ECONOMICS EXTRA CREDIT HOMEWORK

Monday, June 16, 2014

HOMEWORK 6

The impact of economic fluctuations on the economy’s real output and price level in both the short run and long run

· Consumers will spend more with a decrease in price level (increase GDP)

·
Decrease in price level causes a decrease in interest rate which encourages greater spending on investment. (increase GDP)

·
Decrease in price level will decrease interest rate and decrease real value of dollar in F.E markets, dec NX

· Economic fluctuations implies fluctuations in the major economic indicators like GDP, National income, Price level, etc. These indicators will increase during the peak periods & decrease during the recessionary periods. So the ups & down swings in the economic activities like investment, consumption, employment & in economic indicators are referred as economic fluctuations.

· It is the ups and downs of the value of our dollar.
Currently the stock market and other financial investments (eg. businesses, employment , funds, bonds, etc. These financial indicators move up in down in value and are somewhat unstable.

· Small but frequent changes in economic variables

· For a quarter of a century, fiscal policy had been the neglected stepchild of government management of the economy. Monetary policy—essentially controlling interest rates—had become not merely the preferred policy tool to counteract either recession or economic overheating but, in the minds of many theoreticians and policymakers, the only effective countercyclical policy tool.

· How It is the ups and downs of the value of our dollar

· How it affects the private sector

· How it affects the public sector

· Are there policies in place to regulate it

· What are the main effects of economic fluctuations

· How often do they happen

· What do they happen as a result of

· Economic fluctuation is a part of the business or economic cycle, and refers to the economy-wide fluctuations in production, trade, and all other economic activity. This takes place in often free-enterprise principles.

Understand to define the four functions of money

· Money is any good that is widely accepted in exchange of goods and services, as well as payment of debts. Most people will confuse the definition of money with other things, like income, wealth, and credit. Three functions of money are:

1. Medium of exchange: Money can be used for buying and selling goods and services. If there were no money, goods would have to be exchanged through the process of barter (goods would be traded for other goods in transactions arranged on the basis of mutual need). For example: If I raise chickens and want to buy cows, I would have to find a person who is willing to sell his cows for my chickens. Such arrangements are often difficult. But Money eliminates the need of the double coincidence of wants.
2. Unit of account: Money is the common standard for measuring relative worth of goods and service.
3. Store of value: Money is the most liquid asset (Liquidity measures how easily assets can be spent to buy goods and services). Money’s value can be retained over time. It is a convenient way to store wealth.

· How is money regulated

· How is money circulated

· Who authorizes the distribution of money

· How do the functions of money affect the economy

· Why is money a better medium of exchange

· What influences the worth of a dollar

In the real world, money supply has different definitions: M1 and M2. Money is categorized according to its liquidity. The most liquid items are in M1.

M1: includes currency (coins minted by the U.S. Treasury and paper currency issued by the Federal Reserve), checkable deposits and traveler’s checks (issued by the commercial banks and thrift institutions).

Currency and checkable deposits belonging to the federal government, Federal Reserve, or other financial institutions are not included in M1.

M1 = Currency + Checkable deposits + Traveler’s checks

M2: includes all of the components of M1 plus near-moneys which includes items like:

a) Small Time deposits: interest-earning deposits with a value of less than $100,000, and having a specified maturity.

b) Savings deposits: interest-earning deposits with no specific maturity of maximum value.

c) Money market accounts: savings that invest in short-term financial instruments, pay higher than savings account interest.

d) Overnight repurchase agreements: agreements by a financial institutions to sell short –term securities to its customers, accompanied by an agreement to repurchase the securities within 24 hours.

e) Overnight Eurodollar deposits: 24-hour dollar-denominated deposits held in financial institutions outside the United States.

Understand to explain what is meant by “transaction” and “asset” demand for money

· Transactions demand, in economic theory, specifically Keynesian economics, is one of the determinants of demand for money (and credit), the others beingspeculative demand and precautionary demand. Transactions demand is illustrated as a vertical line on the money demand graph. The demand of money has arisen from the absence of perfect synchronization of payments and receipts. The holding of money is to bridge the gap between payments and receipts. Transactiondemand for money is due to the household's motive to hold money for daily transaction and the business's motive to facilitate the daily operation. The transactions demand for money is positively related with the amount of real income. It also depends on the timing of expenditures and the length of the payment period.

· The amount of money needed to cover the needs of an individual, firm, or nation. That is, transaction demand for money is a measure of how much of a certain currency people need in order to buy the goods and services they use. Generally speaking, if an economy is healthy, there is a high transaction demand for money because people are buying more goods and services. Conversely, if an economy is in trouble, people buy fewer goods and services. Unless there is a significant, sudden change in the transaction demand, central banks have little trouble adjusting the money supply to accommodate the changes that do occur.

· On a daily basis people need money on hand for the things that they routinely buy. You have to get a haircut or stop by the store on the way home from work to pick up some milk. You have transactions that you need to conduct, and therefore you have a demand for money. The transactions demand for money is using money as a medium of exchange. Notice in the graph below that the Transactions Demand for Money (DMT) is denoted as a vertical line when graphed against the interest rate. The demand for money as a medium of exchange is independent of the interest rate, because when you are on your way home from work and need to pick up milk, the interest rate does not affect how much milk you buy.

· Some people hold money as a financial asset just like stocks and bonds. Holding money as a liquid asset is using money as a store of value. Consider a person who has a portfolio of investments. Perhaps he owns some stocks, bonds, jewelry, artwork, a home, a savings account at his credit union, and has $5,000 in a fireproof box hidden in his basement. In an emergency, the cash is the most liquid asset that the person has, and is far more spendable than a painting or a piece of jewelry that might take weeks to turn into cash. The liquidity of cash is the advantage of holding cash. The disadvantage of holding money as an asset is that there is very little or no return on this asset.

· What is the inverse relationship between interest rate and asset demand for money?

· What is considered asset money?

· How can the DMT be further explained

· The cost of holding money as an asset is the foregone interest rate and there is an inverse relationship between the interest rate and the asset demand for money. This inverse relationship is illustrated in the graph below as a downward sloping asset demand for money (DMA). The total demand of money (DM) is just the sum of the transactions demand and the asset demand, and has the same downward slope as the asset demand.

· Asset demand for money is amount of money that people want so they can hold money as assets. The asset demand for money is inversely proportional to the interest rate. The reason

HOMEWORK 5

1. What are the three causes the aggregate demand curve to slope downward?

The first reason for the downward slope of the aggregate demand curve is Pigou's wealth effect. Recall that the nominal value of money is fixed, but the real value is dependent upon the price level. This is because for a given amount of money, a lower price level provides more purchasing power per unit of currency. When the price level falls, consumers are wealthier, a condition which induces more consumer spending. Thus, a drop in the price level induces consumers to spend more, thereby increasing the aggregate demand.

T he second reason for the downward slope of the aggregate demand curve is Keynes's interest-rate effect. Recall that the quantity of money demanded is dependent upon the price level. That is, a high price level means that it takes a relatively large amount of currency to make purchases. Thus, consumers demand large quantities of currency when the price level is high. When the price level is low, consumers demand a relatively small amount of currency because it takes a relatively small amount of currency to make purchases. Thus, consumers keep larger amounts of currency in the bank. As the amount of currency in banks increases, the supply of loans increases. As the supply of loans increases, the cost of loans--that is, the interest rate--decreases. Thus, a low price level induces consumers to save, which in turn drives down the interest rate. A low interest rate increases the demand for investment as the cost of investment falls with the interest rate. Thus, a drop in the price level decreases the interest rate, which increases the demand for investment and thereby increases aggregate demand.

The third reason for the downward slope of the aggregate demand curve is Mundell-Fleming's exchange-rate effect. Recall that as the price level falls the interest rate also tends to fall. When the domestic interest rate is low relative to interest rates available in foreign countries, domestic investors tend to invest in foreign countries where return on investments is higher. As domestic currency flows to foreign countries, the real exchange rate decreases because the international supply of dollars increases. A decrease in the real exchange rate has the effect of increasing net exports because domestic goods and services are relatively cheaper. Finally, an increase in net exports increases aggregate demand, as net exports is a component of aggregate demand. Thus, as the price level drops, interest rates fall, domestic investment in foreign countries increases, the real exchange rate depreciates, net exports increases, and aggregate demand increases.

2. What is the difference between the causes of the shifts of the aggregate demand curve and movements along the aggregate demand curve?

A movement along the aggregate demand curve is the result of a change in price. As the law of demand states - all other factors being equal, as the price of a good or service increases, consumer demand for the good or service will decrease and vice versa.

A shift in the demand curve is if there is more demand - A shift in demand curve results from changes in demand - if all other factors that were held constant there is a change in price of other commodities, change in supply of the commodity in question, change in tastes and preferences of consumers, change in income of consumers etc., then the demand curve will shift (outwards if there is an increase in demand and inwards - to the left - if there is a decrease).

3. Why is there a difference between LRAS curve and the SRAS curve?

In the long run (ceteris paribus), aggregate supply is perfectly inelastic, represented by a vertical line. No matter the inflation or deflation, there will be constant real product. However, in the short run, aggregate supply is much more elastic (and, according to Keynes, can become perfectly elastic (horizontal) if the economy gets into a rut). The real GDP will change because of the price level. But by definition, in the long run real variables are resistant to nominal changes, so real GDP will not be influenced by price level while in the short run it is not constant.

4. What is the difference between the causes of the shifts of the aggregate supply curve and movements along the aggregate supply curve?

1. Why does the multiplier effect occur?

The multiplier effect occurs because:

as saving levels increase, a greater pool of loanable funds is available for investment spending by businesses.

increases in income cause a chain reaction of spending by many businesses and individuals.

increases in income cause tax revenues to increase, thereby stimulating increases in government spending levels.

businesses copy the spending decisions of their competitors.

2. If the MPC is 0.75 and there is an increase in autonomous expenditure of $100 billion, what will the multiplier be?

3. How does the federal budget deficit impact private investment?

The rising federal budget deficit has garnered increased attention from policy makers and the public, who are concerned about its long-term effects. The Congressional Budget Office (CBO) projected in August 2011 that federal expenditures would exceed revenues by more than $1.2 trillion for the year, the third consecutive year the deficit will top $1 trillion. The CBO warns that the deficit can seriously impact economic growth and living standards in the U.S

1. Which macroeconomic schools of thought believe that there is no difference between the short run and the long run aggregate supply curve?

Keynesian economics is a theory of total spending in the economy and its effects on output and price level. Keynesian economists believe that aggregate demand is influenced by a host of economic decisions-both public and private- and erratically. According to Keynesian economists, changes in aggregate demand, whether anticipated or unanticipated, have their greatest short-run effect on real output and employment, not on prices. Keynesians believe that, because prices are somewhat rigid, fluctuations in any component of spending- consumption, investment, or government expenditures- cause output to fluctuate. Furthermore, Keynesians believe the rigidity of prices; especially wages causes periodic shortages and surpluses, especially of labor. Many Keynesians advocate stabilization policy to reduce the amplitude of the business cycle, which they rank among the most important of all economic problems.

1. Which economic schools of thought believe that the equilibrium level of real GDP per year is completely supply determined, and, that changes in aggregate demand affect only the price level, not real GDP?

Keynesian economics (/ˈkeɪnziən/ KAYN-zee-ən; or Keynesianism) is the view that in the short run, especially during recessions, economic output is strongly influenced by aggregate demand (total spending in the economy). In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is

2. Which macroeconomic schools of thought believe that prices, especially the price of labor (wages), were inflexible downward due to the existence of unions and long-term contracts between businesses and workers?

3. In whose model is increase in aggregate demand (AD) only leads to increase in real GDP and not the price level?

This is for the same reason that increased demand leads to higher prices in microeconomics.The idea is that there is greater demand, which means that there are more people who are willing to buy a given product. When that happens, the people are typically willing to pay higher prices because they know that if they do not pay that price, someone else will and the product will be gone.So when there is more demand, there is more "money chasing goods" and the prices have to rise and you end up with demand-pull inflation.

4.In whose analysis does increase in AD lead to a lower short-run equilibrium increase than when the SRAS curve is horizontal, and to a higher price level that then causes planned purchases of goods and services to decline or rise to a level less than when the SRAS curve is horizontal?

The AD–AS or aggregate demand–aggregate supply model is a macroeconomic model that explains price level and output through the relationship of aggregate demand and aggregate supply. It is based on the theory of John Maynard Keynes presented in his work The General Theory of Employment, Interest, and Money. It is one of the primary simplified representations in the modern field of macroeconomics, and is used by a broad array of economists, from libertarian, Monetarist supporters of laissez-faire, such as Milton Friedman, to Post-Keynesian supporters of economic interventionism, such as Joan Robinson.

Which macroeconomic school of thought said that when price level rises partially, real GDP can be expanded beyond the level consistent with its long-run growth path?

John Maynard Keynes issued the most telling challenge. He argued that wage rigidities and other factors could prevent the economy from closing a recessionary gap on its own. Further, he showed that expansionary fiscal and monetary policies could be used to increase aggregate demand and move the economy to its potential output. Although these ideas did not immediately affect U.S. policy, the increases in aggregate demand brought by the onset of World War II did bring the economy to full employment. Many economists became convinced of the validity of Keynes’s analysis and his prescriptions for macroeconomic policy.

4. An increase in aggregate demand will not raise the price level, and a decrease in aggregate demand will not cause the firms to lower prices.

5. Which macroeconomic schools of thought made this statements and why?

It is often cited that the aggregate demand curve is downward sloping because at lower price levels a greater quantity is demanded. While this is correct at the microeconomic, single good level, at the aggregate level this is incorrect. The aggregate demand curve is in fact downward sloping as a result of three distinct effects: Pigou's wealth effect, the Keynes' interest rate effect and the Mundell-Fleming exchange-rate effect. Additionally, the higher the price level is to be, the less demanded and thus it is downward sloping.[3]

1. What is your prediction of what you are about to read?

I think it is a lot of work but I can digest it.

2. How will you remember what you are about to read?

I will remember what I read by reading it more than one time and then putting it into my own understanding

3. What are some things you are about to do to learn this information?

I compare it to other things I have learnt and try to interpret it in real life.

4. As you read, did you put each passage in your own words?

Yes I did. I try to write the information out in bullet points in my own words so it is better understood.

HOMEWORK 3

What are the two types of market failures?

Market failures are often associated with time-inconsistent preferences, information asymmetries,[6] non-competitive markets, principal–agent problems, externalities, or public goods. The existence of a market failure is often the reason for government intervention in a particular market.[9][10] Economists, especially microeconomists, are often concerned with the causes of market failure and possible means of correction.[11] Such analysis plays an important role in many types of public policy decisions and studies. However, some types of government policy interventions, such as taxes, subsidies, bailouts, wage and price controls, and regulations, including attempts to correct market failure, may also lead to an inefficient allocation of resources, sometimes called government failure

2. What gives rise to the first type of market failure?

Some have argued that governments should subsidize research and development, since it will have positive externalities to everyone else. Another method is to allow patents to give monopoly rights to new inventions for a period of time, and encourage such activity. Without this method, there could be an under investment in research. Positive externalities in production means that social cost is less than private cost, and more of the good should be produced than will occur in a free market.

3. What does the second type of market failure gives rise to?

When economic agents not directly involved, negative externalities can exist, such as pollution. A free market tends to over-produce the good which produces a negative externality, and under produce those with positive externality. If we include costs borne by everyone, then we get social costs, which are the total costs of production no matter who bears them. We say that the total cost is equal to private costs plus external costs. -

4. What are the two types of spillovers?

The two types of spillovers are knowledge spillovers and technology spillovers

5. What are spillover costs?

Spillover costs are basically the costs that are paid by people who do not agree to the action causing the cost.

6. What are spillover benefits?

Spillover effects are the external outcomes of economic activities which can affects those people which are not directly involved in this process. It is quite natural and realistic. For example, the war of Amercian-Afganistan is badly affecting the economy of Pakistan

7. What are the economic consequences of both spillover costs and spillover benefits? Support your explanation graphically.

Economists call effects on those not involved in a market externalities, and externalities vary along two dimensions. First, externalities can be either negative or positive. Not surprisingly, negative externalities impose spillover costs on otherwise uninvolved parties, and positive externalities confer spillover benefits on otherwise uninvolved parties. (When analyzing externalities, it's helpful to keep in mind that costs are just negative benefits and benefits are just negative costs.) Second, externalities can be either on production or consumption. In the case of an externality on production, the spillover effects occur when a product is physically produced. In the case of an externality on consumption, the spillover effects occur when a product is consumed.

http://www.camargueum.co.za/sites/default/files/figure1.jpg

8. How does the government correct for both negative externalities and positive externalities?

Positive externalities are benefits that are infeasible to charge to provide; negative externalities are costs that are infeasible to charge to not provide. Ordinarily, as Adam Smith explained, selfishness leads markets to produce whatever people want; to get rich, you have to sell what the public is eager to buy. Externalities undermine the social benefits of individual selfishness. If selfish consumers do not have to pay producers for benefits, they will not pay; and if selfish producers are not paid, they will not produce. A valuable product fails to appear. The problem, as David Friedman aptly explains, “is not that one person pays for what someone else gets but that nobody pays and nobody gets, even though the good is worth more than it would cost to produce

1.What is the purpose of the circular-flow model and products?

One of the main basic economic models is the circular-flow model, which describes the flow of money and products throughout the economy in a very simplified way. The model represents all of the actors in an economy as either households or firms (companies), and it divides markets into two categories:

markets for goods and services

markets for factors of production (factor markets)

2.What do firms need in order to produce goods and services?

In economics, factors of production are the inputs to the production process. Finished goods are the output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function. There are three basic factors of production: land, labour, capital. Some modern economists also consider entrepreneurship for a factor of production

3.Who are the owners of the factors of production?

If you are equating market economy with capitalism (which is not accurate, but still common),
then the answer you probably want is that ownership is in private hands.
Most big companies are publicly-held corporations. There is no single owner; the stock may be widely distributed.
Much of the stock in the U.S. is owned by pension funds, which nominally act on the behalf of workers. That means you could say that workers own many of the means of production, even if they have no control over them.
Much of the rest of stock is owned by mutual funds. But mutual funds don't actually exercise any control over the companies whose stock they hold. Thus they may be legal owners, but they don't behave like owners.
Then there are the sovereign wealth funds where foreign governments buy stocks and other assets:

4. What are the of factor resources owned by households?

Households own all the factors of production, that is land, labor, capital. These factors of production are sold to the firms to produce goods and services through factor markets. Firms make use of these resources and provide goods and services to the household through product markets. However the exchange of goods and services and factors of production takes place with the help of the financial flows that move in the reverse direction. As the households purchase goods and services from firms it is their consumption expenditure which in turn becomes income or profits for the firms. On the other hand when firms buy factors of production from the households they pay factor payments in the form of wages, rent, interest.

5. In the form of what do households receive money income or payment from firms?

Spending patterns vary by age, region of the county, the size of the household, and income, among other things. Some things are purchased infrequently, others on a regular basis. The Bureau of Labor Statistics conducts the Consumer Expenditure Survey to quantify some of these observations. The seven major categories in the Survey are food, housing, apparel and services, transportation, health care, entertainment, and an "other" category that is mostly taken up by personal insurance and pensions, but also includes personal care products, reading, education, tobacco products, cash contributions, and miscellaneous items. Although the dollar amounts vary with every Survey report, some trends have been in place for many years.

6. What do households spend their income on?

7. What does the financial system consist of?

A financial system can be defined at the global, regional or firm specific level. The firm's financial system is the set of implemented procedures that track the financial activities of the company. On a regional scale, the financial system is the system that enables lenders and borrowers to exchange funds. The global financial system is basically a broader regional system that encompasses all financial institutions, borrowers and lenders within the global economy.

8. What does the government’s ability to borrow money depend on?

Government debt is one method of financing government operations, but it is not the only method. Governments can also create money to monetize their debts, thereby removing the need to pay interest. But this practice simply reduces government interest costs rather than truly canceling government debt,[3] and can result in hyperinflation if used unsparingly.

9. What is the importance of a viable financial system?

There are multiple components making up the financial system of different levels: Within a firm, the financial system encompasses all aspects of finances. For example, it would include accounting measures, revenue and expense schedules, wages and balance sheet verification. Regional financial systems would include banks and other financial institutions, financial markets, financial services In a global view, financial systems would include the International Monetary Fund, central banks, World Bank and major banks that practice overseas lending.

10. Why do firms want to produce goods and services?

In business, products that are sold, traded or otherwise provided to consumers or other companies can be classified as either goods, which are tangible, or services, which are intangible. Most countries measure their economies on the production and consumption of both physical goods and intangible services. Some companies provide both goods and services, and others provide only one or the other. Firms produce goods and services primarily to make profit and to circulate money into the economy.

11. What are the types of reward or payment received by the different factor resources?

Payments made of scarce resources, or the factors of production in return for productive services. They are also categorized according to the services of the productive resources being rewarded. As wages are being paid for services of labor, interest is paid for the services of capital, rent is paid for the services provided by the land and profit is for the factor of payment to entrepreneurship

12. What do governments pay to households for using their resources?

13. What does all expenditures by the households, government, firms, and the rest of the world equal to?

14. What does GDP stand for?

Gross Domestic Product. The total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports. The GDP report is released at 8:30 am EST on the last day of each quarter and reflects the previous quarter. Growth in GDP is what matters, and the U.S. GDP growth has historically averaged about 2.5-3% per year but with substantial deviations. Each initial GDP report will be revised twice before the final figure is settled upon: the "advance" report is followed by the "preliminary" report about a month later and a final report a month after that. Significant revisions to the advance number can cause additional ripples through the markets. The GDP numbers are reported in two forms: current dollar and constant dollar

15. What do households do with the portion of their income that they do not spend?

16. What are imports?

An import is a good brought into a jurisdiction, especially across a national border, from an external source. The party bringing in the good is called an importer. An import in the receiving country is an export from the sending country. Importation and exportation are the defining financial transactions of international trade.

17. What are exports?

The term export means shipping the goods and services out of the port of a country. The seller of such goods and services is referred to as an "exporter" who is based in the country of export whereas the overseas based buyer is referred to as an "importer". In International Trade, "exports" refers to selling goods and services produced in the home country to other markets.

18. What similarities and differences did you find between the assigned pages and the instructor’s prepared video?

The pages assigned gave more information on the subject where the videos give a more vivid and illustrated idea of what the concepts are about. They are both informative.

1.Why do we need to consider the definition of GDP carefully?

We need to consider the GDP carefully because it is commonly used as an indicator of the health of a country, as well as the country’s standard of living. Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a year, or over a given period of time. GDP per capita is often used as an indicator of a country's material standard of living.

2. What is the difference between how we measure total production in microeconomics and macroeconomics?

When you think of microeconomics, think of a microscope. You are analyzing one little bit of information at a time. In microeconomics, we tend to focus on one individual, or one firm, and how it interacts with the market. Examples include deciding how many pieces of pizza to buy, or whether or not you should purchase insurance. Problems generally deal with utility functions and budget constraints for consumers, and profit maximization problems for firms.

Now imagine you are standing on the moon looking at the economy on earth. You would see huge land masses only. This far away approach is considered a macro approach, because it aggregates all of the decisions of the individuals and firms to a regional or national level. Macro tends to focus on government policy and the potential impacts it can have on the general economy. Government policies include taxes, subsidies, regulations and rules. Macroeconomics strives to understand how these policies impact the economy.

Also, in microeconomics we are concerned with things like individual salaries, purchasing decisions, exports or taxes for one product, and welfare or help for a specific demographic. In macroeconomics we tend to think about more general terms, such as money supply, inflation, unemployment, GDP, exchange rates and trade.

3.Why does GDP include only the market value of final goods?

The dollar value of final goods includes the dollar value of intermediate goods. If
intermediate goods were counted, then multiple counting would occur. The value of steel
(an intermediate good) used in autos is included in the price of the auto (a final product).
This value is not included in GDP because such sales and purchases simply transfer the
ownership of existing assets; such sales and purchases are not themselves (economic)
investment and thus should not be counted as production of final goods and services.
Used furniture was produced in some previous year; it was counted as GDP then. Its
resale does not measure new production.

4.What is the value of GDP if the quantity and price of eye examinations produced is 100 and $50 respectively?

The GDP would be approximately $150 dollars.

5. Why does the value of total production equal to the value of total income?

Consider the new car that you just bought. Assume (only to simplify the discussion) that it was built entirely within the same country that you live in, and that you bought it in. Also to simplify, assume that it was built entirely in this year. The car being built obviously is production. But how to you value it so that it's value counts in GDP? The price that you paid is the method of valuing that would be used. That would be the value of production, how it would be counted using the expenditures approach. But if you traced that amount of money back through the production process, it all adds up to income for the factors of production along the line. The manufacturers of all the different parts receive income when they sell the parts to the automaker. Even before that, those parts were final products for somebody else that used raw materials to make the parts. The automaker, and everybody else along the line, pays wages for workers. They pay other expenses as part of the process. The companies along the way also receive profit. The total price that you paid is income for somebody along the way. The total value of production equals income.

6.What are the four components of GDP and their defining characteristics?

GDP is made up of four basic groups. The first three are types of expenditures: consumer expenditure, government expenditure and investment expenditure. The fourth component measures net exports. Net exports comprise both exports, which are items produced at home and bought by consumers overseas, and imports, which are goods produced by overseas companies but bought by domestic consumers. With the exemption of imports, an increase in every component leads to an increase in GDP. GDP is measured in one time period, usually in units of one year or quarters of a year.

7.How can GDP be measured using the value-added method?

In business, the difference between the sale price and the production cost of a product is the unit profit. In economics, the sum of the unit profit, the unit depreciation cost, and the unit labor cost is the unit value added. Summing value added per unit over all units sold is total value added. Total value added is equivalent to revenue less outside purchases (of materials and services). Value added is a higher portion of revenue for integrated companies,

1. How do you calculate the following: Real GDP, nominal GDP, and price index?

Real GDP:

Add a country's cumulative expenditures to arrive at nominal GDP. Nominal GDP is the actual dollar amount a country spends. GDP expenditures are made up of personal expenditures, gross private investment, government consumption, imports and exports.

Nominal GDP:

Calculate the total consumer spending by adding up all purchases of goods and services by households. These can include food, gas and clothing.

Price Index:

A consumer price index (CPI) is an estimate as to the price level of consumer goods and services in an economy which is used as a way to estimate changes in prices and inflation. A CPI takes a certain basket of common goods and services, for instance a gallon of gas, a loaf of bread and a haircut, and tracks the changes in the prices that basket of goods over time.