Question

ECON 2307 Week 2 Discussion

1. What are roles (activities) of households, firms, and governments in an economy?

2. What is nominal GDP? Why do we need to calculate real GDP?

3. A Bakery buys $4.00 of flour from a Mill and uses the flour to make bread sold to the public for $12.00. Taking these two transactions into account, what is the effect on GDP?

4.  Explain why it is the case that the value of intermediate goods produced and sold during the year is not included directly as part of GDP, but the value of intermediate goods produced and not sold is included directly as part of GDP.

Answer 1

1. What are roles (activities) of households, firms, and governments in an economy?

Households act as consumers, they consume final goods and services produced in the economy. They are owners of factors of production like labor, land, capital and entrepreneur, which are supplied to firms.

Households act as savers since excess income over consumption is saved and lent out as investment. Households pay taxes.

Firms make the decision to manufacture and sell goods and services. They employ and pay for the factors of production like labor, land and capital.

Government plays a key role in all types of economies like capitalist, socialist and mixed economies. In capitalist economy, the government has to encourage free competition, provide incentives for private sector, be a regulatory body, prohibit restrictions on free enterprise like regulating monopolies, maintain law and order, protect property rights, regulate money supply.

In socialist economies, the government controls all production, distribution and consumption decisions. Decisions related to production, allocation of resources, employment, pricing, and consumption are made solely by the government or its central planning authority.

Mixed economy is where both free enterprise and socialism prevail. The government owns public sector corporations like banks, electricity, water, gas etc. The government regulates and provides incentives for the private sector, as well as, provides basic infrastructure for common good.

2. What is nominal GDP? Why do we need to calculate real GDP?

Nominal GDP is current year prices times current year quantity, it gives the value of goods and services produced at the current year prices.

Real GDP is base year prices times current year quantity. Real GDP controls for the effect of inflation. It gives a more realistic picture. Nominal GDP is always higher than real GDP.

3. $12, since it is the value of final goods and services produced.