Question 1
A domestic clothing manufacturer sells shirts to a local retailer. The retailer is owned by a foreign company that repatriates its profits abroad. Which of the following correctly describes how these transactions are classified in national income accounts?No clue? Show me the answer
Correct answerCorrect!
IncorrectStep-by-step walkthrough
Choose a solution method
Method #1Direct ClassificationStep 1: Identify what GDP and GNI each measure
GDP measures output produced within a country's borders, regardless of who owns the factors involved. GNI measures income earned by a country's residents, regardless of where in the world that income was generated.
Step 2: Apply to the shirt production
The shirts are produced domestically, so they count toward the country's GDP — it does not matter that the retailer is foreign-owned. Ownership of the firm does not determine whether output is domestic.
Step 3: Apply to the repatriated profit
The profit repatriated abroad is income leaving the domestic economy to flow to foreign residents. This means net income from abroad is negative for the domestic country, so domestic GNI is reduced below GDP, but GDP itself is unaffected.
Step 4: Select the correct answer
The shirt production raises GDP; the repatriated profit lowers GNI (not GDP). The correct option is: 'The shirt production counts in GDP, and the repatriated profit reduces GNI but not GDP.'
Method #2Process of EliminationStep 1: Identify what is being asked
The question asks how to classify domestic production by a foreign-owned firm and the outflow of profits, distinguishing between their effects on GDP and GNI.
Step 2: Eliminate: 'shirt production reduces GDP'
The option 'The shirt production counts in GDP, but the repatriated profit reduces GDP and also reduces GNI' incorrectly states that repatriated profits reduce GDP — they do not. GDP is unaffected by who owns the firm.
Step 3: Eliminate: 'shirt production excluded from GDP'
The option 'The shirt production is excluded from GDP because the retailer is foreign-owned' is wrong. GDP includes all output produced within borders regardless of the nationality of the owner.
Step 4: Eliminate: 'both reduce GNI leaving GDP unchanged'
The option stating both reduce GNI and leave GDP unchanged misidentifies the shirt production: production adds to GDP rather than merely failing to harm it. The phrasing is inaccurate.
Step 5: Select the correct answer
The remaining option — 'The shirt production counts in GDP, and the repatriated profit reduces GNI but not GDP' — correctly applies the GDP/GNI distinction.
Question 2
In a given year, an economy reports the following data (in billions): Wages = $500, Rent = $70, Interest = $40, Profit = $120, Taxes on production and imports = $30, Subsidies = $10. What is GDP using the income approach?No clue? Show me the answer
Correct answerCorrect!IncorrectStep-by-step walkthrough
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Method #1Direct CalculationStep 1: Recall the income approach formula
The income approach formula is: where = wages, = rent, = interest, = profit, = taxes on production and imports, and = subsidies.
Step 2: Sum the four factor incomes
Step 3: Add taxes and subtract subsidies
Step 4: State the result
**GDP = 730 billion, which represents national income at factor cost, not GDP at market prices.
Method #2Process of EliminationStep 1: Identify what is being calculated
The question requires applying the income approach: , noting the tax/subsidy adjustment is essential.
Step 2: Eliminate $730 billion
W + R + I + P = 500 + 70 + 40 + 120$ — this omits the tax/subsidy adjustment entirely and gives national income at factor cost, not market-price GDP.
Step 3: Eliminate $760 billion
30) without subtracting subsidies (730 + 30 = 760$. This incorrectly ignores the subsidy deduction.
Step 4: Eliminate $780 billion
730 + 30 + 10 = 770$ (not even that), so this figure is inconsistent with any plausible application of the formula.
Step 5: Select the correct answer
Applying the formula correctly: 730 + 30 - 10 = \mathbf{\750 \text{ billion}}$.