Answers to Text Questions and Problems to Chapter 5

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1 Answers to Text Questions and Problems to Chapter 5 Answers to Review Questions 1. Using market values permits economists to add together different goods and services to get a measure of total output. For example, we can t add together apples, bananas, and shoes, but we can add together their market values. Using market values to aggregate gives a higher weight to high-value items. For example, a $20,000 automobile counts for 5000 times as much in GDP as a $4 double cheeseburger. This makes economic sense, as the market price of each item is a measure of the value that its purchasers place on it. 2. Food that is consumed by its producers does not pass through markets and thus does not get assigned a market price. To measure GDP properly in this case requires estimating the value of food consumed by producers, a difficult task. To the extent that the value of food produced by subsistence farmers is ignored or underestimated by the statisticians, the country s official GDP will understate the true GDP. 3. Consumption: any consumer good or service (an automobile or a haircut, for example). Investment: purchase of a factory, a machine, a home, or other form of capital. Government purchases: goods or services acquired by the government, such as military hardware or the services of public-school teachers. Net exports: exports less imports, for example, Canadian-grown wheat purchased by India (an export) or a German car purchased by a Canadian citizen (an import). Consumption represents the largest share of GDP of the four components. Net exports can be negative, if imports exceed exports. 4. Nominal GDP, the current market value of production, equals 1000 shines $4 per shine, or $4000 last year, and 1200 shines $5 per shine, or $6000 this year. Real GDP is the market value of production measured using the prices of the base year. So real GDP last year is 1000 shines $4 per shine or $4000. (Remember that last year is the base year; real GDP and nominal GDP are the same in the base year). Real GDP this year, equal to this year s output valued at last year s prices, is 1200 shines $4 per shine, or $4800. Notice that Al s contribution to real GDP has grown by 20% since last year ($4800/$4000 = 1.20), which is the same as the increase in the physical volume of his output (1200 shines/1000 shines = 1.20). Real GDP is the better statistic to use when measuring Al s change in productivity, since it eliminates the effects of price changes and measures instead the physical volume of production. 5. Maximization of real GDP is inappropriate as a sole goal for economic policy because it does not consider non-working time, environmental quality and resource depletion, and the quality of daily life and working life. 6. False. The participation rate is the labour force (the sum of employed and unemployed workers) as a share of the adult population. Essentially it measures the fraction of the adult population who are either working or who are looking for work. It is possible for the participation rate to be high, even though many people in the labour force are currently unemployed. 7. Costs include economic costs (loss of output), psychological costs (e.g., depression and loss of selfesteem on the part of unemployed workers), and social costs (e.g., increases in crime). There is room for debate on the likely effects of increased government assistance. More generous government benefits would probably increase the economic costs of unemployment, as unemployed workers would face less incentive to find work quickly; however, these costs would be borne less by the unemployed themselves and more by taxpayers. Increased government support would probably reduce some psychological costs (anxiety about feeding one s family) and increase others (loss of self-esteem induced by taking charity ). Copyright 2005 McGraw-Hill Ryerson Limited 5-1

2 Some social costs, such as the costs of crime, would probably be reduced by providing a higher level of income support to the unemployed. Answers to Problems 1a. Government purchase of a service; GDP increases by $1 billion. b. Transfer payment; GDP does not change. c. Government purchase of a good; GDP increases by $1 billion. d. Government interest payment; GDP does not change. e. Government purchase of goods of $1 billion is exactly offset by net exports of $1 billion (the oil is imported); GDP does not change. This makes sense, since no additional production occurred within Canada. 2. Value added by each firm is as follows: Intelligence Inc.: 100 chips $200 = $20,000. Macrosoft: 100 software packages $50 = $5000. Bell: 100 computers $800 minus purchased inputs ($20,000 in chips and $5000 in software) = $80,000 $25,000 = $55,000. PC Charlie s: 100 computers $1000 minus purchased inputs ($80,000 in computers at wholesale) = $100,000 $80,000 = $20,000. Sum of value added: $20,000 + $ $55,000 + $20,000 = $100,000. This is the same result we get by summing up the market values of final goods and services (the 100 computers sold by PC Charlie s at $1000 each equals $100,000). 3a. Canadian GDP and consumption both rise by the value of the new car. b. Consumption rises by the value of the car, net exports fall by the value of the car (as imports rise). There is no change in Canadian GDP. c. Canadian GDP and investment both rise by the value of the car (purchase of the car by a business counts as investment). d. Investment rises by the value of the car, net exports fall by the value of the car. There is no change in Canadian GDP. 4. We find the four components of expenditure: Consumption expenditures are 600. These already include household purchases of durable goods, so those would not be counted again. Investment expenditures equal construction of new homes and apartments (100) plus business fixed investment (100) plus inventory investment (change in stocks over the year, or 25), for a total of 225. Sales of existing homes and apartments are not counted in investment or GDP. Government purchases are 200. Government payments to retirees are transfers and are not counted. Net exports are exports (75) minus imports (50), or 25. GDP is the sum of the four components: = For the year 2000, nominal GDP is (100 $5) + (300 $20) + (100 $20) = $8500, and real GDP (using prices from 2000) is (100 $5) + (300 $20) + (100 $20) = $8500. Notice that nominal GDP and real GDP are the same for the base year. For the year 2005, nominal GDP is (125 $7) + (250 $20) + (110 $25) = $8625, and real GDP (using prices from 2000) is (125 $5) + (250 $20) + (110 $20) = $7825. Real GDP therefore declined between 2000 and Real GDP for the fourth quarter of 1998 would be nominal GDP ($928.3 billion) divided by the GDP deflator (99.1), or $936.7 billion. When the GDP deflator falls, real GDP can exceed nominal GDP. Copyright 2005 McGraw-Hill Ryerson Limited 5-2

3 7. It would not be correct to decide against the policy because it is projected to reduce real GDP. Rather, the costs and benefits of the policy should be compared. The reduction (if any) in real GDP is relevant when measuring the cost of the proposed policy, as it captures the loss in output. However, the benefits of the policy, in terms of cleaner air, are not captured in GDP and must be assessed in some other way (for example, by trying to value the health benefits of cleaner air). Economists would recommend implementing the policy only if its benefits exceed its costs. 8. Of the 65 people, the 10 children under age sixteen, the 10 retired people, the 5 full-time homemakers, the 5 full-time students, and the 2 ill people are not in the labour force. Of the remaining 33 people, 30 people are employed (either part-time or full-time). So three people do not have jobs but would like one. However, one of these three people has not looked for work for three months and so is counted as not in the labour force rather than unemployed; the other two people are unemployed. In summary, of 65 people, 33 are not in the labour force. So the labour force is 32 people. The participation rate is the share of the population in the labour force, equal to 32/65 = 49%. Of those in the labour force, 30 are employed, 2 are unemployed. The unemployment rate, the share of the labour force that is unemployed, is 2/32, or 6.25%. 9. As the participation rate is 62.5%, we know that 62.5% of the working-age population is in the labour force and the remaining 37.5% is not in the labour force. Sixty million people are not in the labour force, so the total working-age population must be 160 million (60 million is 37.5% of 160 million). The labour force is 62.5% of 160 million, or 100 million people. The unemployment rate is 5.0%, so 5.0% of the 100 million people in the labour force are unemployed, or 5 million people. To summarize, the labour force is 100 million, the working age population is 160 million, and 5 million workers are unemployed. Sample Homework Assignment 1. Determine whether each of the following would or would not be included in the calculation of the current year s GDP. If it should not be included, explain why. a. The purchase of a 1990 Chrysler Caravan manufactured in Ontario. b. A purchase of a share of Nortel stock. c. Coffee beans purchased by Tim Hortons. d. A dry cleaning bill. e. The money you saved by doing your own laundry rather than using a dry cleaning service. f. $25 paid to a neighbourhood kid to mow your lawn. g. $25 if you mow your lawn yourself. h. Money used to purchase marijuana. 2. Suppose that, in the country Beta, the population is 1 million, the labour force is 600,000, and the number employed is 570,000. Calculate: a. the unemployment rate. b. the participation rate. 3. Using the following data for the country Beta, calculate Beta s GDP. Explain why each item was or was not included in GDP. a. Consumption expenditures 1000 b. Exports 125 c. Government purchases of goods and services 300 d. Construction of new homes and apartments 125 e. Sales of existing homes and apartments 320 Copyright 2005 McGraw-Hill Ryerson Limited 5-3

4 f. Imports 90 g. Beginning-of-year inventory stocks 140 h. End-of-year inventory stocks 160 i. Business fixed investments 250 j. Government payments to retirees 160 k. Household purchases of durable goods 265 Multiple Choice Quiz 1. Gross domestic product is a measure of a. output. b. input. c. prices. d. employment. e. interest rates. 2. Canadian gross domestic product is measured in a. units. b. dollars. c. workers. d. percentages. e. euros. 3. The value of the flour used to make a loaf of bread is not included in GDP because it is not a(n) a. capital good. b. service. c. intermediate good. d. final good. e. market good. 4. A good that is used to produce other goods is known as a(n) a. capital good. b. final good. c. intermediate good. d. value added good. e. economic good. 5. Which of the following is not one of the components added together to measure GDP using the expenditures approach? a. Consumption. b. Investment. c. Government purchases. d. Capital. e. Net exports. 6. GDP that has been adjusted for inflation is called a. nominal GDP. b. real GDP. c. money GDP. d. market GDP. Copyright 2005 McGraw-Hill Ryerson Limited 5-4

5 e. dollar GDP. 7. Which of the following individuals is classified as part of the labour force? a. A high school teacher enjoying the summer off. b. A 14-year-old working at a fast food restaurant. c. A retired computer analyst. d. A full-time university student. e. A government employee. 8. The unemployment rate is found by dividing the number of people classified as unemployed by the a. population. b. labour force. c. number of people who are employed. d. number of people out of the labour force. e. participation rate. 9. If an individual would like to have a job, but has given up looking for one, she is classified as a. discouraged. b. unemployed. c. in the labour force. d. disgruntled. e. unproductive. 10. Which of the following is not a type of cost associated with unemployment? a. Economic. b. Social. c. Psychological. d. Shoe leather. e. Opportunity. Short Answer/Problems 1. Classify each of the following individuals as employed, unemployed, or not in the labour force. a. A factory worker laid off indefinitely during a recession. b. A computer technician on vacation. c. A 14-year-old grape picker during the grape harvest. d. A banker who quits his job to (unsuccessfully) seek fame and fortune as an actor. e. A stay-at-home dad. f. A full-time university student. g. A recent university graduate looking for her first job. h. An auto mechanic without a job who has given up looking for work. 2. Suppose that, in the country Beta, the number unemployed is 8000, the number employed is 15,000, and the population is 45,000. Calculate: a. the size of the labour force. b. the participation rate. c. the unemployment rate. Copyright 2005 McGraw-Hill Ryerson Limited 5-5

6 Answer Key to Extra Questions in Instructor s Manual Sample Homework Assignment 1a. No; it was produced in 1990, not the current year. b. No; stock represents ownership, not production. c. No; they are an intermediate good. d. Yes. e. No; there was no market transaction. f. Yes. g. No; there was no market transaction. h. No; illegal production is not included in GDP calculations. 2a. Unemployment rate = 30,000/1,000,000 = 0.03 or 3%. b. Participation rate = 600,000/1,000,000 = 0.60 or 60%. 3. GDP = C + I + G + NX. a. Included as part of C. b. Included as part of NX. c. Included as part of G. d. Included as part of I. e. Not included, as it was not produced during the period. f. Included as part of NX. g. Included as part of calculating I. h. Included as part of calculating I. i. Included as part of I. j. Not included, as it was not a payment for a good or service. k. Included as part of C. GDP = ( ) + (250 + [ ] + 125) + (300) + (125 90) = = Multiple Choice 1. a 2. b 3. d 4. a 5. d 6. b 7. e 8. b 9. a 10. d Problems/Short Answer 1a. Unemployed: not working, but seeking work. b. Employed: has a job. Copyright 2005 McGraw-Hill Ryerson Limited 5-6

7 c. Not in the labour force: must be 16 to be in the labour force. d. Unemployed: not working and actively seeking work. e. Not in the labour force: not seeking work outside the home. f. Not in the labour force: not seeking work outside of school. g. Unemployed: not working and actively seeking work. h. Not in the labour force: discouraged. 2a. Labour force = 15, = 23,000. b. Participation rate = 23,000/45,000 = 0.51 or 51%. c. Unemployment rate = 8000/23,000 = 0.35 or 35%. Copyright 2005 McGraw-Hill Ryerson Limited 5-7

Chapter 5: Production, Income and Employment

Chapter 5: Production, Income and Employment We will take our first look at production and employment, focusing on two key variables: Gross Domestic Product and Unemployment Rate The nation s Gross Domestic