Gross Domestic Product (GDP) is the total market value of all domestically produced final goods and services for a particular year. Its five key factors are: market value, final goods and services, produced, within a country, during a specific time period.

• Only final goods and services count; GDP includes goods and services purchased by final users. Intermediate goods purchased for resale or for the production of another good or service are excluded, to avoid double-counting. Their value is embodied in the value of the goods purchased by the end user.

• GDP is a flow variable; it measures the market value of production that flows through the economy.

• Financial transactions and income transfers (e.g., social security and welfare payments) are excluded because they represent exchanges, not productions, of goods and services. GDP counts transactions that add to current production.

• GDP counts only goods and services produced domestically, whether by citizens or foreigners.

• It includes only goods produced during the current period. Thus, sales of used goods are not counted in GDP. However, sales commissions count toward GDP because they involve services provided during the period.

Government services and household production are estimated and included in the GDP. Activities occurring in the underground economy, although sometimes productive, are not included in GDP.

Nominal and Real GDP

When comparing GDP across time periods, we confront a problem: the nominal value of GDP may increase as the result of either expansion in the quantities of goods produced or higher prices. Since the former will improve our living standards, we have to adjust the nominal values (nominal GDP, or money values) for the effects of inflation to get real values (real GDP).

A price index is used for the adjustment. It measures the cost of purchasing a market basket or bundle of goods at a point in time relative to the cost of purchasing the identical market basket during an earlier reference period (e.g., a base year).

Consumer price index (CPI) (not included in the required reading) is an indicator of the general level of prices. It attempts to compare the cost of purchasing the market basket bought by a typical consumer during a specific period with the cost of purchasing the same market basket during an earlier period. The CPI is better at determining how rising prices affect the money income of consumers. The CPI is more widely used for price changes over time.

The GDP deflator is a price index that reveals the cost during the current period of purchasing the items included in GDP relative to the cost during a base year. Because the base year is assigned a value of 100, as the GDP deflator takes on values greater than 100, it indicates that prices have risen. It is a broader price index than the CPI since it is better at giving an economy-wide measure of inflation. It is designed to measure the change in the average price of the market basket of goods included in GDP. In addition to consumer goods, the GDP deflator includes prices for capital goods and other goods and services purchased by businesses and governments. The GDP deflator also allows the basket of goods to change as the composition of GDP changes, while the CPI is computed using a fixed basket of goods.

We can use the GDP deflator together with nominal GDP to measure the real GDP (GDP in dollars of constant purchasing power).

Suppose the nominal GDPs in 1992 and 2010 were $6244 and $8509 billion dollars, respectively. This amount has increased by 36.3%. The GDP deflator for 1992 and 2010 was 100 and 112.7, respectively. The real GDP in 2010, therefore, should be:
Nominal GDP in 2010 x GDP deflator in 1992 / GDP deflator in 2010
= 8509 x 100 / 112.7
= $7550 billion dollars
Measured in terms of 1992 dollars, the real GDP in 2010 was only 20.9% higher than that in 1992.

Practice Question 1

GDP is ______.

A. the market value of an economy's production of final goods and services in a one-year period
B. the sum of coins, bills, and demand deposits circulating in an economy in a one-year period
C. the total expenditures of the federal government over the period of one year

Correct Answer: A

That's the definition of GDP.

Practice Question 2

Which of the following is an example of an intermediate product?

A. A pair of skis sold by a sporting goods retailer to a skier
B. A share of IBM stock
C. The lumber produced by Boise Cascade and sold to a builder of new houses
D. An antique car sold to the highest bidder

Correct Answer: C

Intermediate products are products used as inputs in the production of some other product.

Practice Question 3

Suppose the economy of Duckland produces 3 pizzas at $5 a pizza, 6 gallons of ice cream at $3 a gallon, and 5 cases of soda pop at $10 a case. The gross domestic product of Duckland is ______.

Correct Answer: $83

Gross domestic product (GDP) is the value of all goods and services produced within an economy during a given year. In this case, GDP is $15+$18+$50=$83.

Practice Question 4

Call-Mart Inc. bought 1000 fur coats from a wholesaler in 2011, at $200 each. Its retail price for the fur coat was $300. During 2011, it sold 700 fur coats at its retail price, leaving 300 in its warehouse. Under the expenditure approach, how much should be added to GDP?

A. $300,000 (1000 x $300). Total expected sales revenue of Call-Mart (since 700 were sold and 300 were ready to go).
B. $210,000 (700 x $300). The 300 coats should be counted as intermediate goods and not included in the GDP of the year unless they were sold.
C. $200,000 (1000 x $200). Retail profits should not be counted in GDP.

Correct Answer: A

Practice Question 5

Inventory investment ______

A. reduces GDP because it is produced but not sold during the period.
B. reduces GDP because it belongs to intermediate goods.
C. should be counted in GDP because it represents goods that are produced (although not sold) during the period.

Correct Answer: C

GDP is designed to measure current production, not sales. Inventory investment consists of goods produced but not sold in the current time period. The production of these goods represents economic activity in the current period and must be counted in the current time period even if the units of output are sold in a later time period.

Practice Question 6

A miller buys a pound of wheat from a farmer for 30 cents, grinds it into flour, and sells it to a baker for 60 cents. The baker combines the flour with other ingredients and makes a loaf of bread. The baker then sells it to the grocery store for 90 cents. The grocery store then adds 10 cents and sells it to a customer. How much should be included in the GDP in this example?

Correct Answer: $1

The one-dollar price reflects the value added at each stage of production. It should be added to GDP.

Practice Question 7

Which one(s) should be counted toward a country's GDP?

A. An American purchases domestic stocks at NYSE.
B. An American purchases a Japanese stock in Tokyo.
C. A stockbroker helps an investor buy a portfolio of stocks for $100,000, receiving $800 as commission.

Correct Answer: C

Financial transactions are excluded from GDP since they don't involve production. They merely transfer ownership from one party to another. It does not matter where such transactions happen.

The commission is included in GDP since it involves a service.

Practice Question 8

If nominal GDP increased from $4 billion to $5 billion while real GDP increased from $3 billion to $4 billion, it follows that ______

A. the price level rose by 25 percent.
B. output increased at a faster rate than the price level.
C. the price level increased at a faster rate than output.

Correct Answer: B

Since output rose by 33 percent but nominal GDP increased by only 25 percent, the price level must have increased by less than 25 percent.

Practice Question 9

Real GDP is ______.

A. the GDP deflator multiplied by real GDP
B. expressed in inflation-adjusted prices
C. nominal GDP multiplied by the GDP deflator

Correct Answer: B

Real GDP is GDP adjusted for the effects of inflation.

Practice Question 10

The GDP deflator is ______

A. a measure of real GDP.
B. a measure of nominal GDP.
C. an index of how prices change over time.
D. the difference between real and nominal GDP.
E. a measure of the growth rate of GDP.

Correct Answer: C

The GDP deflator is a price index that is used to measure how prices change over time.

Practice Question 11

Suppose the base year for the GDP deflator was 1990 and its value was 100. The value of the deflator was 148 for 2010. This indicates that the general level of prices ______

A. remained constant between 1990 and 2010.
B. was lower in 2010 than in 1990.
C. was higher in 2010 than in 1990.

Correct Answer: C

Increases in the GDP deflator indicate a rising price level.

Practice Question 12

Given the following information, the price level increased (from 1990 to 2000) by ______.

Correct Answer: 50%

The increase in the GDP deflator from 120 to 180 is approximately 50 percent.

Practice Question 13

Given the following information, and measured in terms of 1990 prices, the real GDP in 2000 was ______.

Correct Answer: 6,000 billion

Real GDP for 2000 = Nominal GDP for 2000 x (GDP Deflator for 1990/ GDP Deflator for 2000) = $9000 x (120/180) = $6000

Practice Question 14

The size of underground economies differs across countries. In Greece, the underground economy has been estimated to be as big as 30% of GDP; in Spain, 25%; in Italy, 20%; and in the United States, about 7%. Given this information, official GDP measures understate true economic activity the most in ______.

A. Greece
B. The United States
C. Italy

Correct Answer: A

Since Greece has the reportedly largest relative underground economy, official statistics underestimate Greek production the most.

Practice Question 15

Which of the following is considered to be included in the underground economy?

A. The value of the cleaning you do for your own home
B. Gambling winnings not reported on your taxes
C. A meal purchased in a restaurant that replaces a meal you could cook at home
D. The purchase of a used bicycle

Correct Answer: B

It is not illegal to win money from gambling (this, of course, varies from state to state). If you do not report the winnings as part of your income, however, you are attempting to evade taxes (which is illegal).

Practice Question 16

Which one should be counted toward GDP?

A. A Vietnam veteran receives veteran's payments from the federal government.
B. Your uncle gives you $1,000 to pay for your college expenses.
C. When a wholesale distributor sells steak to a restaurant, the restaurant owner pays $400 to the distributor.

Correct Answer: None of these payments should be counted toward GDP.

A: Income transfers are excluded from GDP since they don't involve production. The veteran is not producing any goods in return for the money (although he served in the war).

B: Income transfers are excluded from GDP since they don't involve production. Your uncle will have less wealth and you have more; the net effect is zero - the transaction adds nothing to current production.

C:The steak is still an intermediate good. Only the final purchase price paid by the patron of the restaurant for the steak dinner should be counted.

Practice Question 17

A consumer purchases a refrigerator (a durable good) which costs $1,000. The retail store makes a $50 profit out of the transaction. The refrigerator is expected to last for 10 years. The GDP should be added to by ______.

A. $100, since it is depreciable for 10 years using straight-line depreciation
B. $1,000
C. $950, since the retail store's profit should not be counted in GDP

Correct Answer: B

Although the refrigerator will be enjoyed for over 10 years, its price is fully counted at the time it is bought.

Practice Question 18

An Indian software engineer works for a computer manufacturer in San Jose. He makes $60,000 a year and sends $10,000 to his family in India each year. The amount that should be counted towards U.S. GDP is ______.

A. 60,000
B. 50,000
C. 10,000

Correct Answer: A

$60,000 should count towards U.S. GDP, since GDP counts goods and services produced within the geographic borders of the country. The fact that he sends $10,000 to India is another matter (balance of trade).

Practice Question 19

In 2008, an American taught spoken English in China; he made $30,000 that year. When he came back to the U.S., he brought $25,000 home with him and then bought a new computer for $2,000 and a used car for $12,000. He then deposited the rest of the money in his bank account. Through the series of transactions, the amount counted towards U.S. GDP should be ______.

A. $0, since he did not make the money in the U.S.
B. $2,000
C. $14,000

Correct Answer: B

The income was not generated within the borders of the United States. However, the purchase of the new computer counted towards U.S. GDP; the purchase of the used car did not.

Practice Question 20

Mike is a real estate broker. Recently he helped John purchase a 5-year-old house in New York for $300,000, making $12,000 (excluded from the $300,000 house price) as his commission. The amount counted towards U.S. GDP should be ______.

A. $0, since the house is old
B. $12,000 commission only
C. $312,000, the total price John paid

Correct Answer: B

Transactions involving the exchange of goods or assets produced during previous periods are not included, since they don't reflect current production. However, Mike provided services to arrange the sale and the $12,000 commission should be counted.

Practice Question 21

GDP is the market value of all ______.

A. final goods and services produced domestically during the period
B. final goods and services minus intermediate goods produced domestically during the period
C. goods and services sold during the period

Correct Answer: A

Remember the five key factors of GDP: Market value, final goods and services, produced, within a country, during a specific time period.

Practice Question 22

Desert Corporation spent $320,000 on a significant amount of raw materials inventory for a new product that it was manufacturing. The raw material was the only material the new product needed. Later on, the corporation used all the raw materials and sold the new product for $800,000. It paid a total of $180,000 to its engineers, workers, and sales agents as their salaries, wages and commissions. Then it paid $120,000 rent and $30,000 interest on borrowed funds for this project. The net profit was $100,000 after tax ($50,000). This was the only project the company took during the year. How much did Desert Corporation added to GDP?

A. $800,000, since this was the final product's price.
B. $700,000, since this was the company's total cost (including tax) before net profit ($100,000).
C. $480,000, since this was the net price difference between the raw material and final products.

Correct Answer: C

By purchasing the raw material for $320,000 and selling the final product for $800,000, Desert Corporation added a value of $480,000 (the income created at a stage of production). It is the difference between the firm's revenue and the value of its purchases of resources from other firms.

Practice Question 23

Real gross domestic product is best defined as ______.

A. all goods and services produced in an economy stated in the prices of a given year
B. the market value of all final goods and services produced in an economy stated in the prices of a given year
C. the market value of goods and services produced in an economy stated in current-year prices

Correct Answer: B

That's the definition of real GDP.

Practice Question 24

If prices have risen by 5% in one year, real output ______

A. must have risen by less than 5% in that same year.
B. must have risen by more than 5% in that same year.
C. may have changed by any amount in that same year.

Correct Answer: C

The percentage change in real output equals the percentage change in nominal output less the percentage change in the price level. We cannot know how much real output changed without knowing the change in nominal output, too.

Practice Question 25

In a simple economy containing only two goods - apples and shirts - the prices and quantities in the base period and the current period are:

Base Period | Quantity | Price
Apples | 25 | 1.00
Shirts | 5 | 20.00

Current Period | Quantity | Price
Apples | 25 | 1.25
Shirts | 5 | 20.50

Assuming the base period consumer price index (CPI) = 100, the CPI for the current period is closest to ______.

A. 105.60
B. 107.00
C. 109.75

Correct Answer: B

The cost of the CPI basket at base period prices is: (25 x $1.00) + (5 x $20.00) = $125. The cost of the CPI basket at current period prices is: (25 x $1.25) + (5 x $20.50) = $133.75. The CPI for the period is ($133.75 / $125) x 100 = 107.