Chapter 11: Problems
11. Describe the effects of each of the following on U.S. GDP.

a. A flood that destroys 1,500 homes along the Mississippi River.
b. A ban on U.S. imports from Japan.
c. The legalization of marijuana.
d. U.S. involvement in a war in Central America.
a. The flood itself would have no effect on GDP. However, if the homes were reconstructed, this reconstruction would be counted as a part of gross domestic private investment, thereby increasing GDP.
b. Imports are excluded from GDP. As a result, a ban on U.S. imports from Japan would have no immediate effect on GDP. However, if U.S. firms increase their output to meet the demand previously satisfied by these imports, GDP may rise.
c. Illegal activities, including the production of marijuana, are not included in GDP. If marijuana were legalized, its market value would be included in GDP. GDP, therefore, would rise.
d. If the United States became involved in a war in Central America, the federal government would increase their purchases of goods and services in order to provide supplies for the war effort. As a result of these increased purchases, GDP would rise.
5. "An increase in nominal GDP means that more goods and services are available to society." Using a specific example, explain why this statement is true or false.

This statement is false. To illustrate consider the following table which shows the price and quantity of the two goods produced by the 'Tropical Economy" during two consecutive years.

____Bananas $1.00/lb.___100 lbs.____$3.00/1b.________100 lbs.___________
____Coconut $2.00/qt.___300qts.____$6.00/qt.________300qts._____________

Nominal GDP in 1994 would be ($1.00 X 100) + ($2.00 X 300) = $700.
Nominal GDP in 1995 would be ($3.00 X 100) + ($6.00 X 300) = $2,100.

As can be seen, nominal GDP increased in 1995; however, this increase is due solely to the increase in prices. Output was the same in both years. Because nominal GDP reflects both changes in prices and output, it is possible for it to rise without more goods and services being produced.
6. Fill in the blanks in the following table.

________YEAR NOMINAL GDP______________REAL GDP____________GDP
___________(billions of current $)________(billions of 1987 $)_________ DEFLATOR


Real GDP = Nominal GDP/Price Deflator (in decimal form). Solving for nominal GDP gives Real GDP X Price Deflator: Nominal GNP. Hence, nominal GNP in 1993 is $4,800 X 1.20, or $5,760.
Real GDP: Nominal GDP/Price Deflator. Solving for the price deflator gives Price Deflator = Nominal GDP/Real GDP. This must be multiplied by 100 to remove the decimal Hence, the GDP price deflator in 1994 is ($6,500/$5,000) X 100, or 130.00.
Real GDP = Nominal GDP/Price Deflator. Hence real GDP in 1995 is $9,000/1.50, or $6,000.
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