Economics 【Reading 19】Sample 2012, interest, country, earned

MarginofSafety

When calculating the Gross Domestic Product (GDP) of a country:

A) the output, expenditure, and income measures are always equal.

B) only the value of goods and services at the final stage of production are included.

C) the income (rent, interest, profits, and dividends) earned by all of the residents of the country is included, regardless of where the assets are located.

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Including goods and services at the intermediate stages of production in the GDP calculation would overstate the economic activity of a country; therefore, only finished products are included

MarginofSafety

Gross Domestic Product (GDP), a measure of a country’s output, is best defined as the:

A) total goods and services produced by a country’s citizens in one year, adjusted for the shadow economy.

B) total market value of all final goods and services produced in a country in one year.

C) total goods and services produced by a country’s citizens in one year.

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GDP is the sum of all economic value produced in one year in a country, regardless of who owns the assets. It does not account for depreciation or the productivity of the country’s shadow economy.

MarginofSafety

James Willingham, CFA, is an equity portfolio manager and partner in a large investment firm in New York. The firm hires a group of new college graduates each year for its internship program, in which the interns rotate through each of the investment departments of the firm for a six week period to gain insight into the different areas of the firm’s operations. The interns attended top universities around the country and have studied the basic theories of finance, but for the most part have no practical experience working with investments.
Willingham, as head of the domestic equity desk, is responsible for the supervision of the interns while they are in his department. Over the past several years, Willingham has noticed that although the interns are selected from a highly qualified pool of candidates, they seem to not have a firm working knowledge of some of the basic economic principles necessary to successfully manage an investment portfolio. Willingham has written a sample case study for the interns to analyze to strengthen their skills when assessing equities for investment. He feels that it will provide knowledge that will be useful as they rotate through each of the departments of the firm.
The case study begins with a review of the most common measures of economic activity: gross domestic product (GDP), gross national income (GNI) and net national income (NNI). Willingham believes it is very important to understand the differences in the composition of the three measures in order to meaningfully compare and contrast the reported results among different countries. He formulates sample data for a country in order for each of the interns to practice calculating the different measures of a country’s productivity.

Sample Data (year ending 12/31/05)

NNI	$45,000,000
Net property income from abroad	$7,250,000
Deprecation	$3,875,000
Indirect taxes	$2,465,000
Subsidies	$2,935,000

Willingham also expects the interns to have a full working knowledge of the three components of GDP: output, expenditure, and income. He believes that knowing the interrelationship of these three measures, how they are derived, and how they should be interpreted is crucial for assessment of a country’s economy as well as the effect it can have on an individual stock.Among the three most widely used measures of economic activity:

A) GDP understates economic activity to the greatest degree because the production of the underground economy is not included in the measure.

B) GNI is theoretically the most accurate, although not widely used because of the difficulty in quantifying the economic cost of depreciation.

C) GDP only counts production from within a country’s geographic boundaries, while GNI includes productivity of a country’s citizens regardless of where assets are located.

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There is typically very little difference between GDP and GNI, in spite of the fact that they are two distinct measures of a country’s productivity. (Study Session 4, LOS 19.a)

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Calculate the GDP based upon the information given above:

A) $48,375,000.

B) $37,750,000.

C) $41,625,000.

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Working backwards: NNI + depreciation − net property income from abroad = GDP
$45,000,000 + $3,875,000 − $7,250,000 = $41,625,000. (Study Session 4, LOS 19.a)

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Utilizing the information given above, which of the following measures of productivity should produce the highest number, all other things being equal?

A) GDP at market prices.

B) GDP at factor cost.

C) GNI.

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This can be solved intuitively and without calculations. GNI equals GDP plus net property income from abroad, so assuming a positive income number, GNI will be higher than GDP at either factor cost or market prices. NNI is simply GNI minus depreciation, so GNI will be higher than NNI. (Study Session 4, LOS 19.a)

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Assume that a United States-owned company operates a production facility in India, and produces $25,000,000 of goods per year at that location. Which of the following statements regarding the production of the facility is most accurate?

A) The production of the facility in India would not be included in the GDP measure for India.

B) The production of the facility in India would not be included in the GDP measure for the United States.

C) The production of the facility in India would not be included in the GNI measure for the United States.

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GDP only counts the goods and services produced within the geographic boundaries of a country. (Study Session 4, LOS 19.a)

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In order to convert GDP at factor cost to GDP at market prices, which of the following adjustments should be made to GDP at factor cost?

Indirect Taxes

Subsidies

A) Add Subtract

B) Subtract Subtract

C) Subtract Add

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GDP at factor cost is the net of taxes and subsidies, so an adjustment must be made for consistent comparison. Beginning with GDP at factor cost, add back indirect taxes and subtract subsidies to arrive at GDP at market prices. (Study Session 4, LOS 19.b)

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Which of the following statements regarding the measurement of the productivity of a country is most accurate?

A) Income is presented as an index, with a base year’s income set equal to 100, and subsequent years expressed as a percentage of the base year.

B) Output is considered to be the most reliable of the three measures, while expenditure is considered to be the least reliable.

C) The most comprehensive measure of a country’s expenditure component is derived by adding all consumption, investment, and export of goods and services.

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Total Final Expenditure (TFE) is used as a proxy for the expenditure component, and is the sum of consumption, investment, and export of goods and services. (Study Session 4, LOS 19.a)

MarginofSafety

Which of the following would NOT be included in the calculation of Gross Domestic Product (GDP) for the United States?

A) Profits of a factory in located in California that is owned by a Japanese corporation.

B) Rental income from apartment buildings located in Texas.

C) Profits from a customer service center located in India that is owned by a U.S. corporation.

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The GDP calculation includes only counts those goods and services produced within the geographic boundaries of the country.

MarginofSafety

Gross Domestic Product (GDP) typically understates a country’s productivity because it does not fully account for:

A) depreciation / depletion of assets.

B) any productive assets physically located in other countries.

C) the country’s shadow economy.

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Transactions that are intentionally hidden from authorities (for whatever reason) cannot be included in a measure of productivity, thus resulting in an understatement of a country’s productivity.

MarginofSafety

When considering the effect of depreciation on the measurement of a country’s economic activity, most economists believe it:

A) must be included in the calculation in order to provide the most accurate assessment of the country’s economic position.

B) is difficult to accurately quantify and is generally excluded from the calculation.

C) may or may not be included in the calculation as long the calculation is clearly identified as a “gross” or “net” number.

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Depreciation is an estimate of an asset’s usage based on accounting conventions and not the actual amount consumed. Because it is difficult to reliably calculate, depreciation is generally excluded from productivity measures.

MarginofSafety

James Biggs, is a CFA candidate preparing for the upcoming Level III exam. He is also currently working full time as an intern in the training program at Waverly Brothers, a large investment banking firm in New York. During the course of the two year program, he will spend eight weeks in each of the major areas of the company. This week, Biggs is beginning his rotation in the research department, where he has been assigned to work under the guidance of Alicia Carroll, a senior economist at the company.
Carroll has been with Waverly Brothers for nearly twenty years, and is herself a graduate of their training program. She believes the best way to instruct the interns is through the assignment of a “real life” task that is similar in nature to what is expected of actual employees of the firm. Carroll has asked Biggs to prepare an evaluation of the current economic climate of Qatar, a small, Middle Eastern country who has emerged in recent years as a major producer and exporter of oil and other petroleum-based products. She believes that information on this relatively new entrant to the market will be helpful in assessing the global energy situation and providing valuable information to those clients of the firm that may have energy holdings.
As a starting point, Carroll presents Biggs with the available economic data on Qatar. In his analysis, she would like him to consider such factors as the country’s economic activity and projected productivity. Prior to the discovery of oil within their borders, the geographically small country had little economic activity and was largely undeveloped. Historically, the government of Qatar has not actively attempted to stabilize the country’s economy through monetary policy, but instead had taken a rather passive approach. Due to their oil production, rapid expansion of the country’s economy is anticipated for several more years to come. Carroll recommends that Biggs search for any demographic trends and their possible effect on the country’s economy. Lastly, Biggs should be prepared to analyze the government of Qatar’s stance on monetary policy, and the potential ramifications of the policy on the growth of the country’s economy.
Select economic data for Qatar as of 12/31/06 (in millions of Q$):

Net National Income:	Q$27,000,000
Net Property Income from Abroad:	2,160,000
Indirect Taxed:	3,280,000
Depreciation:	4,590,000

In addition to its oil production within its own borders, the government of Qatar also has a significant investment in wells in a neighboring country. Which of the following statements is most accurate?

A) The productivity of a Qatar-owned company not located within their own geographic borders would not be included in their Gross National Income (GNI) measure.

B) The productivity of a Qatar-owned company not located within their own geographic borders would be included in their Gross Domestic Product (GDP) measure.

C) The productivity of a Qatar-owned company not located within their own geographic borders would not be included in their Gross Domestic Product (GDP) measure.

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GDP only counts goods and services produced in a country. GNI, and therefore NNI, includes income earned by its citizens regardless of where the assets are located.

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The three productivity measures of a country are output, expenditure and income. Which of the following statements regarding these three measures is most accurate?

A) Output is considered to be the most reliable measure, while expenditure is regarded as the least reliable.

B) Expenditure data is expressed as an index, with a designated base year’s expenditures set equal to 100, and subsequent years expressed as a percentage of the base year.

C) Output is measured as the net value added (total production less total cost) of all business in a country in a year.

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Output is measures as the net value added, is expressed as an index, and is considered to be the most reliable of the three measures.

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Calculate the GDP of Qatar based upon the information given above:

A) Q$26,150,000.

B) Q$32,710,000.

C) Q$29,430,000.

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Working backwards: NNI + depreciation – net property income from abroad = GDP Q$27,000,000 + 4,590,000 – 2,160,000 = Q$29,430,000

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Biggs reads online that after nearly a decade of economic expansion, the government of Qatar is considering enacting a more restrictive monetary policy. Which of the following scenarios is most likely to occur in response to this change in policy?

A) Any subsequent downturn in the economy will be exaggerated by the restrictive policy.

B) Any subsequent downturn in the economy will be prevented by the restrictive policy.

C) Any subsequent downturn in the economy will be less severe in response to the restrictive policy.

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Historical experience has shown that a restrictive monetary policy after a period of economic prosperity has exaggerated the subsequent downturn in the economy and the stock market.

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Which of the following statements are legitimate reasons for imposing trading restrictions with trading partners?

A) Developing industries should be protected while they get up to world standards of productivity and quality.

B) Trade barriers protect jobs.

C) Trade with low-wage countries depresses wage rates in high-wage countries.

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Protecting developing industries through trade restrictions has some support from economists. The other arguments for trade restrictions have very little support among economists. The number of jobs protected by import restrictions will be offset by jobs lost in other industries. In the long run trade restrictions do not create jobs and in fact limit trading partner's ability to develop purchasing power needed to buy exports thus exporting jobs are not created, domestic prices are higher thus sales of domestic goods are lower further reducing jobs. As long as countries are trading products in which they have a comparative advantage both countries will benefit and the higher wage country will not see a decrease in their wages.

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Assuming the U.S. has a comparative advantage over Qatar in producing cars and trades cars in exchange for oil with Qatar which of the following results are most likely?

A) A tarif would be more harmful than a quota in either country.

B) An import quota on U.S. cars is necessary to protect the car manufacturing industry in Qatar.

C) Each country can consume at a point outside its production possiblity frontier.

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Since each country has a comparative advantage in their respective industries both countries will benefit through trading with each other by allowing each country to consume more than they had without trading. Quotas are more harmful than tariffs because the government does not receive any funds from imposing a quota whereas the importers receive higher prices for all goods sold under the import license. VERs allow the firms exporting the goods with export permits to accrue gains not the importing firm which would instead need an import license related to a quota. An import quota would only be effective if the car industry in Qatar was in a developing stage.

MarginofSafety

The modification of Gross Domestic Product (GDP) to reflect indirect taxes and subsidies is called the:

A) GDP deflator.

B) factor cost adjustment.

C) gross national income (GNI).

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The factor cost adjustment is utilized to allow consistent comparisons of the components of the GDP measure (expenditure, income, and output) as well as to isolate the effect of certain governmental policies upon productivity.

bigredhockey55

For which of the following is gross domestic product (GDP) adjusted to calculate GDP at factor cost?

A) Self-employment income.

B) Rental income.

C) A value-added tax.

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Factor cost adjustments to GDP include indirect taxes (such as a value-added tax) and subsidies

bigredhockey55

Which is the least accurate statement regarding the Gross Domestic Product (GDP) deflator?

A) The GDP deflator that is calculated from the expenditure component of GDP is also known as the implicit price deflator.

B) The GDP deflator is consistently an accurate predictor of general inflationary trends even though the composition of GDP may change over time.

C) The GDP deflator is an not an accurate predictor in times of swiftly changing prices.

The GDP deflator is directly affected by changes in the composition of GDP because it is derived from the expenditure component of GDP.