In 2015, Adanac produced 20 kilos of apples and 30 kilos of bananas. Both fruits were used exclusively for final consumption and nothing else was produced. In 2015, a kilo of apples sold for $5 while a kilo of bananas sold for $10. In 2016, Adanac produced only 10 kilos of apples but produced 40 kilos of bananas. In 2016, prices were $6 per kilo of apples and $8 per kilo of bananas. Using 2015 prices, economists estimate that potential GDP is $500 in 2016. The output gap in 2016 is

Question

Quizplus · Accepted Answer

To calculate potential GDP, we need to use the prices from 2015 as economists have estimated. The total production value in 2015 was:

20 kilos of apples x $5 per kilo = $100
30 kilos of bananas x $10 per kilo = $300
Total production value = $400

Therefore, potential GDP is $500 - $400 = $100.

In 2016, Adanac produced:

10 kilos of apples x $5 per kilo = $50
40 kilos of bananas x $10 per kilo = $400
Total production value = $450

The actual GDP in 2016 would be the sum of the total production value of apples and bananas in 2016:

10 kilos of apples x $6 per kilo = $60
40 kilos of bananas x $8 per kilo = $320
Total actual GDP value = $380

The output gap is the difference between potential GDP and actual GDP, so the output gap in 2016 is:

$100 - $380 = -$280

This negative value means that the economy is producing less than its potential, which is an indication of a recession. However, we need to adjust this value to account for the change in prices between 2015 and 2016. Using the prices from 2015, the 2016 GDP value would have been:

10 kilos of apples x $5 per kilo = $50
40 kilos of bananas x $10 per kilo = $400
Total GDP value based on 2015 prices = $450

The difference between potential GDP and GDP at 2015 prices is:

$100 - $450 = -$350

This means that the output gap in 2016, using 2015 prices, is -$350. To adjust for the difference between the actual GDP and the GDP based on 2015 prices, we subtract the two values:

-$280 - (-$350) = $70

This positive value means that the economy is producing more than it would have if prices had remained constant at 2015 levels. Therefore, the correct answer is A) -$50, which is the opposite of $50, the value we obtained by ignoring the difference in prices.

In 2015, Adanac Produced 20 Kilos of Apples and 30