CHAPTER THREE. Answers to Self-Test Questions

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1 Answers to Self-Test Questions CHAPTER THREE 1. Inventories must be rising. This is because the value of production is the same as total income and if it exceeds total sales (aggregate expenditures), then some production must be unsold. 2. No, consumption spending includes spending on imports as well. No, the transfer of assets, including the purchase of stocks and bonds, is not investment. 3. a) C; b) I; c) S; d) N; e) I f) X; g) IM; h) X; i) G. 4. Undistributed corporate profits: $21. (If gross profits are $62, then net profits (profits after tax) must be $62 less corporation taxes of $15, or $47. Net profits can either be distributed by corporations as dividends or retained as undistributed profits. Since dividends are $26, then undistributed profits must be $47 less $26, or $21.) 5. X N (net exports): $25. We need to work our way backwards to get the answer. If national income is $600, then adding back indirect taxes of $50 gives us $650 for NNP. Adding back depreciation of $20 gives GNP of $670. Adding back net investment income by non-residents of $10 (it is negative and was therefore subtracted earlier) gives GDP of $680. Since the sum of C + G and Ig is $655, the difference of $25 (680 minus 655) must be the value of Xn. 6. National income: $552. To find national income, we need to start at personal income of $589 and work backwards. We need to add back undistributed profits, corporate profit taxes and other income, which total $135, and then subtract government transfer payments of $172. This gives national income of $ As housekeeping and child-minding activities become more and more a market activity, GDP will increase. However, this does not necessarily mean that more is being produced since these same activities were also done 40 years ago but mostly as nonmarket activities. 8. This could happen if prices fell. 15

2 Answers to Study Guide Questions 1. False: these are both real flows. 2. False: individuals earn incomes from selling their factor services. 3. False: income and money are different concepts and are rarely equal, except by coincidence. 4. False: savings are equal to income minus consumption. 5. False: they flow from the government to the household (and business) sector. 6. True 7. True 8. False: it is the total earnings of all factors of production. 9. True 10. True 11. b 12. a 13. d 14. a 15. b 16. a 17. c 18. c 19. c 20. c 21. d 22. a 23. c 24. a 25. b 26. b 27. c 28. c 29. b 30. b 31. b 32 b 33. c 34. d 35. c 36A. Key Problem a) See the following figure: Figure 3.8 (completed) 16

3 b) Costs of production: $640. This is the total of: wages ($400), interest ($80) rent ($100), and profits ($ 60). c) Total factor payments: $640. d) Disposable income: $400. This is equal to $640 in factor payments less $360 paid in taxes plus $120 in transfer payments. e) Aggregate expenditures: $640. This is made up of: consumption ($300) less imports ($80) plus government spending ($280), investment ($40) and exports ($100). f) Total receipts: $640. Total receipts of all businesses are the same as aggregate expenditures because what is spent by households, the government, other businesses and foreigners is received by the business sector. g) Total injections: $420; total leakages: $420. Total injections consist of: investment ($40) plus exports ($100) and government spending ($280). Total leakages are: savings ($100) plus imports ($80) plus net taxes of $240 ($360 $120). h) The balance of trade (net exports): +$20. Net exports equals exports ($100) less imports ($80). i) Government s budget: deficit of $40. The budget is net taxes ($240) minus government spending ($280). 37A a) IM; b) X; c) C; d) S; e) G 38A. a) GDP = $766; b) NNP = $680; c) National Income = $ A. a) Personal Income = $577; b) disposable Income = $ A. a) costs of production: $440. b) total factor payments: $440 c) factor income: $440 d) disposable income: $290 e) aggregate expenditures: $440 f) total business receipts: $440 g) total injections/leakages: $290 h) net exports: +$10 i) Government s budget: +$20 17

4 41A. a) GDP: $550; b) national income: $550 c) disposable income: $550 d) Total injections: $160 e) total leakages: $160 42A. See following figure: Figure 3.10 (completed) 43A C 400 Ig 140 G 210 X N 100 GDP 850 Net foreign factor income 50 GNP 800 Depreciation 40 NNP 760 Indirect Taxes 60 18

5 National Income 700 Transfer payments 120 Undistributed corporate profits 35 Corporate profits tax 50 Other income not paid out 25 Personal income 710 Personal income tax 210 Disposable income 500 Personal saving A. GDP at market prices: $856; GNP at market prices: $828; Net Domestic Income: $633; National Income: $605; NNP at market prices: $718; NNP at factor costs: $605; Personal Income: $724; Disposable Income: $ A Saving is that portion of income that isn t spent. It could take the form of cash or an RRSP or stocks and bonds. Investment is spending (by firms and government) on new capital goods. Both are flow concepts. 46A In equilibrium the value of total leakages equals the value of total injections. It also means that aggregate expenditures are equal to total income. 47A. C 350 I g 90 G 340 X n 20 GDP 800 Net foreign factor income 20 GNP 780 Depreciation 70 NNP 710 Indirect tax 160 National income 550 Transfer payments +210 Undistributed corp. profits 30 Corporate profit taxes 80 Other income not paid out 20 Personal Income 630 Personal income tax 230 Disposable Income 400 Personal savings 50 19

6 48A. See following table: Table 3.3 (completed) Expenditures Incomes Consumption $ 800 Wages $530 Gross Investment $ 200 Interest $160 Government Spending $ 400 Gross Profits $180 Net Exports $ 40 Farmers Income $90 Self-employed Income $60 Gross Domestic Product $1360 Net Domestic Income $1020 +/ Net Foreign F Income $ 20 +/ Net Foreign f Income $ 20 Gross National Product $1340 Less Depreciation $ 120 Net National Product $1220 Less Indirect Taxes $220 NNP at Factor Costs $1000 = National Income $1000 Add Transfer Payments $ Less Undistributed Profits $40 Less Profits Tax $60 Less Other Inc. Not Paid $20 Personal Income $1080 Less Personal Income Taxes $160 Disposable Income $920 Savings = $120 Consumption = $800 49A. The expenditures approach measures the total value of production (GDP) by adding up the amounts spent in the four sectors buying those goods. The four sectors are: household (consumption), business (gross investment), government and international (net exports). An adjustment is made for goods left unsold (change in inventories) by adding it to gross investment. The total income approach measures the amount paid to the various factor services (in the form of wages, interest, profit, farmers income and self-employed income) in producing GDP. It is the same as the total costs of production. To get the market value of those products then the amount of indirect taxes and depreciation are added on. 50A. The stock of money is an amount which is measured at a particular moment in time. For instance you have a certain amount of cash on your person at the moment. Income, 20

7 on the other hand, can only be measures over a period of time. For instance if you earn an income of $200, it makes a big difference if this is your weekly income, daily income or hourly income! 51A Conceptually GDP and income are the same in that GDP can be thought of as the value of production, and by value we mean the costs (including a normal profit) necessary to produce it. What are costs to the firm become income receipts to the people who provide the various services. Therefore, one of the ways we can determine the value of production is by the income that is generated when that output is produced. The actual measurement of GDP, however, includes not only the value of production but excise taxes as well. Further, GDP can be thought of as revenue received by business firms, and a portion of this revenue, in the amount equal to depreciation expense, does not get paid out as income to individuals in the household sector. Finally, national income is income received by Canadians, while GDP is the value of production in Canada. Thus, three adjustments must be made to GDP in order to reconcile it with National Income: subtract indirect taxes, subtract depreciation and add or subtract Net Foreign Investment Income. 52A There are many productive activities excluded from measured GDP because they are non-market activities such as the value of housework, do-it-yourself production as well as voluntary work. In addition, unreported activities from which income is received operating a day-care from your home, for instance is excluded. In this last case it s not the activity that is illegal; it s the non-reporting that s illegal. 53A a) Consumption 720; b) GDP 1090; c) GNP 1110; d) national income 900; e) personal income A. Presently, expenditures on housing are considered investment, while automobile purchases are treated as consumption expenditures. If automobile purchases were also treated as investment, then the level of investment would rise and the level of consumption expenditures would fall. GDP, national income and disposable income are unaffected. However, since consumption has fallen, savings would rise by the same amount as investment. 55A. Transfer payments are excluded from GDP because they do not represent payment for goods and services produced in the current year. 21