ANSWERS:

1. D

Ø Household production (non-market transactions) are not included in GDP. Therefore, an increase in household production would result in an underestimated GDP.

2. A

Anything that increases the costs of inputs (productive resources) will raise the cost of production and, therefore the short-run AS curve will decrease (shift to the left).

3. C

Ø Real GDP is measured on the horizontal axis and price level is on the vertical axis. Thus the intersection of the AD and AS curves will result in the economy’s equilibrium levels of real national output and price level.

4. C

Ø By only counting final goods, intermediate goods won’t be counted twice in GDP.

5. D

Ø Full employment is around 94-96% employment of the labor force (not the total population). Thus, it can be restated as the level of employment where 4-6% of the labor force is unemployed.

6. D

Ø Real Income = Nominal Income – Inflation. Since we don’t know by how much nominal income is increasing, we can’t be certain that one’s real income is reduced when there is inflation. All we can tell is that the purchasing power of the dollar has decreased.

7. C

Ø Higher prices mean people will need more money. As people demand more money, interest rates will rise causing investment and consumption spending to decrease.

8. B

Ø A reduction in taxes increases one’s disposable income. Thus, businesses and individuals will increase AS and AD through an increased level of consumption and investment spending.

9. D

Ø Discouraged workers aren’t included in the labor force and, therefore our unemployment rate should be higher simply because there are more people unemployed than are calculated by this official measure.

10. D

Ø This activity is excluded simply because no market transaction occurs.

11. B

Ø Investment consists of expenditures on capital and equipment, changes in inventory, and all forms of construction.

12. C

Ø Automobiles would be most sensitive since they represent a larger portion of one’s income and would most likely require a loan of some sorts.

13. C

Ø Nominal GDP doesn’t account for inflation and, thus it simply price time quantity of all goods and services produced in one year.

14. A

Ø If we buy more imports and fewer domestic goods, our net exports will decline leading to a decrease in equilibrium income. Since imports > exports, our trade balance moves toward deficit.

15. D

Ø In order to be considered part of the labor force and unemployed, you must still be searching for work.

16. D

Ø Second hand sales (used items) are not included in the current year’s GDP since they were already included in a previous year’s GDP.

17. E

Ø Definition of GDP. The key words are final goods and services, produced within a nation, and in one year.

18. A

Ø Structural unemployment results when there is a mismatch of skills.

19. C

Ø If the price of an input resource increases, the cost of production will also increase. This cause AS to decrease (shift to the left). Thus, price level increases and output decreases.

20. C

Ø CPI tells us the level of prices. If the CPI goes from 100 to 200, prices in an average consumer’s market basket have obviously doubled.

21. A

Ø If productivity increases, AS will increase (shift to the right). This will most likely lead to an increase in output and a decrease in price level.

22. Real GDP adjusts Nominal GDP for changes in the price level (inflation and deflation).

Real GDP = Nominal GDP / Price Index.

23. The difference between GDP and GNP is simply the fact that GDP include the incomes of foreigners in the U.S.

24. Pure financial transactions, secondhand sales, non-market transactions, or illegal activities are some examples of items not counted in the calculation of GDP.

25. Changes in consumer spending, investment, government spending, and net exports will

cause AD to shift. If consumer wealth increases, expectations become positive, household indebtedness decreases, or taxes decrease, AD will shift to the right (increase). If interest rates decrease or profit expectations increase, AD will shift to the right (increase). Profit expectations depend upon things such as expectations on future business expectations, technology, excess capacity, or business taxes. Net exports may change based on the amount of national income abroad or the value of the dollar.

26. Changes in input prices, productivity, or the legal (institutional) environment will result in a shift of the AS curve. Increases in domestic resource availability, decreases in the price of imports, or decreases in market power, will cause AS to shift to right (increase). Increases in subsidies, decreases in taxes, or reductions in government regulation will shift AS to the right. And, increases in productivity will lower per-unit production costs and increase AS.

27. See Business Cycle Handout … Expansion, Peak, Recession, Trough.

28. Excess capacity is unused capital. As excess capacity decreases, expected returns

increase, the demand for capital increases, and thus AD increases. As AD increases, price level increases. So, as excess capacity decreases we’ll experience inflation.

29. Demand-pull inflation exists hen total spending exceeds the economy’s ability to

produce output at the current price level. Cost-push inflation exists when prices rise

because of a rise in the per-unit production costs.

30. a) A widespread fear of depression on the part of consumers will cause consumer

spending to decrease. This, in turn, causes AD to decrease (shift to the left).

b) A large purchase of wheat by Russia means exports are increasing. As exports

increase, net exports also increase. Therefore, AD increases (shifts to the right).

c) A cut in Federal spending for higher education means government expenditures

have decreased. Thus, AD decreases (shifts to the left).

d) The complete disintegration of OPEC (decrease in market power) will cause AS to

increase (shift to the right) since input prices are now lower.