Macroeconomics Tutorial 2

Measuring a Nation’s Income & the cost of living

I. Terms

1. Inflation
2. Macroeconomics
3. Total income
4. Total expenditure
5. Gross domestic products.
6. Gross national products
7. Government purchases
8. Net exports
9. Real GDP
10. Nominal GDP
11. GDP deflator
12. consumer price index (CPI)
13. inflation rate
14. nominal interest rate
15. real interest rate

II. Practice problems

1. The government purchases component of GDP does not include spending on

transfer payments such as Social Security. Thinking about the definition of GDP,
explain why transfer payments are excluded.
2. As the chapter states, GDP does not include the value of used goods that are resold.
Why would including such transactions make GDP a less informative measure of
economic well-being?
3. Consider an economy that produces only chocolate bars.
In year 1, the quantity produced is 3 bars and the price is $4.
In year 2, the quantity produced is 4 bars and the price is $5.
In year 3, the quantity produced is 5 bars and the price is $6.
Year 1 is the base year.
a. What is nominal GDP for each of these three years?
b. What is real GDP for each of these years?
c. What is the GDP deflator for each of these years?
d. What is the percentage growth rate of real GDP from year 2 to year 3?
e. What is the inflation rate as measured by the GDP deflator from year 2 to year 3?
4. The participation of women in the U.S. labor force has risen dramatically since
1970.
a. How do you think this rise affected GDP?
b. Now imagine a measure of well-being that includes time spent working in the home
and taking leisure. How would the change in this measure of well-being compare to
the change in GDP?
c. Can you think of other aspects of well-being that are associated with the rise in
women’s labor-force participation? Would it be practical to construct a measure of
well-being that includes these aspects?
5. Suppose you lend money to your sister at a nominal interest rate of 10 % because
you both expect the inflation rate to be 6 %. Furthermore, suppose that after the loan
has been repaid, you discover that the actual inflation rate over the life of the loan was
only 2%. Who gained at the other’s expense- you or your sister? Why?
6. Henry Ford paid his workers $5 a day in 1914. If the consumer price index was 10
in 1914 and 218 in 2010, how much is the Ford paycheck worth in 2010 dollars?
7. The residents of Vegopia spend all of their income on cauliflower, broccoli, and
carrots. In 2010, they buy 100 heads of cauliflower for $200, 50 bunches of broccoli
for $75, and 500 carrots for $50. In 2011, they buy 75 heads of cauliflower for $225,
80 bunches of broccoli for $120, and 500 carrots for $100.
a. Calculate the price of each vegetable in each year.
b. Using 2010 as the base year, calculate the CPI for each year.
c. What is the inflation rate in 2011?
8. A small nation of ten people idolizes the TV show American Idol. All they produce
and consume are karaoke machines and CDs, in the following amounts:
Karaoke Machines CDs
Quantity Price Quantity Price
2011 10 $40 30 $10
2012 12 60 50 12
a. Using a method similar to the consumer price index, compute the
percentage change in the overall price level. Use 2011 as the base year,
and fix the basket at 1 karaoke machine and 3 CDs.
b. Using a method similar to the GDP deflator, compute the percentage
change of the overall price level. Also use 2011 as the base year.
c. Is the inflation rate in 2012 the same using the two methods?
Explain why or why not.
9. The New York Times cost $0.15 in 1970 and $2.00 in 2009. The average wage in
manufacturing was $3.23 per hour in 1970 and $20.42 in 2009.
a. By what percentage did the price of a newspaper rise?
b. By what percentage did the wage rise?
c. In each year, how many minutes does a worker have to work to earn
enough to buy a newspaper
d. Did workers’ purchasing power in terms of newspapers rise or fall?
10. Suppose that a borrower and a lender agree on the nominal interest rate to be paid
on a loan. Then inflation turns out to be higher than they both expected.
a. Is the real interest rate on this loan higher or lower than expected?
b. Does the lender gain or lose from this unexpectedly high inflation? Does
the borrower gain or lose?
c. Inflation during the 1970s was much higher than most people had
expected when the decade began. How did this affect homeowners who
obtained fixed-rate mortgages during the 1960s? How did it affect the
banks that lent the money?

III. Multiple- Choice Questions

1. An example of transfer payment is

a. Wages.
b. Profit.
c. Rent.
d. Government purchases.
e. Unemployment benefits.
2. The value of plant and equipment worn out in the process of manufacturing goods
and services is defined by
a. consumption
b. Depreciation.
c. Net national product.
d. Investment.
e. Intermediate production.

3. Which of the following would be excluded from 2009 GDP? The sale of
a. A 2009 Honda made in Tennessee.
b. A haircut.
c. A realtor’s services.
d. A home built in 2008 and first sold in 2009.
e. All of the above should be counted in 2009 GDP.

4. Gross domestic product can be measured as the sum of

a. Consumption, investment, government purchases, and net exports.
b. Consumption, transfer payment, wages, and profits.
c. Investment, wages, profits, and intermediate production.
d. Final goods and services, intermediate goods, transfer payment, and rent.
e. Net national product, gross national product, and disposable personal income.

5. U.S gross domestic product (in contrast to gross national product) measures the
production and income of
a. Americans and their factories no matter where they are located in the world
b. People and factories located within the borders of the United States.
c. The domestic service sector only.
d. The domestic manufacturing sector only.
e. None of the above.

6. Gross domestic product is the sum of the market value of the

a. Intermediate goods.
b. Manufactured goods.
c. Normal goods and services.
d. Inferior goods and service.
e. Final goods and services.

7. If nominal GDP in 2010 exceeds nominal GDP in 2009, then the production of
output must have
a. Risen.
b. Fallen.
c. Stayed the same.
d. Risen or fallen because there is not enough information to determine what
happened to real output.

8. If a cobbler buys leather for $100 and thread for $50 and uses them to produce and
sell $500 worth of shoes to consumers, the contribution to GDP is
a. $50.
b. $100.
c. $500.
 d. $600.
e. $650.

9. GDP would include which of the following?

a. housework
b. illegal drug sales
c. intermediate sales
d. consulting services
e. the value of taking a day off from work

10. Real GDP is measured in ….. Prices while nominal GDP is measured in …..
Prices.
a. current year; base year
b. base year; current year
c. intermediate; final
d. domestic; foreign
e. foreign; domestic

11. If U.S. GDP exceeds U.S. GNP, then

a. Foreigners are producing more in the United States than Americans are
producing in foreign countries.
b. Americans are producing more in foreign countries than foreigners are
producing in the United States.
c. Real GDP exceeds nominal GDP.
d. Real GNP exceeds nominal GNP.
e. Intermediate production exceeds final production.

12. How is your purchase of a $40,000 BMW automobile that was produced entirely
in Germany recorded in the U.S. GDP accounts?
a. Investment increases by $40,000 and net exports increase by $40,000.
b. Consumption increases by $40,000 and net exports decrease by $40,000.
c. Net exports decrease by $40,000.
d. Net exports increase by $40,000.
e. There is no impact because this transaction does not involve domestic
production.

13. If your grandparents buy a new retirement home, this transaction would affect
a. Consumption.
b. Investment.
c. Government purchases.
d. Net exports.
e. None of the above.

14. Inflation can be measured by all of the following except the

a. GDP deflator.
b. Consumer price index.
c. Producer price index.
d. Finished goods price index.
e. All of the above are used to measure inflation.
15. The CPI will be most influenced by a 10 percent increase in the price of which of
the following consumption categories?
a. housing
b. transportation
c. medical care
d. food and beverages
e. All of the above would produce the same impact.

16. In 1989, the CPI was 124.0. In 1990 it was 130.7. What was the rate of inflation
over this period?
a. 5.1 percent
b. 5.4 percent
c. 6.7 percent
d. 30.7 percent
e. You can’t tell without knowing the base year.

17. Which of the following would likely cause the CPI to rise more than the GDP
deflator?
a. an increase in the price of Fords
b. an increase in the price of tanks purchased by the military
c. an increase in the price of domestically produced fighter planes sold
exclusively to Israel
d. an increase in the price of Hondas produced in Japan and sold in the United
States
e. an increase in the price of Jhon Deere tractors

18. The “basket” on which the CPI is based is composed of

a. Raw materials purchased by firms.
b. Total current production.
c. Products purchased by the typical consumer.
d. Consumer production.
e. None of the above.

19. If there is an increase in the price of apples that causes consumers to purchase
fewer pounds of apples and more pounds of oranges, the CPI will suffer from
a. substitution basis
b. Bias due to the introduction of new goods.
c. Bias due to unmeasured quality change.
d. Base-year bias.
e. None of the above.

20. Suppose your income rises from $19,000 to $31,000 while the CPI rises from 122
to 169. Your standard of living has likely
a. Fallen.
b. Risen.
c. Stayed the same.
d. You can’t tell without knowing the base year.

21. If the nominal interest rate is 7 percent and the inflation rate is 3 percent, then the
real interest rate is
 a. -4 percent.
b. 3 percent
c. 4 percent.
d. 10 percent.
e. 21 percent.

22. Which of the following statements is correct?

a. The real interest rate is the sum of the nominal interest rate and the inflation
rate.
b. The real interest rate is the nominal interest rate minus the inflation rate.
c. The nominal interest rate is the inflation rate minus the real interest rate.
d. The nominal interest rate is the real interest rate minus the inflation rate.
e. None of the above is true.

23. If inflation is 8 percent and the real interest rate is 3 percent, then the nominal
interest rate should be
a. 3/8 percent.
b. 5 percent.
c. 11 percent.
d. 24 percent.
e. -5 percent.

24. Under which of the following conditions would you prefer to be the lender?
a. The nominal rate of interest is 20 percent and the inflation rate is 25 percent.
b. The nominal rate of interest is 15 percent and the inflation rate is 14 percent.
c. The nominal rate of interest is 12 percent and the inflation rate is 9 percent.
d. The nominal rate of interest is 5 percent and the inflation rate is 1 percent.

25. Under which of the following conditions would you prefer to be the borrower?
a. The nominal rate of interest is 20 percent and the inflation rate is 25 percent.
b. The nominal rate of interest is 15 percent and the inflation rate is 14 percent.
c. The nominal rate of interest is 12 percent and the inflation rate is 9 percent.
d. The nominal rate of interest is 5 percent and the inflation rate is 1 percent.

26. If borrowers and lenders agree on a nominal interest rate and inflation turns out to
be less than they had expected,
a. Borrowers will gain at the expense of lenders.
b. Lenders will gain at the expense of borrowers.
c. Neither borrowers nor lenders will gain because the nominal interest rate has
been fixed by contract.
d. None of the above is true.

27. If workers and firms agree on an increase in wages based on their expectations of
inflation and inflation turns out to be more than they expected,
a. Firms will gain at the expense of workers.
b. Workers will gain at the expense of firms.
c. Neither workers nor firms will gain because the increase in wages is fixed in
the labor agreement.
d. None of the above is true.