Principles of Macroeconomics EC101

Lekima Nalaukai Semester 2, 2022

Tutorial 3 Suggested Solutions
A. Multiple Choice

1. The simple circular flow model shows that workers, entrepreneurs, and the owners of
land and capital offer their services through:
A. product markets
B. resource markets
C. employment agencies
D. business firms

2. The circular flow model is used to:

A. show how consumer demand falls during recession
B. show the impact of inflation on economic activity
C. show the real flows and money flows between different sectors of the economy
D. explain how factor prices are determined.

3. If there is an increase in injections, then most likely:

A. real GDP will decrease
B. nominal GDP will decrease
C. real GDP will increase
D. nominal GDP will be unchanged.

4. An economy is in equilibrium when:

A. X + M = C + S + T
B. X + I +G = C + S + T
C. X + I + G = M + S + T
D. Y = C + S + T

5. In calculating yearly GDP, all of the following are excluded, except:

A. the value of second hand goods
B. the value of intermediate goods
C. the value of all houses built during the year
D. the value of all transfer payments

6. To avoid double counting in national income accounts, only:

A. intermediate goods and services should be counted
B. final goods and services should be counted
C. both final and intermediate goods and services should be counted
D. primary, intermediate and final goods and services should be counted.
Principles of Macroeconomics EC101
Lekima Nalaukai Semester 2, 2022
Tutorial 3 Suggested Solutions
B. Short Answers

1. Discuss the main components of the Gross Domestic Product.

• GDP (Y ) can be divided into four components: consumption (C ), investment (I ), government purchases
(G ), and net exports (NX ).
o consumption: spending by households on goods and services, with the exception of purchases
of new housing.
o investment: spending on business capital, residential capital, and inventories.
o government purchases: spending on goods and services by local, state, and federal
governments.
o net exports: spending on domestically produced goods by foreigners (exports) minus
spending on foreign goods by domestic residents (imports).

2. What is the difference between Real GDP and Nominal GDP?

Nominal GDP measures the annual production of goods or services at the current
price. On the other hand, Real GDP measures the yearly production of goods or services
calculated at the actual cost without considering the effect of inflation. Hence, nominal
gross domestic product is regarded as a more apt measure of GDP.

3. How will Real and Nominal GDP differ from one another?

In inflationary periods1, Real GDP will be lower than nominal GDP. In deflationary times2, real GDP will be
higher. Take, for example, a hypothetical country that had a nominal GDP of $100 Billion in 2000, which
grew by 50% to $150 billion by 2020. Over the same period of time, inflation reduced the relative
purchasing power of the dollar by 50%. Looking at just the nominal GDP, the economy appears to be
performing very well, whereas the real GDP expressed in 2000 dollars would actually indicate a reading
of $75 billion, revealing in fact a net overall decline in economic growth had occurred. It is due to this
greater accuracy that real GDP is favored by economists as a method of measuring economic
performance.
4. What is the use of GDP Deflator?

GDP deflator is a measure of the price level calculated as the ratio of nominal GDP to
real GDP times 100.

Nominal GDP
GDP deflator =  100
Real GDP

1
Inflationary period is the Unevenly rising prices inevitably reduce the purchasing power of some consumers, and this erosion of real income
is the single biggest cost of inflation. Inflation can also distort purchasing power over time for recipients and payers of fixed interest rates.
2
Deflationary time is when the prices of goods and services decrease across the entire economy, increasing the purchasing power of
consumers. It is the opposite of inflation and can be considered bad for a nation as it can signal a downturn in an economy, leading to a recession
or depression.
Principles of Macroeconomics EC101
Lekima Nalaukai Semester 2, 2022
Tutorial 3 Suggested Solutions

C. Calculation

1. Suppose there are only three goods in the economy, as shown in the following table.

Year Good Price Quantity

1999 Apples $2/kilogram 500 kilograms
Bananas $4/kilogram 250 kilograms
Computers $2000 5
2000 Apples $2.50/kilogram 400 kilograms
Bananas $4/kilogram 200 kilograms
Computers $2000 7

a. Calculate nominal GDP for 1999 and 2000.

Nominal GDP for 1999 :

apples: $2 x 500 = 1 000
bananas: $4 x 250 = 1 000
computers: $2000 x 5 = 10 000
$ 12 000

Nominal GDP for 2000:

apples: $2.50 x 400 = 1 000
bananas: $4 x 200 = 8 00
computers: $2000 x 7 = 14 000
$15 800

b. Calculate the real GDP in 2000 using 1999 prices and calculate the RGDP Growth.

Real GDP in 2000:

apples: $2 x 400 = 8 00
bananas: $4 x 200 = 8 00
computers: $2000 x 7 = 14 000
$15 600

Economic growth in 2000:

Real GDP in current yr-real GDP in previous yr x 100
Real GDP in previous yr

Base yr: real GDP equals nominal GDP. Above example, 1999 is base year with real GDP for 1999
= $12 000

Economic growth for 2000: 15 600-12 000 x 100

12 000
= 30%
Principles of Macroeconomics EC101
Lekima Nalaukai Semester 2, 2022
Tutorial 3 Suggested Solutions
2. You have the following annual information about a hypothetical country:

$ billions
Personal consumption expenditure 200
Personal Taxes 50
Exports 30
Depreciation 10
Government purchases 50
Gross private domestic investment 40
Imports 40
Government transfer payments 20

A. What is the value of GDP?

GDP: Expenditure = C + I + G + X-M

200 + 40 + 50 + (30-40) = $280 billions

B. What is the value of net domestic product?

NDP = GDP – depreciation

280 – 10 = $270 billion

C. What is the value of net investment?

Net Investment =Gross private domestic Investment – Depreciation

40 – 10 = $ 30 billion

D. What is the value of net exports?

Net exports: X – M : 30 – 40 = -$ 10 billions

Principles of Macroeconomics EC101
Lekima Nalaukai Semester 2, 2022
Tutorial 3 Suggested Solutions
Item $m
Compensation of employees 24,100
Operating surplus 15,000
Gross Mixed Income 3, 450
Final private consumption expenditure 30,200
Final government consumption expenditure 10,100
Change in stocks 2,500
Consumption of fixed capital 4,500
Indirect taxes 6,350
Private gross fixed capital formation 9,200
Government fixed capital formation 5,300
Subsidies 950
Exports 17,800
Imports 20,700

3. Using the above data, calculate the Gross Domestic Product for the economy using the:

A. Income approach (calculate both GDP at factor cost and GDP at market prices).

Income at Factor Cost: Compensation of employees + Gross Operating Surplus + Gross Mixed
Incomes: 24 100 + 15 000 + 3 450 = $42 550m
Income at Market Prices: Income at Factor Cost + (Indirect taxes – Subsidies)
42 550 + (6 350 – 950) = $47 950m

B. Expenditure approach

Y=C+I+G+X–M
30 200 + 9 200 + 2 500 + 10 100 + 5 300 + (17 800 – 20 700) = $54 400m
In practice, the two approaches may differ. Errors and data omissions may be the reason for these
differences. Also figures are based on estimates rather than direct measurement. A statistical
discrepancy figure accommodates for this by adding or subtracting to make the estimates equal.