Chapter 6

1. The reason economists include only the value of final goods and services when they calculate GDP is that intermediate goods A) do not create value added. B) do not add to economic welfare. C) have no social value. D) would be double counted otherwise.

2. If national income equals $4,500, employment taxes equal $400, corporate profit taxes equal $250, corporate retained earnings equal $300, transfer payments equal $500, and personal income taxes equal $600, then personal income equals A) $2,450. B) $3,450. C) $3,750. D) $4,050.

3. In comparing the per capita GDPs of two countries, purchasing power parity adjusts for differences in A) exchange rates. B) non-market activities. C) populations. D) relative prices.

4. A) B) C) D)

Which of the following is an example of an intermediate product? A pair of skis sold by a sporting goods retailer to a skier. A share of IBM stock. The lumber produced by Boise Cascade and sold to a builder of new houses. An antique car sold to the highest bidder.

5. A) B) C) D)

Which of the following is not a limitation of national income accounting? Measurement error. The use of real GDP to measure changes in economic activity over time. The use of real GDP to measure changes in social welfare over time. Misinterpretation of subcategories.

Page 1

6. Use the following table to calculate net domestic product. NDP equals $ billions 20 45 55 35 35 30 70 15

Exports Imports Gross investment Net foreign factor income Government expenditures Government transfer payments Personal consumption Depreciation A) B) C) D) $120 billion. $135 billion. $150 billion. $155 billion.

7. Use the following information to answer the question. There are three firms in an economy: X, Y, and Z. Firm X buys $200 worth of goods from firm Y and $300 worth goods from firm Z and produces 250 units of output at $4 per unit. Firm Y buys $150 worth goods from firm X, and $ 250 worth goods form firm Z and produces 300 units of output at $6 per unit. Firm Z buys $75 worth goods from X, and $50 worth goods from firm Y and produces 500 units at $2 per unit. Given this information, what is the economy's GDP? A) $1,825. B) $2,700. C) $2,775. D) $3,800.

8. A) B) C) D)

In calculating GDP, the largest component of total Canadian expenditures is investment. net exports. personal consumption. government spending.

9. A) B) C) D)

Disposable personal income as measured in the National Income Accounts is greater than national income. equal to real GDP. a measure of income available for spending by Canadian households. the best measure of income earned in the nation.

Page 2

10. Which of the following is the best measure available to compare changes in standards of living among countries over time? A) Changes in nominal income. B) Changes in nominal per capita income. C) Changes in real income. D) Changes in real per capita income.

11. A) B) C) D)

The key to the equality of output and income is employee compensation. profit. business taxes. transfer payments.

12. A) B) C) D)

The value of intermediate goods is included in both GDP and GNI. included in GDP but not GNI. included in GNI but not GDI. excluded from both GDP and GNI.

13. Which of the following economic activities would be included in Canadian gross domestic product (GDP)? A) Illegal drug sales. B) Services, such as haircuts. C) Prostitution. D) Work performed, then paid for in cash to avoid income tax.

14. A) B) C) D)

Depreciation estimates the decrease in value of capital goods due to wear and tear over the year. is the reduction in business inventories per year. represents a firm's expenditure in adding to its capital stock. is the decline in the value of a firm's stock.

15. For the purposes of calculating GDP using the expenditure approach, which of the following is NOT included in the government expenditures account? A) Government purchases of pencils. B) The payroll of the federal government. C) Social assistance payments to the poor. D) The government's purchase of a computer.

Page 3

16. A) B) C) D)

The national income identity shows that the value of factor services is equal to the value of final goods plus investment. the value of factor services is equal to the value of final goods plus savings. the value of factor services is equal to the value of final goods sold. the value of consumption goods is equal to the value of factor services.

Use the following to answer question 17:

GNI Investment Government consumption and investment Depreciation GDP

In trillions of dollars 4.2 1.3 1.5 0.4 6.6

17. A) B) C) D)

Refer to the table above. What is the economy's net domestic product? $6.2 trillion. $6.6 trillion. $7.0 trillion. Net domestic product cannot be computed without the data for net exports.

18. A) B) C) D)

Double counting in the national income accounts will occur if GDP is computed by adding up final output sales. adding up value added. adding up all sales. adding up the income earned by a country's residents.

19. National income accounting A) provides a set of rules for determining macroeconomic policy. B) provides a set of rules and definitions for measuring economic activity in the aggregate economy. C) is a useful tool for microeconomists. D) can be used to measure a nation's output but not its production or consumption.

Page 4

20. If Saudi Arabia has invested substantially more money in foreign countries than foreigners have invested in Saudi Arabia, then we might expect A) Saudi net foreign factor income to be negative. B) Saudi net foreign factor income to be zero. C) Saudi GDP to exceed Saudi GNI. D) Saudi GNI to exceed Saudi GDP.

21. A) B) C)

To calculate GDP add the quantity of all final goods and services produced in an economy in a year. add the quantity of all goods and services sold in an economy in a year. weight the output of each final good and service produced in an economy in a year by its price in that year and then add the result. D) weight the output of each good and service produced in an economy in a year by its price in that year and then add the results.

22. A) B) C) D)

Purchasing power parity will most likely increase the relative value of output in developing countries. lower the relative value of output in developing countries. leave the relative value of output in developing countries unchanged. show that prices in developing countries are higher than prices in developed countries.

23. If substantially more foreign money is invested in Ireland than Irish citizens have invested abroad, then one will likely expect A) Irish net foreign factor income to be positive. B) Irish net foreign factor income to be zero. C) Irish GDP to exceed Irish GNI. D) Irish GNI to exceed Irish GDP.

24. In 1998, gross investment was $1,580 billion and net investment was $513 billion; therefore depreciation was A) $513 billion. B) $1,067 billion. C) $1,324 billion. D) $2,093 billion.

Page 5

25. A) B) C) D)

To move from gross domestic product (GDP) to gross national product (GNI), add depreciation to GDP. subtract depreciation from GDP. subtract net foreign factor income from GDP. add net foreign factor income to GDP.

Use the following to answer question 26:

Consumption Investment Transfer payments Government expenditures Exports Imports Net foreign factor income

In billions of dollars 3,600 800 750 1,000 650 450 -30

26. A) B) C) D)

Calculate net exports using the table above. 170. 200. 450. 650.

27. A) B) C) D)

If inflation is 10 percent and nominal GDP goes up 20 percent, real GDP goes up approximately 1 percent. 10 percent. 20 percent. 30 percent.

28. A) B) C) D)

Per capita gross domestic product (GDP) is calculated by dividing population by GDP. multiplying population by GDP. dividing GDP by population. adding GDP and population.

Page 6

29. A) B) C) D)

Suppose that both nominal GDP and prices double. We can conclude that real output more than doubled. real output doubled. real output remained constant. real output fell.

30. If a firm sells bonds on the capital market, the amount the firm must pay for the use of those funds is counted in the national income and product accounts as A) interest. B) rents. C) employee compensation. D) profits.

Use the following to answer question 31:

GDP Government purchases Transfer payments Exports Imports Net foreign factor income

In trillions of dollars 5.0 1.0 0.2 0.4 0.5 0.4

31. A) B) C) D)

Refer to the table above. What is consumption in this economy? $3.6 trillion. $3.9 trillion. $4.1 trillion. There is not sufficient information to compute consumption.

32. A) B) C) D)

Which of the following equations is the correct equation for GDP? GDP = C + I + G. GDP = C + I + G + X + IM. GDP = C + I + G - X - IM. GDP = C + I + G + X - IM.

Page 7

33. A) B) C) D)

Comparisons of GDP levels across countries are most accurate when the value of non-market activities is the same across countries. prices are the same across countries. prices and the value of non-market activities are the same across countries. prices for non-market activities are the same across countries.

34. A) B) C) D)

Which of the following is a stock concept? Income. Wealth. Rent. Expenditures.

35. A) B) C) D)

National income accounting defines relationships among firms. measures microeconomic concepts. was developed by Keynesian economists. has dominated economic discourse since Adam Smith and The Wealth of Nations.

36. The total annual market value of a nation's final output of goods and services computed at existing prices is called A) net national product. B) national income. C) nominal GDP. D) real GDP.

37. A) B) C) D)

Value added is calculated by subtracting the cost of materials used in production from the value of sales. adding the cost of materials used in production to the value of sales. subtracting the value of sales from the cost of materials used in production. adding the value of output to the value of inputs.

Use the following to answer question 38:

Page 8

Exports Imports Gross investment Net foreign factor income Employment (CPP, EI) taxes Personal income taxes Indirect business taxes Corporate retained earnings Corporate income taxes Government transfer payments Government expenditures Personal consumption Depreciation

$ billions 20 45 55 35 15 10 15 10 10 30 50 70 15

38. A) B) C) D)

Use the table above to calculate personal income. Personal income equals $115 billion. $135 billion. $150 billion. $155 billion.

Use the following to answer question 39:

GDP Government purchases Transfer payments Exports Imports Net foreign factor income

In trillions of dollars 5.0 1.0 0.2 0.4 0.5 0.4

39. A) B) C) D)

Refer to the table above. What is GNI in this economy? $5.4 trillion. $3.9 trillion. $4.1 trillion. There is not sufficient information to compute GNI.

Page 9

40. A) B) C) D)

Value added by individuals and business in a nation in a year equals the value of intermediate products. the value of investment goods. total profits. GDP.

41. A) B) C) D)

Gross private domestic investment is investment purchases by business firms. investment purchases by government. foreign investment. purchases by investment banks.

42. Which of the following economic activities would NOT be included in U.S. gross domestic product (GDP)? A) A firm changes its packaging to earth-friendly wrappers and charges 50 cents more per package. B) A firm hires local teenagers 10 hours a month to clean up trash from a local park. C) A firm sells machinery that is used to extract PCPs from the waterways. D) A firm reduces its pollution by changing its production process in a way that does not affect its costs or its revenues.

43. A) B) C) D)

Which of the following would not be included in personal consumption expenditure? College tuition. A Personal computer. Police protection. A movie ticket.

44. A) B) C) D)

National income accounting is useful because it makes it possible to measure aggregate economic activity. because it defines the relationships between subaggregates such as consumption and investment. because it makes it possible to measure a nation's production and consumption. for all of the above reasons.

45. A) B) C) D)

GNI is the aggregate output of the citizens and businesses of an economy in a one-year period. aggregate final output of the citizens and businesses of an economy in a one-year period. total market value of all goods and services produced in an economy in a one-year period. total market value of all final goods and services produced in an economy in a one-year period.

Page 10

46. What is the economy's gross domestic product? In trillions of dollars 5.2 2.7 2.6 0.6 0.6 0.6

Consumption Investment Government purchases Transfer payments Exports Imports A) B) C) D) $10.5 trillion. $11.1 trillion. $11.7 trillion. $12.3 trillion.

47. A) B) C) D)

Net domestic product is a better measure of output than gross domestic product because it controls for depreciation. is a worse measure of output than gross domestic product because it is distorted by depreciation. cannot be computed since depreciation cannot be measured. increases as depreciation increases.

48. A) B) C) D)

Gross investment differs from net investment by net exports. net imports. depreciation. transfer payments.

49. A) B) C) D)

Which of the following correctly lists the components of total expenditures? Consumption, investment, depreciation, exports minus imports. Consumption, investment, government expenditures, exports minus imports. Rent, profit, interest, and wages. Consumption, net foreign factor income, investment, and government expenditures.

50. A) B) C)

Comparisons of GDP levels across countries are least accurate when non-market activities are a small part of total economic activity. prices differ across countries. prices differ across countries and non-market activities are a large part of total economic activity. D) purchasing power parity prevails.

Page 11

Answer Key
1. D Response: Including the value of intermediate goods (i.e. goods used to produce other goods) in GDP leads to double counting since the value of these goods is also reflected in the value of the final goods and services they are used to produce. 2. D Response: Personal income is derived by subtracting employment taxes, corporate profit taxes and retained earnings from national income and then adding transfers. 3. D Response: See the definition of purchasing power parity in the text. 4. C Response: Intermediate products are products used as inputs in the production of some other product. 5. B Response: See the discussion of the limitations of national income accounting in the text. 6. A Response: Net domestic product = consumption + investment + government expenditures + net exports depreciation. 7. C Response: GDP is the sum of the value added by the three firms, which equals 500 + 1400 + 875, or 2775. 8. C Response: Consumption accounted for 57% of total expenditures in 2003. 9. C Response: Disposable personal income is the income available to households for spending. 10. D Response: Nominal GDP must be adjusted for price level increases before comparisons over time can be made. Dividing total real income by the population is a good indication of relative standards of living. 11. B Response: Profit is what remains after all other income is paid out. It is what equates income and output. 12. D Response: Intermediate goods are goods used to produced other goods. Since GDP and GNI include only the value of final goods and services, intermediate goods do not enter into GDP or GNI. 13. B Response: GDP does not measure underground or illegal economic activity. 14. A
Page 12

15.

16.

17.

18.

19.

20.

21.

22.

23.

24.

25.

Response: See the definition of depreciation in the text. C Response: Transfer payments are spent and included in consumption or saved and channeled to investment. C Response: The national income identity shows that all income (value of factor services) equals all expenditures (value of goods sold to individuals). A Response: NDP = GDP - depreciation, which equals $6.2 trillion in this case. C Response: Including the value of intermediate goods (i.e. goods used to produce other goods) in GDP leads to double counting since the value of these goods is also reflected in the value of the final goods and services they are used to produce. B Response: See the definition of national income accounting in the text. D Response: Net foreign factor income is the difference between the foreign income of citizens and the income of residents who are not citizens. If Saudi Arabia has invested more money in foreign countries than foreigners have invested in Saudi Arabia, it is likely that the foreign income of Saudi citizens will exceed income of Saudi residents who are not citizens. This implies that net foreign factor income will be positive, so GNI will exceed GDP in Saudi Arabia. C Response: Each good is weighted by its market price. To include all good and services sold would be to double count. A Response: Since market prices are often lower in developing countries, using purchasing power parity will increase the relative value of output in developing countries. C Response: Net foreign factor income is the difference between the foreign income of one's citizens and the income of residents who are not citizens. If more foreign money is invested in Ireland than Irish citizens have invested abroad, it is likely that the income of Irish residents who are not citizens will exceed the foreign income of Irish citizens. That is net foreign factor income will be negative and GDP will exceed GNI in Ireland. B Response: Depreciation is gross investment minus net investment ($1580-$513). D Response:

Page 13

26.

27.

28.

29.

30.

31.

32.

33.

34.

35.

36.

37.

Because GDP measures the market value of the final output produced within a country's borders and GNI measures the market value of the final output produced by a country's citizens, the income earned abroad by domestic factor sources must be added to GDP and the income earned domestically by foreign factor sources must be subtracted from GDP in order to move from GDP to GNI. B Response: Net exports equal exports minus imports. B Response: Subtract nominal GDP growth from inflation to find real GDP growth as a first approximation. C Response: To arrive at per capita GDP, divide GDP by the country's total population. C Response: Since the entire increase in nominal GDP resulted from rising prices, real GDP (which controls for inflation) did not change. A Response: Interest includes payments for loans by households to firms. D Response: Consumption equals the difference between GDP and the sum of investment, government purchases, and net exports. Since we do not know investment in this case, we cannot determine consumption. D Response: The sum of consumption (C), investment (I), government expenditure(G), and net exports (X-IM) equals total expenditure or GDP. C Response: The presence and extent of non-market activities complicates international comparisons of living standards because the value of these activities is not reflected in GDP. Price differences also complicate such comparisons because these differences imply that the value of output may differ across countries even when the quantity of output is the same. B Response: Only wealth is a stock concept. All the others are defined with respect to time. C Response: National income accounting was developed from the work of Keynesian macroeconomists, including Stone and Kuznets. C Response: See the definition of nominal GDP in the text. A Response: Value added is the increase in value that a firm or an individual contributes to a product or service.
Page 14

38. C Response: PI = NI + transfer payments - Corporate retained earnings - corporate income taxes employment taxes. GNI = GDP + Net foreign factor income = 70+55+50+20-45 + 35= 185. NI = GNI - depreciation - indirect business taxes = 185-15-15=155. PI = 155+30-10-10-15=150. 39. A Response: GNI = GDP + Net foreign factor income. 40. D Response: Value added is the increase in value that a firm or an individual contributes to a product or service. Summing value added is one way to calculate GDP. 41. A Response: See the definition of gross private domestic investment in the text. 42. D Response: GDP includes only market activities. 43. C Response: Personal consumption expenditures consist of household and individual purchases of services and durable and nondurable goods. Police protection is part of government expenditures. 44. D Response: National income accounting provides a means for combining subaggregates into a single aggregate measure of production and consumption that can then be used to gauge total economic activity. 45. B Response: See the definition of GNI in the text. 46. A Response: GDP = Consumption + Investment + Government purchases + Exports - Imports. 47. A Response: Since depreciation reduces investment and hence output, accounting for depreciation produces a better measure of output. 48. C Response: Net investment equals gross investment less depreciation. 49. B Response: GDP = C + I + G + (X - IM). 50. C Response: The presence and extent of non-market activities complicates international comparisons of living standards because the value of these activities is not reflected in GDP. Price differences also complicate such comparisons because these differences imply that the value of output may differ across countries even when the quantity of output is the same.
Page 15