HOMEWORK 6

Some economists argue that Gross Domestic Product (GDP) does not fully capture the well-being of a society because it only measures economic output and ignores negative externalities like pollution or environmental degradation. For example, an increase in production that leads to pollution can increase GDP, but it doesn't account for the harm caused by the pollution, which might reduce overall welfare. This is a limitation of using GDP as the sole measure of economic well-being.

When using the expenditure approach to calculate GDP, the largest component is usually consumption (C), which represents spending by households on goods and services. Compensation of employees is a significant component, but it is considered a part of income-based calculations of GDP, not the expenditure approach.

The expenditure approach focuses on consumption (C), investment (I), government spending (G), and net exports (exports minus imports).

A sales tax is considered an indirect business tax because it is collected by businesses from consumers at the point of sale. Businesses act as intermediaries, collecting the tax and then remitting it to the government. It's indirect because the tax burden is on the consumer, but the business is responsible for collecting and forwarding the tax.

Net exports are calculated as the difference between exports and imports (Net Exports = Exports - Imports). Net exports do not always have to be positive. When a country imports more than it exports, net exports are negative, which is called a trade deficit. Conversely, if a country exports more than it imports, net exports are positive, resulting in a trade surplus.

The Easterlin Paradox suggests that higher income does not necessarily lead to higher levels of happiness once basic needs are met. However, the research of economists Stevenson and Wolfers contradicts the Easterlin Paradox. Their studies suggest that there is a positive relationship between income and happiness, and as income rises, happiness tends to increase over time, both within countries and across countries.

So, while the Easterlin Paradox implies no long-term happiness improvement with rising income, Stevenson and Wolfers' findings do not support this view.

A recession occurs during the contraction phase of the business cycle, where economic activity slows down, leading to a decline in GDP, higher unemployment, and lower consumer spending. The contraction phase marks a downturn in the economy after a peak and can lead to a recession if the decline is significant and prolonged.

• Peak → The highest point of the business cycle, before the economy starts to slow down.

• Expansion → A period of growth in the economy, marked by increasing GDP and employment.

• Recovery → A phase where the economy starts to improve after a recession, but before reaching a new peak.

Increases in import spending generally lead to a decrease in GDP, ceteris paribus (assuming all other factors remain the same). This is because when a country imports goods, the spending is directed to other countries, meaning money is flowing out of the domestic economy. In the expenditure approach to calculating GDP, imports are subtracted from exports, so an increase in imports reduces net exports, which in turn lowers GDP.

Real GDP is always measured in base-year dollars.

To derive Net Domestic Product (NDP) from Gross Domestic Product (GDP), we subtract the capital consumption allowance, also known as depreciation, from GDP. Depreciation represents the wear and tear or obsolescence of capital goods used in production, and NDP accounts for this reduction in the value of capital.

An intermediate good is a good that is used as an input in the production of another good or service.

Gross Domestic Product (GDP) measures the total market value of all final goods and services produced within a country in a given year. It excludes intermediate goods (which are used to produce other goods) to avoid double counting.

The largest component of national income in the United States is compensation of employees, which includes wages, salaries, and benefits paid to workers. This component typically makes up the largest share of national income because labor is a significant factor of production in most economies.

Government purchases refer to the total dollar amount spent by all levels of government — federal, state, and local — on goods and services. This includes spending on things like defense, education, public safety, and infrastructure. Government purchases do not include transfer payments like social security or unemployment benefits, as those are not payments for goods or services.

The sum of durable goods, nondurable goods, and services represents consumption in the economy. This category reflects the total spending by households on goods and services for personal use.

Net exports is calculated as the difference between exports (goods and services sold to other countries) and imports (goods and services purchased from other countries).

If the market value of all intermediate goods is added to the market value of final goods in the calculation of GDP, it would overstate the actual value of GDP. This is because intermediate goods are already included in the value of final goods, and including them again would result in double counting.

For example, if you add the value of flour (an intermediate good) to the value of a loaf of bread (a final good), you're counting the same value twice.

The correct method is to only include the value of final goods to avoid overestimating GDP.

A business cycle refers to the recurrent fluctuations in economic activity, typically measured by changes in Real GDP. These cycles involve periods of expansion (growth) and contraction (recession), and they are a natural part of most economies.

In the United States, consumption expenditures typically account for around 70% of GDP. This includes spending by households on goods and services, such as durable goods, nondurable goods, and services like healthcare, education, and entertainment.