Lecture I

Question 1

What is GDP?

Answer 1

A measure of all currently produced final goods and services.

Formula: GDP (Y) = C + I + G + NX

Question 2

Describe each component of the GDP formula: GDP (Y) = C + I + G + NX

Answer 2

Consumption: Household purchases of goods and services. It can be broken down into consumer durable goods, consumer non-durable goods, and consumer services.

Investment: Three subcomponents: Fixed investment, residential construction investment, and inventory investment.

Government Purchases: Goods and services bought by the government, such as military
spending, road work, etc. Note that this does not include transfer payments/income
redistributions such as welfare grants.

Net Exports (NX): Gross exports (X) minus gross imports (Z). NX represents contribution of foreign sector to GDP. Exports are added because foreigners are buying part of your domestic production. Imports are subtracted because purchases of foreign goods will decrease purchases of domestic goods.

Question 3

What is GNP? Describe the formula.

Answer 3

Gross national product (GNP) offers a way to measure all of the goods and services produced by a country’s residents and businesses.

GNP = Consumption + Investment + Government + X (net exports) + Z (net income earned by domestic residents from overseas investments minus net income earned by foreign residents from domestic investments)

Question 4

Define the unemployment rate.

Answer 4

The number of unemployed persons expressed as a percentage of the labor force.

Question 5

What causes inflation?

Answer 5

Inflation is defined as a rise in the general level of prices; a plethora of factors contribute towards inflation–with one of the most common being excessive government spending that devaluates the currency.

Question 6

What is the price index?

Answer 6

A measure of the aggregate price level–which is a measure reflecting the overall prices of goods and services in an economy–relative to a chose base year.

Question 7

What is the Consumer Price Index (CPI)?

Answer 7

A measure of the retail prices of a fixed “market basket” of several thousand goods and services purchased by households.

Question 8

Explain the factors in the Federal Budget Deficit.

Answer 8

Federal government tax revenues minus outlays.

Question 9

What is a trade deficit?

Answer 9

The excess of imports over exports.

Question 10

Define Aggregate Demand.

Answer 10

The sum of the demands for current output by each buying sector of the economy: households, businesses, the government, and foreign purchasers of exports.

Question 11

What are the characteristics of a capital good?

Answer 11

Capital resources such as factories and machinery used to produce other goods.

Question 12

Define depreciation.

Answer 12

Portion of the capital stock that wears out each year.

Question 13

What constitutes an investment?

Answer 13

Part of GDP purchased by the business sector plus residential construction.
Goods or services purchased to create new goods or services.

Question 14

What are Net Exports?

Answer 14

Total gross exports minus imports.

Question 15

Describe the factors in National Income.

Answer 15

Sum of the earnings of all factors of production that come from current production.

Minus:
Corporate profits taxes and undistributed profits
Contributions to Social Security
Plus:
Transfer payments to persons (usually from government)
Personal interest income

Question 16

What is the Net National Product?

Answer 16

Gross National Product minus Depreciation.

Question 17

What is Nominal GDP?

Answer 17

GDP measured in current dollars.

Question 18

What is the Implicit GDP Deflator?

Answer 18

Index of the prices of goods and services included in GDP.

Question 19

What are the components of the Producer Price Index (PPI)?

Answer 19

Measures the wholesale prices of approximately 3,000 items.

Question 20

How does the CPI and PPI have an advantage over the Implicit GDP Deflator?

Answer 20

The CPI and PPI are available monthly, whereas the IGD is available only quarterly.

Question 21

Define monetary policy.

Answer 21

Central bank’s use of control of the money supply and interest rates to influence the level of economic activity.

Question 22

What is the difference between GDP and GNP?

Answer 22

GDP is the measure of final goods and services produced within a nation’s
geographical boundaries, regardless of who owns it (hence the term gross DOMESTIC
product). It therefore includes earnings that accrue to foreign workers or firms.

GNP is the measure of output owned by the citizens (or corporations or government) of a nation regardless of where it is actually produced and therefore includes profits earned from overseas enterprises and wages earned by citizens working in foreign nations.
For example, profit earned from a car produced in the UK by Ford, an American
company, is counted as part of the UK’s GDP but not GNP, and conversely is counted as part of US GNP but not GDP. Note that only the profit from the car is counted differently by GDP and GNP, not the whole value of the car. The car is produced using British workers
and parts, such as steel from a British steel company, and these are not part of the USA’s GDP or GNP (unless, of course, the workers or some of the parts are imported from America)

Question 23

Why is national income not equal to GNP?

Answer 23

Gross national product and gross domestic product differ in their treatment of international transactions. Gross national product includes earnings of U.S. corporations overseas and U.S.
residents working abroad; gross domestic product does not. Conversely, gross domestic product includes earnings from current production in the United States that accrue to foreign residents or foreign-owned firms, although gross national product excludes these items

Question 24

Differentiate personal income from personal disposable income.

Answer 24

Personal income is the national income accounts’ measure of the income received by persons from all sources. When we subtract personal tax payments from personal income, we get personal
disposable income. These measures differ from national income in that they include income to persons from sources other than current factor services (government transfer payments, for example)
and exclude elements of national income not paid out to persons (undistributed corporate profits, for
example). Personal income or personal disposable income, are useful measures because they gauge
the income households can actually use for purposes of consumption or saving

Question 25

Thoroughly explain the concept of potential output, and explain why it is difficult to measure.

Answer 25

Potential output is the level of output that would be achieved if all resources were used to their highest rates of utilization. Potential output is not directly observable but must be estimated based on
what economists think is the sustainable level of resource utilization over long periods of time. This is fraught with ambiguities.

Question 26

Suppose a worker’s income was $15,000 in 1960 and $45,000 in 2010. Using the GDP deflator as a price index, calculate whether the worker’s real income had increased or decreased over this period.

Answer 26

To convert 1960 dollars to 2010 dollars, you must multiply by the ratio of the GDP deflation in 2010 to the deflator in 1960. Thus, $15,000 in 1960 dollars is equal to 15,000(111/18.6)= $89516 in 2010
dollars.

Question 27

What are Net Taxes?

Answer 27

We can define net taxes (T) as tax
payments (Tx) minus transfer payments (Tr)
T = Tx – Tr
And personal disposable income (PDI) is National Income (recall NI =Y) minus net taxes
(T)

Question 28

What are the formulas relative to PDI?

Answer 28

Simplified income approach to calculating output:
Recalling from the simplifications that PDI = Y – T and that PDI can be either
consumed (C) or saved (S), we have:
PDI = Y – T = C + S
Rearranging this equation yields:
Y = C + S + T
This is the income approach to calculating output. Income is divided among consumption,
savings, and tax payments.

Question 29

What is the final equation for calculating output?

Answer 29

This is the income approach to calculating output. Income is divided among consumption,
savings, and tax payments.
By combining the two approaches we have that:
C + I + G = Y = C + S + T
Subtracting C from both sides yields:
I + G = S + T
What this final equation says is that government spending and investment must equal the
amount saved and collected in taxes.