Intro to Macroeconomics and GDP Problem Set Answer Key

Definition of Macroeconomics The study of the economy as a whole

Creator of Macroeconomics John Maynard Keynes

Historical Events that led to the field Great Depression – severe unemployment and economic shut
of Macroeconomics down

Three Major Goals of 1. Promote Economic Growth

Macroeconomics
2. Promote Full Employment (Limit Unemployment)

3. Promote Price Stability (Limit Inflation)

What do we use to measure REAL Gross Domestic Product

economic growth?
Define Gross Domestic Product. The dollar value of all final goods and services produced within a
county within a year (or quarter)

Why are intermediate goods not The prices of intermediate goods are reflected in the price of the
included in GDP? final good. Therefore, by counting the intermediate good and
the final good, double counting would occur.
Why are financial transactions and Financial transactions simply involve moving money or ownership
used goods not included in GDP? from one place to another. Nothing new is created. Used goods
do not reflect new output. They were included in GDP when new.
Why are illegal and non-paid We do not have accurate data on these activities.
activities not included in GDP?

Define Per Capita GDP. (GDP/population)

or GDP per person

Why do people care about per Per capital GDP gives us a better idea of standard of living than
capita GDP? does total GDP. For example, China’s Real GDP is very high, but
their population is so high that GDP per capita is relatively low
when compared with other developed nations.

How do we use GDP? We compare REAL GDP from one year to another to determine if
an economy has grown.

What are some of the GDP does not include a lot of “valuable” activities, like playing,
problems/limitations of using GDP as vacation time, spending time with family, cleaning your own
a major indicator of standard of house, etc. It also include negative activities such as divorce,
living? cleaning up from natural disasters, etc.
Why do GDPs differ across Country’s vary in their economic systems, educational levels of
countries? individuals, resources, production methods, capital goods.

Formula for using GDP to determine (New REAL GDP- Old REAL GDP) X 100 = Economic Growth Rate
if an economy grew Old REAL GDP

Describe Expenditure Approach to The expenditure approach involves adding up all EXPENDITURES
Measuring GDP in the economy from all different sectors.

C+I+G+(X-Im) C = Household Consumption

I= Business Investment and New Home Purchases
G = Government Expenditures
Define each letter in expenditure X = Exports
approach formula. Im = Imports X-IM = Net Exports
Describe income approach to The income approach simply adds up all profits, wages, rents,
measuring GDP and interest earned in an economy.

Describe Value Added approach to To complete the value added approach, you determine the value
measuring GDP (p.106-107- Reading added by each producer and add it up. To determine the value
only) added by each producer, you take the selling price of their good
and subtract the cost of their intermediate goods.
Nominal GDP GDP in current dollars / NOT adjusted for inflation

Real GDP GDP placed in base year dollars / Adjusted for inflation

Why is it important to convert GDP Inflation from year to year makes it difficult to compare GDP.
to Real GDP to determine economic Higher prices in later years overstate GDP. Therefore, nominal
growth? GDP must be put in base year prices so that economists can
compare “apples to apples.” In other words, they are eliminating
the variable of price change.

Module 10 p.110

Check Your Understanding

1. Explain why the three Expenditure GDP should equal Income GDP because ALL
methods of calculating GDP expenditures become someone’s income. Value Added should
produce the same estimate equal expenditure because every final good or service is going to
of GDP. be purchased by someone or added to inventories. You are
subtracting out intermediate goods in value added to get to the
final “expenditure” level.
2. Identify each of the sectors Firms sell to other firms, households, government, and the rest of
to which firms make sales. the world. Households sell their factors of production to firms
 What are the various ways and government. Households purchase goods and services from
households are linked to firms and receive services from government. Households and
other sectors of the firms provide taxes to government. Households purchase
economy? (ie, government, products from other parts of the world and interact through
financial institutions, other financial markets with firms, government, and the rest of the
countries..) world.

3. Consider Figure 10.3. Explain You are counting the value of the steel twice: once when it was
why it would be incorrect to sold by American Steel to American Motors and once as part of
calculate total value added the car sold by American Motors.
as $30,500, the sum of the
sales price of a car and a
car’s worth of steel.

Tackle the Test p.111

Number Answer Explanation

1. C Circular flow includes factor AND product markets and shows a simplified economy.
2. E (a) Is incorrect because it doesn’t say FINAL goods and services
(b) Is incorrect because it leaves out exports
(c) Is incorrect because it is double counting
(d) Is incorrect because it is incomplete (The income approach includes wages,
rent, interest, profits)

3. A Changes to inventories is included as a business investment. It changes the ability of

the firm to do business in the future.
4. B Imports are subtracted out via net exports.
5. A Consumer spending makes up 70% of the economy on average.

Module 11 p.116-117

Check Your Understanding

1. See Problem and Questions on p.116.

 2. From 1990 to 2000 the price of housing A price index based on 1990 prices will contain
rose dramatically. What are the relatively low housing prices compared to 2000
implications of this in deciding whether to prices This means that a 2000 price index to
use 1990 or 2000 as the base year in calculate real GDP in 2010 will magnify housing
calculating 2010 Real GDP. prices and make the housing sector appear as a
bigger component of GDP.

Tackle the Test MC Questions p. 116-117

Number Answer Explanation

1. D We know that real GDP is adjusted for inflation and it increases when aggregate
output increases. It is only equal to nominal GDP if that year is used as the base
year for comparison.
2. B Only real GDP will control for changes in price. Per capita could obscure the picture
due to potential changes in population.
3. C

4. C The expenditures on natural disasters make it look like life is better, when in fact
life could be worse due to the disaster.
5. C (I) We don’t know population size.
(II) We don’t’ know because we do not have population data.
(III) This is ALL we know for sure.

2007 FRQ – From 2007 AP Exam

The way it was graded on the 2007 AP Exam

8 point question (2+2+2+2)

(a) 2 points:
a. One point is earned for stating that the value of the textbook was not included.
b. One point is earned for explaining that a used item has already been counted in a
previous year or is not part of 2006 production.
(b) 2 points:
a. One point is earned for stating that the rent payment is included.
b. One point is earned for explaining that the payment is for service provided in 2006.
(c) 2 points:
a. One point is earned for stating that the commissions are included.
b. One point is earned for explaining that the commissions represent income for providing
service in 2006.
(d) 2 points:
a. One point is earned for stating that the value is not included in the US GDP.
b. One point is earned for explaining that US GDP does not include production outside of
the US.

LONG FRQ Example

See page 151 in textbook. Complete #2.

2. a. We can measure GDP in Macronia as the sum of all spending on domestically

produced final goods and services. Spending consists of consumer spending, investment
spending, government purchases of goods and services, and exports less imports, or $800
($510 + $110 + $150 + $50 − $20).
b. Net exports are exports less imports. In Macronia, net exports equal $30 ($50 − $20).
c. Disposable income is income received by households less taxes plus government
transfers. In Macronia, disposable income equals $710 ($800 − $100 + $10).
d. Yes. Consumer spending plus taxes plus private savings equals $810—the same as the
wages, profit, interest, rent, and government transfers received by households.

e. In Macronia, the government needs to finance $160 in spending ($150 on purchases of

goods and services and $10 in government transfers). The government finances $100 of
its spending with tax revenue and the other $60 through borrowing in financial markets.