Chapter 8

Question 0

The simple circular flow

Answer 0

The concept of a circular flow of income (ignoring taxes) involves two principles.

1. In every economic exchange, the seller receives exactly the same amount that the buyer spends.
2. Goods and services flow in one direction and money payments flow in the other.

Question 1

National income accounting

Answer 1

A measurement system used to estimate national income and it’s components. One approach to measuring a economy’s aggregate performance.

Question 2

Profits explained

Answer 2

Profit is a cost of production. Entrepreneurs must be rewarded for providing their services. The reward -the profit- is included in the cost of doing business. Just as workers expect wages, entrepreneurs expect profits.

Question 3

Total income or total output

Answer 3

From businesses to house holds-a payment for something, whether it be wages paid for labor services, rent paid for use of land, interest paid for the use of capital, or profits paid to entrepreneurs. It is the. Amount paid to the resource suppliers. Total income is also defined as the annual cost of producing the entire output of final goods and services.

From households to businesses, the dollar value of of output in the economy. This is equal to the total monetary value of all final goods and services. It represents the total business receipt.

Question 4

Product markets

Answer 4

Transactions in which households buy goods takes place in product markets– that’s where households are the buyers and businesses are the sellers of consumer goods.

Question 5

Factor markets

Answer 5

In the factor market, households are the sellers. They sell resources such as labor, land, capital, and entrepreneurial ability. Businesses are the buyers in factor markets.

Question 6

Total income

Answer 6

The yearly amount earned by the nations resources (factors of production). Total income therefore includes wages, rent, interest payments, and profits that are received by workers, land owners, capital owners, and entrepreneurs, respectively.

Question 7

Final goods and services

Answer 7

Goods and services that are at their final stage of production and will not be transformed into yet other goods or services. For example, wheat ordinarily is not considered a final good because it is usually used to make a final good, bread.

Question 8

Why the dollar value of total output must equal total income.

Answer 8

First, spending by one group is income to the other.
Second, it is a matter of simple accounting and the economic definition of profit as a cost of production. Profit is defined as what is left over from total business receipts after all other costs–wages, rents, interest– have been paid. Profit is always the residual item that makes total income equal to the dollar value of total output.

Question 9

National income accounting

Answer 9

Economists use historical statically records on the performance of the national economy for testing their theories about how the economy really works. The most commonly presented statistic on the national economy is the Gross Domestic Product (GDP).

Question 10

Gross Domestic Product (GDP)

Answer 10

The total market value of all final goods and services produced in an economy during that year. The value of a flow of production. A nation produces at a certain rate, just as you receive income at a certain rate. You have to specify a time period for all flows. All the measures of domestic products and income are specified as rates measured in dollars per year.

Question 11

Gross Domestic Product (GDP)

Answer 11

The total market value of all final goods and services produced in a year by factors of production located within a nations borders.

Question 12

Stress on final output

Answer 12

GDP does not count intermediate goods ( goods used up entirely in the production of final goods) because to do so would be to count them twice.
Ex. Grain- the farmers final product but is not the final product for the nation. It is sold to make bread. Bread is the final product.
If each intermediate good was counted twice –once when it was produced and again when the good it was used to produce– this double counting would greatly exaggerate the GDP.

Question 13

Intermediate goods

Answer 13

Goods used up entirely in the production of final goods.

Question 14

Value added

Answer 14

The dollar value of an industry’s sales minus the value of intermediate goods ( for example, raw materials and parts) used in production.

Question 15

Exclusion of financial transactions, transfer payments, and secondhand goods.

Answer 15

Remember that GDP is the measure of the dollar value of all final goods and services produced in on year. Many more transactions occur that have nothing to do with final goods and services produced. There are financial transactions, transfers of ownership of ore existing goods, and other transactions that should not (and do not) get included in our measure of GDP.

Question 16

Financial transactions

Answer 16

There are three general categories of purely financial transactions:

(1) the buying and selling of securities,
(2) government transfer payments, and
(3) private transfer payments.

Question 17

Securities

Answer 17

When you purchase shares of existing stock, there was nearly a transfer of ownership rights. No producing activity was consummated at that time, unless a broker received a fee for performing the transaction, in which case only the fee is part of GDP. The $100 transaction is not included when we measure GDP.

Question 18

Government transfer payments

Answer 18

Transfer payments are payments for which no productive services are concurrently provided in exchange. The most obvious government transfer payments are Social Security benefits and unemployment compensation. Government transfer payments are not included in GDP.

Question 19

Private transfer payments

Answer 19

Funds from your parents, a gift of cash. This payment is merely a transfer of funds from individual to another. As such, it does not constitute productive activity and is not included in GDP.

Question 20

Transfer of secondhand goods

Answer 20

If I see you my two year old lap top computer, no current production is involved. I transfer to you the ownership, in exchange you transfer to me $250. The original price was included in the GDP the year I purchased it, to include it again would be to count it twice.

Question 21

Other excluded transactions

Answer 21

Household production– task performed by people in their own homes
Otherwise legal underground transactions– paid under the table, no taxes paid.
Illegal underground activities– prostitution and such.

Question 22

Recognizing the limitations of GDP

Answer 22

A concept that can be both well used and misused. Especially valuable as an overall indicator of a nations economic performance, but GDP has significant weaknesses.

Problems in comparing the GDP of an industrialized country with the GDP of a highly agrarian nation in which no market production is relatively more important.

Also if nations have different definitions of legal verses illegal activities. For instance, gambling. This can complicate comparing GDP in the nation where gambling is legal with GDP in the country that prohibits gambling.

Not necessarily a good measure of the well being of a nation.
*a measure of the value of production not a measure of the nations overall welfare.