Chapter 23: Measuring a Nation’s Income

Section A (MCQ)

10. In a certain economy in 2005, GDP amounted to $5,000; consumption amounted to

$3,000; government purchases were equal to investment; and the value of imports
exceeded the value of exports by $200. It follows that government purchases amounted
to
a. $900. GDP = 5000, C = 3000, G = I, nhập khẩu > xuất khẩu = 200:
Ta có: GDP = C + I + G + NX
b. $1,100. => 5000 = 3000 + I + G - 200
c. $1,250. Vì G = I, => 5000 = 3000 + 2G - 200 => 5000 = 2800 + 2G
d. $1,325. => 2G = 2200 => G = 1100

Section B
Question 1
Why do economists use real GDP rather than nominal GDP to gauge economic well-being?
Economists prefer real GDP over nominal GDP because:
 Nominal GDP measures the value of goods and services at current prices, which can be
distorted by inflation or deflation.
 Real GDP adjusts for changes in the price level by using constant base-year prices, allowing
us to compare economic output across different years accurately.
Real GDP reflects the actual growth in production and living standards, while nominal GDP might
rise simply because of rising prices, not because of increased output.

Question 2
Below are some data from the land of milk and honey.
Year Price of Milk Quantity of Milk Price of Honey Quantity of Honey
2001 $1 100 $2 50
2002 $1 200 $2 100
2003 $2 200 $4 100

Compute nominal GDP, real GDP, and the GDP deflator for each year, using 2001 as the base
year.
a) Nominal GDP = Price × Quantity for each good in the same year
 2001: (1×100) + (2×50) = 100 + 100 = $200
 2002: (1×200) + (2×100) = 200 + 200 = $400
 2003: (2×200) + (4×100) = 400 + 400 = $800
b) Real GDP (base year = 2001): use 2001 prices
 2001: (1×100) + (2×50) = $200
 2002: (1×200) + (2×100) = $400
 2003: (1×200) + (2×100) = $400
c) GDP Deflator = (Nominal GDP / Real GDP) × 100
 2001: (200 / 200) × 100 = 100
 2002: (400 / 400) × 100 = 100
 2003: (800 / 400) × 100 = 200

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Question 3
Consider the following data on a country’s GDP:
Year Nominal GDP Deflator
GDP (base year: 1992)
(billions)
1996 $7,662 110
1997 $8,111 112

a) What was the growth rate of nominal GDP between 1996 and 1997?

b) What was the growth rate of the GDP deflator between 1996 and 1997?

c) What was real GDP in 1996?

d) What was real GDP in 1997?

e) What was the growth rate of real GDP between 1996 and 1997?

f) Was the growth rate of nominal GDP higher or lower than the growth rate of real
GDP? Explain.
Nominal GDP grew by 5.86%, Real GDP grew by 4.02%
Because the GDP deflator increase (inflation ≈ 1.82%), a portion of the nominal increase
reflects higher prices rather than additional physical output. Hence the real growth
rate is lower than the nominal rate.

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Question 4
Suppose you are watching a news report with a friend. The news report points out that a
certain African nation generates a GDP per capita of only $2,000 per year. Since your
friend knows that Malaysia's GDP per capita is approximately $20,000, he suggests that
Malaysian are materially 10 times better off than the people of the African nation.
a) Is your friend’s statement accurate?
a) Accuracy of the “10 times richer” claim
 Mention that GDP per capita = (total GDP)/(population), an average.
 Point out it ignores distribution (e.g., inequality) and cost-of-living differences.
 Conclude that while the average Malaysian output is numerically ten times larger,
it does not guarantee Malaysians are literally ten times “better off.”
b) What general category of production is not captured by GDP in both Malaysia and
the African nation?
b) Non-market (unpaid) production
GDP counts only market transactions at official prices; it omits all non-market
production.
c) Provide some examples of this type of activity.
c) Examples of non-market production
 Household chores (cooking, cleaning, child‐care) performed within the family.
 Subsistence agriculture (growing vegetables for home consumption).
 Informal or barter exchanges (neighbors exchanging labor without payment).
 Volunteering (e.g., community work without pay).
d) Why would the exclusion of this type of production affect the measurement of
African output more than Malaysian output?
d) Because Greater undercount in less developed economies
In lower‐income countries a larger share of total output happens off the books
(subsistence farming, household production). Thus, GDP misses a bigger fraction of real
activity there than it does in Malaysia, where formal markets dominate.
e) Does this mean that residents of the African nation are as well off materially as
residents in Malaysia?
No. Even accounting for non-market production, the African nation likely still has lower
access to healthcare, education, infrastructure, and formal employment. Quality‐of‐life
factors beyond GDP—such as life expectancy, literacy, and public services—remain
lower, so material well-being is still less.
GDP per capita is a useful summary, it doesn't tell the whole story. True well-being requires
looking at income distribution, non-market work, and broader social indicators.

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 Chapter 24: Measuring the cost of living
Section B
Question 1
Economists and policymakers monitor both the GDP deflator and the consumer price
index to gauge how quickly prices are rising. However, these two statistics may not always
tell the same story. Discuss two important differences that can cause them to diverge.
Two reasons the GDP deflator and the CPI can diverge:
1. Different baskets and weights
 CPI uses a fixed “consumption” basket of goods and services bought by urban consumers, with
quantities locked in from a base‐period survey.
 GDP deflator uses a changing basket consisting of all goods and services produced domestically
in the current year, with weights that automatically update as the economy’s mix of output
changes.
 Result: If consumers substitute toward cheaper goods, the CPI—still using the old basket—
overstates cost‐of‐living increases, whereas the GDP deflator reflects that substitution.
2. Coverage of imports and investmen
 CPI includes imported consumer goods (e.g. gasoline, electronics) but excludes capital goods and
exports.
 GDP deflator excludes imports (since they’re not produced domestically) but includes investment
goods (equipment, structures) and exports.
 Result: A rise in import prices (say, oil) shows up in the CPI but not in the GDP deflator;
conversely, a boom in domestic investment drives up the deflator but leaves the CPI unchanged.

Question 3
Describe the three problems that make the consumer price index an imperfect measure of
the cost of living.
Three problems that make the CPI an imperfect measure of the cost of living:
[Link] bias: Consumers switch away from goods whose prices rise most (e.g. if beef gets
expensive, they buy more chicken), but the CPI’s fixed basket fails to reflect this, overstating the
true increase in cost of living.
2. Introduction of new goods: New products (smartphones, streaming services) increase
consumer choice and effectively raise real purchasing power, but they don’t enter the fixed CPI
basket until the next survey, causing an upward bias.
3. Unmeasured quality change: Improvements in product quality (longer‐lasting cars, faster
computers) mean that a higher price partly reflects better quality, not pure inflation; CPI
adjustments often understate quality gains, again overstating true inflation.

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Question 2
Calculate the consumer price index and the rate of inflation if given a fixed basket of goods of 4
hamburgers and 2 apples by taking the year 2001 as the base year.

Year Price($)
Hamburger Apple
2001 $1 $0.50
2002 $2 $1.00
2003 $3 $1.50
1. Compute the cost of the fixed basket (4 hamburgers + 2 apples)
o 2001: 4 × $1.00 + 2 × $0.50 = $4.00 + $1.00 = $5.00
o 2002: 4 × $2.00 + 2 × $1.00 = $8.00 + $2.00 = $10.00
o 2003: 4 × $3.00 + 2 × $1.50 = $12.00 + $3.00 = $15.00
2. CPI in each year
Year Basket Cost CPI (2001 = 100)
2001 $ 5.00 (5.00 / 5.00) × 100 = 100
2002 $ 10.00 (10.00 / 5.00) × 100 = 200
2003 $ 15.00 (15.00 / 5.00) × 100 = 300
3. Inflation rate (year-to-year)

So:
 CPI: 100 (2001), 200 (2002), 300 (2003)
 Inflation: 100% from 2001 to 2002; 50% from 2002 to 2003.

Question 4
Convert the salary of Mr. A in the year 1930 to dollars in the year 2000 by using the
following information.
a) A’s salary in the year 1930 was $80,000
b) The price level in the year 2000 was 160
c) The price level in the year 1930 was 52

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Question 5
Suppose you’ve been talking to a friend’s father who told you that he gave up smoking cigarettes
in 1995. When you asked him why he quit, you got a surprising answer. Instead of reciting the
health benefits of quitting smoking, he said, "I quit because it was just getting too expensive. I
started smoking in 1965 and cigarettes were only 45 cents a pack. The last pack I bought was
$2.00 and I just couldn't justify spending more than four times as much on cigarettes as I used
to."
a) In 1965, the CPI was 31.5. In 1995 the CPI was 152.4. While it is commendable that
your friend’s father quit smoking, what is wrong with his explanation?
He compared only nominal prices (“4× more expensive”) without adjusting for the
overall rise in the price level. Between 1965 and 1995, the Consumer Price Index
increased from 31.5 to 152.4, so a pack that cost $0.45 in 1965 would cost much more in
1995 dollars even if its real price hadn’t changed.
b) What is the equivalent cost of a 1965 pack of cigarettes measured in 1995 prices?

c) What is the equivalent cost of a 1995 pack of cigarettes measured in 1965 prices?

d) Do both methods give you the same conclusion?

Yes. Converting the 1965 price forward gives $2.18 in 1995 money.
 Converting the 1995 price back gives $0.41 in 1965 money.
Both show that, in real terms, the price of cigarettes was almost unchanged (slightly cheaper in
1995). The father’s comparison of “$0.45 → $2.00” overstates how much more he was actually
paying once inflation is taken into account.

e) The preceding example demonstrates what economists refer to as a "money

illusion." Why do you think economists might choose the phrase "money illusion"
to describe this behavior?
Because he reacted to the nominal price change rather than the real price (purchasing power).
Economists use “money illusion” to describe when people think in dollar‐amounts instead of in
inflation‐adjusted terms—mistaking a rise in the monetary price for a real increase in cost or
value.

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 Chapter 25 : Production and Growth

Section A (MCQ)

2. Real Foods produced 300,000 boxes of organic spiral noodles in 2014 and produced
360,000 boxes in 2015. They used the same total hours of work each year. In 2015 their
productivity
a. fell.
b. was the same as in 2014.
c. rose 20%.
d. rose 30%.

7. If the real GDP is $13,000 billion and aggregate labor hours used in production are
270 billion, labor productivity equals
a. $6.50 per hour.
b. $45 per hour.
c. $48 per hour.
d. $650 per hour.

Section B
Question 1
List and describe four determinants of productivity.
1. Physical Capital per Worker (K/L):
o The stock of equipment, machinery, and structures that workers use to produce goods and
services.
o More or better capital (e.g., modern factories, computers) allows each worker to produce
more output per hour.
2. Human Capital per Worker:
o The knowledge and skills that workers acquire through education, training, and
experience.
o A more educated and better-trained workforce can use tools more effectively, adopt new
technologies, and innovate, raising output per worker.
3. Natural Resources per Worker:
o The inputs provided by nature—land, minerals, energy sources—available for
production.
o An abundance of fertile land, oil fields, or mineral deposits can boost productivity,
though natural resources alone are not enough without investment in capital and
technology.
4. Technological Knowledge:
o The understanding of the best ways to combine labor, capital, and natural resources to
produce goods and services.

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 o Advances in research and development (R&D), process improvements, and
organizational innovations enable the same inputs to yield higher output.
Question 2
Why is productivity related to the standard of living? In your answer, be sure to explain
what is meant by productivity and standard.
 Productivity measures output per unit of input—typically real GDP per hour worked.
 Standard of living is commonly gauged by real GDP per capita, which reflects the
average material well-being of individuals.
 A higher productivity means each worker produces more goods and services in the same
amount of time, which translates into higher incomes, better wages, and the ability to
consume more (or work less for the same consumption).
 Thus, as productivity rises, real GDP per capita tends to rise, lifting the material standard
of living.

Question 3
Why does a nation’s standard of living depend on property rights?
 Property rights guarantee individuals and firms secure ownership of assets (land,
buildings, intellectual property) and the fruits of their labor or investment.
 When property rights are well-protected by law:
1. People are willing to invest in physical capital (e.g., factories, machinery) and
human capital (education), since they expect to reap the returns.
2. Entrepreneurs innovate and engage in R&D without fear that competitors or the
state will expropriate their ideas or profits.
3. Credit markets function, because collateral (e.g., land titles) can be enforced,
enabling firms to borrow and expand.
4. Contracts are enforced, lowering transaction costs and fostering specialization and
trade.
 Without secure property rights, investment and innovation plummet, productivity growth
stalls, and average incomes (standard of living) remain low.

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Chapter 26: Saving, Investment, and Financial System
Section B
Question 2
Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving is $0.5 trillion, and public
saving is $0.2 trillion. Assuming the economy is closed, calculate consumption, government
purchases, national saving, and investment.