GDP - Eilya Torshizian`s Blog

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Tutorial 1
MACROECONOMICS – ECON 111
Eilya Torshizian
PhD student and research assistant
Email address
[email protected]
Office
Room 260-6121, Level 6, Owen G. Bld.
Tutorial forum
Economics bulletin at Facebook
http://Eilya.Torshizian.com
TUTORIAL INFORMATION
ME
Academic Experience
ECON 721, 711, 701, 322, 212, 111 and MATHS 105, 108

Education
The University of Auckland, PhD student, under supervision of Professor Arthur Grimes.
The University of Tehran, MA and BA in Theoretical Economics
IUST, Information Technology engineering.

Work Experience
Member of the board of directors at Rateb Construction and Development Co.
Chief executive officer at Exir Kish mineral water manufacturer.
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QUESTION 1
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1. Why is it desirable for a country to have a
large GDP? Give an example of something that
would raise GDP and yet be undesirable?
GDP represents the amount of money
one would need to purchase one year’s
worth of the economy’s production of all
final goods and services.
FINAL GOOD
It is desirable for a country to have a large GDP
because people could enjoy more goods and
services.
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GDP is not the only important measure of well-being.
For example, laws that restrict pollution cause GDP to
be lower.
If laws against pollution were eliminated, GDP would
be higher but the pollution might make us worse off.
 for example, an earthquake would raise GDP, as
expenditures on clean-up, repair, and rebuilding
increase.
2. WHAT COMPONENTS OF GDP, IF ANY, WOULD EACH OF
THE FOLLOWING TRANSACTIONS AFFECT? EXPLAIN.
-
A family buys a new refrigerator
Aunt Jane buys a new house
Fisher and Paykel sells a washing machine from its stock
You buy a pizza
Transit New Zealand repaves Highway 1
Your parents buy a bottle of Australian wine from a store
in Dunedin
- Nestle Australia builds a new chocolate factory in
Christchurch
Y = C + I + G + NX

A family buys a new refrigerator
Consumption (C):
the spending by households on goods and services, with the
exception of purchases of new housing.
Investment (I):
the spending by firms on capital equipment, inventories, and
structures, including new housing.
Government purchases (G):
the spending on goods and services by local, state, and
federal governments
Y = C + I + G + NX

Aunt Jane buys a new house
Consumption (C):
the spending by households on goods and services, with the
exception of purchases of new housing.
Investment (I):
the spending by firms on capital equipment, inventories, and
structures, including new housing.
Government purchases (G):
the spending on goods and services by local, state, and
federal governments
Y = C + I + G + NX

Fisher and Paykel sells a washing machine from its stock
Consumption (C):
the spending by households on goods and services, with the
exception of purchases of new housing.
Investment (I):
the spending by firms on capital equipment, inventories, and
structures, including new housing.
Consumption increases because a washing machine is a good purchased by a
household, but investment decreases because the washing machine in Fisher
and Paykel’s inventory had been counted as an investment good until it was sold.
Y = C + I + G + NX

You buy a pizza
Consumption (C):
the spending by households on goods and services, with the
exception of purchases of new housing.
Investment (I):
the spending by firms on capital equipment, inventories, and
structures, including new housing.
Government purchases (G):
the spending on goods and services by local, state, and
federal governments
Y = C + I + G + NX

Transit New Zealand repaves Highway 1
Consumption (C):
the spending by households on goods and services, with the
exception of purchases of new housing.
Investment (I):
the spending by firms on capital equipment, inventories, and
structures, including new housing.
Government purchases (G):
the spending on goods and services by local, state, and
federal governments
Y = C + I + G + NX

Your parents buy a bottle of Australian wine from a store in Dunedin
Consumption (C):
the spending by households on goods and services, with the
exception of purchases of new housing.
Investment (I):
the spending by firms on capital equipment, inventories, and
structures, including new housing.
Government purchases (G):
the spending on goods and services by local, state, and
federal governments
Y = C + I + G + NX

Nestle Australia builds a new chocolate factory in Christchurch
Consumption (C):
the spending by households on goods and services, with the
exception of purchases of new housing.
Investment (I):
the spending by firms on capital equipment, inventories, and
structures, including new housing.
Government purchases (G):
the spending on goods and services by local, state, and
federal governments
QUESTION 3

The government purchases component of GDP
does not include spending on transfer
payments such as the superannuation benefit.
Think about the definition of GDP; explain why
transfer payments are excluded.
GDP represents the amount of money
one would need to purchase one year’s
worth of the economy’s production of all
final goods and services.
With transfer payments, nothing is produced, so there is no
contribution to GDP.
QUESTION 4

Goods and services that are not sold in
markets, such as food produced and consumed
at home, are generally not included in GDP.
Can you think of how this might cause the
numbers in the second column of table 7.3 to
be misleading in a comparison of the economic
well-being of New Zealand and India? Explain.
Average Measure
NOT INCLUDED IN GDP?!
Infrastructure
Inequality
NOT INCLUDED IN GDP

Some things that contribute to well-being are not
included in GDP. (Have a look at question 1)

the value of leisure

the value of a clean environment

the value of almost all activities that takes place outside of
markets, such as the value of the time parents spend with
their children and the value of volunteer work.
In countries like India, people produce and consume a fair amount of food
at home that is not included in GDP. So GDP per person in India and New
Zealand will differ by more than their comparative economic well-being
QUESTION 5

Suppose the following table records the total output and the prices for an entire
economy in a country. Assume the base year in the following table is 2006.
Year
Price of
Qty of Pizzas Price of Mac
Qty of Mac
Pizzas
Combo
Combos
2006
$10
240
$8
400
2007
$12
400
$10
600
2008
$14
360
$15
550
(a) Calculate the Nominal Gross Domestic Product (GDP) for the years 2006,
2007 and 2008, explain clearly why economists do not use Nominal GDP to
measure economic growth.
(b) Calculate the Real GDP for the years 2006, 2007 and 2008.
(c) Compute the GDP Deflator for the years 2006, 2007 and 2008, and explain
clearly what the GDP Deflator tells you about the price level in the economy.
(d) Explain fully whether or not Real GDP figures of a developed country and an
underdeveloped country can be used to measure the relative prosperity of
people living in those two countries in a meaningful manner.
(a)
Calculate the Nominal Gross Domestic Product (GDP) for the years 2006,
2007 and 2008, explain clearly why economists do not use Nominal GDP to measure
economic growth.
Nominal GDP for the years:
2006 = 10*240 + 8*400 = $5,600
2007 = 12*400 + 10*600 = $10,800
2008 = 14*360 + 15*550 = $13,290
Nominal GDP is not used by economists to measure economic growth, because of the
distortion created by the price effect.
(b)
Calculate the Real GDP for the years 2006, 2007 and 2008.
Real GDP for the years:
2006 = 10*240 + 8*400 = $5,600
2007 = 10*400 + 8*600 = $8,800
2008 = 10*360 + 8*550 = $8,000
(c)
Compute the GDP Deflator for the years 2006, 2007 and 2008, and explain
clearly what the GDP Deflator tells you about the price level in the economy.
GDP deflator for the years:
2006 = 1000
2007 = 1227.2
2008 = 1661.2
The GDP deflator in this instance explains the increase in the price level.
(d) Explain fully whether or not Real GDP figures of a developed country and an
underdeveloped country can be used to measure the relative prosperity of people
living in those two countries in a meaningful manner.
The real GDP figures cannot be used meaningfully to compare the relative prosperity
levels of a developed and an underdeveloped country as the real GDP figure in an
underdeveloped country is understated due to the inability of this statistic to capture
the value of the large amount of non-market economic activities, including the black
economy. This is because most activities are cash transactions and no invoices are
raised, whereas in a developed country only a very small proportion of such unrecorded
economic activities take place.
(e)
The Per Capita Real GDP in New Zealand is approximately NZ$37000. Explain
fully whether this figure is a clear indication or not of the standard of living of people
living in New Zealand.
(f)
A recent World Bank report stated that New Zealand was well above Australia
as a pleasant place to live in although the per capita Real GDP of Australia is well above
that of New Zealand. Explain clearly the basis of this ranking.
Year
Qty of Pizzas
2006
Price of
Pizzas
$10
240
Price of Mac
Combo
$8
Qty of Mac
Combos
400
2007
$12
400
$10
600
2008
$14
360
$15
550

(e) The Per Capita Real GDP in New Zealand is approximately NZ$37000. Explain
fully whether this figure is a clear indication or not of the standard of living of people
living in New Zealand.
The per capita GDP figure given in the question is only an average and fails to give any
indication of the distribution of income in New Zealand. Averages can be misleading as
the national cake is not divided equally amongst the population.

(f)
A recent World Bank report stated that New Zealand was well above Australia
as a pleasant place to live in although the per capita Real GDP of Australia is well
above that of New Zealand. Explain clearly the basis of this ranking.
The reason for ranking New Zealand above Australia as a pleasant place to live is based
on aspects of the quality of life such as the level of crime, the amount of pollution, and
the amount of leisure time that can be enjoyed by inhabitants of New Zealand in
comparison with Australia. These aspects cannot be quantified in terms of dollars, but
affect the quality of life in the two countries.
EXTRA QUESTION 1




One day Barry the Barber collects $500 for haircuts.
Over this day, his equipment depreciates in value by
$50. Of the remaining $450, Barry sends $30 to the
government as GST, pays $100 to his new employee who
is an exchange student from the UK and has a work
permit, takes home $220 in wages and retains $100 in
his business to add new equipment in the future. From
the $220 that Barry takes home, he pays $70 in income
taxes. Based on this information, compute Barry’s
contribution to the following measures of income:
a) Gross Domestic Product
b) Gross National Income
c) National Disposable Income
- Depreciation
- Depreciation
- Depreciation
- Depreciation
- Depreciation
NCT: Net Current Transfer (Immigrants, aids)
NFIA: Net Factor Income from Abroad
GNDI: Gross National Disposable Income
a) GDP equals the dollar amount Barry collects, which is $500.
b) Gross National Product (GNP) tracks down total income of all citizens of a country =
= GDP - $100 = 400 = GNI.
c) NNP = GNP – depreciation = $400 - $50 = $350.
National Disposable income (NDI) =
NNP + NCT= $350 + $0.
Gross National Disposable income = NDI + depreciation =
$350 + $50 = $400.
FOR PRACTICE
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Consider an economy that produces only one good. In
year 1, the quantity produced is Q1 and the price is P1.
In year 2, the quantity produced is Q2 and the price is
P2. In year 3, the quantity produced is Q3 and the price
is P3. Year 1 is the base year. Answer the following
questions in terms of these variables, and be sure to
simplify your answer if possible.
What is nominal GDP for each of these three years?
What is real GDP for each of these three years?
What is the GDP deflator for each of these three years?
What is the percentage growth rate of real GDP from
year 2 to year 3?
What is the inflation rate as measured by the GDP
deflator from year 2 to year 3?
YEAR I: PI QI
Nominal GDP values the production of
goods and services at current prices.
Real GDP uses constant base-year prices
to value the economy’s production of
goods and services.
The GDP deflator – calculated from the ratio of
nominal to real GDP – measures the level of
prices in the economy.
Real GDP growth rate year 2 to 3
Inflation rate Year 2 to 3
P1Q1
P1Q1
P2Q2
P3Q3
P1Q2
P1Q3
1000 1000P2/P1 1000P3/P1
1000P1 Q3 −1000P1 Q2
1000P1 Q2
Q3
− 1 x 100
Q2
P3 /P1 −P2 /P1
P2 /P1
x 100 =
x 100 =
P3
P2
− 1 x 100

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