The GDP Puzzle
A country's national accounts show: Consumption = $500 billion, Investment = $150 billion, Government spending = $200 billion, Exports = $100 billion, Imports = $120 billion. Depreciation = $50 billion. Net income from abroad = -$10 billion. The population is 50 million. The government is concerned about slow growth and proposes increasing government spending by $20 billion. The marginal propensity to consume is estimated at 0.8.
1. Calculate GDP, GNP, NNP, and per capita GDP. Show formulas and calculations.
Read the worked answer
GDP = C + I + G + (X - M) = 500 + 150 + 200 + (100 - 120) = 500 + 150 + 200 - 20 = $830 billion. GNP = GDP + Net income from abroad = 830 + (-10) = $820 billion. NNP = GNP - Depreciation = 820 - 50 = $770 billion. Per capita GDP = GDP / Population = 830 billion / 50 million = $16,600.
2. Using the multiplier, calculate the total increase in GDP from the proposed $20 billion increase in government spending. What assumptions underlie this calculation?
Read the worked answer
Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.8) = 1 / 0.2 = 5. Total increase in GDP = 5 * $20 billion = $100 billion. Assumptions: The economy is below full employment, prices are constant, the MPC is stable, there are no crowding-out effects, and the increase in government spending is financed without affecting private investment. In reality, some of these may not hold, so the actual increase may be smaller.