Week 1

Question 1

Gross Domestic Product (GDP)

Answer 1

Total market value of all FINAL goods & services produced within a specific territory in a given period of time
*does not take into account intermediate goods!

Question 2

3 measures of GDP

Answer 2

1. Expenditure measure
   - national income accounting identity, Y (GDP) = Consumption + Investments + Gov. purchases + Net Exports
2. Income measure
   - includes depreciation. GDP - dep. = Net domestic product
3. Production measure
   - only NEW production of goods & services adds to GDP, creation of new income!
   *doesn’t count if only a transfer of income
   Value added = the amount each producer contributes to GDP = revenue generated by each producer - value of intermediate products

Question 3

Real GDP vs Nominal GDP

Answer 3

Real GDP
- total value of goods and services measured at base-year prices(constant)
Nominal GDP
- total value of goods and services measured at current prices
= price level * real GDP

Question 4

Measures of price level:

CPI vs Implicit GDP price deflator

Answer 4

CPI (Laspeyres index, has a fixed basket of goods)

• fixes quantities to base year
• if want to measure change in quantities, fix prices from base/initial year

GDP deflator (Paasche index, has a changing basket of goods )

• ratio of nominal GDP to real GDP
• fixes quantities to current year
• if want to measure change in quantities, fix prices from current year

Question 5

When prices of different goods are changing by diff. amounts, why does the Laspeyres index tend to give a higher inflation rate, & the Paasche index a lower inflation rate?

Answer 5

Laspeyres index has a fixed basket of goods and does not take into account the substitution effect, in which consumers can substitute to the relatively less $$ good.

Paasche index does not reflect the fact that consumers feel worse off by the substitution to the relatively less $$ goods.

Question 6

What is inflation rate?

Inflation - general increase in prices

Answer 6

% change in price level

Question 7

Why does real GDP a better measure of wellbeing than nominal GDP?

Answer 7

Economic satisfaction for citizens ultimately depends on quantities of goods & services produced. If prices doubled but quantities stayed the same, nominal GDP doubled but it would be misleading to say that the economy’s ability to satisfy demands has doubled.

Question 8

3 problems in measuring real GDP, CPI, price level

Answer 8

1. Substitution effect cannot be observed in CPI b/c fixed basket of goods
2. These measures can count the quantity & prices, but it’s not really the same product anymore (eg. olden day phones vs today’s). The price indexes don’t keep track of QUALITY changes.
3. The basket calculated in CPI may be outdated because some G&S became obsolete. + intro of new G&S. This complicates things when we compare CPI across time.