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Study Questions
¤ Read the chapters carefully – learn the definitions!
¤ Provide a precise definition of GDP
Exam 2 Review
¤ What counts in GDP? What does not count in GDP?
Chapters 10, 11, and 12
¤ What is the difference between real and nominal GDP?
Disclaimer – this review guide gives you additional practice with
the material. Studying just this review guide is not sufficient effort.
How do you calculate each?

Please be sure to review Module content, textbook chapters,

¤ Is GDP a good measure of economic well-being?
homework problems, quizzes, posted practice problems, chapter ¤ Identify three measures of well-being that are not accurately
worksheets, and of course your definitions and calculations. represented in our GDP measure
¤ Identify three measures of well-being that are omitted from
GDP
¤ See section 10-5

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Study Questions Study Questions

¤ Identify the four expenditure categories ¤ What are the 4 categories of income?
¤ What is consumption spending? ¤ What does a price index measure?
¤ What are the three types of investment spending? ¤ What is the consumer price index?
¤ How do we measure net exports? ¤ What is the GDP deflator?
¤ What types of government spending count in GDP? ¤ What is the difference between the CPI and GDP
deflator?
¤ What are government transfer payments?
¤ Does it matter if inflation is 4% or 2%? Why or why not?
¤ What does value added measure?
¤ What are intermediate goods? Do they count in GDP?

¤ What are capital goods?

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Study Questions Study Tips

¤ How do you calculate a person’s real income in 2016 ¤ Understand how to calculate:
measured in base year dollars?
¤ The GDP deflator
¤ How do you calculate a person’s real income in 2016 ¤ Percentage change
measured in 2020 dollars? ¤ Real GDP and Real GDP per capita
¤ Nominal GDP
¤ How do you give an employee a cost of living adjustment?
¤ The CPI
¤ What is the difference between the real interest rate and ¤ The inflation rate
the nominal interest rate?
¤ Understand how to convert nominal income to real income
¤ What is the difference between the standard of living and
the cost of living? ¤ Understand how to calculate the cost of living adjusted pay

¤ How is productivity measured? What causes it to change? ¤ Find the (approximate) RGDP per capita growth rate if you
know the growth rate of nominal GDP, the inflation rate,
¤ What is the rule of 70? and the population growth rate

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Value Added – Calculate GDP Value Added – Calculate GDP

Firm Cost of Value of Value
Intermedia productio Added • The rubber is sold to Firm Cost of Value of Value
Intermediate production = Added
te Goods n=
revenue the tire company Goods revenue

Cars Rubber Co. $0 $0.75 • The tires and steel Cars Rubber Co. $0 $0.75 0.75
Tire Co. $1.50 are sold to the car Tire Co. 0.75 $1.50 0.75
Steel Co. $0 $2.00 Steel Co. $0 2 $2.00
manufacturer, who
Car $4.00 Car Manufacturer 3.5 $4.00 0.50
Manufacturer then sells to the car
dealer
Car dealer $0.50 Car dealer 4 4.5 $0.50
• The farmer sells to
Food Farmer $0.75 $0.75 Food Farmer 0 $0.75 $0.75
the supermarket
Supermarket $0.25 Supermarket 0.75 1 $0.25
• What is the value of
Hint: value added = value of production – cost of
GDP in this simple
intermediate goods purchased from other companies GDP = value of final goods = 4.5 + 1 = sum of value added for
economy? all firms

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Which Spending Category? Which Spending Category?

¤ Do each of the following count as consumption, investment, government
spending, net export, or none of these? ¤ A firm builds 10 new homes.

¤ A firm builds 10 new homes.

¤ (residential) investment

¤ A firm buys 10 boxes of computer paper. ¤ A firm buys 10 boxes of computer paper.
¤ A restaurant buys a new stove. ¤ None (intermediate good)
¤ The government buys 100 barrels of oil from Saudi Arabia.
¤ A restaurant buys a new stove.
¤ Ford sells a car from last year’s inventory to Joe.
¤ Investment (new capital)
¤ Company A successfully launches a hostile takeover of Company B, in which it
purchases all the assets of Company B. ¤ The government buys 100 barrels of oil from Saudi
¤ A restaurant purchases fresh fish at the market. Arabia.
¤ The government pays to build a new courthouse. ¤ Government spending and imports

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Which Spending Category? What counts in GDP? Yes or no?

¤ You pay for a haircut
¤ Ford sells a car from last year’s inventory to Joe.
¤ Consumption spending and (inventory) investment ¤ You pay your 15 year old neighbor to rake leaves

¤ Company A successfully launches a hostile takeover of ¤ You pay $500,000 for an existing business
Company B, in which it purchases all the assets of
Company B. ¤ You buy stock for $10,000 and pay a 1% broker fee

¤ None because nothing new was produced ¤ You buy fish for dinner

¤ A restaurant purchases fresh fish at the market. ¤ The local restaurant buys fish
¤ None intermediate good ¤ You buy an eraser

¤ The government pays to build a new courthouse. ¤ UCF buys an eraser

¤ Government spending
¤ You buy a pair of new shoes at the local sporting goods store and
find they were made in China

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What counts in GDP? What is the value of GDP?

¤ You pay for a haircut – yes purchase of a new service ¤ Consumption $56,000

¤ You pay your 15 year old neighbor to rake leaves – no (undeclared income)
¤ Personal saving $15,000
¤ Taxes $20,000 GDP = C + I + G + NX
¤ You pay $500,000 for an existing business – no (purchase of existing asset)
¤ Wages and salaries $60,000 GDP = 56,000 + 15,000 +
¤ You buy stock for $10,000 and pay a 1% broker fee – the broker fee is a new ¤ Interest payments $10,000 18,000 + 7,000 – 10,000
service so the fee counts (the $1,000 is a transfer so does not count)
¤ Investment $15,000
¤ You buy fish for dinner – yes new good
¤ Government spending $18,000
¤ The local restaurant buys fish - no intermediate good
¤ Government transfer payments $5,000
¤ You buy an eraser – yes new good ¤ Imports $10,000
¤ UCF buys an eraser – no intermediate good ¤ Exports $7,000
¤ Rental payments $5,000
¤ You buy a pair of new shoes at the local sporting goods store and find they were
made in China – yes consumption and imports ¤ Profit $11,000

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RGDP and NGDP – base 2012 RGDP and NGDP – base 2012
Good Price Quantity Price Quantity Good Price Quantity Price Quantity
2012 2012 2013 2013 2012 2012 2013 2013
Apples $2 3,000 $3 4,000 Apples $2 3,000 $3 4,000
Bananas 3 6,000 2 14,000 Bananas 3 6,000 2 14,000
Oranges 4 8,000 5 32,000 Oranges 4 8,000 5 32,000

NGDP 2012 = NGDP 2012 = $56,000

RGDP 2012 = RGDP 2012 = $56,000
NGDP 2013 = NGDP 2013 = $200,000
RGDP 2013 = RGDP 2013 = $178,000
Growth rate RGDP = Growth rate RGDP = 218%
GDP deflator 2012 = GDP deflator 2012 = 100
GDP deflator 2013 = GDP deflator 2013 = 112.36
Inflation rate = Inflation rate = 12.36%

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GDP GDP
¤ The farmer grows cotton ¤ The farmer grows cotton and sells
his entire crop to the T-shirt
and sells his entire crop to factory. The T-shirt factory uses
the T-shirt factory. The T- the cotton to produce T-shirts.
shirt factory uses the
cotton to produce T-shirts. ¤ What is the contribution to GDP?
¤ The value of the final good
¤ What is the contribution to $500,000
GDP? ¤ What is profit for each firm?
¤ Farmer profit = 10,000
¤ What is profit for each
¤ Factory profit = 100,000
firm?
¤ What is value added for each
¤ What is value added for firm?
each firm? ¤ Value added farmer = 100,000
¤ Value added factory = 400,000

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GDP GDP
¤ Firm A produces 100 units of output at a cost of $9 each. Firm A sells 50 units of ¤ Firm A produces 100 units of output at a cost of $9 each. Firm A sells 50 units of
output to consumers at a price of $12 each, 30 units of output to Firm B at a price output to consumers at a price of $12 each, 30 units of output to Firm B at a price
of $11 each, and does not sell the remaining 20 units in this time period. of $11 each, and does not sell the remaining 20 units in this time period.

¤ Firm B produces 60 units of output using the 30 units of output that it purchased ¤ Firm B produces 60 units of output using the 30 units of output that it purchased
from Firm A. Firm B sold all 60 units to consumers for a total of $900. from Firm A. Firm B sold all 60 units to consumers for a total of $900.

¤ Value of consumption spending? ¤ Value of consumption spending? $12 x 50 + $900 = $1,500

¤ Value of investment spending? ¤ Value of investment spending? 20 x $9 = $180 (inventory)

¤ Value GDP? ¤ Value GDP? $1,680

¤ Value added by Firm A? ¤ Value added by Firm A? (50 x $12) + (30 x $11) + (20 x $9) – 0 = $1,110

¤ Value added by Firm B? ¤ Value added by Firm B? = $900 – (30 x $11) = $570

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GDP GDP
¤ A firm produces 100 units this year and 100 units next year. They ¤ A firm produces 100 units this year and 100 units next year. They
sell their output to consumers. The cost for both years is $10 per sell their output to consumers. The cost for both years is $10 per
unit. The price this year is $12 per unit and the price next year is unit. The price this year is $12 per unit and the price next year is
$15 per unit. The firm sells 95 units this year and 105 units next $15 per unit. The firm sells 95 units this year and 105 units next year.
year.
The firm’s contribution to GDP this year is _______ and its contribution
The firm’s contribution to GDP this year is _______ and its to GDP next year is ________.
contribution to GDP next year is ________.

This year, consumption = 95 x $12 and inventory investment = 5 x $10

so GDP = $1,190

Next year, consumption = 105 x $15 and inventory investment is -$50

so GDP = $1,525

Remember, GDP measures the value of production in each year.

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GDP
Ted’s Terrific Autos bought 10 new cars last year for $25,000. They RGDP
sold 8 to consumers last year for $30,000 and the remaining two to
consumers this year for $28,000. In GDP this year we would record

a. $6000 under consumption. Real GDP is calculated by multiplying

b. $6000 under investment. a. base year quantities times current year prices.

c. $56,000 under consumption. b. base year prices times current year quantities.

d. $56,000 under consumption and -$50,000 under investment. c. base year quantities times base year prices.

d. current year quantities times current year prices.

D b

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Millions and Billions Millions and Billions

¤ In 1988 the value of RGDP was $8,474.492 billion, the population was ¤ In 1988 the value of RGDP was $8,474.492 billion, the population was
244.499 million, and the number of people employed was 115,060 244.499 million, and the number of people employed was 115,060
measured in thousands. measured in thousands.

¤ What was the value of real GDP per capita? ¤ What was the value of real GDP per capita?

$8,474.492 billion / 0.244499 billion = $34,660.64

¤ What is the value of employment as a percentage of the population? ¤ What is the value of employment as a percentage of the population?

115.060 million / 244.499 million à 47.06%

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CPI – base year 1992 CPI – base year 1992

¤ Cost basket 1992 = ¤ Cost basket 1992 = $30

¤ Cost basket 1999 = ¤ Cost basket 1999 = $42

¤ CPI 1992 = ¤ CPI 1992 = 100

¤ CPI 1999 = ¤ CPI 1999 = 140

¤ Inflation rate = ¤ Inflation rate = 40%

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Real Income Real Income

¤ Suppose that in 1990 Joe’s income was $1,000 per month and in 1995, Joe’s ¤ Suppose that in 1990 Joe’s income was $1,000 per month and in 1995, Joe’s
income was $1,200 per month. Joe looked up information on the CPI for the income was $1,200 per month. Joe looked up information on the CPI for the two
two years and he found the CPI in 1990 was 130.7 and the CPI in 1995 was 152.4. years and he found the CPI in 1990 was 130.7 and the CPI in 1995 was 152.4.

¤ Calculate the percentage change in Joe’s nominal income ¤ Calculate the percentage change in Joe’s nominal income 20%

¤ Calculate the percentage change in the price level ¤ Calculate the percentage change in the price level 16.6%
¤ Calculate Joe’s real income in each year measured in base year dollars ¤ Calculate Joe’s real income in each year measured in base year dollars

¤ Calculate Joe’s real income in each year measured in 1990 dollars ¤ 1990 real income = $1,000 x (100/130.7)

¤ 1995 real income = $1,200 x (100/152.4)

¤ Calculate Joe’s real income in each year measured in 1990 dollars

¤ 1990 real income = $1,000 x (130.7/130.7)

¤ 1995 real income = $1,200 x (130.7/152.4)

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Real Income Real Income

¤ Joe earns $32 per hour and the CPI is 100. The following ¤ Joe earns $32 per hour and the CPI is 100. The following
year the CPI rises to 108. year the CPI rises to 108.
¤ How much of a raise should Joe receive to keep his real ¤ How much of a raise should Joe receive to keep his real
wage constant? wage constant?
¤ He needs a raise equal to the rate of inflation or 8%
¤ If his wage remains at $32 per hour then what happens to
his real wage in percentage terms? ¤ If his wage remains at $32 per hour then what happens to
his real wage in percentage terms?
¤ Real wage = $32 x (100/108) = $29.63
¤ In the second year Joe finds he can buy less with his $32
(nominal) wage per hour due to higher prices
¤ His real wage is 7.41% lower

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Real and Nominal Prices Real and Nominal Prices

¤ The price of gas in 1992 was $1.09 per gallon and in 2013 it was ¤ The price of gas in 1992 was $1.09 per gallon and in 2013 it was $3.51.
$3.51. The price index in 1992 was 140 and in 2013 it was 233. The price index in 1992 was 140 and in 2013 it was 233. Based on this
Based on this information, which increased by a greater information, which increased by a greater percentage, the nominal
percentage, the nominal price of gas or the overall price level? price of gas or the overall price level?
¤ The nominal price of gas increased by 222.02%
¤ You have been offered a job in Tampa that pays $45,000 per
¤ The inflation rate was 66.43%
year. You have been offered a job in San Francisco that pays
$60,000 per year. Prices in SF are 40% higher than Tampa. Which ¤ You have been offered a job in Tampa that pays $45,000 per year.
job should you take if only money matters? You have been offered a job in San Francisco that pays $60,000 per
year. Prices in SF are 40% higher than Tampa. Which job should you
take if only money matters?
¤ If prices in SF are 40% higher then you want to be paid at least 40% more so
$45,000 x 1.40 = $63,000
¤ You should take the job in Tampa

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Cost of Living Adjustment Cost of Living Adjustment

¤ You earn $65,000 per year. If the inflation rate is 2% per year, how ¤ You earn $65,000 per year. If the inflation rate is 2% per year, how
much of a cost of living adjustment do you need to keep real much of a cost of living adjustment do you need to keep real
income constant? In other words, how much should you be paid in income constant? In other words, how much should you be paid in
total? total?
¤ You want to be paid 2% more, or $1,300 more
¤ You want to be paid $66,300 in total

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Economic Growth Economic Growth

¤ If you receive a 4% raise every year, in how many years will your ¤ If you receive a 4% raise every year, in how many years will your income double?
¤ 70/4 = 17.5 years
income double?
¤ If I start with $100 and I earn 4% more each year then in 17.5 years I will have $198.65 =
$100(1.04)17.5
¤ If nominal GDP is growing at 5% per year, the inflation rate is 2%
per year, and population growth is -1% per year then real GDP per ¤ If nominal GDP is growing at 5% per year, the inflation rate is 2% per year, and population
capita is growing at ___ percent per year. growth is -1% per year then real GDP per capita is growing at ___ percent per year.
¤ 5 – 2 – (-1) = 4%
¤ A country aims to double real GDP per capita in the next 25 years.
¤ A country aims to double real GDP per capita in the next 25 years. This means that on average
This means that on average real GDP per capita must grow at ____ real GDP per capita must grow at ____ per year.
per year. ¤ 70/x = 25 so 2.8%

¤ A country aims to double real GDP per capita in the next 25 years. ¤ A country aims to double real GDP per capita in the next 25 years. If the rate of population
growth in the country is 1% per year then this means that real GDP must grow at ____ per year.
If the rate of population growth in the country is 1% per year then
¤ Growth rate RGDP per capita = growth rate RGDP – population growth rate
this means that real GDP must grow at ____ per year. ¤ 2.8% = x – 1% so 3.8%

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Economic Growth Economic Growth

¤ At an annual growth rate of 1.75% it will take _______ years for a ¤ At an annual growth rate of 1.75% it will take _40_ years for a
country’s GDP to double. country’s GDP to double.
¤ Over the next 200 years, how many times will GDP double, ¤ Over the next 200 years, how many times will GDP double,
assuming the growth rate does not change? ________ assuming the growth rate does not change? __5___

¤ If GDP starts at a value of $100 million, then in 200 years the value ¤ If GDP starts at a value of $100 million, then in 200 years the value
of GDP will be __________. of GDP will be ___$3,200 million____.

¤ In 200 years the value of GDP will be ______ times larger than it is ¤ In 200 years the value of GDP will be ___32___ times larger than it is
today. today.

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