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Ch 22 Study Guide Practice Problem #1. $5140. $3127. $913. 1b. Largest expenditure component of GDP? Consumption C. does investment include the purchase of stocks and bonds? Why? No, they are financial transactions. There is no production of goods or services

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slide2

1b. Largest expenditure component of GDP?

  • Consumption
  • C. does investment include the purchase of stocks and bonds? Why?
  • No, they are financial transactions. There is no production of goods or services
  • D. Do government purchases include government spending on unemployment checks? Why?
  • No – considered transfer payments. No production or exchange of goods/services
  • E. What does it mean when NX are negative?
  • The country imports more goods than it exports
  • NX = X-M ….so if –NX , then M>X
practice problem 2
Practice Problem #2

Year Production of X Price X

2000 20 $5

2001 20 $10

2002 20 $20

a. Nominal GDP (P x Q) b. Real GDP (current year Q x base yr P)

  • $100 2000 $100
  • $200 2001 $100
  • $400 2002 $100
economic growth
Economic Growth?
  • What does it tell us when NGDP increases?
  • Could be increase in production
  • Could be increase in price
  • Could be combination of production and price
  • What does it tell us when RGDP increases?
  • …b/c P is held constant to base year
  • ….increase is due to increase in Q
  • ….= ECONOMIC GROWTH
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Year Production of X Price X

2000 20 $5

2001 20 $10

2002 20 $20

Nominal GDP (P x Q) Real GDP (current year Q x base yr P)

  • $100 2000 $100
  • $200 2001 $100
  • $400 2002 $100

Conclusions??? Economic growth? Price Levels?

There was no economic growth.

There was only an increase in price level

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#3

a. $700

b. $700

Year P soda Q soda P jeans Q jeans NGDP RGDP

2000 $1 200 $10 50

  • $1 220 $11 50

Mistake – avoid looking at each individual good – remember this is a model for the entire economy

ex of wrong answer: conclude the economy grew for soda but not for jeans……this does not make sense

e. Value of GDP Deflator in 2000?

NGDP / RGDP x 100 : always 100 in base year

f. Value of GDP Deflator in 2001?

770/720 x 100 = 107

GDP = $$$$$$ Deflator is NOT $$ nor %% …IS index based on 100

c. $770

d. $720

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g. from 2000-2001: prices rose approximately what percentage?

  • Compare GDP deflators – measure the change in price level
  • 2nd -1st / 1st
  • 107-100/100 = 7%
  • h. was the increase in NGDP from 2000-01 mostly due to an increase in real output or prices?
  • NGDP rose from $700 to $770 = 10% increase
  • Increase in real output = RGDP
  • 2000=$700 2001 = $720 2.85% (3%)
  • Increase in prices = Deflator = 7%
  • Conclude – 10%increase in NGDP was MOSTLY due prices (7%) vs. output (3%)
evaluate
Evaluate
  • Was there economic growth?
  • Yes …
  • RGDP…. Or
    • Real output…. Or
      • ……the economy …….
      • Grew at a 3% rate
      • The growth rate of the economy was 3%

….”normal growth” = 3% per year – long term trend since the 1950’s

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………but………
  • Price level or inflation increased by 7%
  • …..not good to have inflation outpace production
  • “normal” inflation is 1%-2%
4 complete table
#4 Complete Table

$100

Year NGDP RGDP GDP Deflator

1. ----- $100 100

2. $120 ---- 120

  • $150 $125 ----

Year 1 Math: Nom/Real x 100 = Deflator…$x / $100 x 100 = 100 = NGDP = $100

Year 2 Math: $120 /$x x100 = 120 RGDP = 100

Year 3 Math: $150/$125 x 100 = 120

  • What is base year? How can you tell ?

If Nom and Real are always same in base year, then GDP Deflator will always be 100 in the base year…..so year 1 is base year

$100

120

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$100

Year NGDP RGDP GDP Deflator

1. ----- $100 100

2. $120 ---- 120

  • $150 $125 ----

b. From year 1 to year 2, did real output rise or did prices rise? Explain

The change from year 1 to 2 was due to price rising.

The Nom and Deflator rose 20% but Real did not change at all ..indicating no change in output(RGDP measures growth in output) …so prices rose by 20%

c. From year 2 to year 3, did real output rise or did prices rise? Explain

The change from year 2 to 3 was due to output rising .

The Nom and Real both increased by 25% but the Deflator did not change….indicating no change in price….so output rose by 25%

$100

120

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Year NGDP RGDP GDP Deflator

1. ----- $100 100

2. $120 ---- 120

  • $150 $125 ----

$100

$100

120

BONUS: Evaluate the growth of this economy from year 1 to year 3

The economy grew by 25% (based on RGDP) ….

…but prices also grew by 20% (based on the deflator)