1.

What components of GDP (if any) would each of the following transactions
affect? Explain.
a. A family buys a new refrigerator.
b. Aunt Jane buys a new house.
c. Ford sells a Thunderbird from its inventory.
d. You buy a pizza.
e. California repaves Highway 101.
f. Your parents buy a bottle of French wine.
g. Honda expands its factory in Marysville, Ohio.
2. GDP does not include the value of used goods that are resold. Why would
including such transactions make GDP a less informative measure of
economic well-being?
3. If prices rise, peoples income from selling goods increases. The growth of real
GDP ignores this gain, however. Why, then, do economists prefer real GDP as
a measure of economic well-being?
4. One day Barry the Barber, Inc., collects $400 for haircuts. Over this day, his
equipment depreciates in value by $50. Of the remaining $350, Barry sends
$30 to the government in sales taxes, takes home $220 in wages, and retains
$100 in his business to add new equipment in the future. From the $220 that
Barry takes home, he pays $70 in income taxes. Based on this information,
compute Barrys contribution to the following measures of income:
a. Gross Domestic Product.
b. Net national product.
c. National income.
d. Personal income.
e. Disposable personal income.
5. Suppose that the residents of Proteinland spend all of their incomes on ham,
chicken, and roast beef. In 2006, they buy 50 pounds of ham for $150, 35
pounds of chicken for $140, and 100 pounds of roast beef for $500. In 2007,
they buy 35 pounds of ham for $140, 50 pounds of chicken for $200, and 100
pounds of roast beef for $600.
a. Calculate the price of each meat in each year.
b. Using 2006 as the base year, calculate the CPI for each year.
c. What is the inflation rate for 2007?
6. Suppose that people consume only 3 goods, as shown in this table:
Tennis balls
Golf balls Bottles of Gatorade
2006 price
$2
$4
$1
2006 quantity
100
100
200
2007 price
$2
$6
$2
2008 quantity
100
100
200
a. What is the percentage change in the price of each of the three
goods?
b. Using a method similar to the consumer price index, compute the
percentage change in the overall price level.
c. If you were to learn that a bottle of Gatorade increased in size from
2006 and 2007, should that information affect your calculation of the
inflation rate? If so, how?
d. If you were to learn that Gatorade introduced new flavours in 2007,
should that information affect your calculation of the inflation rate? If
so, how?

1.
a. Consumption increases because a refrigerator is a good purchased by a household.
b. Investment increases because a house is an investment good.
c. Consumption increases because a car is a good purchased by a household, but
investment decreases because the car in Fords inventory had been counted as an
investment good until it was sold.
d. Consumption increases because pizza is a good purchased by a household.
e. Government purchases increase because the government spent money to provide a
good to the public.
f. Consumption increases because the bottle is a good purchased by a household, but
net exports decrease because the bottle was imported.
g. Investment increases because new structures and equipment were built.
2. If GDP included goods that are resold, it would be counting output of that particular
year, plus sales of goods produced in a previous year. It would double-count goods
that were sold more than once and would count goods in GDP for several years if they
were produced in one year and resold in another year.
3. Economists ignore the rise in people's incomes that is caused by higher prices
because although incomes are higher, the prices of the goods and services that
people buy are also higher. Therefore, they will not necessarily be able to purchase
more goods and services. For this reason, economists prefer to look at real GDP
instead of nominal GDP.
4.
a. GDP equals the dollar amount Barry collects, which is $400.
b. NNP = GDP depreciation = $400 $50 = $350.
c. National income = NNP sales taxes = $350 $30 = $320.
d. Personal income = national income retained earnings = $320 $100 =
$220.
a. Disposable personal income = personal income personal income tax = $220
$70 = $150.
5.
a. See the price of each good in each year in the following table:
Year
2006
2007
b.

Ham
$3
$4

Chicken
$4
$4

Roast Beef
$5
$6

If 2006 is the base year, the market basket used to compute the CPI is 50 pounds
of ham, 35 pounds of chicken, and 100 pounds of roast beef. We must now
calculate the cost of the market basket in each year:
2006: (50 x $3) + (35 x $4) + (100 x $5) = $790
2007: (50 x $4) + (35 x $4) + (100 x $6) = $940
Then, using 2006 as the base year, we can compute the CPI in each year:
2006: $790/$790 x 100 = 100
2007: $940/$790 x 100 = 119

c.
6.

We can use the CPI to compute the inflation rate for 2007:
(119 100)/100 x 100% = 19%
a. The percentage change in the price of tennis balls is (2 2)/2 100% = 0%.
The percentage change in the price of golf balls is (6 4)/4 100% = 50%.
The percentage change in the price of Gatorade is (2 1)/1 100% = 100%.
b. The cost of the market basket in 2006 is ($2 100) + ($4 100) + ($1
200) = $200 + $400 + $200 = $800. The cost of the market basket in 2007 is
($2 100) + ($6 100) + ($2 200) = $200 + $600 + $400 = $1,200. The

percentage change in the cost of the market basket from 2006 to 2007 is
(1,200 800)/800 100% = 50%.
c. This would lower my estimation of the inflation rate because the value of a
bottle of Gatorade is now greater than before. The comparison should be
made on a per-ounce basis.
d. More flavors enhance consumers well-being. Thus, this would be considered a
change in quality and would also lower my estimate of the inflation rate.