Group Members Names:

Group work #1 in class assignment

Work in groups of 3-5 students. Submit one handout per group and write names of all group members.
All questions are 1 point unless otherwise stated.
Multiple choice: 9 questions. Total points: 23

1. How is the value of housing services included in GDP?

  a.  It is valued as the annual depreciation of the house.
  b. It is valued as the mortgage payment made on the house.
  c.  It uses the purchase price of the house in the year it is sold.
  d. It is based on an estimate of its rental value.

2. George buys and lives in a newly constructed home he paid $200,000 for in 2015. He sells the house in
2016 for $225,000. How is GDP impacted?
  a.  The 2016 sale increases 2016 GDP by $225,000 and does nothing to 2015 GDP.
  b. The 2016 sale increases 2016 GDP by $25,000 and does nothing to 2015 GDP.
  c.  The 2016 sale does not increase 2016 GDP and does nothing to 2015 GDP.
  d. The 2016 sale increases 2016 GDP by $225,000, and 2015 GDP is revised upward by $25,000.

3. When a firm produces consumer goods and adds some to inventory rather than selling them, how is
the increase in inventory counted in GDP?
  a.  It is counted in the current quarter GDP as capital consumption allowance.
  b. It is counted in the current quarter GDP as investment.
  c.  It is counted in the current quarter GDP as consumption.
  d. It is counted in the current quarter GDP as a statistical discrepancy.

4. A firm produces consumer goods and adds some to inventory in the third quarter. In the fourth
quarter, the firm sells the goods at a retail outlet. As a result of these actions, what happens to the
consumption and investment components of GDP in the fourth quarter?
  a.  investment decreases, consumption does not change
  b. investment increases, consumption decreases
  c.  investment decreases, consumption increases
  d. investment does not change, consumption increases

Table 6-3
In the country of Shem, the CPI is calculated using a market basket consisting of 5 apples, 4 kg of chicken,
3 shirts, and 2 litres of gasoline. The per-unit prices of these goods have been as follows:
Year Apples Chicken Shirts Gasoline
2012 $1.00 $2.00 $10.00 $1.00
2013 $2.00 $1.50 $8.00 $1.50
2014 $2.00 $2.00 $11.00 $2.00
2015 $3.00 $3.00 $14.00 $3.00

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5. Refer to the Table 6-3. What was the inflation rate, as measured by the CPI, between 2012 and 2013?
  a.  –4.44 percent
  b. –7.14 percent
  c.  3.75 percent
  d. 11.25 percent

6. If the price index in the first year was 90, in the second year was 100, and in the third year was 95, what
did the economy experience?
  a.  10 percent inflation between the first and second years and 5 percent inflation between the
second and third years
  b. 10 percent inflation between the first and second years and 5 percent deflation between the
second and third years
  c.  11 percent inflation between the first and second years and 5 percent inflation between the
second and third years
  d. 11 percent inflation between the first and second years and 5 percent deflation between the
second and third years

7. What is an important difference between the GDP deflator and the consumer price index?
  a.  The GDP deflator reflects the prices of goods and services bought by producers, whereas the
consumer price index reflects the prices of goods and services bought by consumers.
  b. The GDP deflator reflects the prices of all final goods and services produced domestically,
whereas the consumer price index reflects the prices of some goods and services bought by
consumers.
  c.  The GDP deflator reflects the prices of all final goods and services produced by a nation’s
citizens, whereas the consumer price index reflects the prices of final goods and services
bought by consumers.
  d. The GDP deflator reflects the prices of all goods and services bought by producers and
consumers, whereas the consumer price index reflects the prices of final goods and services
bought by consumers.

8. If there is a reduction in the price of large tractors imported into Canada from Russia, what will happen
to the GDP deflator and the consumer price index?
  a.  The GDP deflator and the consumer price index will decrease.
  b. The GDP deflator will not change; the consumer price index will decrease.
  c.  The GDP deflator will decrease; the consumer price index will not change.
  d. Neither the GDP deflator nor the consumer price index will change.

9. In 1990, Professor Fellswoop made $12,000, in 2000 he earned $24,000, and in 2015 he earned $36,000. If
the CPI was 40 in 1990, 60 in 2000, and 100 in 2015, then in real terms, when was Professor Fellswoop’s
salary highest and lowest?
  a.  highest in 1990; lowest in 2000
  b. highest in 2015; lowest in 2000
  c.  highest in 2000; lowest in 1990
  d. highest in 2015; lowest in 1990

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Problem 1 (4 points) A hypothetical economy produces only two items: maple syrup and trips to a local
tourist attraction. Calculate nominal GDP, real GDP, and the GDP deflator, and fill in the corresponding
columns in the following table:

Price of Quantity of Number of Nominal

Year Price of Trips Real GDP GDP Deflator
Maple Syrup Maple Syrup Trips GDP

1 $11 $250 300 425      

2 $13 $258 310 570      
3 $12 $260 324 550      
4 $14 $262 410 580      

Problem 2 (5 points) In a simple economy, people consume only two goods: food and clothing. The
market basket of goods used to compute the CPI has 50 units of food and 10 units of clothing.
Food Clothing
Last year’s price $4 $10
This year’s price $6 $20

a. What are the percentage increases in the price of food and in the price of clothing?
b. What is the percentage increase in the CPI?
c. Do these price changes affect all consumers to the same extent? Explain.

Problem 3 (5 points)
Explain why real GDP might be an unreliable indicator of the standard of living.

Answers multiple choice

1d
2c
3b
4c
5a
6d
7b
8d
9c

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Exercise1
ANominal GDP = Sum of current prices × Current quantities; Real GDP = Sum of base year
N(Year 1) prices × Current quantities; GDP deflator = Nominal GDP / Real GDP × 100. The
Sresults are given in the following table.
W
E Price of GDP
Price of Quantity of Number of Nominal
RYear Maple Real GDP Deflator
Trips Maple Syrup Trips GDP
: Syrup (%)
 1 $11 $250 300 425 $109 550 $109 550 100.0
 2 $13 $258 310 570 $151 090 $145 910 103.6
3 $12 $260 324 550 $146 888 $141 064 104.1
4 $14 $262 410 580 $157 700 $149 510 105.5

Exercise 2
ANSWER: a. The price of food increased by 50 percent. The price of clothing has
increased by 100 percent.
% change price food = ((6-4)/4)*100=50%
%change clothing = ((20-10)/10)*100=100%

b. Last year, the market basket was $300; this year it is $500.
CPI last year = (300/300)*100=100
CPI this year = (500/300)*100=166.67
The percentage increase in the CPI is ((166.67-100)/100)*100 = 66.7 percent
Base year is last year.

c. Since the price of clothing increased relatively more than did the price of food, people who
purchase a lot of clothing and little food became worse off relative to people who purchase a
lot of food and little clothing.

Exercise 3
Real GDP is sometimes used to measure the standard of living but real GDP can be
misleading for several reasons. Real GDP does not include household production, productive
activities done in and around the house by the homeowner. Because these tasks often are an
important component of people’s work, this omission creates a major measurement problem.
Real GDP omits the underground economy, economic activity that is legal but unreported or
that is illegal. In many countries the underground economy is an important part of economic
activity, and its omission creates a serious measurement problem. Real GDP does not include
a measurement of people’s health and life expectancy, both factors that obviously affect
economic well being. The value of leisure time is not included in real GDP. People value their
leisure hours, and an increase in people’s leisure that enhances people’s economic welfare but
can lower the nation’s real GDP. Environmental damage is excluded from real GDP. So an
economy wherein real GDP grows but at the expense of its environment, as was the case with
Eastern European countries under communism, falsely appears to offer greater economic
welfare than a similar economy that grows slightly more slowly but at less environmental
cost. Real GDP does not indicate the extent of political freedom and social justice enjoyed by a
nation’s citizens.