Discussion Session 6
Outline
• Measuring Production
• Spending Allocation Model
• Growth Accounting Formula
• Quantity Equation of Money
Measuring Production
• Spending Approach
• Income Approach
• Production Approach
Measuring Production
Spending Approach (Expenditure approach)
Y= C + I + G + X
Measuring Production
Income Approach
Y = Labor Income (wages, salaries and fringe benefits) +
Capital Income (profits, rental payments, and interest
payment) + Depreciation + Tax – Subsidy + Net income of
foreigners
Measuring Production
Production Approach: Sum of the value added by each of the
manufacturers. (value of a firm’s production less the value of
the intermediate goods used in the production)
Question 1
Which components of GDP (spending approach) will be affected by each of the
following transactions involving a farmer in the United States, and why?
a. The farmer buys a used tractor from a friend, to be used for his farming
business
b. The farmer has a mechanic replace one of the tractor parts with a new one.
c. The farmer sells corn overseas.
d.
e.
f.
g.
The farmer uses some of the corn to make cornbread for his family.
The farmer receives a subsidy from the government.
The farmer buy a new four-wheel-drive vehicle to use on vacation
The farmer buys a newly constructed house
Question 1
a. The farmer buys a used tractor from a friend, to be used for his
farming business
Question 1
a. The farmer buys a used tractor from a friend, to be used for his
farming business
There is no change in GDP, because the tractor is a used good
Question 1
b. The farmer has a mechanic replace one of the tractor parts with a
new one.
Question 1
b. The farmer has a mechanic replace one of the tractor parts with a
new one.
Investment will increase by the cost of the tractor part and mechanic
service, so GDP increases
Question 1
c. The farmer sells corn overseas.
Question 1
c. The farmer sells corn overseas.
Net export will increase, because the farmer is exporting corn. GDP
increases
Question 1
d. The farmer uses some of the corn to make cornbread for his family.
Question 1
d. The farmer uses some of the corn to make cornbread for his family.
Home production is not included in GDP
Question 1
e. The farmer receives a subsidy from the government.
Question 1
e. The farmer receives a subsidy from the government.
This is a transfer from the government to the farmer; it does not count
towards GDP
Question 1
f. The farmer buy a new four-wheel-drive vehicle to use on vacation
Question 1
f. The farmer buy a new four-wheel-drive vehicle to use on vacation
This is counted towards Consumption. GDP increases
Question 1
g. The farmer buys a newly constructed house
Question 1
g. The farmer buys a newly constructed house
This is counted towards Investment (Residential Investment). GDP
increases
Measuring Production
Question 2: Given the data, calculate Investment, Net Exports, and GDP
–using spending approach
Components of Spending
Consumption
Business Fixed and Residential Investment
Value (billion of US$)
$140
$27
Inventory Stocks at the end of 2007
$10
Inventory stock at the end of 2008
$5
Government Purchases
$65
Exports
Imports
$21
$17
Spending Allocation Model
• Y=C+I+G+X
• Dividing both sides by Y,
• 1= C/Y + I/Y + G/Y+ X/Y
• Which says that the sum of shares of spending in GDP must equal one
Question 3
Suppose the government introduces a new tax policy that encourages
investment. Using diagrams, showing what will happen to real interest
rate. What will happen to the spending shares of GDP in the long run.
Question 3
Suppose the government introduces a new tax policy that encourages
investment. Using diagrams, showing what will happen to real interest
rate. What will happen to the spending shares of GDP in the long run.
Production function
Production function with technology:
• Y = F(L, K, T)
• where
T = technology
Y = GDP
K = capital input
L = labor input
Growth Accounting Formula
The growth accounting formula states that
Growth rate
of
=
productivity
1
3
Growth rate of
capital per hour of +
work
Growth rate
of technology
Question 4
In country A, capital per hour of work from 1950 to 1973 grew by 3 %
per year and output per hour of work grew by about 3% per year.
Suppose that from 1973 to 1991, capital per hour of work did not grow
at all and output per hour of work grew by about 1 % per year. How
much of the slow down in productivity (output per hour of work)
growth was due to technological change? Explain.
Question 4
In country A, capital per hour of work from 1950 to 1973 grew by 3 % per year and
output per hour of work grew by about 3% per year. Suppose that from 1973 to
1991, capital per hour of work did not grow at all and output per hour of work grew
by about 1 % per year. How much of the slow down in productivity (output per
hour of work) growth was due to technological change? Explain.
2% decline in productivity growth
3% decline in growth rate of capital per hour of work
Question 4
In country A, capital per hour of work from 1950 to 1973 grew by 3 % per year and
output per hour of work grew by about 3% per year. Suppose that from 1973 to
1991, capital per hour of work did not grow at all and output per hour of work grew
by about 1 % per year. How much of the slow down in productivity (output per
hour of work) growth was due to technological change? Explain.
2% decline in productivity growth
3% decline in growth rate of capital per hour of work
-- But only one-third of the capital growth rate impacts productivity
1% decline in productivity growth can be explained by decline in growth rate of
capita per hour of work
The other 1% is explained by slowdown in technology growth
Quantity Equation of Money
• MV = PY
• M is money supply
• P is the price level (sometimes called the GDP deflator)
• V is the velocity (a measure of how quickly money is turned over in
the economy)
• Y is real GDP
Question 5—The Fed and Money Supply
• If the Federal Reserve increases the money supply in the U.S. by 10%
in 2014, while real GDP increases by only 2%; what will be the long
run effect on prices?
• MV = PY
• Money growth + velocity growth = inflation + real GDP growth
• Inflation = money growth + velocity growth- real GDP growth
= 10% + v% -2% = 8% + v%
If velocity doesn’t change, inflation would be 8%
Question
• Suppose personal income tax rates are cut. Using a diagram, show
what will happen to real interest rates. What will happen to the
spending shares of GDP in the long run.
Question
• Suppose personal income tax rates are cut. Using a diagram, show
what will happen to real interest rates. What will happen to the
spending shares of GDP in the long run.
The C/Y* shifts right; this shifts NG/Y* right also. Interest rates will rise.
I/Y*and X/Y* shares will fall.