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Chapter 5: Problem 1

What components of GDP (if any) would each of the following transactions affect? Explain. a. A family buys a new refrigerator. b. Aunt Jane buys a new house. c. Ford sells a Thunderbird from its inventory. d. You buy a pizza. e. Quebec repaves Highway 50 f. Your parents buy a bottle of French wine. g. Honda expands its factory in Alliston, Ontario.

Short Answer

Expert verified
Purchases affect Consumption (a, d); Investment affects (b, c, g); Government affects (e); Net Exports affect (f).

Step by step solution

01

Understanding GDP Components

GDP, or Gross Domestic Product, is composed of four main components: Consumption (C), Investment (I), Government Purchases (G), and Net Exports (NX), where Net Exports is calculated as Exports minus Imports. Identifying which transaction affects which component is key.
02

Analyzing Transactions: A Family Buys a New Refrigerator

When a family buys a new refrigerator, this transaction falls into the Consumption component of GDP because it is a household purchase of a durable good.
03

Analyzing Transactions: Aunt Jane Buys a New House

The purchase of a new house by Aunt Jane is classified under the Investment component of GDP, as it represents residential investment.
04

Analyzing Transactions: Ford Sells a Thunderbird from its Inventory

This transaction affects the Investment component, specifically Inventory Investment. The sale decreases Ford's inventory, which impacts GDP calculations.
05

Analyzing Transactions: You Buy a Pizza

Buying a pizza is similar to the purchase of the refrigerator, categorized under the Consumption component of GDP, reflecting household spending on non-durable goods.
06

Analyzing Transactions: Quebec Repaves Highway 50

Repaving a highway is a government expenditure for infrastructure, classified under the Government Purchases component of GDP.
07

Analyzing Transactions: Parents Buy French Wine

The purchase of French wine by your parents affects the Net Exports component. Although it counts as Consumption for them, it increases imports, thus decreasing Net Exports.
08

Analyzing Transactions: Honda Expands Factory in Alliston, Ontario

Honda's factory expansion is considered Investment in GDP, specifically non-residential fixed investment.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Consumption
Consumption is a key component of Gross Domestic Product (GDP). It reflects total spending by households on goods and services within an economy. Whenever a family buys something for daily use or enjoyment, it falls under consumption.
Such purchases include both durable goods and non-durable goods:
  • **Durable goods** are items expected to last for a significant amount of time, such as refrigerators. When families invest in these, it enhances the Consumption component of the GDP.
  • **Non-durable goods**, like food items or clothing, are consumed quickly. Buying a pizza is an example that fits here, impacting GDP through Consumption spending.
  • **Services**, which encompass transactions such as haircuts or recreation, are also considered part of Consumption.
Understanding Consumption within GDP helps economists gauge household confidence in the economy. If people are spending more, the economy is likely performing well. Monitoring this component is essential for predicting economic trends.
Investment
Investment, within the context of GDP, refers to spending on goods that will be used for future production. This component absorbs expenditures made not only by businesses but also by households and governments when engaging in activities like building and constructing assets.
  • **Residential Investment** includes new home purchases by households. For instance, when Aunt Jane buys a new house, it is classified under this category.
  • **Non-residential Fixed Investment**, like factory expansions, involves businesses investing in facilities and equipment. Honda's factory enhancement in Alliston typifies this.
  • **Inventory Investment** reflects changes in the stock of unsold goods. When Ford sells a Thunderbird from its inventory, it affects Inventory Investment as part of GDP.
Investment is crucial as it fuels future productivity and economic growth. An uptick in investment usually indicates that businesses and individuals are optimistic about the future.
Government Purchases
Government Purchases, or Government Spending, measures the expenditure by the government on goods and services that are consumed by the public or provide public benefits. This includes spending on infrastructure, defense, education, and more. For example, when Quebec repaves Highway 50, it represents a typical Government Purchase.
  • Spending on infrastructure projects such as highways, bridges, and public buildings falls under this category.
  • Expenditures on defense and public safety, including police and military operations, are also considered Government Purchases.
  • Investments in public services like education and health services contribute to this component, reflecting how government activities can stimulate economic activity.
Government Purchases are pivotal in maintaining and enhancing public welfare and are often used as a tool to stabilize the economy in times of downturn by boosting demand.
Net Exports
Net Exports is an essential part of GDP that calculates a country's total exports minus its total imports. By assessing Net Exports, we gain insight into a nation's trade balance, indicating whether it is a net seller or net buyer in the global market.
  • **Exports** are goods and services sold to other countries, which bring money into the home country. A strong export market can increase GDP.
  • **Imports** are goods and services purchased from other countries, which means money flows out to foreign markets. When your parents buy French wine, it increases Imports, thereby reducing Net Exports.
Tracking Net Exports helps understand a nation's economic relations and trade dynamics. A positive net export figure suggests a trade surplus, while a negative one points to a trade deficit. Balancing imports and exports is a continuous focus for economies to maintain healthy GDP growth.

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Most popular questions from this chapter

Consider an economy that produces only chocolate bars. In year 1 , the quantity produced is 3 bars and the price is \(\$ 4 .\) In year \(2,\) the quantity produced is 4 bars and the price is \(\$ 5 .\) In year 3 , the quantity produced is 5 bars and the price is \(\$ 6 .\) Year 1 is the base year. a. What is nominal GDP for each of these three years? b. What is real GDP for each of these years? c. What is the GDP deflator for each of these years? d. What is the percentage growth rate of real GDP from year 2 to year \(3 ?\)

Below are some data from the land of milk and honey. $$\begin{array}{|c|c|c|c|c|}\hline & & \text { Quantity } & \text { Price } & \text { Quantity } \\\\\text { Year } & \begin{array}{c}\text { Price } \\\\\text { of Milk }\end{array} & \begin{array}{c}\text { of Milk } \\ \text { (litres) }\end{array} & \begin{array}{c}\text { of } \\\\\text { Honey }\end{array} & \begin{array}{c}\text { of Honey } \\\\\text { (litres) }\end{array} \\\\\hline 2013 & \$ 1 & 100 & \$ 2 & 50 \\\\\hline 2014 & 1 & 200 & 2 & 100 \\\\\hline 2015 & 2 & 200 & 4 & 100 \\\\\hline\end{array}$$ a. Compute nominal GDP, real GDP, and the GDP deflator for each year, using 2013 as the base year. b. Compute the percentage change in nominal GDP, real GDP, and the GDP deflator in 2014 and 2015 from the preceding year. For each year, identify the variable that does not change. Explain in words why your answer makes sense. c. Did economic well-being rise more in 2014 or \(2015 ?\) Explain.

The participation of women in the Canadian labour force has risen dramatically since \(1970 .\) a. How do you think this rise affected GDP? b. Now imagine a measure of well-being that includes time spent working in the home and taking leisure time. How would the change in this measure of well- being compare to the change in GDP? c. Can you think of other aspects of well-being that are associated with the rise in women's labour-force participation? Would it be practical to construct a measure of well-being that includes these aspects?

Consider the following data on Canadian GDP: $$\begin{array}{|c|c|c|}\hline \text { Year } & \begin{array}{c}\text { Nominal GDP } \\\\\text { (in billions) }\end{array} & \begin{array}{c} \text { GDP Deflator } \\\\\text { (base year }2007)\end{array} \\\\\hline 2013 & \$ 1893 & 111 \\\\\hline 2014 & \$ 1975 & 113 \\\\\hline \end{array}$$ a. What was the growth rate of nominal GDP between 2013 and \(2014 ?\) (Note: The growth rate is the percentage change from one period to the next.) b. What was the growth rate of the GDP deflator between 2013 and \(2014 ?\) c. What was real GDP in 2013 measured in 2007 prices? d. What was real GDP in 2014 measured in 2007 prices? e. What was the growth rate of real GDP between 2013 and \(2014 ?\) f. Was the growth rate of nominal GDP higher or lower than the growth rate of real GDP? Explain.

The "government purchases" component of GDP does not include spending on transfer payments such as Employment Insurance. Thinking about the definition of GDP, explain why transfer payments are excluded.
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