Question

1. Assume that in year 1 an economy produces 1000 units of output and they sell for $90 a unit, on average. In year 2, the economy produces the same 1000 units of output, and sells it for $110 a unit, on average. Use year 1 prices as base year to calculate real GDP in Year 1 and Year 2. What happened to real GDP between years 1 and 2?

2. Which of the following are included and which are excluded in calculating this year’s GDP? Explain in each instance.

(a) A homeowner who mows her own lawn

(b) A decline in the average hours worked per week

(c) Business expenditures on pollution control equipment

(d) Income from illegal drug activities

(e) The person who purchases a health care product

3. The next four questions refer to the following price and output data over a five-year period for an economy that produces only one good. Assume that year 2 is the base year.

Year Units of output Price per unit

1 16 $2

2 20 3

3 30 4

4 36 5

5 40 6

a. Give the nominal GDP for year 3.

b. What is the real GDP for year 3?

Answer 1

1.

Real GDP is the product of base year price and base year quantity; and base year price and current year quantity.

Real GDP of base year = Base year price × Base year quantity

                                    = $90 × 1,000

                                    = $90,000

Real GDP of current year = Base year price × Current year quantity

                                    = $110 × 1,000

                                    = $110,000

Real GDP increases by (110,000 – 90,000 =) $20,000.

2.

No. a: This is excluded from GDP calculation, since this is the personal work (mowing) as the homeowner is not paid.

No. b: This is included in GDP calculation, since per hour rate depends on the hours worked.

No. c: This is included in GDP calculation, since there is expenditure which makes others’ income and country’s GDP.

No. d: This is excluded from GDP calculation, since the act is illegal.

No. e: This is included in GDP calculation, since healthcare products constitute GDP.

3.

a.

Nominal GDP is the product of current price and current quantity.

Nominal GDP of year 3 = Year 3 price × Year 3 quantity

                                        = $4 × 30

                                        = $120

b.

Real GDP is the product of base price and current quantity.

Real GDP of year 3 = Year 2 price (base) × Year 3 quantity

                                        = $3 × 30

                                        = $90