Unit-1

Introduction to Macroeconomics and

National Income Accounting

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Chapter-1 (Abel, Bernanke and Croushore)

Review Questions
Q2. What is business cycle? How does the unemployment rate behave over the course of
business cycle? Does the unemployment rate ever reach zero?
The business cycle refers to the short-run movements (expansions and recessions) of
economic activity. The unemployment rate rises in recessions and declines in expansions.
The unemployment rate never reaches zero, even at the peak of an expansion.

Q3. Define inflation and deflation. Compare the behaviour of consumer prices in the united
states in the years before and after world war 2?
A period of inflation is one in which prices (on average) are rising over time. Deflation occurs
when prices are falling on average over time. Before World War II, prices tended to rise
during war periods and fall after the wars ended; over the long run, the price level remained
fairly constant. Since World War 11, however, prices have risen fairly steadily.

Q4. Historically , when has the federal government been most likely to run budget deficits ?
What has been the recent experiences?
The budget deficit is the annual excess of government spending over tax collections- The
U.S. federal government has been most likely to run deficits during wars. From the early
1980s to the mid–1990s, deficits were very large, even without a major war. The U.S.
government ran surpluses for several years, from 1998 to 2001.

Q5. Define trade deficit and trade surplus. In recent years, has the U.S economy had trade
deficits or surpluses?
The trade deficit is the amount by which imports exceed exports; the trade surplus is the
amount by which exports exceed imports, so it is the negative of the trade deficit. In recent
years the United States has had huge trade deficits.

Q6. List the principal professional activities of macroeconomists. What role does
macroeconomic research play in each of these activities?
Macroeconomists engage in forecasting, macroeconomic analysis, macroeconomic research,
and data development. Macroeconomic research can be useful in investing forecasting
models to improve forecasts, in providing more information on how the economy works to
help macroeconomic analysts, and in telling data developers what types of data shou1d be
collected. Research provides the basis (results and ideas) for forecasting, analysis, and data
development.

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Q7. What steps are involved in developing and testing an economic theory or model? What
are the criteria for a useful theory or model?
The steps in developing and testing an economic model or theory are: (1) state the research
question; (2) make provisional assumptions that describe the economic setting and the
behaviour of the economic actors; (3) work out the implications of the theory; (4) conduct
an empirical analysis to compare the implications of the theory with the data; and (5)
evaluate the results of your comparisons. The criteria for a useful theory or model are that
(1) it has reasonable and realistic assumptions; (2) it is understandable and manageable
enough studying real problems; (3) its implications can be tested empirically using real-world
data and (4) its implications are consistent with the data.

Q8. Might two economists agree about the effects of a particular economic policy but
disagree about the desirability of implementing the policy? Explain your answer
Yes; it is possible for economists to agree about the effects of a policy (that is, to agree on
the positive analysis of the policy), but to disagree about the policy’s desirability (normative
analysis). For example, suppose economists agreed that reducing inflation to zero within the
next year would cause a recession (positive analysis). Some economists might argue that
inflation should be reduced, because they prefer low inflation even at the cost of higher
unemployment. Others would argue that inflation isn’t as harmful to people as
unemployment is, and would oppose such a policy. This is normative analysis. as it involves a
value judgment about what policy should be.

Q9. Compare the classical and Keynesian views on the speed of wage and price adjustment.
What are the important consequences of the differences in their views?
Classical see wages and price adjustment occurring rapidly, while Keynesians think that
wages and prices adjust only slowly when the economy is out of equilibrium. The classical
theory implies that unemployment will non-persist because wages and prices adjust to bring
the economy rapidly back to equilibrium. But if Keynesian theory is correct, then the slow
response of wages and prices means that unemp1oyit may persist for long periods of time
unless the government intervenes.

Q10. What was stagflation, and when did it occur? How did it change economists views about
macroeconomics?
Stagflation was a combination stagnation (high unemployment) and inflation in the 1970s. It
changed economists’ views because the Keynesian approach couldn’t explain stagflation
satisfactorily.

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Analytical Problems
Q1. Can average labour productivity fall even though total output is rising? Can the
unemployment rate rise even though total output is rising?
Yes, average labour productivity can fall even when total output is rising. Average labour
productivity is total output divided by employment. So average labour productivity can fall if
output and employment are both rising but employment is rising faster. Yes, the
unemployment rate can also rise even though total output is rising. This can occur in a
number of different ways. For example, average labour productivity might be rising with
employment constant, so that output is rising, but labour force may be increasing as well, so
that the unemployment rate is rising. Or average labour productivity might be constant, and
both employment and unemployment could rise at the same time because of an increase in
the labour force, with the number of unemployed rising by a greater percentage.

Q2. Prices were much higher in the united states in 2009 than in 1890.Does this fact mean that
people were economically better off in 1890?why or why not?
Just because price were lower in 1890 than they were in 2003 does not mean that people
were better off hack then. People’s incomes have risen much faster than prices have risen
over the last 100 years, so they are better off today in terms of real income.

Q3. State a theory for why people vote republican or democratic that potentially could satisfy
the criteria for a useful theory given in the text .How would you go about testing your
theory?
There are many possible theories. One possibility is that people whose last names begin with
the letters A through M vote Democratic, while those whose names begin with the letters N
through Z vote Republican. You could test this theory by taking exit polls or checking the lists
of registered voters by party. However, this theory fails the criterion of being reasonable,
since there is no good reason to expect the first letters of people’s last names to matter for
their political preferences.
A better theory might be one based on income. For example, you might make the
assumption that the Republican Party promotes business interests, while the Democratic
Party is more interested in redistributing income. Then you might expect people with higher
incomes to vote Republican and people with lower incomes to vote Democratic. This could
be tested by taking a survey of people as they left the polls. In this case the assumptions of
the theory seem reasonable and realistic, and the model is simple enough to understand and
to apply. So it is potentially a useful model.

Q4. Which of the following statements are positive in nature and which are normative?
a. A tax cut will raise interest rate
b. A reduction in the payroll tax would primarily improve poor and middle class workers
c. Payroll taxes are too high
d. A cut in the payroll tax would improve the president’s popularity ratings

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 e. Payroll taxes should not be cut unless capital gains taxes are cut also
(a) Positive. This statement tells what will happen, not what should happen.
(b) Positive. Even though it is about income-distribution issues, it is a statement of fact,
not opinion. If the statement said “The payroll tax should be reduced because it . . .
,“ then it would be a normative statement.
(c) Normative. Saying taxes are too high suggests that they shoulder be over.
(d) Positive. Says what will happen as a consequence of an action
(e) Normative. This is a statement of preference absolute policies.

Q5. In 2002 states imposed tariffs on steel because the foreign steel producers were able to
sell steel cheaply because they received subsidy from their respective governments
causing unemployment in the states .what might a classical economist say in response to
these claims? Would a Keynesian economist be more or less sympathetic to the imposition
of tariffs why?
A classical economist might argue that the economy would work more efficiently without
the government trying to influence trade. The imposition of tariffs increases trade barriers,
interfering, with the invisible hand. The tariffs simply protect an industry that is failing to
operate efficiently and is not competitive internationally.
A Keynesian economist might be more sympathetic to concerns about the steel industry.
Keynesians might argue that there may need to be a long-run adjustment in the steel
industry, but would want to prevent workers in the steel industry from becoming
unemployed in the short run.

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Multiple Choice Questions

1. The two major reasons for the tremendous growth in-output in the U.S. economy over the
last 125 years are
(a) population growth and low inflation
(b) population growth and increased productivity.
(c) low unemployment and [ow inflation.
(d) low inflation and low trade deficits.
Answer: (b)
2. The main reason that the United States has such a high standard of living is
(a) low unemployment
(b) high average labor productivity.
(c) low inflation.
(d) high government budget deficits.
Answer: (b)
3. Average labor productivity is the
(a) amount of workers per machine
(b) amount of machines per machine
(c) ratio of employed to unemployed workers.
(d) amount of output per
Answer: (d)
4. In which of the following periods did average labor productivity in the United States grow
the fastest?
(a) 1929 to 1935
(b) 1949 to 1973
(c) 1973 to 1995
(d) 1995 to 2002
Answer: (b)
5. The most direct effect of an increase in the growth rate of average labor productivity would
be an increase iii
(a) the inflation rate.
(b) the unemployment rate
(c) the long–run economic growth rate.
(d) imported goods.

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 Answer: (c)
6. Short-run contractions and expansions in economic activity are called
(a) recessions.
(b) expansions.
(c) deficits.
(d) the business cycle.

Answer: (d)
7. When national output rises, the economy is said to be in
(a) an expansion.
(b) a deflation.
(c) an inflation.
(d) a recession.
Answer: (a)
8. Which of the following best describes a typical business cycle ?
(a) Economic expansions are followed by economic contractions
(b) Inflation is followed by unemployment
(c) Trade surpluses are followed by trade deficits
(d) Stagflation is followed by inflationary economic growth
Answer: (a)
9. During recessions, the unemployment rate  and output 
(a) rises; falls
(b) rises; rises
(c) falls; rises
(d) falls; falls
Answer: (a)
10. The number of unemployed divided by the labor force equals
(a) the inflation rate.
(b) the labor force participation rate.
(c) the unemployment rate.
(d) the misery index.
Answer: (c)
11. The highest and most prolonged period of unemployment in the United States over the last
125 years occurred during
(a) World War II.
(b) the 1890s Depression.

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 (c) the 1990–1991 recession.
(d) the Great Depression of the 1930s.
Answer: (d)
12. During the Great Depression, the unemployment rate for the United States peaked at
approximately
(a) 10%
(b) 70%
(c) 45%
(d) 25%
Answer: (d)
13. A country is said to be experiencing inflation when
(a) prices of most goods and services are rising over time
(b) prices of most goods and services are falling over time.
(c) total output is rising overtime
(d) total output is failing over time
Answer: (a)
14. From 1800 to 194p, the price level in the Limited States
(a) wended neither upward nor downward.
(b) fluctuated wildly.
(c) declined slowly.
(d) increased slowly.
Answer: (a)
15. Before World War II, the average level of prices in the United States usually
(a) fell during wartime and rose during peacetime.
(b) fell during wartime and fell during peacetime.
(c) lose during wartime and fell during peacetime.
(d) rose during wartime and rose during peacetime.
Answer: (c)
16. The inflation rate is the
(a) percent increase in the average level of prices over a year.
(b) percent increase in output over a year.
(c) percent increase in the unemployment rate over a year.
(d) price level divided by the level of output.
Answer: (a)
17. If the price level was 100 in 1999 and 102 in 2000 the inflation rate was

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 (a) 102%.
(b) 20%.
(c) 2%.
(d) 0.2%.
Answer: ©
18. A closed economy is a national economy that
(a) doesn’t interact economically with the rest of the world.
(b) has a stock market that is not open to traders from outside the country.
(c) has extensive trading and financial relationships with other national economies.
(d) has not established diplomatic relations with other national economies.
Answer: (a)
19. An economy that doesn't interact economically with the rest of the world is called 
economy.
(a) a closed
(b) an open
(c) a surplus
(d) an authoritarian
Answer: (a)
20. U.S. imports are goods and services
(a) produced abroad and sold to Americans.
(b) produced in the United States and sold to Americans.
(c) produced abroad and sold to foreigners.
(d) produced in the United States and sold to foreigners.
Answer: (a)
21. Following World War I and World War II, the United States had a
(a) small trade surplus.
(b) small trade deficit.
(c) large trade deficit.
(d) large trade surplus.
Answer: (d)
22. In the 1980s and 1990s, the United States has had a
(a) small trade surplus.
(b) small trade deficit
(c) large trade deficit.
(d) large trade surplus.

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 Answer: (c)
23. A country has a trade surplus when
(a) imports exceed exports.
(b) imports equal exports.
(c) exports exceed imports.
(d) import is zero.
Answer: (c)
24. A country has a trade deficit when
(a) imports exceed exports.
(b) imports equal exports.
(c) exports exceed imports.
(4) export is zero.
Answer: (a)
25. Data on exports and imports for the United States over the period from 1890 to 2001 show
that
(a) the United States had large trade deficits throughout this entire period.
(b) the United Slates had large trade surpluses throughout this entire period.
(c) the percentage of total output exported by U.S. firms fell dramatically during World War I
and World War II.
(d) a higher percentage of U.5 goods was exported in recent years than in earlier years.
Answer: (d)
26. A central bank is an institution that
(a) pays for government expenditures.
(b) controls a nation’s monetary policy.
(c) runs a county’s stock market.
(d) determines a nation’s fiscal policy.
Answer: (b)
27. In the United States, monetary policy is determined by
(a) the Federal Reserve.
(b) the president.
(c) private citizens.
(d) the Treasury Department.
Answer: (a)
28. The peak in U.S. government spending as a percent of GDP occurred during
(a) World War II.
(b) the 1960s war on poverty

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 (c) the Great Depression.
(d) the 1990s war on drugs
Answer: (a)
29. Why were the U.S. government budget deficits of the I 980s and 1990s so unusual from a
historical point of view?
(a) It was the first time the U.S. government had ever run deficits.
(b) In the past, deficits were usually that large only in wartime.
(c) It was the first time that deficits were accompanied by very high rates of inflation.
(d) It was the first time that deficits diverted funds from other productive uses, such as
investment in modern equipment.
Answer: (b)
30. Critics of the government’s fiscal policies argued that government deficits
(a) prevented capital from flowing into the United States.
(b) were linked to the excess of imports over exports that occurred in the 1980s.
(c) caused the level of unemployment in the United States to increase during the 1980s.
(d) had directly contributed to a decline in the level of demand in the American economy.
Answer: (b)
31. The difference between micro-economics and macroeconomics is that
(a) microeconomics looks at supply and demand for goods, macroeconomics looks at supply
and demand for services.
(b) microeconomics looks at prices, macroeconomics looks at inflation
(c) microeconomics looks at individual consumers, macroeconomics looks at national totals.
(d) microeconomics looks at national issues, macroeconomics looks at global issues.
Answer: (c)
32. Aggregation is the process of
(a) calculating real GDP based on nominal GDP and the price index
(b) summing individual economic variables to obtain economy wide totals
(c) forecasting the components of GDP.
(d) predicting when recessions will occur.
Answer: (b)
33. A country that has many well-trained macroeconomic analysts will not necessarily have
more beneficial macroeconomic policies because
(a) economists’ understanding of the economy remains poor.
(b) there are few ways in which economists' complex models can be applied to the real
word.
(c) economists agree on so few government policies.

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 (d) economic policy is usually made by politicians, not economists.
Answer: (d)
34. The main goal of macroeconomic research is to
(a) predict how the macroeconomy will perform in the future.
(b) analyze current macroeconomic data.
(c) develop new data that can be used to understand better the operation of the economy.
(d) make general statements about how the economy works.
Answer : (d)
35. A set of ideas about the economy that have been organized in a logical framework is called
(a) empirical analysis.
(b) a methodology.
(c) economic theozy.
(d) data development.
Answer: ©
36. If the theory behind an economic model fits the data poorly, you would probably want to

Text
(a) use the theory to predict what would happen if the economic setting or economic
policies change
(b) start from scratch with a new model.
(c) enrich the model with additional assumptions.
(d) restate the research question.
Answer: (b)
37. Positive analysis of economic policy
(a) examines the economic consequences of po1ices not address the question of whether
those consequences are desirable.
(b) examines the economic consequences of policies and addresses the question of whether
those consequences are desirable.
(c) generates less agreement among economists than normative analysis
(d) is rare in questions of economic policy.
Answer; (a)
38. Equilibrium in the economy means
(a) unemployment is zero
(b) quantities demanded and supplied are equal in all markets.
(c) prices are not changing over time.
(d) tax revenues equal government spending, so the government has no budget deficit.
Answer : (b)

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39. Adam Smith’s idea of the “invisible hand” says that given a country’s resources and its initial
distribution of wealth, the use of markets will
(a) insulate a nation from the effects of political instability.
(b) eliminate problems of hunger and dissatisfaction,
(c) eliminate inequalities between the rich and the poor.
(d) make people as economically well off as possible.
Answer: (d)
40. The two most comprehensive, widely accepted macroeconomic models are
(a) the classical model and the supply-side model.
(b) the supply-side model and the real business cycle model.
(c) the classical model and the Keynesian model.
(d) the Austrian model and the Keynesian model.
Answer: (c)
41. Classical economists argue that
(a) the government should have an active role in the economy.
(b) government policies will be ineffective and counterproductive.
(c) the government should actively intervene in the economy to eliminate business cycles.
(d) wages and prices don’t adjust quickly, so the economy is slow to return to equilibrium.
Answer: (b)
42. Keynes was motivated to create a macroeconomic theory different from classical theory
because
(a) he believed in government intervention in the economy
(b) he believed in the idea of the invisible hand.
(c) monetary policy was more important than the officials acknowledged.
(d) classical theory was inconsistent with the data in the Great Depression.
Answer: (d)
43. Keynes assumed that wages and prices were slow to adjust in order to explain
(a) persistently high unemployment
(b) high inflation.
(c) the high level of interest rates
(d) why inflation fell in recession
Answer: (a)
44. How did Keynes propose to solve the Problem of high unemployment?
(a) Increase the growth rate of the money supply.
(b) Allow wages to decline, so that firms will want to hire more workers:

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 (c) Put on wage and price controls, so wages won’t rise and firms won’t have to lay people
off to cut costs.
(d) Have the government increease its demand for goods and services.
Answer: (d)
45. The primary factor that caused most economists to lose their faith in the classical approach
to macroeconomic policy was
(a) the high levels of unemployment that occurred during the Great Depression.
(b) the presence of both high unemployment and high inflation during the 1970s.
(c) the theoretical proof that classical ideas were invalid.
(d) the evidence that classical ideas were useful during economic booms, but not during
economic recessions. a
46. The primary factor that caused some economists to lose their faith in the Keynesian
approach to macroeconomic policy was
(a) the high levels of unemployment that occurred during the Great Depression
(b) the presence of both high unemployment and high inflation during the 1970s
(c) the theoretical proof that Keynes’s ideas were invalid.
(d) the evidence that Keynes’s ideas were useful during economic recessions, but not during
economic booms.
Answer : (b)

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Chapter-2 (Abel, Bernanke and Croushore)

Review Questions
Q1. What are the three approaches to measuring economic activity? Why do they give the same
answer?
Answer: The three approaches to national income accounting are the product approach, income
approach and the expenditure approach .They all give the same answer because they are designed
that way ;any entry based on one approach has an entry in the other approaches with the same
value. Whenever output is produced and sold, its production is counted in the product approach, its
sale is counted in the expenditure approach, and the funds received by the seller are counted in the
income approach

Q2. Why are goods and services counted in GDP at market value? Are there any disadvantages in
using market values to measure production?
ANSWER: Goods and services are counted at market value in GDP accounting so that different types
of goods and services can be added together. Using market prices allows us to count up the total
money value of all the economy’s output .The problem with this approach is that not all goods and
services are sold in markets, so we may not be able to count everything. Important examples are
homemaking and environmental quality

Q3. What is difference between intermediate and final goods and services? In which of these two
categories do capital gods such as factories and machines, fall? Why is the distinction between
intermediate and final goods important for measuring GDP?
ANSWER: Intermediate goods and services are used up in producing other goods in the same period
in which they were produced, while final goods and services are those that are purchased by
consumers or are capital goods that are used to produce future output.Thus factories and machines
will be final goods. The distinction is important, because we want to count only the value of final
goods produced in the economy, not the value of goods produced each step along the way

Q4. How does GDP differ from GNP? If a country employs many foreign workers, which is likely to
be higher: GDP OR GNP?
ANSWER: gross national product is the market value of final goods and services newly produced by
domestic factors of production like labour and capital during the current period, whereas GDP is
production taking place within a country. If a country employs many foreign workers than GDP is
likely o be higher

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Q5. List the four components of total spending. Why are imports subtracted when GDP is
calculated in the expenditure approach?
ANSWER: The four components of spending are consumption, investment, government purchases,
and net exports. Imports must be subtracted because they are produced abroad and e want GDP to
count only those gods and services produced within the country. For example, suppose a car built in
Japan is imported into the United States .The car counts consumption spending in US GDP, but is
subtracted as an import as well, so on net it does not affect US GDP. However, it is counted in japans
GDP as an export

Q6. Define private saving .How is private saving used in the economy? What is the relationship
between private saving and national saving?
ANSWER: Private saving is private disposable income minus consumption. Private disposable income
is total output minus taxes paid plus transfers and interest received from the government. Private
saving is used to finance investment spending, the government budget deficit, and the current
account. National saving is private saving plus government saving
Put in symbols
Spvt = ( Y+NFP+TR+INT-T) –C

Sgovt = ( T-TR-INT) –G
Government saving is the same as government budget surplus and is the negative of government
budget deficit

NATIONAL SAVING ( S) private saving + government saving

= Y+NFP –C-G

Q7. What is national wealth? Why is it important? How is national wealth related to national
saving?
Answer: National wealth is the total wealth of the residents of a country, and consists of its domestic
physical assets and net foreign assets. Wealth is important because the long-run economic well-
being of a country depends on it. National wealth is related to national saving because national
saving is the flow of additions to the stock of national wealth.

Q8. For the purposes of assessing an economy’s growth performance, which is more important
statistic; real GDP or nominal GDP?
Answer: Real GDP is the useful concept for figuring out a country’s growth performance. Nominal
GDP may rise because of increases in prices rather than growth in real output.

Q9. Describe how CPI and CPI inflation are calculated. What are some reasons that CPI inflation
may overstate the true increase in the cost of living?

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Answer: The CPI is a price index that is calculated as the value of a fixed set of consumer goods and
services current prices divided by the value of the fixed set at base-year prices. CPI inflation
is the growth rate of the CPI. CPI inflation overstates true inflation because it is hard to
measure changes in quality, and because the price index doesn’t account for substitution
away from goods that become relatively more expensive towards goods that become
relatively cheaper.

Q10. Explain the differences between the nominal intrest rate, the real intrest rate, and the
expected real intrest rate . Which intrest rate concept is the most important for the
decisions made by borrowers and lenders?
Answer: The nominal interest rate is the rate at which the nominal (or dollar) value of an asset
increases over time. The real interest rate is the rate at which the real value or purchasing
power of an asset increases time, and is equal to the nominal interest rate minus the
inflation rate. The expected real interest rate is the rate at which the real value of an asset is
expected to increase overtime. It is equal to the nominal interest rate minus the expected
inflation rate. The concept that is most important to borrowers and lenders is the expected
real interest rate, because it affects their decisions to borrow or lend.

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Multiple Choice Questions
1. The three approaches to measuring economic activity are the
(a) Cost, income, and expenditure approaches.
(b) Product, income, and expenditure approaches.
(c) Consumer, business and government approaches.
(d) Private, public and international approaches.
Ans.(b)
2. The value of a producer’s output minus the value of the inputs it-purchases from other
producers is called the producer’s
(a) Surplus (b) profit.
(c) value added. (d) gross product.
Ans.(c)
3. The Bigdrill company drills for oil, which it sells for $200 million to the l3igoil company to be
made into gas. The Bigdrill company’s gas is sold for a total of $600 million. What is the total
contribution to the country’s GDP from companies Bigdrill and Bigdrill?
(a) $200 million (b) $400 million
(c) $500 million (d) $800 million
Ans.(c)
4. Sam’s Semiconductors produces cornputerchips, which it sells for $10 million to Carl’s
Computer Company (CCC). CCC’s computers are sold for a total of $16 million. What is the
value added to CCC?
(a) $6 million (b) $10 million
(c) $16 million (d) $26 million
Ans.(a)
5. The Compagnie Naturelle sells mounted butterflies, using butterfly bait it buys from another
firm for $20,000. It pays its workers $35,000, pays $1000 in taxes, and has profits of $3,000.
What is its value added?
(a) $3000 (b) $19,000
(c) $39,000 (d) $59,000
Ans.(c)
6. To ensure that the fundamental identity of national income accounting holds, changes in
inventories are
(a) Treated as part of expenditure (b) treated as part of saving.
(c) Ignored. (d) Counted as consumption.
Ans.(a)

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7. To what extent are homemaking and child-rearing accounted for in the government’s GDP
accounts?
(a) Not at all
(b) Only to the extent that they are provided for pay
(c) Only to the extent that taxes are paid on them
(d) All homemaking and childrearing are accounted for
Ans.(b)
8. The measurement of GDP includes
(a) Nonmarket goods such as homemaking and child-rearing.
(b) The benefits of clean air and water.
(c) Estimated values of activity in the underground economy.
(d) Purchases and sales of goods produced in previous periods.
Ans.(c)
9. Which of the following is included in U.S. GDP?
(a) The sale of a new car from a manufacturer’s inventory
(b) The purchase of a watch from a Swiss company
(c) The sale of a used car
(d) A newly constructed house
Ans.(d)
10. Because government services are not sold in markets,
(a) They are excluded from measurements of GDP.
(b) The government tries to estimate their market value and uses this to measure the
government’s contribution to GDP.
(c) They are valued at their cost of protection.
(d) Taxes are used to value their contribution.
Ans.(c)
11. Intermediate goods are
(a) Capital goods, which are used up in the production of other goods but were produced in
earlier periods.
(b) Final goods that remain in inventories.
(c) Goods that are used up in the production of other goods in the same period that they
were produced.
(d) Either capital goods or inventories.
Ans.(c)
12. Capital goods are
(a) A type of intermediate good.

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 (b) Final goods, because they are not used up during a given year.
(c) produced in the same year as the related final good, whereas intermediate goods are
produced in different years.
(d) produced in one year, whereas final goods are produced over a period of more than one
year.
Ans.(b)
13. Marvin’s Metal Company produces screws that it sells to Ford, which uses the screws as a
component profits cars. In the national income accounts, the screws are classified as
(a) inventory. (b) final goods.
(c) capital goods. (d) intermediate goods.
Ans.(d)
14. Fred the farmer purchased five new tractors at $20,000 each. Fred sold his old tractors to
other farmers for $50,000. The net increase in GDP of these transactions was
(a) $50,000. (b) $100,000.
(c) $125,000. (d) $150,000.
Ans.(b)
15. Inventories include each of the following EXCEPT
(a) unsold finished goods. (b) goods in process.
(c) raw materials held by firms. (d) office equipment.
Ans.(d)
16. GDP differs from GNP because
(a) GDP = GNP – net factor payments from abroad.
(b) GNP = GDP – net factor payments from abroad.
(c) GDP GNP – capital consumption allowances.
(d) GNP = GDP – capital consumption allowances.
Ans.(a)
17. If an American construction company built a road in Kuwait, this activity would be
(a) Excluded from U.S. GNP.
(b) Fully - included in U.S. GDP.
(c) Included in U.S. GNP only for that portion that was attributable to American capital and
labor.
(d) Included in U.S. GDP but not in U.S. GNP.
Ans.(c)
18. Nations such as Egypt and Turkey may have wide differences between GNP and GDP
because both the countries
(a) Have a high level of imports and exports relative to GNP.
(b) Have a large portion of their GNP produced by multinational corporations.

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 (c) Have a large number of citizens working abroad.
(d) Purchase large amounts of military wares from other countries.
Ans.(c)
19. If C = $500, I = $150, C = $100, NX = $40, and GNP = $800, how much is NFP?
(a) –$10 (b) –$5
(c) $5 (d) $10
Ans.(d)
20. The income-expenditure identity says that
(a) Y = C + S + T. (b) Y = C + I + G
(c) Y = C + I + G + NX. (d) Y = C + I + G + NX + CA.
Ans.(c)
21. Which of the following is not a category of consumption spending in the national income
accounts?
(a) Consumer durables (b) Nondurable goods
(c) Services (d) Housing purchases
Ans.(d)
22. Consumer spending is spending by households on final goods and services produced
(a) domestic; domestically and abroad
(b) domestic; domestically
(c) domestic and foreign; domestically arid abroad
(d) domestic and foreign; domestically
Ans.(a)
23. In the expenditure approach to GDP, which of the following would be excluded from
measurements of GDP?
(a) Government payments for goods produced by foreign firms
(b) Government payments for goods produced by firms owned by stale or local governments
(c) Government payments for welfare
(d) All government payments are included in GDP
Ans.(c)
24. Net national product equals
(a) gross national product minus indirect business taxes.
(b) gross national product minus depreciation.
(c) national income minus indirect business taxes.
(d) national income plus depreciation.
Ans.(b)

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25. Monica grows coconuts and catches fish. Last year she harvested 1500 coconuts and 600
fish. She values one fish as having a worth of three coconuts. She gave Rachel 300 coconuts
and 100 fish for helping her to harvest coconuts and catch fish, all of which were consumed
by Rachel. Monica set aside 200 fish to help with next year’s harvest. In terms of fish,
Monica’s income would equal
(a) 700 fish. (b) 900 fish.
(c) 1100 fish. (d) 2700 fish.
Ans.(b)
26. Monica grows coconuts and catches fish. Last year she harvested 1500 coconuts and 600
fish. She values one fish as having a worth of three coconuts. She gave Rachel 300 coconuts
and 100 fish for helping her to harvest coconuts and catch fish, all of which were consumed
by Rachel. Monica consumed the remaining fish and coconuts. In terms of fish, total
consumption by both Monica and Rachel would equal
(a) 700 fish. (b) 900 fish.
(c) 1100 fish (d) 2700 fish.
Ans.(c)

27. Private disposable income equals

(a) GNP – taxes + transfers + interest.
(b) NNP – taxes + transfers + interest.
(c) national income – taxes + transfers + interest.
(d) national income – taxes – transfers + interest.
Ans.(a)
28. The value of a household’s assets minus the value of its liabilities is called
(a) wealth. (b) income.
(c) debt. (d) stock.
Ans.(a)
29. If a local government collects taxes of $500,000, has $350,000 of government consumption
expenditures, makes transfer payments of $100,000, and has no interest payments or
investment, its budget would
(a) show a surplus of $75,000.
(b) show a surplus of $50,000.
(c) be in balance with neither a surplus nor a deficit.
(d) show a deficit of $75,000.
Ans.(b)
30. The government budget surplus equals
(a) government purchases plus transfers.

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 (b) net government receipts minus government purchases.
(c) government purchases minus net receipts.
(d) government purchases minus transfers.
Ans.(b)
31. National saving equals private saving plus government saving, which in turn equals
(a) C + S + T (b) GDP + C + G.
(c) GDP + NFP. (d) GDP + NFP + G.
Ans.(d)
32. The uses-of-saving identity says that an economy’s private saving is used for
(a) investment, interest expenses, and the government budget deficit.
(b) investment, the government budget deficit, and the current account.
(c) investment, interest expenses, the government budget deficit, and the current account.
(d) investment, interest expenses, the government budget deficit, transfer payments, and
the current account.
Ans.(b)
33. The uses-of-saving identity shows that if the government budget deficit rises, then one of
the following must happen.
(a) Private saving must rise, investment must fall, and/or the current account must fall.
(b) Private saving must rise, investment must fall, and/or the current account must rise.
(c) Private saving must rise, investment must rise, and/or the current account must fall1
(d) Private saving must rise, investment must rise, and/or the current account must rise.
Ans.(a)
34. In 2002, private saving was $1590 billion, investment was $1945 billion, and the current
account balance was –$489 billion. From the uses-of-saving identity, how much was
government saving?
(a) –$134 billion (b) –$844 billion
(c) $844 billion (d) $134 billion
Ans.(a)
35. In 2002, national saving was $1456 billion,-investment was $1945 billion, and private saving
was $1590 billion. How much was the current account balance?
(a) $489 billion (b) $221 billion
(c) –$221 billion (d) -$489 billion
Ans.(d)
36. In the mid-to-late 1980s, the United States had “twin deficits” because both  and
 were negative.
(a) government saving; private saving
(b) saving; investment

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 (c) the current account; investment
(d) government saving; the current account
Ans.(d)
37. The country of Old Jersey produces milk and butter, and it has published the following
macroeconomic data, where quantities are in gallons and prices are dollars per gallon.
Good 2003 2004
Quantity Price Quantity Price
Milk 500 $2 900 $3
Butter 2000 $1 3000 –$2
Between 2003 and 2004, nominal GDP grew by
(a) 60.0%. (b) 65.5%.
(c) 83.3% (d) 190A3%.
Ans.(d)
38. The value of real GDP in the current year equals
(a) The value of current-year output in prices of the base year.
(b) The value of current-year output in prices of the current year
(c) The value of base-year output in prices of the base year.
(d) The value of base-year output in prices of the current year.
Ans.(a)
39. The country of Old Jersey produces milk and butter, and it has published the following
macroeconomic data, where quantities are in gallons and prices arc dollars per gallon.
Good 2003 2004
Quantity Price Quantity Price
Milk 500 $2 900 $3
Butter 2000 $1 3000 $2
Between 2003 and 2004, the percent change in real GDP (based on 2003 as a base year) was
(a) 58% (b) 60%
(c) 130% (d) 190%
Ans.(b)
40. The country of Old Jersey produces milk and butter, and it has published the following
macroeconomic data, where quantities are in gallons and prices are dollars per gallon.
Good 2003 2004
Quantity Price Quantity Price
Milk 500 $52 900 $3
Butter 2000 $1 3000 $2
Between 2003 and 2004, the GDP deflator (based on 2003 as a base year) rose

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 (a) 60.00%. (b) 81.25%.
(c) 83.33%. (d) 123.00%.
Ans.(b)
41. Currently, the U.S. national income and product accounts (NIPA) use what type of price
index to calculate real GDP?
(a) Fixed–weight (b) Variable–weight
(c) Chain-weight (d) Heavy–weight
Ans.(c)
42. If nominal GDP for 2003 is $6400 billion and real GDP for 2004 is $6720 billion (in 2003
dollars), then the growth rate of real GDP is
(a) 0%. (b) 0.5%.
(c) 5%. (d) 50%.
Ans.(c)
43. If the price index was 100 in 1990 and 120 in 2000, and nominal GDP was $360 billion in
1990 and $480 billion in 2000, then the value of 2000 GDP in terms of 1990 dollars would be
(a) $300 billion. (b) $384 billion.
(c) $400 billion. (d) $424 billion.
Ans.(c)
44. Nominal GDP in 1970 was $1,035.6 billion, and in 1980 it was $23842 billion. The GDP price
index was 30.6 for 1970 and 60.4 for 1980, where 1992 was the base year. Calculate the
percent change in real GD? in the decade from 1970 to 1980. Round off to the nearest
percentage point
(a) 36% (b) 97%
(c) 136% (d) 169%
Ans.(a)
45. Nominal personal consumption expenditures in the United States were $1760.4 billion in
1980 and rose to $3839.3 billion in 1990. The price index for personal consumption
expenditures was 58.5 for 1980 and 919 for 1990, where 1992 was the base year. Calculate
the percent change in real personal consumption expenditures (rounded to the nearest
percentage point) in the decade.
(a) 37% (b) 59%
(c) 118% (d) 137%
Ans.(a)
46. A chain-weight PT-ice index
(a) equals the value of current output at current prices divided by the value of current
output at base-year Prices
(b) equals the value of a fixed basket at current prices divided by the value of a fixed basket t
base-year prices.

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 (c) is an average of fixed-weight and variable-weight indexes.
(d) is used to calculate the CPI.
Ans.(c)

47. A disadvantage of chain-weighting is that

(a) Past inflation rates change whenever the base year changes.
(b) Past growth rates of real GDP change whenever the base year changes.
(c) It causes output growth to slow.
(d) The components of real GDP don’t sum to real GDP.
Ans.(d)
48. The U.S. inflation rate  in the l960s and 1970s,  in the l980s, and  in the
1990s.
(a) was steady; rose sharply; fell
(b) was steady; rose sharply; remained high
(c) rose; fell sharply; remained low
(d) rose; fell sharply; rose again
Ans.(c)
49. In 2002 the GDP deflator for Old York was 300, and in 2004 it had risen to 330.75. Based on
this information the annual average inflation rate for the two years was
(a) 5%. (b) 5.125%.
(c) 10%. (d) 10.25%.
Ans.(a)
50. lf the price index last year was 1.0 and today it is 1.4, what is the inflation rate over this
period?
(a) –4% (b) 1.4%
(c) 4% (d) 40%
Ans.(d)
51. You are given information on the consumer price index (CPI), where the values given are
those for December31 of each year,
Year CPI
1989 126.1
1990 133.8
1991 137.9
1992 141.9
1993 145.8

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 In which year was the inflation rate the highest?
(a) 1990 (b) 1991
(c) 1992 (d) 1993
Ans.(a)
52. The consumer price index (CPI) was 180 for 2002 when using 1983 as the base year (1983 =
100). Now suppose we switch and use 2002 as the base year (2002 = 100). What is the CPI
for 1983 with the new base year?
(a) 18.0 (b) 55.6
(c) 80.0 (d) 111.2
Ans.(b)
53. The Boskin Commission concluded that the CPI overstates increases in the cost of living by
 percentage point(s) per year.
(a) Less than 1 (b) 1 or 2
(c) About 3 (d) Over 4
Ans.(b)
54. The CPI may overstate inflation for all the following reasons EXCEPT
(a) Problems measuring changes in the quality of goods.
(b) Substitution by consumers towards cheaper goods.
(c) Problems measuring the quality of services.
(d) Changes in Social Security benefits.
Ans.(d)
55. The nominal interest rate minus the inflation rate is the
(a) Depreciation rate. (b) Real interest rate.
(c) Discount rate. (d) Forward rate.
Ans.(b)
56. By Marks buys a one-year German government bond (called a bund) for $400. He receives
principal and interest totaling $436 one year later. During the year the CPJ rose from 150 to
162. The nominal interest rate on the bond was  and the real interest rate was

(a) 9%; 1% (b) 9%; –1%
(c) 36%; 24% (d) 36%; 12%
Ans.(a)
57. The expected real interest rate (r) is equal to
(a) Nominal interest rate minus inflation rate.
(b) nominal interest rate minus expected inflation rate.
(c) expected nominal interest rate minus inflation rate.
(d) nominal interest rate plus expected inflation rate.

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Ans.(b)
58. By Marks buys a one-year German government bond (called a bund) for $400. He receives
principal and interest totalling $436 one year later. During the year the CPI rose from 150 to
162, but he had thought the CII would beat 159 by the end oldie year. By Marks had
expected the real interest rate to be , but it actually turned out to be
(a) 8%; 1% (b) 6%; 3%
(c) 3%; 1% (d) 1%; 3%
Ans.(c)
59. Historical analysis of real interest rates in the United States shows that
(a) real interest rates were unusually low in both the 1970s and l980s.
(b) real interest rates were unusually high in both the 1970s and 1980s.
(c) real interest rates were unusually low in the 1970s and unusually high in the-1980s.
(d) real interest rates were unusually low in the 1980s, spurring the economic growth that
occurred during the Reagan administration.
Ans.(c)

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Numerical Problems
1. After a boat rescues everyone else from Gilligan’s Island the Professor and Gilligan remain
behind, afraid of getting shipwrecked again with the same bunch of people. The Professor
grows coconuts and catches fish. Last year he harvested 1000 coconuts and caught 500
fish. He values one fish as worth two coconuts. The Professor gave 200 coconuts to Gilligan
in exchange for help in the harvest, and he gave Gilligan 100 fish in exchange for collecting
worms for use in fishing. The Professor stored 100 of his coconuts in his hut for
consumption at some future time. Gilligan consumed all his coconuts and fish.
In terms of fish, what is the CDI’ of Gilligan’s Island? What are consumption and
investment? What are the incomes of the Professor and Gilligan?
GDP is the value of all final goods and services produced during the year. The final output of
is 1000, which is worth 500 fish, because two coconuts are worth one fish. Of the 500 fish caught
during the yew; the 100 fish used as fertilizer are an intermediate good, so the final output is 400
fish. So in terms of fish, GDP consists of 500 fish worth of coconuts plus 400 fish, with a total value of
900 fish.
To find consumption and investment, we must find out what happens to all the coconuts and fish.
Gilligan consumes all his 200 coconuts (worth 100 fish) and 100 fish, so his consumption is worth 200
fish. The Professor stores 100 coconuts with a value of 50 fish. In an ideal accounting system, these
stored coconuts would be treated as investment. However, in the national income accounts,
because it is so difficult to tell when durable goods are consumed and when they are saved, they are
counted as consumption. So the Professor’s consumption consists of 800 coconuts (value 400 fish)
and 300 fish, for a total value of 700 fish. Thus the economy’s total consumption is valued at 900 fish
and investment is zero.
In terms of income, Gilligan’s income is clearly worth 200 fish (100 fish plus 200 coconuts worth 100
fish). The Professor’s income is less easily calculated, because he uses 100 fish to fertilize the
coconut trees. These 100 fish are therefore not income to him. Thus the Professor’s income is 800
coconuts (1000 coconuts minus the 200 coconuts paid to Gilligan) plus 300 fish (500 fish minus 100
fish paid to Gilligan and minus 100 fish used as fertilizer). In terms of fish, the Professor’s income has
a value of 700 fish.
This question illustrates some of the nuances of national income accounting. Many difficult choices
and measurement issues are involved in constructing the accounts. Here, for example, it is clear that
what we call consumption really isn’t just the amount of goods cosnsumers use up during the year,
but also includes consumption goods that are purchased but saved for the future. Since there is no
way to measure when goods are used after they are purchased, the accounts are unable to
distinguish consumption from storage of goods.
Another subtlety is the treatment of the fish used as fertilizer. If the fertilizer increases future output
rather than current output, then the fertilizer is not used up during the year and represents
investment of 100 fish. In this case, GDP would equal 100 fish, consumption is 900 fish, investment is
100 fish, the Professor’s income is 800 fish, and Gilligan's income is 200 fish.

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2. National income and product data are generally revised. What effects would the following
revisions have on consumption, investment, government purchases, net exports, and
COP?
a. It is discovered that consumers bought $6 billion more furniture than previously
thought. This furniture was manufactured in North Carolina.
b. It is discovered that consumers bought $6 billion more furniture than previously
thought. This furniture was manufactured in Sweden.
c. It is discovered that businesses bought $6 billion more furniture than previously
thought. This furniture was manufactured in North Carolina.
d. It is discovered that businesses bought $6 billion more furniture than previously
thought. This furniture was manufactured in Sweden.
(a) Furniture made in North Carolina that is bought by consumers counts as consumption, so
consumption increases by $6 billion investment is unchanged, government purchases are
unchanged, net exports are unchanged, net exports are unchanged and GDP increases by $6
billion.
(b) Furniture made in Sweden that is brought by consumers counts as consumption and
imports, so consumption increases by $6 billion investment is unchanged, government
purchases are unchanged, net exports fall by $6 billion, and GDP is unchanged.
(c) Furniture made in North Carolina that is bought by businesses counts as investment, so
consumption is unchanged, investment increases by $6 billion, government purchases are
unchanged, net exports are unchanged, and GDP increases by $6 billion.
(d) Furniture made in Sweden that is bought by businesses counts as investment and imports,
so consumption is unchanged, investment increases by $6 billion, government purchases are
unchanged, net exports decline by $6 billion, and GDP is unchanged.

3. ABC Computer Company has a $20,000,000 factory in Silicon Valley. During the current
year ABC builds $2,000,000 worth of computer components. ABC’s costs are labor,
$1,000,000; interest on debt, $l00,lXtl; and taxes, $200,000.
ABC sells all its output to XYZ Supercomputer. Using ABC’s components, XYZ builds four
supercomputers at a cost of $800,000 each ($500,000 worth of components, $200,000 in
labor costs, and $100,000 in taxes per computer). XYZ has a $30,000,000 factory
XYZ sells three of the supercomputers for $1,000,000 each. At year’s end, it had not sold
the fourth. The unsold computer is carried on XYZ’s books as an $800,000 increase in
inventory
a. Calculate the contributions to CDI’ of these transactions, showing that all three
approaches give the same answer.
b. Repeat part (a), but now assume that, in addition to its other costs, ABC paid
$500,000 for imported computer chips.
(a) ABC produces output valued at $2 million and has total expenses of $l.3 million
($1 million for labor, $0.l. million interest. $0.2 million taxes). So its profits are $0.7 million.
XYZ produces output valued at $3.8 million ($3 million for the three computers that were

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 sold, plus $0.8 million for the unsold computer in inventory) and has expenses of $3.2
million ($2 million for componei3ts, $0.8 million for labor, and $0.4 million for taxes). So its
profits are $0.6 million. According to the product approach, the GDP contributions of these
companies are $3.8 million, the value of the final product of XYZ. ABC’s production is of an
intermediate good, used completely by XYZ, and so is not counted in GDP.
According to the expenditure approach, the GDP contribution is also $3.8 million, with $3
million (of sold computers) adding to the capital stock (as investment spending), and $0.8
million (the unsold computer) as inventory investment.
The income approach yields the same GDP total contribution. The amounts are:
ABC XYZ TOTAL
Labor $1.0 million $0.8 million $1.8 million
Profit $0.7 million $0.6 million $1.3 million
Taxes $0.2 million $0.4 million $0.6 million
Interest $0.1 million $0.0 million $0.1 million
Total of all incomes = $3.8 million
(b) If ABC pays an additional $.5 million for computer chips from abroad, the results change
slightly. The correct answer is easiest to see using the expenditure approach. As in part a,
there is $3.8 million spent on final goods, but now there are also net exports of –$0.5
million. So the total expenditure on domestically produced goods is only $3.3 million. [The
product approach gets the same answer because the $9.5 million is a contribution to GDP of
the country in which the chips were made, and so must he deducted from the GDP of the
United States. The value added in the United States is only $3.3 million. Finally, the income
approach gives the same answer as in part a, except that the cost of importing the chips
reduces ABC's profits by $0.5 million, so the sum of the incomes is only $3.3 million.

4. For each of the following transactions, determine the contribution to the current year’s
GDP. Explain the effects on the product, income, and expenditure accounts.
a. On January 1, you purchase 10 gallons of gasoline at $2.80 per gallon. The gas
station purchased the gasoline the previous week at a wholesale price
(transportation included) of $2.60 per gallon.
b. Colonel Hogwash purchases a Civil War–era mansion for $1,000,000. The broker’s
fee is 6%.
c. A homemaker enters the work force, taking a job that will pay $40,000 over the
year. The homemaker must pay $16,000 over the year for professional child care
services.
d. A Japanese company builds an auto plant in Tennessee for $100,000,000, using
only local labor and materials. (Hint: The auto plant is a capital good produced by
Americans and purchased by the Japanese.)
e. You are informed that you have won $3,000,000 in the New Jersey State Lottery,
to be paid to you, in total, immediately

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 f. The New Jersey state government pays you an additional $5000 fee to appear in a
TV commercial publicizing the state lottery
g. Hertz Rent-a-Car replaces its rental fleet by buying $100,000,000 worth of new cars
from General Motors. It sells its old fleet to a consortium of used- car dealers for
$40,000,009. The consortium resells the used cars to the public for a total of
$60,000,000.
(a) Product approach: $1 = gas station’s value added = $14 product minus $13 value of product
produced in the previous year. Expenditure approach $14 consumption spending plus
inventory investment of –$13. Income approach: $1 paid to the factors of production at the
gas station (wages of employees, interest, taxes, profits).
(b) Product approach: $60,000 broker’s fee providing brokerage services. Expenditure
approach: $60,000 counts as residential investment made by the home buyer. The
important point here is that the transfer of an existing good, even at a higher value than that
at which it was originally sold, does not add to GDP, income approach: $60,000 income to
the broker for wages, profits, etc.
(c) Product approach: $20,000 salary plus $8,000 child care equals $28,000. Note that there is a
sense in which the child care is an intermediate service and should net be counted because
without it the homemaker would not be able to work. But in practice there is no way to
separate such intermediate services from final services, so they are all added to GDP.
Expenditure approach: $28,000 ($8,000 consumption spending on child care services plus
$20,000 in categories that depend on what job the homemaker has). Income approach:
$28,000 ($20,000 compensation of homemaker plus $8,000 income to the factors producing
the child care: employees’ wages interest taxes, profits).
(d) Product approach $100 million of a capital good. Since it is produced with local labor and
materials, and assuming no payments–go to Japanese factors of production, this is all added
to U.S. GOP. Expenditure approach: $100 million net exports, since the plant is owned by the
Japanese. (It is not part of gross domestic investment because the plant is not a capital good
owned by U.S. residents.) Income approach: $100 million paid to U.S. factors of production.
(e) Product approach: $0 because nothing is produced. Expenditure approach: $0 because this
is a transfer, not a government purchase of goods or services. Income approach: $0, because
this is not a payment to a factor of production, just a transfer.
(f) Product approach: $5,000 worth of advertising services--Expenditure approach: $5,000 of
government purchases. Income approach: $5,000 compensation of employees.
(g) Product approach: $120 million composed of $l00 million of new cars produced plus $20
million of sales services provided by the consortium ($60 million sales price minus $40
million cost). Expenditure approach: $100 million by Hertz as investment plus $60 million by
the public for consumption of the used cars minus $40 million of investment goods sold by
Hertz, for a total of $120 million. Income approach: $100 million to the factors of production
of GM plus $20 million in payments to the factors of production and profits for the
consortium.

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5. You are given the following information about economy:
Gross private domestic investment = 40
Government purchases of goods and services = 30
Gross national product (GNP) = 200
Current account balance = –20
Taxes = 60
Government transfer payments to the domestic private sector = 25
Interest payments from the government to the domestic private sector = 15
(Assume all interest payments by government go to domestic households.)
Factor income received from rest of world = 7
Factor payments made to rest of world = 9
Find the following, assuming that government investment is zero:
a. Consumption
b. Net exports
c. GOP
d. Net factor payments from abroad
e. Private saving
f. Government saving
g. National saving
Given data :
I = 40, G = 30, GNP = 200, CA = –20 = NX + NFP,
T = 60, TR = 25,INT = 15, NFP 7 – 9 = –2.
Since GDP = GNP – NFP,
DDP = 200 – (–2) = 202 = Y.
Since NX + NFP = CA,
NX = CA – NFP = –20 – (–2) = –18.
Since Y = C + I + G + NX,
C = Y – (I + G + NX) = 202 – (40 + 30 + (–l8)) = 150
Spvt = (Y + NFP – T + TR + INT) – C
= (202 + (–2) – 60 + 25 + 15) – 150 = 30.
Sgovt. = (T – TR – INT) – G = (60 – 25 – 15) – 30 = –10
S = Spvt + Sgovt = 30 + (–10) = 20
(a) Consumption = 150
(b) Net exports = –l8
(c) GDP = 202
(d) Net factor payments from abroad = –2
(e) Private saving = 30

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(g) Government saving = –10
(h) National Saving = 20

6. Consider an economy that produces only three types of fruit: apples, oranges, and
bananas. In the base year (a few years ago), the production and price data were as
follows:
Fruit Quantity Price
Apples 3,000 bags $2 per bag
Bananas 6,000 bunches $3 per bunch
Oranges 8,000 bags $4 per bag
In the current year the production and price data are follows:
Fruit Quantity Price
Apples 4,000 bags $3 per bag
Bananas 14,000 bunches $2 per bunch
Oranges 32,000 bags $5 per bag
a. Find nominal GOP in the current year and in the base year. What is the percentage
increase since the base year?
b. Find real GOP in the current year and in the base year. By what percentage does
real GOP increase from the base year to the current year?
c. Find the GOP deflator for the current year and the base year. By what percentage
does the price level change from the base year to the current year?
d. Would you say that the percentage increase in nominal GDP in this economy since
the base year is due more to increases in prices or increases in the physical volume
of output?
Base – year quantity at current – year price at base-year prices
Apples 3,000  $3 = $ 9,000 3000  $2 = $ 6,000
Bananas 6,000  $2 = $ 12,000 6000  $3 = $ 18,000
Oranges 8,000  $5 = $10,000 8000  $4 = $ 32,000
$ 61,000 $ 56,000

Current – year quantity at current – year price at base-year prices

Apples 4,000  $3 = $ 12,000 4,000  $2 = $ 8,000
Bananas 14,000  $2 = $ 28,000 14,000  $3 = $ 42,000
Oranges 32,000  $5 = $160,000 32,000  $4 = $ 128,000
$ 200,000 $ 178,000
(a) Nominal GDP is just the dollar value of production in a year at prices in that year. Nominal
GDP is $56 thousand the base year and $200 thousand in the current year. Nominal GDP

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 grew 257% between the base year and the current year: [($200,000/$56,000) – 1]  100% =
257%.
(b) Real GDP is calculated by finding the value of production in each year at base-year prices.
Thus, from the table above, real GDP is $56,000 in the base year and $178,000 in the current
year. In percentage terms, real GDP increases from the base year to the current year by
[($178,000/$56,000) – 1]  100% =218%.
(c) The GDP deflator is the ratio of nominal GDP to real GDP. In the base year, nominal GDP
equals real GDP, so the GDP deflator is 1. In the current year, the GDP deflator is
$200,000/$178,000 = 1,124. Thus the GDP deflator changes by
[(1.124/1) – 1]  100% = 12.4% from die base year to the current year.
(d) Nominal GDP rose 257%, prices rose 12.4%, and real GDP rose 218%, so most of the increase
in nominal GDP is because of the increase in real output, not prices. Notice that the quantity
of oranges quadrupled and the quantity of bananas more than doubled.

7. For the consumer price index values shown, calculate the rate of inflation in each year
from 1930 to 1933. What is unusual about this period, relative to recent experience?
Year 1929 1930 1931 1932 1933
CPI 51.3 50.0 45.6 40.9 38.8
Calculating inflation rates:
1929–30: [50.0/51.3) – 1]  100% = –2.5%
1930–31: [45.6/50.0) – 1]  100% = –8.8%
1931–32: [40.9/45.6) – 1]  100% = –10.3%
1932–33: [(38.8/40.9) – l]  100% = –5.1%
These all show deflation (prices are declining over time), whereas recently we have had nothing but
inflation (prices rising over time).

8. Hy Masks buys a one-year government bond on January 1,2009, for $500. He receives
principal plus interest totaling $545 on January 1, 2010. Suppose that the CPI is 200 on
January 1,2009, and 214 on January 1, 2010. This increase in prices is more than Fly had
anticipated; his guess was that the CPJ would be at 210 by the beginning of 2010. Find the
nominal interest rate, the inflation rate, the real interest rate, Fly’s expected inflation rate,
and Hy’s expected real interest rate.
The nominal interest rates is
[(545/500) – 1]  100% = 9%.
The inflation rate is [(214/200) – 1]  100% = 7%.
So the real interest rate is 2% (9% nominal rate 7% inflation rate).
Expected inflation was only
[(210/200) – 1]  100% = 5%,
So the expected real interest rate was 4% (9% nominal rate – 5% expected inflation rate).

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9. The GOP deflator in Econoland is 200 on January 1,2008. The deflator rises to 242 by
January 1,2010, and to 266.2 by January 1,2011.
a. What is the annual rate of inflation over the two-year period between January 1,
2008, and January 1, 2010? In other words, what constant yearly rate of inflation
would lead to the price rise observed over th6setwo years?
b. What is the annual rate of inflation over the three- year period from January
1,2008, to January 1, 2011?
c. In general, if P0 is the price level at the beginning of an n-year period, and Pn is the
price level at the end of that period, show that the annual rate of inflation it over
that period satisfies the equation
(1 + n)n = Pn/P0.
(a) The annual rate of inflation from January 1, 2002 to January 1, 2004, is 10%. This can be
found by calculating the constant rate of inflation that would raise the deflator from 200 to
242 in two years. This gives the equation (1 + )(1 + ) which has the solution = 10%. An
easy way to think about this question is this. A constant inflation rate of  raises the deflator
from 200 on January 1, 2002, to 200  (l +  on January 1, 2003, and to 200  (1 + )  (1 +
) = 242 on January 1, 2004. So we need to the expression (1 + ) = 242/200.
(b) By similar reasoning, the inflation rate over the three year period is
(1 + )3 = 266,2/200, or = 10%. ‘
(c) We can derive a general expression in the same way:
1 +  = P1/P0
1 +  = P2/P1

1 +  = Pn/Pn-1
Multiplying all these together, we get: (1 + )n = (P1/P0)  (P2/P1)    (Pn/Pn-1) = Pn/P0

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Chapter-5 (Abel, Bernanke and Croushore)
Balance of Payment
Examples of Paired Transactions

Some examples will show how the principle of double entry bookkeeping operates in practice.
Imagine you buy an ink-jet fax machine from the Italian company Olivetti and pay for your purchase
with a $1,000 check. Your payment to buy a good (the fax machine) from a foreign resident enters
the US current account with a negative sign. But where it the offsetting balance of payments credit ?
Olivetti's U.S. sales person must do s1omething with your check let’s say he deposits- it in Olivetti's
account at Citibank in New York in this case, Olivetti has purchased and Citibank has sold, a US asset
– a bank deposit worth $1,000–and the transaction shows up as a $1,000 credit in the U.S. financial
account. The transaction creates the following two offsetting bookkeeping entries in the U.S.
balance of payments:
Credit Debit
Fax machine purchase (Current account, U.S. good import) –$1,000
Sale of bank deposit by Citibank +$1,000
(Financial account, U.S. asset export)
As another example, suppose that during your travels in France you pay $200 for a fine dinner at the
Restaurant de I’Escargot d’Or. Lacking cash, you place the charge on your Visa credit card. Your
payment, which is a tourist expenditure, would be counted as a service import for the United States,
and therefore as a current account debit. Where is the offsetting credit? Your signature on the Visa
slip entitles the restaurant to receive $200 (actually, its local currency equivalent) from First Card,
the company that issued your Visa card. It is therefore an asset, a claim on a future payment from
First Card. So when you pay for your meal abroad with your credit card, you are selling an asset to
France and generating a $200 credit in the U.S. financial account The pattern of offsetting debits and
credits in this case is:
Credit Debit
Meal purchase (Current account, U.S. service import) –$2--
Sale of claim on First Card +$200
(Financial account, U.S. asset export)
Imagine next that your Uncle Sid from Los Angeles buys a newly issued share of stock in the U K oil
giant British Petroleum (BP) He places his order with his stockbroker Go for Broke mc, paying $95
with a check drawn his Go-for-Broke money market account BP, in turn deposits the $95 dollars Sal
has paid its drawn US bank account at Second Bank of Chicago Uncle Sid 5 acquisition of the stock
create& a $95 debit in the U S financial account (he has purchased an asset from a foreign resident,
HP), while HP s $95 deposit at its Chicago bank is the offsetting financial Account credit (HP has
expanded its U S asset holdings) The mirror-image effects on the U balance of payments therefore
both appear in the financial account:
Credit Debit

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 Uncle Sid s purchase of a share of HP –$95
(Financial account, U.S. asset import)
HP’s deposit of Uncle Sid’s payment at Second Bank of Chicago +$95
(Financial account, U.S. asset export) .:
Finally, let’s consider how the U.S. balance of payments accounts are affected when US. banks
.forgive (that, is, announce that they will simply forget about) $5,000 in debt owed to-them by flip
government of the imaginary country of Bygoni. In this case, the United States makes a $5,000
capital transfer to Bygbnia, which appears as a –$5,000 entry in the capital account. The associated
credit is in the financial account, in the form of a $5,000 reduction in U.S. assets held abroad (a net
asset “export,” and therefore a positive balance of payments entry):
Credit Debit
U.S. banks’ debt forgiveness –$5,000
(Capital account, U.S. transfer payment)
Reduction in banks’ claims on Bygonia +$5,000
(Financial account, U.S. asset export)
These examples show that many circumstances can affect the way a transaction generates its
offsetting balance of payments entry. We can never predict with certainty where the flip side of a
particular transaction will show up, but we can be sure it will show up somewhere.

IMP Qs.
1. Explain how each of the following transactions generates two entries—a credit and a debit—in
the American balance of payments accounts, and describe how each entry would be classified:
a. An American buys a share of French stock, paying by writing a check on an account
with a Swiss bank.
b. An American buys a share of French stock, paying the seller with a check on an
American bank.
c. The Japanese government carries out an official foreign exchange intervention in
which it uses dollars held in an American bank to buy Japanese currency (yen)
from its citizens.
d. A tourist from Boston buys a meal at an expensive restaurant in London, England,
paying with a traveler’s check.
e. A California winemaker contributes a case of cabernet sauvignon for a Madrid
wine tasting.
f. A U.S-owned factory in Argentina uses local earnings to boy additional machinery.
a. The purchase of the German stock is a debit in the U.S. financial account. There is a
corresponding credit in the U.S. financial account when the American pays with a check on
his Swiss bank account because his claim on the Switzerland fall by the amount of the check.
This is a case in which an American trade one foreign asset for another
b. Again, there is a U S financial account debit as a result of the purchase of a German stock by
an American. The corresponding credit in this case occurs when the German seller the US

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 check in its German bank and that bank lends the money to a German importer in which
case the credit ill be in the US current account) or to an individual or corporation that
purchases a US asset (in which case the credit will be in the US financial account). Ultimately,
there will be some action taken by the bank which results in a credit in the US balance of
payments.
c. The foreign exchange intervention by the French government involves the sale of a U.S.
asset, the dollars it holds in the United States, and thus represents a debit item in the U.S.
financial account. The French citizens who buy the dollars may use them to buy American
goods which would be an American current account credit or an American assets which
would be an American financial account credit
d. Suppose the company issuing-the traveler’s check uses a checking account in France to make
payments. When this company pays the French restaurateur for the meal, its payment
represents a debit in the U.S. current account. The company issuing the traveler’s check
must sell assets (depleting its checking account in France) to make this payment. This
reduction in the French assets owned by that company represents a credit in the American
financial account.
e. There is no credit or debit in either the financial or the current account since there has been
no market transaction.
f. There is no recording in the U.S. Balance of Payments of this offshore transaction.

2. A person from New Hampshire travels to Maine to buy a $50 telephone answering
machine. The Maine company that sells the machine then deposits the $50 check in its
account at a New Hampshire bank. How would these transactions show up in the balance
of payments accounts of New Hampshire and Maine? What if the person from New
Hampshire pays cash for the machine? -
The purchase of the answering machine is a current account debit for New York and a current
account credit for New Jersey. When the New Jersey Company deposits the money in its New York
bank, there is a financial account credit for New York and a corresponding debit for New Jersey. If
the transaction is in cash then the corresponding debit for New Jersey and credit for New York also
show up in their financial accounts. New Jersey acquires dollar bills (an import of assets from New
York, and therefore a debit item in its financial account); New-York losses the dollars (an export of
dollar bills, and thus a financial account credit). Notice that this last adjustment is analogous to what
would occur under a gold standard

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