CFA 17: Aggregate Output, Prices, & Economic Growth

Which of the following statements is the most appropriate description of gross domestic product (GDP)? The total income earned by all households, firms, and the government whose value can be verified. The total amount spent on all final goods and services produced within the economy over a given time period. The total market value of resalable and final goods and services produced within the economy over a given time period. correct answer- B is correct. GDP is the total amount spent on all final goods and services produced within the economy over a specific period of time. The component least likely to be included in a measurement of gross domestic product (GDP) is: the value of owner occupied rent. the annual salary of a local police officer. environmental damage caused by production. correct answer- C is correct. By-products of production processes that have no explicit market value are not included in GDP. Which of the following conditions is least likely to increase a country's GDP? An increase in net exports. Increased investment in capital goods. Increased government transfer payments. correct answer- C is correct. Government transfer payments, such as unemployment compensation or welfare benefits, are excluded from GDP. Which of the following would be included in Canadian GDP for a given year? The market value of: wine grown in Canada by US citizens. electronics made in Japan and sold in Canada. movies produced outside Canada by Canadian film makers. correct answer- A is correct. Canadian GDP is the total market value of all final goods and services produced in a given time period within Canada. The wine was produced in Canada and counts towards Canadian GDP. Suppose a painting is produced and sold in 2010 for £5,000. The expenses involved in producing the painting amounted to £2,000. According to the sum-of-value-added method of calculating GDP, the value added by the final step of creating the painting was: £2,000. £3,000. £5,000. correct answer- B is correct. This is the value added by the artist: £5,000 - £2,000 = £3,000. A GDP deflator less than 1 indicates that an economy has experienced: inflation. deflation. stagflation. correct answer- B is correct. The GDP Deflator = Nominal GDP/Real GDP. To get a ratio less than 1, real GDP exceeds nominal GDP, which indicates that prices have decreased and, accordingly, deflation has occurred. The most accurate description of nominal GDP is: a measure of total expenditures at current prices. the value of goods and services at constant prices. a measure to compare one nation's economy to another. correct answer- A is correct. Nominal GDP is defined as the value of goods and services measured at current prices. Expenditure is used synonymously with the value of goods and services since aggregate expenditures must equal aggregate output of an economy. From the beginning to the ending years of a decade, the annual value of final goods and services for country X increased from €100 billion to €300 billion. Over that time period, the GDP deflator increased from 111 to 200. Over the decade, real GDP for country X increased by approximately: 50%. 67%. 200%. correct answer- B is correct. Real GDP in the first year was €100 billion/1.11 = €90 and in the last year it was €300 billion/2.00 = €150. Thus, (€150 - €90)/€90 = 0.67 or 67%. If the GDP deflator values for 2008 and 2010 were 190 and 212.8, respectively, which of the following best describes the annual growth rate of the overall price level? 5.8%. 6%. 12%. correct answer- A is correct: (212.8/190)1/2 - 1 = 0.0583 or 5.8%. The numerator of the GDP price deflator reflects: the value of base year output at current prices. the value of current year output at current prices. the value of current year output at base year prices. correct answer- B is correct. GDPdeflator=ValueofcurrentyearoutputatcurrentyearpricesValueofcurrentyearoutputatb aseyearprices×100. Consider the following data for 2010 for a hypothetical country: Account name Amount ($ trillions) Consumption 15.0 Capital consumption allowance 1.5 Government spending 3.8 Imports 1.7 Gross private domestic investment 4.0 Exports 1.5 Based only on the data given, the gross domestic product and national income are respectively closest to: 21.1 and 20.6. 22.6 and 21.1. 22.8 and 20.8. correct answer- B is correct. GDP = Consumption + Gross private domestic investment + Government Spending + Exports - Imports = 15 + 4 + 3.8 + 1.5 - 1.7 = 22.6. National income = GDP - CCA = 22.6 -1.5 = 21.1 In calculating personal income for a given year, which of the following would not be subtracted from national income? Indirect business taxes. Undistributed corporate profits. Unincorporated business net income. correct answer- C is correct. Unincorporated business net income is also known as proprietor's income and is included in personal income. Equality between aggregate expenditure and aggregate output implies that the government's fiscal deficit must equal: Private saving - Investment - Net exports. Private saving - Investment + Net exports. Investment - Private saving + Net exports. correct answer- A is correct. The fundamental relationship among saving, investment, the fiscal balance, and the trade balance is S = I + (G - T) + (X - M). This form of the relationship shows that private saving must fund investment expenditures, the government fiscal balance, and net exports (= net capital outflows). Rearranging gives G - T = (S - I) - (X - M). The government's fiscal deficit (G - T) must be equal to the private sector's saving/investment balance (S - I) minus net exports. Because of a sharp decline in real estate values, the household sector has increased the fraction of disposable income that it saves. If output and investment spending remain unchanged, which of the following is most likely? A decrease in the government deficit. A decrease in net exports and increased capital inflow. An increase in net exports and increased capital outflow. correct answer- C is correct. The fundamental relationship among saving, investment, the fiscal balance, and the trade balance is S = I + (G - T) + (X - M). Given the levels of output and investment spending, an increase in saving (reduction in consumption) must be offset by either an increase in the fiscal deficit or an increase in net exports. Increasing the fiscal deficit is not one of the choices, so an increase in net exports and corresponding increase in net capital outflows (increased lending to foreigners and/or increased purchases of assets from foreigners) is the correct response. Which curve represents combinations of income and the real interest rate at which planned expenditure equals income? The IS curve. The LM curve. The aggregate demand curve. correct answer- A is correct. The IS curve represents combinations of income and the real interest rate at which planned expenditure equals income. An increase in government spending would shift the: IS curve and the LM curve. IS curve and the aggregate demand curve. LM curve and the aggregate demand curve. correct answer- B is correct. The IS curve represents combinations of income and the real interest rate at which planned expenditure equals income. Equivalently, it represents combinations such that S(Y) = I(r) + (G - T) + (X - M) where S(Y) indicates that planned saving is a (increasing) function of income and I(r) indicates that planned investment is a (decreasing) function of the real interest rate. To maintain this relationship, an increase in government spending (G) requires an increase in saving at any given level of the interest rate (r). This implies an increase in income (Y) at each interest rate level—a rightward shift of the IS curve. Unless the LM curve is vertical, the IS and LM curves will intersect at a higher level of aggregate expenditure/income. Since the LM curve embodies a constant price level, this implies an increase in aggregate expenditure at each price level—a rightward shift of the Aggregate Demand curve. An increase in the nominal money supply would shift the: IS curve and the LM curve. IS curve and the aggregate demand curve. LM curve and the aggregate demand curve. correct answer- C is correct. The LM curve represents combinations of income and the interest rate at which the demand for real money balances equals the supply. For a given price level, an increase in the nominal money supply is also an increase in the real money supply. To increase the demand for real money balances, either the interest must decline or income must increase. Therefore, at each level of the interest rate, income (= expenditure) must increase—a rightward shift of the LM curve. Since the IS curve is downward sloping (higher income requires a lower interest rate), a rightward shift in the LM curve means that the IS and LM curves will intersect at a higher level of aggregate expenditure/income. This implies a higher level of aggregate expenditure at each price level—a rightward shift of the Aggregate Demand curve. An increase in the price level would shift the: IS curve. LM curve. aggregate demand curve. correct answer- B is correct. The LM curve represents combinations of income and the interest rate at which the demand for real money balances equals the supply. For a given nominal money supply, an increase in the price level implies a decrease in the real money supply. To decrease the demand for real money balances, either the interest must increase or income must decrease. Therefore, at each level of the interest rate, income (= expenditure) must decrease—a leftward shift of the LM curve. As the price level declines along the aggregate demand curve, the interest rate is most likely to: decline. increase. remain unchanged. correct answer- A is correct. A decrease in the price level increases the real money supply and shifts the LM curve to the right. Since the IS curve is downward sloping, the IS and LM curves will intersect at a higher level of income and a lower interest rate. The full employment, or natural, level of output is best described as: the maximum level obtainable with existing resources. the level at which all available workers have jobs consistent with their skills. a level with a modest, stable pool of unemployed workers transitioning to new jobs. correct answer- C is correct. At the full employment, or natural, level of output the economy is operating at an efficient and unconstrained level of production. Companies have enough spare capacity to avoid bottlenecks, and there is a modest, stable pool of unemployed workers (job seekers equal job vacancies) looking for and transitioning into new jobs. Which of the following best describes the aggregate supply curve in the short-run (e.g., 1 to 2 years)? The short run aggregate supply curve is: flat because output is more flexible than prices in the short run. vertical because wages and other input prices fully adjust to the price level. upward sloping because input prices do not fully adjust to the price level in the short run. correct answer- C is correct. Due to long-term contracts and other rigidities, wages and other input costs do not fully adjust to changes in the price level in the short-run. Given input prices, firms respond to output price changes by expanding or contracting output to maximize profit. Hence, the SRAS is upward sloping. If wages were automatically adjusted for changes in the price level, the short-run aggregate supply curve would most likely be: flatter. steeper. unchanged. correct answer- B is correct. The slope of the short-run aggregate supply curve reflects the extent to which wages and other input costs adjust to the overall price level. Automatic adjustment of wages would mitigate the impact of price changes on profitability. Hence, firms would not adjust output as much in response to changing output prices—the SRAS curve would be steeper. The least likely cause of a decrease in aggregate demand is: higher taxes. a weak domestic currency. a fall in capacity utilization. correct answer- B is correct. A weak domestic currency will result in an increase in aggregate demand at each price level—a rightward shift in the AD curve. A weaker currency will cause a country's exports to be cheaper in global markets. Conversely, imports will be more expensive for domestic buyers. Hence, the net exports component of aggregate demand will increase. Which of the following is most likely to cause the long-run aggregate supply curve to shift to the left? Higher nominal wages. A decline in productivity. A increase in corporate taxes. correct answer- B is correct. Productivity measures the efficiency of labor and is the amount of output produced by workers in a given period of time. A decline in productivity implies decreased efficiency. A decline in productivity increases labor costs, decreases profitability and results in lower output at each output price level—a leftward shift in both the short-run and long-run aggregate supply curves. Increased household wealth will most likely cause an increase in: household saving. investment expenditures. consumption expenditures. correct answer- C is correct. The wealth effect explains the impact of increases or decreases in household wealth on economic activity. Household wealth includes financial and real assets. As asset values increase, consumers save less and spend more out of current income since they will still be able to meet their wealth accumulation goals. Therefore, an increase in household wealth results in a rightward shift in the aggregate demand curve. The most likely outcome when both aggregate supply and aggregate demand increase is: a rise in inflation. higher employment. an increase in nominal GDP. correct answer- B is correct. Higher aggregate demand (AD) and higher aggregate supply (AS) raise real GDP and lower unemployment, meaning employment levels increase. Which of the following is least likely to be caused by a shift in aggregate demand? Stagflation. A recessionary gap. An inflationary gap. correct answer- A is correct. Stagflation occurs when output is declining and prices are rising. This is most likely due to a decline in aggregate supply—a leftward shift of the SRAS curve. Depending on the source of the shift, the LRAS may shift too. Following a sharp increase in the price of energy, the overall price level is most likely to rise in the short run: and remain elevated indefinitely unless the central bank tightens. but be unchanged in the long run unless the money supply is increased. and continue to rise until all prices have increased by the same proportion. correct answer- B is correct. An increase in energy prices will shift the short-run aggregate supply curve (SRAS) to the left, reducing output and increasing prices. If there is no change in the aggregate demand curve, in particular if the central bank does not expand the money supply, slack in the economy will put downward pressure on in input prices, shifting the SRAS back to its original position. In the long run, the price level will be unchanged. Among developed economies, which of the following sources of economic growth is most likely to explain superior growth performance? Technology. Capital stock. Labor supply. correct answer- A is correct. Technology is the most important factor affecting economic growth for developed countries. Technological advances are very important because they allow an economy to overcome the limits imposed by diminishing marginal returns. Which of the following can be measured directly? Potential GDP. Labor productivity. Total factor productivity. correct answer- B is correct. Labor productivity can be directly measured as output/hour. The sustainable growth rate is best estimated as: the weighted average of capital and labor growth rates. growth in the labor force plus growth of labor productivity. growth in total factor productivity plus growth in the capital-to-labor ratio. correct answer- B is correct. Output growth is equal to the growth rate of the labor force plus the growth rate of labor productivity, i.e. output per worker. Unlike total factor productivity, output per worker is observable, so this is the most practical way to approach estimation of sustainable growth. In the neoclassical or Solow growth model, an increase in total factor productivity reflects an increase in: returns to scale. output for given inputs. the sustainable growth rate. correct answer- B is correct. Total factor productivity (TFP) is a scale factor primarily reflecting technology. An increase in TFP means that output increases for any level of factor inputs. An economic forecasting firm has estimated the following equation from historical data based on the neoclassical growth model: Potential output growth = 1.5 + 0.72 × Growth of labor + 0.28 × Growth of capital The intercept (1.5) in this equation is best interpreted as: the long-run sustainable growth rate. the growth rate of total factor productivity. above trend historical growth that is unlikely to be sustained. correct answer- B is correct. The estimated equation is the standard Solow growth accounting equation. The intercept is the growth rate of total factor productivity. An economic forecasting firm has estimated the following equation from historical data based on the neoclassical growth model: Potential output growth = 1.5 + 0.72 × Growth of labor + 0.28 × Growth of capital The coefficient on the growth rate of labor (0.72) in this equation is best interpreted as: the labor force participation rate. the marginal productivity of labor. the share of income earned by labor. correct answer- C is correct. In the standard Solow growth accounting equation, the coefficient on each factor's growth rate is its share of income. Convergence of incomes over time between emerging market countries and developed countries is most likely due to: total factor productivity. diminishing marginal productivity of capital. the exhaustion of non-renewable resources. correct answer- B is correct. Diminishing marginal productivity of capital means that as a country accumulates more capital per worker the incremental boost to output declines. Thus, all else the same, economies grow more slowly as they become more capital intensive. Given the relative scarcity and hence high marginal productivity of capital in developing countries, they tend to grow more rapidly than developed countries. This leads to convergence in income levels over time.