This preview shows pages 1–3. Sign up to view the full content.

BRIEF ANSWERS TO PROBLEMS AND QUESTIONS FOR REVIEW 12 1. Not every market transaction is included in GDP. The items excluded from the calculation of GDP include all of the intermediate goods produced in the country for use as inputs into the production of final goods and services. In addition, nonmarket transactions and illegal transactions are excluded. 2. Although GDP uses current prices as a measure of market value, current prices can distort our measure of real output. A rise in GDP does not mean there is an increase in the quantity of goods and services that the economy produces. To distinguish increases in the quantity of goods and services from increases in their prices, countries construct real GDP. Nominal GDP is the value of final output measured in current prices and real GDP is the value of final output measured in constant prices. When calculating real GDP the market value of goods and services produced in a year is adjusted to account for changing prices. 3. GDP is composed of four components: (1) consumption by the public (C); (2) gross private domestic investment (I); (3) government spending on goods and services (G); and (4) net exports [exports (X) minus imports (M)]. 4. In a closed economy, firms must use any final good or service that individuals do not consume or the government does not purchase to produce new plant and equipment. The easiest way to express this for a closed economy is: Y = C + I + G Y or GDP equals the sum of consumption, investment, and government spending. This equation holds in a closed economy because we have assumed that the public, the government, or the business sector consumed or invested all output. The equation for an open economy is: Y = C + I + G + (X - M) This equation shows that GDP in an open economy is equal to the sum of consumption, investment, government spending, and the trade balance. Since the trade balance is equal to the sum of exports and imports there are three possibilities. It is possible that exports and imports would exactly match and GDP would equal domestic spending. When a country’s exports are greater than its imports, the country has a trade surplus and GDP is greater than domestic spending. When a country’s imports are greater than its exports, the country has a trade deficit and GDP is less than domestic spending. 5. To illustrate this, we can rearrange the open-economy equation to yield: X - M = Y - C - I - G

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
The equation shows that exports minus imports are equal to GDP minus consumption, investment, and government spending. This equation illustrates that a country’s trade deficit or surplus is essentially a residual of what is produced and consumed in the domestic economy. This shows that with GDP of \$10 trillion and the sum of C, I, and G of \$9 trillion, then by definition the trade balance must have a surplus of \$1 trillion. 6.
This is the end of the preview. Sign up to access the rest of the document.