HW7 Solutions

# HW7 Solutions - Homework 7 Solutions ECON 010 Fall 2011...

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ECON 010, Fall 2011 Question 1: Calculating GDP in a Simple Economy a. What is the Gross Domestic Product (GDP)? Answer: Gross Domestic Product (GDP) is the market value of all ﬁnal goods and services pro- duced within a country in a given period of time (year, quarter, month, etc.). b. What is the diﬀerence between nominal GDP and real GDP? Why do we need to distinguish between the two? Answer: Nominal GDP is calculated by summing the current values of ﬁnal goods and services (using current prices). Real GDP is calculated by designating a particular year as the base year and then using the prices of goods and services in the base year to calculate the value of goods and services in all other years. Suppose that the GDP increased from one year to the next. This increase could be attributed to two diﬀerent things: an increase in the production in the economy and an increase in the prices (which would increase the value of production). We like to distinguish between nominal and real GDP in the hope of isolating both of these eﬀects. The problem with this approach, however is choosing which year to set as a base year. Part d) of this question illustrates this. c. Is GDP a stock value or a ﬂow value? Give examples of each. Answer: GDP is a ﬂow value since the GDP for a particular year measures the market value of the all of the ﬁnal goods and services produced in that particular year. Other examples of ﬂow variables are: proﬁts earned by ﬁrms in a year, tax revenue collected in a quarter, etc. Some examples of stock variables are: value of the capital stock, population, etc. For Business students: Balance Sheet of a ﬁrm is meant to show all of the stock variables of a ﬁrm: assets, liabilities, etc. and an Income Statement is meant to show the ﬂow variables of a ﬁrm: Sales in a quarter, wages paid in a quarter, etc. d. Below are some data from the land of milk, honey, and haircuts.

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HW7 Solutions - Homework 7 Solutions ECON 010 Fall 2011...

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