Reading 10: aggregate output, prices, and economic growth

Question 1

The least appropriate approach to calculating a country’s gross domestic product (GDP) is summing for a given time period:
the value of all purchases and sales that took place within the country.
the amount spent on final goods and services produced within the country.
the income generated in producing all final goods and services produced within the country.

Answer 1

Adding all purchases and sales is not appropriate because these would include goods that were produced before the time period in question. All purchases and sales could also result in double-counting intermediate goods. GDP is the market value of all final goods and services produced in a country in a certain period of time. GDP can be calculated either by totaling the amount spent on goods and services produced in the economy (the expenditure approach), or the income generated in producing these goods and services (the income approach). (LOS 10.b)

Question 2

Gross domestic product does not include the value of:
transfer payments.
government services.
owner-occupied housing.

Answer 2

Owner-occupied housing and government services are included in GDP at imputed (estimated) values. Transfer payments are excluded from the calculation of GDP. (LOS 10.a)

Question 3

When GDP is calculated by the sum-of-value-added method, what is the value of a manufactured product in GDP?
The sum of the product’s value at each stage of production and distribution.
The sum of the increases in the product’s value at each stage of production and distribution.
The product’s retail price less the value added at each stage of production and distribution.

Answer 3

Using the sum-of-value-added method, GDP can be calculated by summing the value added at each stage in the production and distribution process. Summing the value of the product at each stage of production would count the value added at earlier stages multiple times. The value added at earlier stages would not be included in GDP if it was deducted from the retail price. (LOS 10.b)

Question 4

Real GDP is best described as the value of:
current output measured at current prices.
current output measured at base-year prices.
base-year output measured at current prices.

Answer 4

Real GDP is the value of current period output calculated using prices from a base year. (LOS 10.c)

Question 5

The GDP deflator is calculated as 100 times the ratio of:
nominal GDP to real GDP.
base year prices to current year prices.
current year nominal GDP to base year nominal GDP.

Answer 5

The GDP deflator is the ratio of nominal GDP to real GDP, or equivalently the ratio of current year prices to base year prices. (LOS 10.c)

Question 6

Which of the following measures of income is the sum of wages and benefits, pretax profits, interest income, owners’ income from unincorporated businesses, rent, and taxes net of subsidies?
Personal income.
National income.
Disposable income.

Answer 6

National income is the income received by all factors of production used in the generation of final output. Personal income measures the pretax income that households receive. Disposable income is personal income after taxes. (LOS 10.d)

Question 7

If a government budget deficit increases, net exports must:
increase, or the excess of private saving over private investment must decrease.
decrease, or the excess of private saving over private investment must increase.
decrease, or the excess of private saving over private investment must decrease.

Answer 7

The fundamental relationship among saving, investment, the fiscal balance, and the trade balance is described by the following equation: (G – T) = (S – I) – (X – M). If the government budget deficit (G – T) increases, the larger budget deficit must be financed by some combination of an increase in the excess of private saving over private investment (S – I) or a decrease in net exports (X – M). (LOS 10.e)

Question 8

The aggregate demand curve illustrates which of the following relationships?
Direct relationship between aggregate income and the price level.
Inverse relationship between aggregate income and the price level.
Direct relationship between aggregate income and the real interest rate.

Answer 8

The inverse relationship between aggregate income (or output) and the price level is the aggregate demand curve. (LOS 10.f)

Question 9

An economy’s potential output is best represented by:
long-run aggregate supply.
short-run aggregate supply.
long-run aggregate demand.

Answer 9

The LRAS curve is vertical at the level of potential GDP. (LOS 10.g)

Question 10

A stronger domestic currency relative to foreign currencies is most likely to result in:
a shift in the aggregate supply curve toward lower supply.
a shift in the aggregate demand curve toward lower demand.
a movement along the aggregate demand curve towards higher prices.

Answer 10

Strengthening of the domestic currency should cause exports to decrease and imports to increase, causing the AD curve to shift to the left (lower demand). At the same time, the cost of raw material inputs should decrease in domestic currency terms, causing the SRAS curve to shift to the right (greater supply). Changes in the price level cause movement along the AD and AS curves; in this case, any shifts along these curves will be towards lower prices. (LOS 10.h)

Question 11

Which of the following factors would be least likely to shift the aggregate demand curve?
The price level increases.
The federal deficit expands.
Expected inflation decreases.

Answer 11

Since the y-axis of the aggregate supply/demand model is the price level, a change in the price level is a movement along the AD curve. As long as inflation expectations are unchanged, an increase in the price level will not shift the aggregate demand curve. (LOS 10.h)

Question 12

Starting from short-run equilibrium, if aggregate demand is increasing faster than long-run aggregate supply:
the price level is likely to increase.
downward pressure on wages should ensue.
supply will increase to meet the additional demand.

Answer 12

If AD is increasing faster than LRAS, the economy is expanding faster than its full-employment rate of output. This will cause pressure on wages and resource prices and lead to an increase in the price level. The SRAS curve will shift to the left—a decrease in supply for any given price level—until the rate of output growth slows to its full-employment potential. (LOS 10.i)

Question 13

A short-run macroeconomic equilibrium in which output must decrease to restore long-run equilibrium is most accurately characterized as:
stagflation.
a recessionary gap.
an inflationary gap.

Answer 13

If output must decrease to restore long-run equilibrium, the short-run equilibrium must be at an output level greater than long-run aggregate supply. This describes an inflationary gap. (LOS 10.j, 10.k)

Question 14

Which of the following combinations of changes in aggregate demand and aggregate supply is most likely to result in decreasing prices? Aggregate demand:
decreases while aggregate supply increases.
decreases while aggregate supply decreases.
increases while aggregate supply decreases.

Answer 14

Decreasing aggregate demand combined with increasing aggregate supply will result in decreasing prices. Increasing aggregate demand combined with decreasing aggregate supply will result in increasing prices. A decrease or an increase in both aggregate demand and aggregate supply may either increase or decrease prices. (LOS 10.l)

Question 15

Labor productivity is most likely to increase as a result of:
an increase in physical capital.
a decrease in net immigration.
an increase in the labor force participation rate.

Answer 15

Increased investment in physical capital can increase labor productivity. Labor force participation rates and net immigration affect the size of the labor force and the aggregate number of hours worked, but do not necessarily affect labor productivity. (LOS 10.m)

Question 16

Long-term sustainable growth of an economy is least likely to result from growth in:
the supply of labor.
capital per unit of labor.
output per unit of labor.

Answer 16

The sustainable rate of economic growth is a measurement of the rate of increase in the economy’s productive capacity. An economy’s sustainable rate of growth depends on the growth rate of the labor supply and the growth rate of labor productivity. Due to diminishing marginal productivity, an economy generally cannot achieve long-term sustainable growth through continually increasing the stock of capital relative to labor (i.e., capital deepening). (LOS 10.m)

Question 17

In a production function model of economic output, total factor productivity represents the output growth that can be accounted for by:
capital growth but not labor growth.
neither labor growth nor capital growth.
the combined effects of labor growth and capital growth.

Answer 17

Total factor productivity represents output growth in excess of that resulting from the growth in labor and capital. (LOS 10.n)

Question 18

In a developed economy, the primary source of growth in potential GDP is:
capital investment.
labor supply growth.
technology advances.

Answer 18

For developed economies, advances in technology are likely to be the primary source of growth in potential GDP because capital per worker is already high enough to experience diminishing marginal productivity of capital. (LOS 10.o)