WEEK 8_TUTORIAL SOLUTIONS
1. Gross domestic product in the economy is measured by the
A) total number of goods and services produced in the economy.
B) market value of all final goods and services produced in the economy.
C) total number of goods produced in the economy.
D) total number of services produced in the economy.
2. Which of the following transactions would be included in the official calculation of
GDP? GDP=C+I+G+(X-M) according to the formula.
A) A student buys a used textbook at the bookshop
B) Bridgestone sells $2 million worth of tyres to General Motors Holden
C) You buy a new SmartPhone
D) You illegally download music off the Internet to put on your iPod
3. Which of the following would not be included in the expenditure category called
‘investment’?
A) Spending on new houses
B) The purchase of shares in a company
C) The purchase of a photocopy machine by the Commonwealth Bank
D) Cars held in inventory by a local Ford car dealer
4. In the equation GDP = C + I + G + NX, the G component refers to
A) federal government expenditures plus all transfer payments.
P a g e 1 | 11
B) the taxes and expenditure of all levels of government.
C) federal government expenditures on transfer payments (thanh toán chuyển
nhượng), such as pensions and unemployment benefits.
D) the purchases of final goods and services by all levels of government,
excluding transfer payments.
5. In the long run, a country will experience an increasing standard of living only if it
experiences
A) a high rate of consumption.
B) continuous technological change.
C) a high rate of labour force growth.
D) a slow rate of population growth.
6. An increase in ________ shifts ________ the production function, and makes it
possible to produce a higher level of GDP with ________ capital per hour worked.
A) technology; down; the same amount of.
B) technology; up; the same amount of.
C) consumption; up; a lesser amount.
D) labour productivity; down; the same amount of.
P a g e 2 | 11
Answers
1. B
2. C
3. B
4. D
5. B
6. B
Short-answer Questions
Question 1
In your own words, define what Gross Domestic Product (GDP) is.
Based on this definition, determine whether each of the following transactions is
included as part of GDP for Australia. For each transaction that is included, state what
component of GDP it belongs to.
a. John grows vegetables in his backyard for his family’s consumption
b. Peter is working on an internship at ANZ in customer service. The
internship is not paid
c. John & Jane purchase a newly built apartment as their first family home for
$600,000
d. Mary sells her house, which she purchased in 2012 to a married couple
from Sydney for $1 million.
e. A baker purchases cake flour from the supermarket for $1,000. The cake
flour will be further processed into cakes.
f. Rio Tinto sells $10 million worth of iron ore to a company in China. In
China, the iron ore will be used to produce steel.
Solutions
Gross Domestic Product (GDP) measures the total market value of all finished/final
goods & services newly produced in a country in a certain period of time (often
quarterly or annually).
a. As the vegetables are consumed by John’s family, there is no market value
for the vegetables. Thus, it is not a part of GDP. This is an example of
“household production”.
b. Since Peter’s internship is not paid, its market value is zero, thus, is not
counted toward GDP. This is an example of “unpaid voluntary work”.
P a g e 3 | 11
c. Since the apartment is newly built, this is included in GDP. Many would
say that it’s part of consumption since the apartment is purchased by
individuals (John & Jane). However, it actually goes to “Residential
Investment”, a part of investment instead.
d. Since the house was already established before the transaction (it was
previously sold in 2012), this is not a part of GDP. Remember that GDP
only counts new production.
e. Since the flour will be processed further into cakes, it is an intermediate
good. Thus, this transaction is not included directly in GDP. Having said
that, the value of cake flour will be added to the value of cakes (the finished
products), which will be included in GDP.
f. Many will be tempted to point out that the iron ore will be processed further
into steel, thus, is an intermediate good. However, from the Australia’s
point of view, the iron ore is already a final/finished good. Iron ore being
converted into steel happens outside Australia (in China). From Australia’s
standing, this transaction is included in GDP. It is counted as part of
Australia’s exports.
Question 2
a. Consider the following transaction: Last year, John successfully saved
$5,000. Instead of leaving the money idle in his bank account, he decided to
“invest” $5,000, purchasing Qantas shares. He hopes the shares will
appreciate in value and give him a nice return on his “investment”.
Should the above transaction be recognised as an “economic investment”?
Explain clearly.
b. Give three examples of economic investment.
Solutions
a. John buying Qantas shares can be viewed as a “financial investment”.
However, it is NOT an economic investment.
It is not a part of GDP either since the Qantas shares already existed and
there is no new production being generated.
From an economic point of view, the purchase of Qantas shares by John is a
form of savings. Instead of saving his money by letting it sit in his bank
account, John chose to save in Qantas shares. He hopes the Qantas share
price will climb, making the shares he would buy appreciate in value and
his savings increase as a result.
P a g e 4 | 11
“Economic investment” and “financial investment” are not the same. In
fact, one of the most common mistakes in macroeconomics is people
mistaking a financial investment as an economic investment.
In the past, many students usually wrote: “When interest rate is higher,
people will invest more in the stock market, government bonds and bank
deposits because the return earned will be higher. Therefore, investment
will increase”. This is a classic example of students misunderstanding
economic investment. In fact, when interest rate increases, economic
investment falls. Firms will find it more expensive to acquire the funds
needed to buy new equipment or build new factories. This results in weaker
incentives for business investment and a drop in economic investment.
b. Economic investment consists of three categories as discussed below:
i. Business investment: Firms building new factories, buying new
machine/equipment, paying for staff training
ii. Residential investment: Spending by both firms and households on
new housing. Refer to Question 1, part (c) above.
iii. Changes in business inventories: For example, Apple anticipates
soaring demand for Iphone 11 at the beginning of next year. As a
result, Apple has already spent the months prior producing and
stacking up a large number of Iphone 11. Since these phones are not
yet sold, they will be sitting in Apple’s warehouse and are the
company’s inventories.
P a g e 5 | 11
Question 3
A simple economy called Economy X produces only three types of products:
sunglasses, suntan lotion and swimmers. The table below shows the production and
price data for Economy X in 2015 and 2016.
Production and Price Data for Economy X
2015 2016
Product Quantity Price per unit Quantity Price per unit
($) ($)
Sunglasses 1,000 20 1,500 25
Suntan Lotion 500 10 550 11
Swimmers 100 80 110 80
a. Calculate Economy X’s Nominal GDP in 2015 and 2016
b. Calculate Economy X’s Real GDP in 2015 and 2016. Assume that 2015 is
chosen as the base year.
c. Calculate the GDP price deflator for Economy X in 2015 and 2016.
d. Calculate Economy X’s rate of economic growth in 2016.
e. Assume that GDP price deflator is used to calculate the inflation rate. Calculate
Economy X’s inflation rate in 2016.
f. Based on your calculations above, what can you say about the differences
between Real GDP and Nominal GDP?
If we are interested in how fast the economy is growing, should we pay
attention to Real GDP or Nominal GDP?
Clearly explain why.
a. Nominal GDP2015= P2015*Q2015= 20*1,000 + 10*500 + 80*100= $33,000.
Nominal GDP2016= P2016*Q2016= 25*1,500 + 11*550 + 80*110= $52,350.
b. Since we chose 2015 as the base year, we will calculate using the price per unit
of 2015 to find Real GDP.
Real GDP2015= Nominal GDP2015= $33,000.
Real GDP2016= P2015*Q2016= 1,500*20 + 550*11 + 110*80= $44,300.
Nominal GDP
c. Price deflator= *100
Real GDP
Nominal GDP 2016 P 2016∗Q 2016 52,350
Price deflator2016= Real GDP 2016 *100= P 2015∗Q 2016 *100= 44,300
*100=118.2.
Solutions
a. In order to calculate Nominal GDP for a year, simply multiply the price with
the quantity of that year.
Nominal GDP (2015)
Sunglasses = 1,000 * 20 = $20,000
P a g e 6 | 11
Suntan Lotion = 500 * 10 = $5,000
Swimmers = 100 * 80 = $8,000
Nominal GDP (2015) = $33,000.
Nominal GDP (2016)
Sunglasses = 1,500 * 25 = $37,500
Suntan Lotion = 550 * 11 = $6,050
Swimmers = 110 * 80 = $8,800
Nominal GDP (2016) = $52,350
b. Calculating Real GDP is different. You still pick the quantity of the year but
have to multiply with the price of the base year. The idea is to keep the price
consistent by always using the price of the base year, so that any change in
Real GDP indicates a change in production.
Since 2015 is chosen as the base year, Real GDP (2015) = Nominal GDP
(2015) = $33,000.
Real GDP (2016)
Sunglasses = 1,500 * 20 = $30,000
Suntan Lotion = 550 * 10 = $5,500
Swimmers = 110 * 80 = $8,800
Real GDP (2016) = $44,300
Nominal GDP
c. GDP price deflator = ∗100
Real GDP
Since 2015 is the base year, the GDP price deflator in 2015 is 100 (always the
case for the base year).
Nominal GDP(2016) 52,350
GDP price deflator (2016) = ∗100= ∗100=118.17
Real GDP(2016) 44,300
d. Economic growth is calculated based on Real GDP.
Economic growth (2016) =
Real GDP ( 2016 )−Real GDP(2015) 44,300−33,000 11,300
∗100 %= ∗100 %= ∗100 %=34.24 %
Real GDP (2015) 33,000 33,000
e. The inflation rate in 2016 can be calculated by comparing the GDP price
deflator in 2016 against that in 2015 (the previous year).
118.17−100
Inflation rate (2016) = ∗100 %=18.17 %
100
We can conclude that: on average, the price in 2016 is 18.17% higher than the
price in 2015.
P a g e 7 | 11
f. Nominal GDP is affected by both changes in prices (aka inflation) and changes
in quantity.
By keeping prices constant (at the base year), Real GDP removes the impact of
prices.
Changes in Real GDP reflect changes in output/production.
If we are interested in how fast the economy is growing, we focus on Real
GDP.
We almost never look at Nominal GDP.
The GDP reported in the news is Real GDP all along.
Question 4
The following table illustrates the value added in the production of a litre of petrol by
each stage of production. (The values are hypothetical, and there are no excise taxes or
sales taxes.)
Stage of
Production Value of Sales ($) Value Added ($)
Oil drilling 0.60
Refining 1.10
Shipping 1.35
Retail sales 1.45
a. What is the value added by each stage of production?
b. What is the total value added?
P a g e 8 | 11
For simplicity, you can ignore the cost of the inputs for oil drilling.
_____________________________________________________________________
________________________
_____________________________________________________________________
________________________
Answer:
Stage of
Production Value of Sales ($) Value Added ($)
Oil drilling 0.60 0.60
Refining 1.10 0.50
Shipping 1.35 0.25
Retail sales 1.45 0.10
$1.45
a. The value added is the difference between the price the firm sells a good for and
the price it paid other firms for the intermediate good. The firm that does the oil
drilling sells the litre of oil to the refinery for $0.60. Since we are assuming no other
input costs for simplicity, the value added by the drilling firm is $0.60. The refinery
processes the oil and then sells it to the transport company for $1.10. The refinery’s
value added is $0.50. The transport company sells the oil to the retail company for
$1.35. The transport company’s value added is $1.35 - $1.10 = $0.25. Finally, the
retail petrol station sells the litre of petrol for $1.45. The value added by the petrol
station is $0.10.
b. The total value added is found by summing the value added by each firm involved
P a g e 9 | 11
the production of the litre of petrol. The retail price is the same at this total of value
added.
Question 5
Starting at point E in the following diagram, identify which combinations of points
illustrate technological change. Give a brief explanation to support your answer.
_____________________________________________________________________
________________________
_____________________________________________________________________
________________________
Answer:
P a g e 10 | 11
The movement from E to B to D in the diagram illustrates technological change.
Technological change is constant along a given production function. Technological
change will shift up the production function as more output is produced ($17 000 GDP
per hour versus $16 000 GDP per hour versus $15 000 GDP per hour) with the same
amount of capital per hour worked ($60 000).
P a g e 11 | 11
