Question 25

what does it mean by “GDP ignores distribution” as a limitation?

Answer 25

the rich get richer, the poor stay the same

• Higher GDP is correlated with better life outcomes

Question 26

what is nominal GDP?

Answer 26

GDP measured in today’s prices

measures the value of GDP right now, based on current prices

Question 27

what is real GDP?

Answer 27

GDP measured in constant prices

excludes the effect of price changes

measures changes in the quantity of output produced

used to measure economic growth

take average of two years to calculate real GDP

Question 28

what is the formula for GDP deflator?

Answer 28

GDP deflator = nominal GDP / real GDP x 100

OR

GDP deflator = (ptqt)/ (p0qt) x100

Question 29

what is the rule of 70?

Answer 29

used to evaluate long-run growth

divide 70 by the GDP growth rate per year