Dr. F. Koray E. J. Ourso College of Business
Louisiana State University
BADM 7200 REVIEW QUESTIONS FOR TEST 1 WITH COMPLETE
SOLUTIONS
1. What is a model? Why do we need models in economics? What is the
distinction between exogenous and endogenous variables?
A model is a simplified representation of reality, often using diagrams or equations that
show how variables interact. Purpose is to dispense with irrelevant details and focus on
underlying connections. Endogenous are variables a model explains; exogenous are
variables a model takes as given.
2. What is a market-clearing model? When is the assumption of market clearing
appropriate?
A market-clearing model assumes prices freely adjust to equilibrate supply and demand;
Assumption is markets are normally in equilibrium where supply and demand curves
intersect
3. How is the GDP computed? (What is included, what is excluded?) What is the
distinction between real and nominal GDP?
The total value of all goods/services, and measures total income of everyone in an
economy; (adjusted for price levels); Nominal GDP is the value of goods at current
prices; Real GDP is the value of goods at a constant price.
4. What is the distinction between the GDP deflator and the consumer price index
(CPI)?
GDP deflator measures prices of all goods and services produced (only domestic) &
assigns changing weights; CPI measures price of goods and services bought by
consumers & assigns fixed weights to different goods; Economists use GDP deflator to
measure inflation and CPI to measure cost of living.
5. How is the GDP deflator (Paasche Index) computed? How is the CPI (Laspeyres
Index) computed?
GDP deflator = (Nominal GDP/Real GDP)
CPI = (# x current price)/(# x price during base year)
6. Does the CPI overstate inflation? Why?
It is not comprehensive, ignores substitution bias, excludes new products, excludes
quality changes; Substitution, Quality, New Product, Outlet Bias.
7. What determines the amount of output an economy produces?
Depends on the quantity of inputs, called the factor of production & the ability to turn
inputs to outputs, as represented by the production function; Function together to
determine the quantity of goods and services combined.
Louisiana State University
BADM 7200 REVIEW QUESTIONS FOR TEST 1 WITH COMPLETE
SOLUTIONS
1. What is a model? Why do we need models in economics? What is the
distinction between exogenous and endogenous variables?
A model is a simplified representation of reality, often using diagrams or equations that
show how variables interact. Purpose is to dispense with irrelevant details and focus on
underlying connections. Endogenous are variables a model explains; exogenous are
variables a model takes as given.
2. What is a market-clearing model? When is the assumption of market clearing
appropriate?
A market-clearing model assumes prices freely adjust to equilibrate supply and demand;
Assumption is markets are normally in equilibrium where supply and demand curves
intersect
3. How is the GDP computed? (What is included, what is excluded?) What is the
distinction between real and nominal GDP?
The total value of all goods/services, and measures total income of everyone in an
economy; (adjusted for price levels); Nominal GDP is the value of goods at current
prices; Real GDP is the value of goods at a constant price.
4. What is the distinction between the GDP deflator and the consumer price index
(CPI)?
GDP deflator measures prices of all goods and services produced (only domestic) &
assigns changing weights; CPI measures price of goods and services bought by
consumers & assigns fixed weights to different goods; Economists use GDP deflator to
measure inflation and CPI to measure cost of living.
5. How is the GDP deflator (Paasche Index) computed? How is the CPI (Laspeyres
Index) computed?
GDP deflator = (Nominal GDP/Real GDP)
CPI = (# x current price)/(# x price during base year)
6. Does the CPI overstate inflation? Why?
It is not comprehensive, ignores substitution bias, excludes new products, excludes
quality changes; Substitution, Quality, New Product, Outlet Bias.
7. What determines the amount of output an economy produces?
Depends on the quantity of inputs, called the factor of production & the ability to turn
inputs to outputs, as represented by the production function; Function together to
determine the quantity of goods and services combined.
